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What Is A Territorial Tax System?

5 min read

What Is A Territorial Tax System?

Paying zero taxes is probably the wildest dream of freedom-seeking individuals. Governments are raising taxes massively, sometimes imposing rates over 50%. Nordic countries and Western nations like the U.S., France, and Australia have confiscatory taxes on high earners, forcing them to work for free for more than half a year. “Taxation is Theft” is not propaganda but a sad reality. 

To some, hearing these words might sound excessive, as we’ve always been told that taxes are necessary to maintain a civilized society, but that’s simply not the case. Crime is rising in multiple high-tax jurisdictions, while some low-tax or even tax-free countries are perfectly safe. 

In this article, we’re diving headfirst into something that, if used correctly, will help you effectively pay zero income tax, keeping it all in your pockets. This is the power of territorial taxation, so read on to learn everything you need to know.


 

In the territorial taxation system, you are only taxed on income earned within the border

In the territorial taxation system, you are only taxed on income earned within the border

A BACKDROP ON THE DIFFERENT TAX SYSTEMS

If you’re reading this article, there’s a decent chance you are sick and tired of paying taxes. Your country’s taxman is always out there snooping around, tracking your bank accounts and making sure you pay your ‘fair share.’ OECD (Organization for Economic Cooperation and Development) countries are also trying very hard to raise taxes and even impose a global minimum tax on the profits of multinationals. 

To add insult to injury and, in most cases, the more you earn, the higher the rates you are charged, while your money is oftentimes used for things you don’t agree with—be it climate change, lobbies, or the woke agenda. And you’re right in thinking you deserve to use the fruits of your labour however you want. 

Now, before you pick just any tax-free country, we need to consider the various types of tax systems. This will help you make an educated decision on where to establish your tax residency:


RESIDENCY-BASED TAX SYSTEMS

Most countries implement this tax system. Put simply, if you live in a country with a residency-based tax system, you pay the taxes of your jurisdiction. For example, if you work in the UK, you pay UK income tax, which can reach up to 45%, as well as taxes on capital gains, dividends, inheritance, and the like. 


CITIZENSHIP-BASED TAX SYSTEMS

This is arguably the ultimate form of oppression, as no matter where you go, you still have tax obligations in your home country. Citizens of these countries may opt to use tax treaties between their country of residency and their home country or even to renounce their citizenship to minimize their tax bill. 

The only two countries in the world that are currently implementing this tax system are Eritrea and the US, but other nations such as France, Canada, and Australia are also considering adopting it.


TERRITORIAL TAX SYSTEMS

Lastly, the protagonist of this article is territorial tax systems. While multiple countries tax their residents on their worldwide income, others opt for source-based taxation. The rule is straightforward: income earned outside the country’s borders is tax-free, also known as the principle of territoriality. That’s right; all that money is yours and yours only. This is one of the reasons why I moved to Panama with my family in 2019, and I pay zero income taxes.

 

Related content: Top 9 Countries With Little Or No Taxes

 

Foreign companies are encouraged to invest in the country and national companies to expand internationally, generating more jobs

Foreign companies are encouraged to invest in the country and national companies to expand internationally, generating more jobs

HOW DOES A TERRITORIAL TAX SYSTEM WORK?

Territorial taxation is based on the distinction between income sourced domestically and abroad. Domestic income is generated within the country’s borders, while foreign income is generated outside the country. 

Here’s how it works: if you live in a country with a territorial tax system, you'll only need to pay taxes on the income you earn within that country’s borders. Domestic income includes what you earn from jobs, businesses, or investments at home. Meanwhile, foreign income covers what’s made through similar means outside the country.

Businesses follow similar rules in these jurisdictions. They are taxed on any income they generate from sales or services within the country but not on money earned from international sales or services.

The tax liability is determined by the tax rate based on the income generated within the country, which varies depending on the type of income and the country's tax laws.

 

Related content: The Basics Of How To Get A Second Passport Or A Second Residency

 

Domestic companies may end up paying higher taxes than foreign companies that earn income within the country

Domestic companies may end up paying higher taxes than foreign companies that earn income within the country

BENEFITS FOR EXPATS

  • Lower Tax Burden: Expats can benefit from a lower tax burden, as their income is only taxed when it is generated within the country’s borders.

