Understanding The Exit Tax: Financial Implications For Expats

An exit tax is a fiscal measure imposed by a government on individuals and businesses that decide to relocate their residency or operational base out of the country. The primary purpose of this tax is to levy a final tax on capital gains or the unrealized appreciation of assets before the taxpayer moves them beyond the reach of the country's tax authority. It aims to capture the value of accumulated wealth or gains while still under the jurisdiction of the nation’s tax laws.

However, when governments levy enormous taxes on so-called revenues that have yet to be realized, we risk having our most fundamental rights violated, such as freedom of movement and property rights. Alex Svanevik, a Norwegian entrepreneur who has migrated to Singapore, describes the enormous financial issue that Norwegian entrepreneurs confront as a result of the exit tax. He demonstrates this using a fictional scenario: Assume you launch a $10 million USD company during a fundraising event and own a 30% ownership. If you decide to relocate abroad to scale your business — given that Norway's population of five million may not be sufficient as a significant market — you will be liable to a 37.8% exit tax on your potential worth of $3 million USD. This tax would be around $1 million USD. Svanevik contends that this high tax practically pushes founders to stay in Norway, as relocating overseas becomes financially costly.

Exit taxes can act as a financial barrier to emigration, effectively deterring individuals from relocating in pursuit of better opportunities or more favourable tax regimes. The exit tax, once again, reveals the tension between the government's desire to exploit fiscal revenues and the individual's right to personal and economic liberty.

Any way you look at it, the exit tax is an embarrassment to the ideal of freedom. By restricting your freedom to leave the country, governments lay claim not only to your wealth but also to your body and your creativity. You do not have to tolerate this kind of humiliation. You can start evaluating your options for you and your family today by subscribing to our free newsletter. I will be happy to help you prepare a Plan-B that fits your priorities. 

UNDERMINING GLOBAL FREE TRADE AND PEACE

Exit taxes show us how difficult it is to protect the principles of individual liberty, freedom of movement, and free market ideals, even in the developed world. These principles assert that individuals should have the utmost freedom in making life decisions. This includes the right to manage and relocate their personal and financial assets. Such actions should be free from undue government interference. The belief in a limited government underscores that the state's role should be minimal. The government should primarily ensure the protection of individual freedoms. It should not impose restrictive measures that curb individual choices.

By taxing individuals as they choose to leave a country, governments are effectively setting a financial barrier that could force individuals to remain in an unfavourable fiscal environment against their will. Exit taxes can be seen as punitive measures that disproportionately impact those who have accumulated wealth. It suggests that their success makes them targets for higher governmental demands. This approach can discourage entrepreneurship and investment in a country, ultimately hindering economic growth and freedom.

On the one hand, the European Union and other liberal democracies are building free trade zones and reaping the benefits of the global division of labour and specialization, while on the other hand, they are doing their best to punish individuals and companies that want to reap the benefits of favourable tax regimes. Governments seem ready to abolish the right to free movement in order to confine productive individuals and companies to their own borders, which they strangle with heavy tax burdens.

Europeans and North Americans seem to have forgotten why they adopted free trade zones after World War II. We must remember the devastating effects of economic nationalism, which led the world into great wars. It is appalling to see how far politicians will go to keep their inefficient tax systems in place. Exit taxes are like a ghost from the past, reminding the advocates of freedom how strong the opposition to economic liberty still is.

THE EXIT TAX TURNED INTO A WEAPON UNDER NAZI GERMANY

No tax issue can be taken lightly, especially if it could prevent you from leaving the country. Germany's first exit tax is a warning that should not be forgotten.

The Reich Flight Tax (Reichsfluchtsteuer) was originally introduced in Germany in 1931, during the Weimar Republic, which was the democratic government in Germany before the rise of the Nazi regime. The tax was introduced against a backdrop of severe economic instability, including the global impact of the Great Depression, which had led to massive financial turmoil and hyperinflation in Germany during the early 1920s.

The tax was levied on the assets of Germans who chose to emigrate from Germany. Originally, the tax rate was set at a high level (initially around 25% of the total asset value) to act as a deterrent against moving large sums of money abroad. The enforcement of this tax required individuals to declare their assets and pay the tax before they could be granted clearance to leave the country.

