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What is the Difference Between Tax Residence and Citizenship?

In an increasingly globalised world, more and more individuals are leading mobile lifestyles. Many no longer want to embed their entire identity in one country. With many of us working remotely from abroad for long durations, it is important to brush up on our rights and responsibilities as citizens, and tax residents.

What is citizenship?
Citizenship is often viewed as the closest connection between a person and a country. In its strictest sense, citizenship is a legal status that means a person has a right to be in a state and that state cannot refuse their entry or deport them in most circumstances. This legal status may be conferred at birth, by descent, or, in some places, through naturalisation. Naturalisation is a process through which states grant citizenship to people who, generally, have legally entered the country (or have been granted political asylum), have been permitted to stay, and have lived there for a specified period. Another way to get citizenship of another country is to invest in its economy using relevant citizenship by investment programme. A nation’s citizenship comes with the right, but not the obligation, to live and work in that nation. It allows one to possess property there, access social services such as education and healthcare, and apply for a passport. One’s citizenship is usually held for life and is difficult to lose.
What is residence?
Residence, on the other hand, indicates where an individual lives and often works. Hence, residence rights are usually dependent upon one’s physical presence in a country. One may lose their residence rights in a particular country if they fail to spend a certain amount of time in that country. While many individuals reside in their country of their nationality, citizenship is not a determinant of residence. For example, someone can be a Spanish citizen but live and work in Germany. Again, unlike citizenship, residence generally requires some degree of physical presence in the country.
What is tax residence?
An individual’s country of tax residence or residence based taxation (also called fiscal residence) is the country to which an individual is responsible for paying taxes. What constitutes tax residence in a particular country is determined by that country’s domestic laws, with each country implementing its own definition of tax residence. Broadly speaking, individuals are considered tax resident in: – countries in which they spend six months or more in a year; or – countries where they have their ‘centre of vital interests’ or habitual abode, provided they spend less than six months in a year in other countries. In the Commonwealth of Dominica, for example, any individual (whether a citizen of Dominica or not) can become a tax resident in Dominica if they: – are physically present in Dominica for at least 183 days in the tax year; or – set up a permanent abode in Dominica and reside there for a period of time in the tax year; or – were a tax resident in the preceding or following tax year. Only in the United States, Hungary, and Eritrea are individuals taxed based on their citizenship.
What is citizenship based taxation?
Citizenship based taxation refers to the process by which a nation taxes its citizens irrespective of their status as residents. This means that if you are a citizen of a country that taxes on the basis of citizenship and choose to reside in a foreign nation, you will still be required to pay taxes to your native home. Some countries adopted a citizenship based taxation (at times with reduced tax duties for citizens living abroad) in the past, including Mexico, Romania, Bulgaria, Vietnam, and the Philippines, however, the practice has now been abandoned. There are also nations that require non-resident citizens to pay taxes only for a short period after migrating, this is usually for six months or up to a year. However, there are two nations that still have a lifelong tax placed on citizens despite where they reside: Eritrea and the United States. Hungary also taxes on the basis of Hungarian citizenship, except where the citizen of Hungary is a dual citizen without a permanent or habitual residence in Hungary.

Eritrea

The East African nation of Eritrea requires all its citizens living abroad to pay a flat tax rate of 2%. Known as the ‘diaspora tax’, the system has received condemnation from the international community due to the methods in which the Eritrean government ensure the payment of the citizenship tax. Most notably, the United Nations Security Council passed a resolution denouncing the diaspora tax for using “extortion, threats of violence, fraud and other illicit means to collect taxes outside of Eritrea from its nationals”.