  • Increased Savings and Investments: With reduced income taxes, expats can save more and invest, allowing them to tap into better financial stability and growth. 

  • Enhanced Quality of Life: Lower taxes can help expats enjoy more disposable income, thus affording a better quality of life. Whether it’s local amenities, travelling or investing in other endeavours, the financial relief territorial taxation offers is evident.

  • Ease of Financial Planning: Simplified tax regulations, as opposed to complex tax codes, help expats easily manage their tax obligations. This reduction in complexity makes it easier to comply with local laws, avoid penalties and manage finances efficiently. 

 

BENEFITS FOR THE COUNTRY

A territorial tax system has many advantages for expats and the countries that adopt this tax policy. Some of the benefits this system offers are:


ATTRACTING FOREIGN INVESTMENT

A country can create a tax environment encouraging foreign companies to invest and expand their operations there. This can lead to economic growth and job creation. The quintessential example is Singapore, which went from poverty to prosperity in little time thanks to this openness. 



SIMPLIFIED TAX SYSTEM

A territorial tax system eliminates the need for complex tax treaties and policies that determine which country must tax the income generated outside its borders. This simplification means that individuals and companies can more easily comply with tax regulations and reduce compliance costs, saving time and resources.


PREVENTING DOUBLE TAXATION

By taxing only the income earned within a country’s borders, a territorial tax system prevents double taxation. Under a worldwide tax system, expats might find themselves taxed by multiple countries on the same income, which can significantly reduce their net earnings. The territorial system ensures expats keep more of what they earn, making their financial planning and wealth management more straightforward and predictable.



COUNTRIES WITH TERRITORIAL TAXATION

Now that you know the benefits of this tax system, it’s time to answer the question you might be asking yourself: “Where can I find this?” Below is a list of some interesting countries where you might want to set up shop. The list is extensive, and I’m sure you will be shocked by some of the options available as of the time of writing (May 2024). 

  • Panama

  • Guatemala

  • Nicaragua

  • Belize

  • Honduras

  • Costa Rica

  • Bolivia 

  • Paraguay 

  • Hong Kong

  • Singapore

  • Uruguay (under 10-year tax holiday)

  • UK (under the non-dom tax regime)

  • Ireland (under the non-dom tax regime)

  • Spain (under “Beckham Law”)

  • Portugal (under the NHR program) 


Note that the last five countries require you to meet specific requirements to benefit from territorial taxation. For example, Spain would still charge you a 24% income tax rate on income from professional economic activities under €600,000 and 47% for the excess. However, you would enjoy a complete exemption from Spanish taxation on foreign-sourced capital gains, dividends, interest, rental income, and royalties. Portugal’s NHR regime works in a similar fashion, while Uruguay’s tax holiday applies to foreign income. 

As always, before making any country your new tax residency, consult a qualified tax attorney and do your due diligence.

 

A territorial tax system can effectively promote economic growth and present good opportunities for expats with online income

A territorial tax system can effectively promote economic growth and present good opportunities for expats with online income

CONCLUSION

The concept of a territorial tax system opens a whole new world of possibilities if you want to pay little to no taxes. While countries like Monaco and some Gulf nations are income-tax-free, if you earn your income outside your country’s borders–as is the case for digital nomads or HNWIs with passive income–territorial tax jurisdictions take this concept to a new level. 

Starting your expat journey by examining a list of countries with a territorial tax system (and not only tax-free income) is crucial. This approach not only maximizes your financial benefits but also provides diverse options for creating a lifestyle that suits your preferences. By focusing on these jurisdictions, you can achieve both tax efficiency and an enhanced quality of life.

 

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Mikkel Thorup

Written by Mikkel Thorup

Mikkel Thorup is the world’s most sought-after expat consultant. He focuses on helping high-net-worth private clients to legally mitigate tax liabilities, obtain a second residency and citizenship, and assemble a portfolio of foreign investments including international real estate, timber plantations, agricultural land and other hard-money tangible assets. Mikkel is the Founder and CEO at Expat Money®, a private consulting firm started in 2017. He hosts the popular weekly podcast, the Expat Money Show, and wrote the definitive #1-Best Selling book Expat Secrets - How To Pay Zero Taxes, Live Overseas And Make Giant Piles Of Money, and his second book: Expats Guide On Moving To Mexico.

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