TRANSFORMATION UNDER THE NAZIS

When the Nazis came to power in 1933, they radically expanded the use and scope of the Reichsfluchtsteuer as part of their broader discriminatory policies against Jews and other persecuted groups. Then, the tax was specifically targeted at Jews and was employed as a punitive financial measure to confiscate wealth and economically disenfranchise the Jewish population.

The Nazis exploited this pre-existing tax mechanism to legally justify the seizure of assets from Jews attempting to flee persecution. This reapplication of the Reich Flight Tax was in line with the regime's racial policies and its goals of Aryanization, which aimed at removing Jews from the German economy and society.

Thus, while the Reich Flight Tax began as a financial control measure during an economically tumultuous time, it was transformed into a tool of oppression by the Nazi regime, further exemplifying how existing structures can be adapted for different and nefarious purposes under different leadership.

Several countries are implementing exit taxes to discourage citizens and businesses from changing their tax residency, reflecting a concerning trend of control over global financial mobility

EXAMPLES OF EXIT TAXES AROUND THE WORLD

Today, it is clear to me that the countries that claim to be the cradles of civilization are seeking to create a kind of tax cartel to keep their citizens and companies within their borders. I have listed below some of the key members of this cartel.

GERMANY: THE STEEP PRICE OF DEPARTURE

Germany's exit tax is applied to unrealized gains in company shares when an individual who owns significant shares relocates from Germany. This tax targets both individuals and companies holding substantial shares, generally defined as owning more than 1% of a company's capital within the last five years while having been subject to German tax liability for at least seven of the twelve years prior to departure.

When determining the tax owed, the fair market value of the shares at the time of departure is taken into account while also subtracting any acquisition costs. This calculation helps to determine the notional capital gain. This gain is then taxed at the individual's income tax rate, up to 45%. However, due to the partial income procedure, 40% of this gain is tax-exempt, resulting in a maximum effective tax rate of approximately 27%, plus the solidarity surcharge and potentially church tax, depending on individual circumstances.

In most cases, individuals are required to pay the exit tax upon leaving Germany. However, an alternative option is available where the tax can be paid in seven yearly installments of equal amounts upon request. This flexibility helps mitigate the tax burden, primarily since the tax is levied on gains that have yet to be realized in actual sales, often catching taxpayers by surprise due to the lack of liquidity from a sale.

NETHERLANDS: BOUND BY TAXES

In the Netherlands, exit taxes are levied on individuals who own a substantial interest, generally defined as at least 5% of a company, and decide to relocate to another country. This tax is applied to the unrealized capital gains on these shares at the time of exit. The goal is to tax gains that have accumulated while the taxpayer was resident in the Netherlands, thus preventing the deferral of tax payment until the actual sale of the shares.

The tax rate for such unrealized gains is aligned with personal income tax rates, which for substantial interests are 24.5% up to €67.000 ($73,000 USD) and 31% for any amount above that. This taxation is intended to ensure that income accrued under Dutch tax residency is appropriately taxed even if the individual no longer resides in the Netherlands.

SPAIN:  SUN, SEA, AND EXIT TAXES

Spain imposes an exit tax on residents who decide to move their tax residence out of the country under certain conditions. This tax targets unrealized capital gains on shares when a taxpayer decides to leave Spain. The tax is applicable if:

• The individual has been a tax resident in Spain for at least 10 of the 15 years before their departure.

• They own shares worth more than €4 million ($4.367 million USD) or shares exceeding €1 million ($1.092 million USD) in a company where they hold at least 25% of the shares.

The exit tax is calculated on the market value of these shares minus their acquisition cost. The tax rates for these unrealized gains align with those for savings income, which can be up to 23%. Depending on future reforms, this could potentially increase to 27%.

NORWAY: COLD CLIMATE, HEFTY TAX

The latest details on Norway's exit tax, as updated in 2024, indicate significant changes intended to tighten the financial constraints on Norwegian citizens who relocate to countries with more favourable tax conditions. Finance Minister Trygve Slagsvold Vedum spearheaded this reform, which targets unrealized gains on assets like shares to discourage wealth migration and ensure tax contribution equity.

