Tax Residency: A Guide to Establishing and Maintaining It

Establishing and maintaining tax residency is a critical aspect of personal financial planning. Tax residency determines the extent of your tax liabilities and the benefits you can access. A lot of our clients do not realise initially that you can change your tax residency away from your “home” country.  Understanding the principles and rules governing tax residency can help you optimise your tax situation.

What is Tax Residency?

Tax residency is the status of an individual as a resident for tax purposes in a particular country. This status dictates which country has the right to tax your global income, and it can significantly impact your tax obligations and benefits. Different countries have varying rules and criteria to determine tax residency, often involving physical presence, domicile, or economic connections. Some countries have much more favourable tax laws than others so if you are a global freelancer, changing your tax residency can lead to huge savings.

Key Concepts in Tax Residency

1.      Physical Presence Test: Many countries use a physical presence test to establish tax residency. Typically, if you spend a certain number of days in a country within a tax year, you may be considered a resident for tax purposes. For example, in Portugal, you are generally considered a resident if you are physically present in the country for more than 183 days during the year. The 183-day rule is common in many jurisdictions.

2.      Domicile: Domicile refers to the country where you have a permanent home and intend to return to if you leave. Some countries consider your domicile when determining tax residency, which can be more subjective than the physical presence test.

3.      Substantial Presence Test: This test combines the physical presence test with additional criteria such as the purpose and nature of your stay.

4.      Economic and Social Ties: Some countries assess your economic and social ties to determine tax residency. These ties may include factors like family connections, ownership of property, and business interests.

5.      Tax Treaties: Tax treaties between countries can influence your tax residency status. These agreements are designed to prevent double taxation and resolve conflicts when an individual qualifies as a resident in multiple countries.

Establishing Tax Residency

Choosing a Country

When choosing a country for tax residency, consider factors such as tax rates, quality of life, healthcare, and legal system. Some countries, like Monaco and the Bahamas, have no income tax, making them attractive to high-net-worth individuals. Others, like Portugal and Malta, offer favourable tax regimes for new residents.

Meeting Residency Requirements

To establish tax residency, you need to meet the specific requirements of the chosen country. Here are some common steps:

Physical Presence

To meet the physical presence requirement for establishing tax residency, you need to spend a specified number of days in the country each year. For example, in Portugal, you are considered a tax resident if you are physically present in the country for more than 183 days within a calendar year.

Tips for Tracking Your Presence:

• Maintain a Detailed Travel Log: Keep a detailed log of your travel dates, including entry and exit stamps in your passport, flight tickets, and hotel receipts. Digital tools and apps can help you track your travel days efficiently.
• Understand Specific Rules: Some countries apply the 183-day rule in a specific way, such as counting part of a day as a full day or considering the number of days in the current year and the two preceding years combined. Be sure to familiarize yourself with these nuances to ensure compliance.

Proof of Domicile

Domicile is a crucial factor in determining tax residency. To establish domicile in your chosen country, you must show a clear intention to make it your permanent home. This can involve several practical steps:

• Purchasing Property: Buying a property in the country is a strong indicator of your intention to reside there permanently. Ensure the property is registered in your name and that you have proof of ownership.
• Enrolling Children in Local Schools: Enrolling your children in local educational institutions can help demonstrate your long-term commitment to the country. This also reinforces your social ties and integration into the local community.
• Relocating Business Operations: If you run a business, moving key operations to the country can be a significant factor. This could include setting up a local office, hiring local employees, or transferring business assets to the country.

Establishing Ties

Strengthening your economic and social ties to the country is essential for maintaining your tax residency. Here’s how you can establish these ties effectively:

• Opening Local Bank Accounts: Open bank accounts with local banks to handle your day-to-day transactions. Having a local bank account is often a requirement for obtaining a residence permit and demonstrates your financial integration.
• Joining Clubs and Organizations: Become a member of local clubs, societies, or professional organizations. Participation in local events and activities can help you build a network and show your commitment to the community.
• Engaging in Community Activities: Participate in community events, volunteer for local charities, or join neighborhood associations. These activities enhance your social connections and underline your intention to integrate into the local community.

