Basics of taxation

Table of contents

Types of taxes

Based on the origin

List of countries by their tax system on Wikipedia

Based on the tax rate

List of countries by their headline tax rates on Wikipedia

Based on the type of income

Based on geography

Types of income

For corporations, gross income is also the top line (on the income statement), while net income is the bottom line.

Companies also distinguish revenue and profit which are slightly different:

Tax base

Tax base (taxation basis) is the portion of income that is subject to tax.

Individuals pay taxes (PIT and socials) on their gross income minus deductions (ex: personal allowance, pension fund contributions, etc.). Socials use your gross income as the tax base, which is sometimes capped at a multiple of min/avg monthly wages.

Corporations pay taxes (CIT) on their profits (or sometimes a lower rate on revenues). Profits are then distributed to shareholders as dividends (which are then taxed again at the personal level).

Most freelancers and digital nomads will fall into one of the following:

Employees are usually taxed at the higher rates because of the progressive PIT and mandatory socials. They may claim personal allowances and home-office deductions, but those are limited. However, employees enjoy labor rights, health insurance, EI/severance pay, PTO, etc.

Self-employed can pay less PIT by deducting business expenses from gross income, but they also pay higher socials (both employee and employer side). Contractors don't get any benefits or PTO, and they often need to purchase private health and contractors insurance.

Despite tax integration, corporations are often the most tax-efficient because they can pay a reduced small business CIT rate at the corporate level, and a flat dividend tax at the personal level (typically, lower than PIT). As a director/manager, you can decide how much you pay yourself in salary and thus in PIT and socials.

Taxable income

Individuals are taxed based on tax residency and source of income:

Similarly, for companies:

These terms are commonly confused. Note that they can all be in different countries simultaneously!

Individual residency

Canadians, see tax residency in Canada.

Each jurisdiction has its own rules for tax residency. Some countries apply residency tests (ex: SRT in the UK, substantial presence test in the US, etc.). Tax authorities publish general guidelines that you can read online. The fine print can be found in the tax act(s) and case law. Finally, if a DTT applies, it will override the domestic rules.

Tax residency is a question of fact. The following factors are commonly (but not always) taken into account:

For most people leaving western countries, the best course of action is to make a clean break i.e. sever all ties with your home country (sell your home, car, close bank accounts, etc.), and permanently move yourself, your family, and your business to the new country. Alternatively, you could sever all significant ties (like your primary residence) but keep some secondary ties (like your driver's license or private pension fund). If you qualify for treaty relief under a DTT, you could have mixed ties in both countries, but only pay taxes in one based on the tie-breaker rules.

As a non-resident of your home country, if you receive local sourced income, a non-resident withholding tax is automaticaly deducted at the source (see WTH taxes). For some types of income (ex: employment), you may also have to file a non-resident tax return (even though some tax was already withheld).

Corporate residency

The exact rules on how a company is taxed are found in the tax code. A tax treaty, if applicable, will override these rules. While the details vary between countries, tax authorities consider one or more of the following:

  1. Registration
    • If a company is incorporated in a country, it is tax resident there
  2. Management and control
    • If a foreign company is managed in a country, it is tax resident there
    • This can include director decisions, senior management, day-to-day management, etc.
    • Related: place of effective management (POEM) where strategic decisions are made
  3. Controlled Foreign Corporation (CFC)
    • If a majority shareholder is personally tax resident in a country, their foreign company is also resident there
    • "Control" may include voting rights, shareholder value, operations/activities, etc. (see OECD on CFC)
  4. Permanent establishment (PE)
    • If a foreign company has a fixed place of business in a country, it is taxable there
    • This can include a branch, an office, a factory, etc.
  5. Source of income
    • If a company generates income in a country, it is attributable and thus taxable there.
    • This is determined by economic substance i.e. where the headquarters, offices, employees, etc. are.
    • Related: nexus or economic presence (i.e. business activity) in a jurisdiction

In most cases, the place of registration is irrevant for taxes. A foreign company can still be deemed resident if it is managed and controlled onshore, or if its shareholding are individually resident in the country. Likewise, a non-resident company is still taxed on its income from PE and other local source income.

Double taxation

Unfortunately, you could be a tax resident of multiple countries. Luckily though, if those countries have a double taxation treaty (DTT), you may still be deemed a tax resident of one country, but not the other, based on the tie-breaker rules (often found in Article IV). The country you would be deemed a tax resident of is typically the one in which you have your:

  1. permanent home or
  2. center of vital interests or
  3. habitual abode or
  4. citizenship

If you satisfy one of these tests, you'd qualify for double taxation relief, as the DTT would override (supersede) any local tax laws. If none of the tests apply, the question is settled in court by mutual agreement of the countries.

If there is no DTT in place (often the case for blacklisted or tax haven countries), then you might be subject to double taxation. However, the other country would usually have no tax, very low tax, or territorial tax (where foreign-sourced income is exempt from taxes). In other cases, you may be exempt from tax based on the terms of your visa (ex: digital nomad visa).

If you run your business in a foreign country (as a dependent agent), depending on the type of activities or presence of a fixed place of business, you may constitute permanent establishment. In that case, your business would be taxable on the portion of income that you generated (or is attributable to, based on how much time you spent there) in said country.

Hybrid mismatch

Tax avoidance vs. tax evasion