The exit tax imposes a 37.8% tax rate on the latent value of shareholdings above NOK 500.000 ($45,680 USD) for individuals moving their fiscal domicile out of Norway. This tax aims to mirror the dividend rate, applying even if the shares are not sold.

Those affected have options for settling this tax. They can pay it immediately, spread interest-free payments over 12 years, or defer payment with interest accruing until the liability is settled. If an individual has paid the exit tax returns to Norway, the tax paid can be refunded, or the obligation may be cancelled. As of December 2023, the exit tax rules also cover the transfer of shares to any individual outside of Norway, not just close family members.

UNITED STATES:  LIBERTY TAXED

If an individual opts to give up their U.S. residency or citizenship, they might face the "expatriation tax." This tax affects those who are either long-term residents or citizens based on specific criteria. Eligibility for this tax hinges on whether their average annual net income tax for the preceding five years exceeds a set limit or if their net worth is $2 million USD or more at the time of expatriation. 

Furthermore, if they cannot affirm on Form 8854 that they have met all federal tax obligations in the U.S. for the five years leading up to their expatriation, they will be liable for this tax. The amount of the expatriation tax is determined by calculating the net unrealized gain on the individual's property, assuming it was sold for its market value on the day before they relinquished their citizenship or residency. 

The applicable tax rate is the same as the US capital gains rate, but higher-income earners may also be subject to the Net Investment Income Tax, which may slightly increase the effective tax rate.

CANADA: NO EASY EXIT

Canada has an exit tax, also known as a departure tax. This tax applies to individuals who are leaving Canada and ceasing their tax residency. When you leave Canada and become a non-resident for tax purposes, the Canada Revenue Agency (CRA) deems that you have disposed of certain kinds of property at their fair market value on the day you leave. This is referred to as a "deemed disposition." The resulting capital gains from this deemed disposition are subject to taxation at normal marginal rates.

The departure tax mainly applies to capital property, including stocks, bonds, and certain other investments. However, some assets are exempt from this tax, such as Canadian real estate, Canadian business property, assets within registered retirement savings plans (RRSPs), and tax-free savings accounts (TFSAs). If the total value of the property owned at the time of departure exceeds CAD 25,000 ($18,205 USD), you must also file a special form with the CRA detailing these assets. 

Besides these countries above, other countries have implemented the Exit Tax. Check it out:

• Australia

• Denmark

• France

• Italy

• Poland

• South Africa

• Sweden

Although exit taxes are implemented to prevent capital flight and ensure tax compliance, the unintended consequence is often to encourage exactly the type of tax behaviour they aim to prevent

ECONOMIC CONSEQUENCES OF EXIT TAX

Exit taxes can significantly affect economic behaviour, affecting individual decisions and broader economic trends. Firstly, they may discourage investment by increasing the financial costs of relocating capital. Investors and business owners often seek jurisdictions that offer favourable tax conditions and political and economic stability. Imposing an exit tax can make it financially unviable for these individuals to move their assets, thus potentially locking investments in less optimal conditions.

Moreover, the existence of exit taxes could incentivize tax evasion. Individuals and corporations might resort to more aggressive tax planning strategies or shift their financial arrangements to minimize recognized gains before relocation. This behaviour not only undermines the tax base but also leads to a complex web of financial arrangements that can obscure true economic activity and strain the administrative capacities of tax authorities.

Strategies against exit taxes can complicate the work of tax authorities by creating a more complex financial system to monitor and regulate. The resources required to audit and verify asset values, ownership structures, and transaction timing can be substantial. This complexity not only strains these authorities' administrative capacities but can also lead to legal battles that further drain resources.

Moreover, when high net-worth individuals or corporations successfully minimize their exit tax liabilities, it results in lower tax revenues than anticipated. This shortfall can have broader economic consequences, especially for countries that rely on these taxes as part of their fiscal strategy. Reduced tax revenues might lead to cuts in public services or the need to increase other forms of taxation, which can have ripple effects throughout the economy.

Ultimately, while exit taxes are designed to prevent capital flight and ensure that tax obligations are met before individuals or assets leave a country, they can have unintended consequences of encouraging exactly the kind of fiscal behaviour they were meant to deter. This leads to a challenging balance for policymakers, who must design tax laws that protect the tax base without hindering economic freedom or encouraging evasion.

