Some people believe you can avoid taxes by spending less than 183 days each year in a particular country. However, that isn’t the case. There are many different things that come into consideration when determining where you are going to be taxed.
So what can you do to make sure you are avoiding high taxes and saving money by going overseas?
As you continue to read, we’ll explain the 183-day rule and other ways you can avoid becoming obligated to pay tax in a high-tax country. We’ll also give a few strategies and requirements for leaving a high-tax country.
In this article, we’ll discuss:
- What is the 183-day rule?
- Why doesn’t the 183-day rule always work?
- Center of Life Test
- Different Countries Have Different Rules
- Residential Tax Countries
- What is a tax residence?
- Avoiding Tax Residence
- The United Kingdom (UK)
- The Trifecta Method
- Why You Might Want to Establish Tax Residence
- What is a residence permit?
WHAT IS THE 183-DAY RULE?
If you spend more than half the year in a country, you may become a tax resident. Most people will use this as a rule and assume that if they spend less than 183 days in a country, they won’t have to pay tax.
While it’s likely that spending over 183 days in a country could pull you into the country’s tax net, spending less than that isn’t a guarantee that you won’t have to pay taxes there. Not all countries operate under the 183 days test.
WHY DOESN’T THE 183-DAY RULE ALWAYS WORK?
While time does play a significant factor in determining your tax residency, it isn’t the only requirement. The 183-day tax rule isn’t always the deciding factor. The rules for becoming a tax resident are going to be different depending on each individual country.
Most countries are also going to look at your center of life. What ties do you have to the country? What assets are in the country in question? Is there another country where you spend more time or have closer ties?
If you fail these tests, you are still going to be obligated to be taxed in that country.
CENTER OF LIFE TEST
What is your center of life?
Your center of life is where you spend your time, own assets, and have a family. It can also include where you are a member of a club or have a house or apartment. Your center of life is the country where you have the most ties.
In what case would the center of life test trump the 183-day rule?
Let’s say you live in Country A 182 days each year. You spend the rest of your time traveling between various countries, continents, and cities. You own a home in Country A that remains empty while you aren’t there and is not leased out. And you belong to the local chamber of commerce.
In this case, you clearly have ties to Country A. You also are traveling a lot to various places and don’t have a Country B that you have more ties to. This makes Country A your center of life. And depending on that country’s tax rules, you may be obligated to pay tax there even if you spent less than 183 days in-country.
DIFFERENT COUNTRIES HAVE DIFFERENT RULES
There are many different types of taxation systems.
Territorial tax countries will only tax you on income that is earned within that country. You can live there the whole year, but you won’t have to pay income tax if your business and all your income are coming from another country.
Living in a zero income tax country means you won’t be taxed on your income there, even if you stayed in-country 365 days a year.
The United States is one of the only citizenship-based tax countries in the world. This means they are going to tax you if you are a US person, whether you are residing within the United States or not.
Many countries are considered residential tax countries. These are the countries we will be addressing.
RESIDENTIAL TAX COUNTRIES
Different countries have different taxation systems. Many western countries (excluding the United States) have residential taxation. This means you are going to be taxed if you are a resident.
Most residential countries are going to tax you on your worldwide income. This means that while you are a resident of that country, you have to pay income tax on all the income you’ve earned, whether it was earned inside or outside of the country.
This is not the same as the United States. If you want to get out of paying taxes in a residential tax country, it’s possible to do so. You just have to stop being a resident of the country. In the United States, even if you are no longer a resident, you can still be taxed as long as you are a citizen. If you give up your residence in a residential tax country, you will no longer be obligated to pay taxes there — and you can keep your citizenship.
This is also not like a territorial tax country. The difference here is that territorial tax countries only have you pay tax on the income made within the country while you are there. A residential tax country will have you pay tax on all the income you make, no matter where it comes from, as long as you are a tax resident there.
What qualifies you as a tax resident?
The first factor is time. The second is your ties to the country (see the center of life test).
Of course, because different countries have different rules, you want to be careful of how much time you spend there and what ties you establish.
WHAT IS A TAX RESIDENCE?
Your tax residence is where you are obligated to pay taxes. This could be based on where you live most of the time or where you have established the most ties. Most countries will not tax you if you are not a tax resident of that country.
