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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.

While there are undoubtedly some benefits to taxing non-resident citizens, such as a continuous influx of tax irrespective of short-term migration, the taxation system has been controversial for several years, with many arguing that it is a draconian measure that should be left in the past.

Some countries adopted a citizenship-based tax (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.

Income tax in the US dates back to 1861 during the Civil War era. Even then, however, the tax excluded income generated by non-resident citizens abroad. Several iterations of worldwide taxation laws were passed in later years, starting with 1864. Citizenship-based tax 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 last year.

Could More Countries Introduce Citizenship-Based Tax?

While much of the world seems to have so far agreed that citizenship-based income taxation is unjust , the pandemic 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 second 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 second citizenship as an insurance policy for when crisis hits. Whether it is political unrest or economic instability, a second citizenship has allowed wealthy investors to make quick decisions to safeguard their future in times of unpredictability. Over the last year, the investment migration industry has witnessed a boom triggered by the pandemic and the following uncertainty on when normalcy will return.

The Caribbean is home to the world’s first citizenship by investment programme which was established in St Kitts and Nevis. The dual-island nation launched the initiative in 1984, one year after gaining independence from the United Kingdom.

In order to qualify for citizenship, applicants must make a one-time investment of US$150,000 into a government fund and pass the necessary security checks before citizenship can be granted. The Sustainable Growth Fund, hailed as the fastest route to second citizenship, was specifically designed to channel generated revenue into socio-economic development in areas like education and healthcare. Currently, investors can take advantage of a limited time offer that offers citizenship to families of up to four for $150,000 instead of $195,000.

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.