The financial burden imposed by exit taxes can lead to a phenomenon known as "brain drain," where a country loses its skilled professionals and entrepreneurs who choose to migrate before accumulating substantial wealth and facing high exit taxes

SOCIAL IMPLICATIONS

The social impact of exit taxes is significant and multifaceted, especially concerning human capital mobility. High-skilled workers and affluent individuals often have the resources and flexibility to consider relocating when faced with unfavourable tax policies. However, exit taxes can impose a substantial financial burden on these decisions. These financial burdens can lead to a phenomenon known as "brain drain," where a country loses its skilled professionals and entrepreneurs because they choose either not to return or to migrate from the country to avoid hefty exit taxes. This loss is not just a matter of reduced tax revenue; it also impacts the country's ability to innovate and grow economically, as the departure of skilled individuals depletes the pool of talent necessary for technological and entrepreneurial advancement.

Furthermore, the structure of exit taxes might unintentionally deepen wealth inequalities. These taxes are typically designed to target higher wealth brackets, aiming to tax the gains and wealth of the affluent. However, they often affect those at the lower end of the wealth spectrum who qualify for the tax. The financial impact can be disproportionately severe for individuals and families whose assets just surpass the threshold for triggering the exit tax. Unlike the very wealthy, who may be able to absorb or avoid these taxes through careful planning, these borderline qualifiers might find the tax an insurmountable barrier.

This situation effectively restricts their economic freedom, limiting their ability to relocate for better opportunities. Whether it's for employment, improved living conditions, or more favourable economic climates elsewhere, the exit tax can tether them to their current location. The consequences extend beyond individual financial concerns—when people cannot move freely, the overall economic dynamism suffers, as does the ability of societies to adjust to new economic realities and opportunities.

NOTABLE EXAMPLES

In 2012, Eduardo Saverin, one of Facebook's co-founders, famously gave up his U.S. citizenship just before the company's initial public offering. This move was widely reported as a way to reduce his tax burden, given that the U.S. imposes taxes on worldwide income and potentially significant exit taxes on the unrealized gains of expatriates. By renouncing his citizenship, Saverin was subject to an exit tax on the gains from his shares at their fair market value. However, this was presumably lower than the tax burden he would have faced had he remained a U.S. citizen as Facebook shares continued to appreciate.

Many startups might also be unable to obtain the funding they need because of the exit tax. The application in Norway will hurt many promising businesses. The story of startups like 1X, Two, and Photoncycle highlights Norway's vibrant and innovative startup scene. Each represents different sectors: robotics, fintech, and energy tech, respectively.

1X, a robotics startup, could leverage cutting-edge technology backed by significant entities like OpenAI, suggesting its focus on advanced robotics solutions. Two operating in the fintech sector likely deal with financial technologies that could revolutionize how businesses and consumers manage finance in a digital-first world. Photoncycle in the energy tech sector might be focused on developing technologies that enhance energy efficiency or production, which is crucial for sustainable development.

These startups illustrate the diversity and potential within Norway's tech ecosystem. However, introducing stringent exit taxes could pose a significant concern for these companies and their investors. Exit taxes on unrealized capital gains could make potential founders and foreign investors hesitant about investing in Norwegian startups, fearing financial penalties if they decide to relocate or sell their interests.

With the rising political risk worldwide and a recession looming in "developed" economies, the current environment is not favourable for high-net-worth individuals

CONCLUSION

Historical and modern examples, from the Reich Flight Tax to contemporary US and European policies, show that governments seek opportunities to disrupt the natural flow of capital and people. On the one hand, governments try to make high-income earners pay for the mistakes of their economic policies with high taxes and regulations, while on the other hand, they try to make it harder for HNWIs and capital to leave.

If you are waiting for the day when your country's economic conditions and tax rates will improve and your talents will be appreciated, you are, unfortunately, fooling yourself. As political risks increase worldwide and recession knocks on the door of so-called developed economies, time does not favour HNWIs. The right time is today to secure your future and wealth by crafting a Plan-B. I have guided expats for over 20 years with my expert team and business partners to safely and swiftly realize their exit plans. I would be happy to help you go over your options.