AVOIDING TAX RESIDENCE
You can avoid becoming a tax resident of a country by establishing no ties there and never setting foot in the country. However, that isn’t very realistic. You have to spend your time somewhere and you have to have ties.
Still, you want to avoid keeping too many things in one place.
Part of this means considering both your business plan and personal plan for your offshore taxes. You might consider living in a territorial tax country but keeping your business in a different country with low corporate tax rates.
Learn the laws for each country you visit so you know what to do to avoid becoming a tax resident.
Avoiding tax residence isn’t as simple as leaving the country. Most Western high-tax countries are going to continue to count you as a tax resident of their country unless you establish a domicile somewhere else.
What is a domicile?
Your domicile is your dwelling place. You can escape high taxes by leaving the high tax country and establishing a domicile in a low tax country.
As you continue to read, we’ll be going over some specific high-tax countries and how you can end your tax residence in each.
Australia determines tax residency based on four tests: the resides test, the domicile test, the 183-day test, and the Commonwealth superannuation test. To no longer be considered a tax resident, you have to make sure you do not qualify under any of the four tests. Passing one will make you a tax resident in Australia.
The resides test looks at your physical presence, intents and purpose in the country, family connections, business and employment ties, social and living arrangements, and the maintenance and location of your assets.
The domicile test requires that you establish a different country outside of Australia as your domicile. You must prove that you have a new permanent place to live outside of the country.
To no longer be a tax resident of Canada, you only have to pass two tests. First, you have to leave Canada and live in another country. Second, you have to cut all residential ties with Canada.
Residential ties include a home you own, a spouse or common-law partner who remains in Canada, dependents living in Canada, personal property (such as a car), social ties (which includes membership in clubs or religious organizations), economic ties (including bank accounts and credit cards), and health insurance that comes from a Canadian provider.
This basically means you can’t just go on a 183-day vacation each year and leave the rest of your life as is. You have to actually leave and either break your ties or take your ties with you.
Tax residence in Ireland is based on three things: residence, ordinary residence, and domicile status.
Residence in Ireland is determined by your physical presence. You are going to be considered a resident of Ireland if you spend more than 183 days a year in Ireland or if you’ve spent more than 280 days in Ireland in the past two years. Spending less than 30 days in Ireland in a one-year period will make you a non-resident of Ireland for that year.
You are considered an ordinary resident if you have kept your residence status in Ireland for three consecutive years. After you’ve become an ordinary resident, that residence won’t expire until you’ve spent three years outside of Ireland.
Basically, if you spend three years in Ireland and then three years outside of Ireland, those three years outside of Ireland will still be taxed as if you were still living in-country.
If you live in Spain for 183 days or more each year you will be subject to pay tax on your worldwide income. If you are earning money through a business in Spain, that income is going to be taxed no matter how little time you spend there or your tax residence status.
Tax status in the United Kingdom is determined by the UK Statutory Residence Test. This can be broken up into three sub-tests, which have to take place in order.
The first test is the Automatic Overseas Test. There are three ways you can qualify for this test:
- The first is if you were a tax resident during one of the last three years but have spent less than 15 days in the UK that year.
- Second, if you weren’t a UK resident during any of the last three years and spent less than 45 days in the UK that year.
- Third, if you work full time overseas and spent less than 30 days working in the UK and less than 90 days in the UK overall that year. If you are working abroad, you shouldn’t have to worry about the 183-day rule.
The second test is the Automatic Residence Test. You are considered a tax resident of the United Kingdom if you fulfill any of these three tests:
- You fail the 183-day rule, meaning you spend 183 days or more in the United Kingdom.
- Your main home is in the UK and you have no other homes. You have access to that home for at least 91 consecutive days and use it for at least 30 days per year.
- You have worked full time in the United Kingdom for a period of 365 days and have had no breaks longer than 31 days.
The third and final test is the Sufficient Ties Test. If you aren’t sure about your tax residence status based on the first two tests, this one will be applied. This test is based on your ties and connections to the United Kingdom.
- It considers your family, including your spouse and any minor children who reside in the UK.
- It also looks at if you have accommodations that could be available to you for 91 or more continuous days.
- If you work in the UK for more than 40 days each year, you could be a tax resident.
- If you spend 90 days or more in the UK in the previous two years, you could be a tax resident under the substantial visits test.
