The discrepancies between the tax systems of different countries can also be used to one’s advantage in the course of changing residence. Indeed, an important element in cross-border planning is to coordinate the timing of the tax events and the taxpayer. For example, the tax treatment of income derived from activities performed before or after a person gives up his residence, and the different qualification of such income in different countries, may yield tax savings through carefully chosen timing of a change of residence.
Finally, it is important to be aware that a change of residence will not only have an impact on one’s personal tax situation but one’s inheritance-tax situation will also be effected. Even if one is not deemed tax resident in the jurisdiction, owning real estate in that jurisdiction may be a factor and in most countries where such taxes exist will still have local inheritance tax implications.
Exit taxes and extended income taxes
One problem with moving your tax domicile to another country, especially to one with low taxation, is that several high-tax countries have taken steps to discourage such moves, namely by introducing a form of exit tax or an extended income tax regime, or a combination thereof.
Exit taxes can be classified as general and limited taxes which are levied on income or capital gain that has accrued but not yet been realized; or as unlimited and limited extended income tax liability, which applies on income or capital gains arising after emigration.
Also a claw back of tax deductions could be invoked – for example whereby a previously tax-deductible accrual would be revoked.10
In Germany, for example, the extended limited tax liability can apply for a period of ten years after emigration which can be very burdensome for the individual. More and more countries are drafting special tax rules to make moves abroad fiscally less attractive.11
Many other high-tax countries impose similar regimes to discourage fiscal emigration.12 It is possible to mitigate – or in some cases even completely bypass – such taxation by appropriate structuring before, during and after a move abroad. However, this almost always requires the taxpayer to make a clean break with the former country of residence and to strictly avoid any links with it such as maintaining a second home there, making frequent visits or longer stays on its territory etc. These conditions can be tough for many expatriates and should be carefully weighed against the tax advantages such a radical change in one’s life will bring.
Double taxation agreements (tax treaties)
Bilateral agreements to avoid double taxation of persons resident in contractual states exist between many countries. Double taxation agreements delimit the tax-imposition rights between two countries and takes precedence over national legislation.
Whereas ownership of property abroad usually implies limited tax liability as a result of ownership of this real estate in the foreign country, a move abroad always affects tax residence and has considerable consequences on tax liabilities. Therefore double-tax agreements can play an important factor in limiting such tax exposure.
Inheritance and gift taxes, which depend primarily on the testator’s last residence, may also be relevant. If a taxpayer who moves abroad has considerable income and assets, experience shows that the tax authorities concerned are particularly interested in the deceased’s last tax residence, as this leads in most countries to unrestricted tax liability on his or her estate. However, relatively few agreements concern inheritance and gift taxes; generally when speaking about double-tax treaties, therefore, these relate to income and possibly wealth taxes only.
It may happen that two countries – according to their respective tax laws – simultaneously consider a particular taxpayer as fiscally resident and unrestrictedly tax liable. This could result in him being taxed on his global income and possibly also on his assets by both countries on the basis of their domestic tax regimes. But if a double taxation agreement exists between the two countries, it will decide where the taxpayer is fiscally resident and thus liable to unrestricted taxation, and which country is to merely apply restricted taxation – namely on any assets or income located within its territory.
Residence in one of the two contractual states is normally the precondition for the application of the relevant double-taxation agreement and all claims on its protection. The agreement formulates precise rules to determine in which of the two contractual countries a taxpayer is deemed to be fiscally resident. They are known as tie-breaker rules and in the majority of double-taxation treaties they follow the OECD Model Convention.
Accordingly, most double-taxation agreements define the country of tax residence as the place where the taxpayer has his main permanent home. If he has homes in both countries, the crucial point is where his personal and/or economic activities are centered. His habitual place of living is then in third place, and citizenship is considered only in fourth place. If the tax residence cannot be determined on the basis of these criteria, it is decided by mutual agreement between the countries concerned.
Double taxation agreements can also be useful in terminating tax residence in the country of emigration more quickly. So if someone no longer wishes to count as a UK tax resident, for instance to avoid paying capital gains tax, UK domestic law stipulates that certain taxes apply up to five years even after moving abroad. But if he moves the tax residence to a country which has a suitable double taxation agreement with the UK, such as Belgium, he can bypass such domestic tax regulations and may be able to reduce the period during which certain UK taxes still apply after a change of residence.
In the absence of a double taxation agreement between the previous and new country of residence (such as when moving for example from the Netherlands to Monaco), only the respective domestic fiscal regulations apply. These are as a rule stricter – at least for high-tax countries – i.e. it is more difficult to terminate one’s former tax residence if you directly move to a no-tax jurisdiction and there is no tax treaty. In order to avoid continuing to pay tax on one’s global income and possibly assets there too, often all links to one’s former country of fiscal residence must be severed, and even then extended taxation may apply for some time after emigration.13
1.7 Financial Planning and Insurance
Anyone who is transferring their residence to another jurisdiction will certainly have to revisit their financial and estate planning. It is implicit that the various parameters of the financial aspects of one’s estate will be affected. The person has adapted and is akin with the legal and fiscal situation and general framework conditions prevailing in their home country but they must become adept with a new framework, and accordingly apply it to their finances without incurring loss.
It makes sense to retain investments in other currencies for example even if one moves from the USA to Europe, where there local reference currency is the Euro. As a rule, however, a move of a person’s regular activities to a new currency area will also lead to different weighting of the currencies in their personal investment portfolio and will require a re-thinking of their financial planning and asset management arrangements. It may be wise to consult a specialized investment advisor familiar with questions of clients with cross-border issues.
It is also sensible to obtain advice from a tax-advisor in the original jurisdiction as there may be some interesting financial and tax planning options, or in a less favorable case, there may be exit taxes due that need to be calculated with.
A move abroad also offers the opportunity for more flexible pension planning, as capital tied to government-regulated pension funds can often be released.