Legal Formalities

Completing the necessary legal formalities is a critical step in establishing and maintaining tax residency. Here’s a detailed look at the key requirements:

• Registering with Tax Authorities: You must register with the local tax authorities to obtain a tax identification number (TIN). This process typically involves submitting forms and providing proof of identity, residence, and income.
• Obtaining a Residence Permit: Apply for a residence permit if required. The application process generally involves submitting documents such as proof of accommodation, financial resources, health insurance, and possibly a background check. The type of permit may vary depending on your reason for residing in the country, such as work, study, or retirement.
• Applying for a Taxpayer Identification Number (TIN): Obtain a TIN from the local tax office. This number is essential for filing tax returns, opening bank accounts, and conducting any financial transactions within the country. Ensure you keep your TIN updated and use it for all your tax-related dealings.

Maintaining Tax Residency

Once you establish tax residency, maintaining it requires ongoing compliance with the country’s rules. Here are some strategies to help you maintain your tax residency status:

Monitor Your Presence

Regularly track your physical presence in the country. Use apps or calendars to log your travel dates and ensure you meet the minimum stay requirements.

Maintain Economic Ties: Continue to maintain significant economic ties within the country to support your claim of residency. This can include holding investments such as real estate, stocks, or bonds within the country. Operating businesses, either directly or through ownership stakes, also helps establish a tangible economic presence. Additionally, earning income from local sources, whether through employment, business activities, or passive investments like rental properties, further reinforces your economic engagement with the country.

Stay Updated with Tax Laws: Tax laws and residency rules can be complex and subject to change. It is crucial to stay informed about any legislative updates or changes that could affect your tax residency status. Regularly review official government publications and announcements related to tax regulations.

File Tax Returns: It is essential to file your tax returns on time and accurately, even if you have no taxable income. Filing returns consistently demonstrates your commitment to maintaining your residency status and complying with local laws. Ensure all necessary documentation is in order and be prepared to provide evidence of your economic activities and residency claims if required by tax authorities. Proper and timely filing of tax returns can also help prevent potential penalties or legal complications.

Avoid Conflicts with Other Jurisdictions: If you spend time in multiple countries, it is important to be aware of the tax residency rules in each jurisdiction to avoid conflicts. Dual residency, where more than one country considers you a resident for tax purposes, can complicate your tax situation. This may require careful planning and documentation to navigate effectively. Understanding the criteria each country uses to determine tax residency, such as the number of days spent in the country or the location of your primary home, can help you manage your obligations.

Special Considerations for Dual Residency

In some cases, you may qualify as a tax resident in more than one country, leading to dual residency. This situation can result in double taxation, where both countries tax the same income. Here’s how to handle dual residency:

Understanding Tax Treaties

Tax treaties between countries can help resolve dual residency conflicts. These treaties typically include tie-breaker rules to determine which country has primary taxing rights. Common tie-breaker criteria include:

1. Permanent Home: The country where you have a permanent home usually takes precedence.
2. Center of Vital Interests: Consider where your personal and economic ties are strongest.
3. Habitual Abode: The country where you spend the most time during the tax year.
4. Nationality: If other criteria don’t resolve the conflict, your nationality may be considered.

Claiming Tax Credits and Deductions

To avoid double taxation, you can often claim foreign tax credits or deductions on your tax return. This reduces your tax liability by the amount of tax paid to the other country.

Conclusion

Establishing and maintaining tax residency is a crucial aspect of financial planning for individuals and businesses with international ties. By understanding the key concepts, meeting residency requirements, and staying compliant with local laws, you can optimise your tax situation and avoid legal complications.

We have helped many clients strategies their tax residency to ensure they are reaping the rewards of adequate planning.

We can help you too! Get in touch via admin@fresh-ops.co.uk