- If you spend more days in the UK than any other individual country you can be a tax resident under the favored country test.
Based on these above tests, you’ll find you can stop being a tax resident of the UK by leaving the country and getting rid of any available accommodations such as a house or apartment. If you own any other real estate, you need to make sure it is rented out.
THE TRIFECTA METHOD
The trifecta method is a possible solution for avoiding tax residency. However, it isn’t perfect. The trifecta method will only work if you properly plan your tax structure. It won’t work if you have all of your personal ties in one place and fail the center of life test.
What is the trifecta method?
The trifecta method takes the 183-day rule one step further. While the 183-day rule proposed that you just had to spend less than half of your year in a country, the trifecta method suggests you only spend a third of the year in a country.
Dividing your time between three countries ensures that you never even come close to violating the 183 days rule. Spending 120 days or less in each country ensures you stay under the limit.
If you don’t fail any of the other tests, such as the center of life test, this method can help you to live a zero-tax lifestyle. One way to avoid failing the center of life test is by having a home in each country in your trifecta. This way there is no one country where you have more ties than the other.
Do be aware of which countries you are using to build your trifecta. Using the United States is not a great option, especially if you are a US citizen. It’s very easy to get caught up in the US tax net. You can guarantee you are going to be taxed by the US if you are a US person (a US citizen or green card holder).
You will also be taxed in the United States if you fail their substantial presence test. The substantial presence test is pretty complex. You are considered a tax resident based on the substantial presence test if you have been in the US for 31 days that year, and have spent over 183 days in the US in the past three years. Days in the previous year only count as ⅓ of a day and days in the year before that count as ⅙.
Switzerland is another country you’ll want to avoid when picking your trifecta. In Switzerland, it doesn’t take as long to become a tax resident. You become a tax resident of Switzerland if you spend 90 days or more in-country, so you’ll want to avoid being there for any extended period of time.
WHY YOU MIGHT WANT TO ESTABLISH A TAX RESIDENCE
Is there ever a reason to establish a tax residence?
Yes. While this may sound counterintuitive, in some cases establishing a tax residence can actually save you money on taxes.
Many western countries have very high tax rates, some higher than 50%. In some cases, the best way to avoid taxation from that high-tax country is to become obligated to pay taxes somewhere else. Most countries will not charge you double taxation.
This is a great strategy for American citizens in particular. As I’ve mentioned, an American citizen can’t avoid US federal income tax simply by leaving the US. Citizenship-based taxation means you will be obligated to pay US taxes no matter where you live so long as you are a US citizen.
However, the United States does have a few tax exemptions that you can use to lower your US tax rate by going overseas.
The first option is the Foreign Earned Income Exclusion. This tax exclusion allows you to exclude just over the first $100,000 you make in foreign earned income from your US taxes. In order to claim this tax benefit, you have to pass one of two tests.
The physical presence test requires that you spend 331 days on foreign soil outside of the US. The bona fide residence test allows you to claim the Foreign Earned Income Exclusion if you can prove that you have more substantial ties to a country that is not the United States. In this case, being a tax resident of another country is a pretty big tie, and can help you qualify for this exclusion.
Another US tax exemption is the Foreign Tax Credit. This was designed specifically to help US persons avoid double taxation. This means that if you are a tax resident in another country where you are paying federal income tax, it allows you to take a dollar-for-dollar credit against your US tax obligation. If you are paying an amount that is the same or higher than your US tax obligation, you will not have to pay US taxes. This can only be claimed if you have a tax residence in another country, not just a residence permit.
WHAT IS A RESIDENCE PERMIT?
A residence permit is different from a tax residence. A residence permit is a permit that gives you permission to spend time in and live in a country. If you are hoping to spend time in a territorial tax country, you’ll need a residence permit to live there.
Having a residence permit does not make you a tax resident. Many people get confused and assume that by establishing a permanent residence they have established a tax residence. This isn’t true.
A residence permit can in many cases eventually lead to a permanent residence or even citizenship in a country.
While the 183-day rule isn’t actually a hard and fast law, there are other ways you can avoid tax residence in high-tax countries. Even if you have already been sucked into a high-tax tax net, there are still ways you can escape.
Remember to not only look at where you are spending your time but also consider where you have the most ties. Having large established ties in a country could pull you into their tax net and raise your taxes.