United States

The US taxes the worldwide income of its non-resident citizens, meaning that Americans living abroad are still required to file federal tax returns each year – a bureaucratic nuisance that many nationals would like to avoid. However, unlike Eritrea, overseas Americans do not have a flat tax rate and must pay the same as residents in the US. Citizenship based taxation as the US knows it today was first introduced in 1913. Despite the United States being the world’s largest economy, this unusual and demanding citizenship tax system has remained in place for over a century with no likelihood that it will be abolished any time soon. This has been one of the leading causes for Americans renouncing citizenship, a process that has seen a record number of individuals giving up their nationality recently.
Are you a US tax resident?
As a general matter, under the US Internal Revenue Code (Code), all US citizens, US permanent residents (green card holders), and US residents who meet the substantial presence test for the calendar year (and are not exempt, such as foreign students) are treated as US tax residents. This means that the US imposes taxes on its citizens for income earned anywhere in the world, and irrespective of where they live. If you are a US citizen and live in in a country that is not the US, you may owe taxes both to the US government and to the country where the income was earned or where you are a tax resident. However, income tax treaties between the US and other countries serve to effectively reduce or eliminate an individual’s tax liability in order to avoid double taxation. For example, a treaty between the US and New Zealand overrides each country’s income tax laws to avoid double taxation. Even so, dual citizens may be required to file US tax returns even if they live and earn income in New Zealand. Because tax laws are complicated and can change from year to year, it’s important for individuals facing this situation to consult with a qualified tax expert or accountant.

Can you be a tax resident of two countries?

It is possible to be a tax resident in more than one country at the same time. For example, you could be a US citizen who resides for more than six months in the UK, which would make you liable to pay tax on your worldwide income in both. You have to look at the double taxation agreement between the two countries to determine where you should pay tax. If you have dual tax residence in the UK and another country, then a double taxation agreement should prevent you from being taxed twice on the same income. We recommend that you seek some professional advice if you find yourself in a dual tax residence situation.
Could more countries introduce citizenship based taxation?
While much of the world seems to have so far agreed that citizenship based income taxation is unjust, the pandemic aftermath may push nations to re-consider the system as a means of tackling the deficit that many economies are facing. India recently introduced its Tax Residency law and, while it differs from a citizenship based taxation, there are some noticeable similarities. Under the law, non-resident Indians who do not pay income tax in the country they reside in must pay tax in India. This law only applies to Indians in specific countries that include the United Arab Emirates, Saudi Arabia, Bahrain, Oman, Brunei, Kuwait, the Maldives, Monaco, and Qatar. However, the new law will not affect those with a foreign citizenship, providing an incentive for non-resident Indians to obtain a dual citizenship (and give up their Indian citizenship) to protect their wealth.
Citizenship by investment
For several decades, high-net-worth individuals and their families have invested in a dual citizenship as an insurance policy for when crisis hits. Whether it is political unrest or economic instability, dual citizenship has allowed wealthy investors to make quick decisions to safeguard their future in times of unpredictability. The Caribbean is home to the world’s first citizenship by investment programme which was established in St Kitts and Nevis. In order to qualify for citizenship, applicants must make a one-time minimum investment of US$125,000 into a government fund and pass the necessary security checks before citizenship can be granted. Those who are successful gain access to numerous benefits that include increased travel freedom, alternative business prospects, and the right to live, work and study in the nation. It is also possible for citizenship to be obtained by the investor’s future children.
Final Thoughts
Except for the United States, Hungary, and Eritrea, possessing a country’s citizenship is not sufficient to make an individual a tax resident in that country. Therefore, citizenship is distinguished from tax residence. Dmitry Zapol, a dual-qualified international tax advisor, says that passports and citizenships alone do not give any tax benefits. “However, [citizenship] allows you to spend a longer period of time in a particular country than had you not had such a passport,“ he added. “It is not sufficient to move to a low tax country that happens to have the Citizenship by Investment [programme]. To give an example, it’s not enough just to move to Spain, Portugal or Switzerland or Malta or Cyprus and payload taxes there. You must also become a non-resident in the country whose taxes you are looking to avoid.” For example, in Russia, “you would have to spend fewer than 183 days (6 months) in any year in Russia to really benefit from such cross-border planning,” he said. For further inquiries on investment immigration opportunities, contact CS Global Partners.

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