how do taxes work

A General Overview on Income Taxes

Whether you are a digital nomad or a young college grad fresh into the “real world”, you will need to understand how taxation works at some point. Every country has its own tax guidelines, and depending on where you reside and how you generate your income, you could potentially optimize your personal income tax situation.

Fiscal Residency

Most countries in the world tax individuals based on their fiscal residency – in other words, which jurisdiction are you a legal resident of.

For most people, that is simply your home country which you grew up and currently live in. You will go to work or run your business and pay the standard income tax rates in your home country/province/state. Typically as an employee at a company in the West, your income tax is already withheld directly from your pay check, meaning that by the time you receive your salary the tax has already been taken.

If you are live the nomadic lifestyle around the globe, then you have many options to optimize your tax situation, by leveraging where you officially reside.

For example, a Canadian citizen can legally reside in Hong Kong and cut fiscal ties with Canada while living abroad, and not pay Canadian taxes. This does not mean cutting ties with the country entirely – you are still a Canadian citizen, you are just officially living full-time in another country. Since you are not living in Canada and not taking advantage of Canada’s social services, you therefore do not need to pay Canadian taxes – makes sense!

For most of you from the West who live and work abroad, whether in China, Thailand, Vietnam, Hong Kong, Singapore, Turkey, or elsewhere, you are likely already a resident of that country as a full-time working expat, and therefore you do not need to pay income taxes to your home country.

This is good because taxation in non-Western countries are usually much lower, and hence people who work abroad for multinational companies are usually encouraged with receiving more salary-in-hand.

Taxation Tiers

Most countries have a tiered income tax system, in order to get more taxes out of high earners and less taxes out of people who make very little income. For example, the federal income tax brackets in Canada is as follows:

  • 15% on the first $48,535 of taxable income, and
  • 20.5% on the portion of taxable income over $48,535 up to $97,069 and
  • 26% on the portion of taxable income over $97,069 up to $150,473 and
  • 29% on the portion of taxable income over $150,473 up to $214,368 and
  • 33% of taxable income over $214,368

As you can see, someone who makes $40,000/year pays a lot less in comparison to someone who makes $250,000/year. A little bit of a balancing act between the rich and poor, I suppose. Keep in mind that the above are Canadian federal numbers, and that each Canadian province also has its own tax rate that goes on top of the federal rates.

Many non-Western countries also have this tiered system, with the exception being the rates generally tend to be lower than in Western Europe or North America.

Corporate Tax and Capital Gains Tax

Generally there are also taxes on other forms of income, notably corporate/business tax and capital gains tax.

If you are an entrepreneur running your own business, you will likely pay a corporate tax on your company’s profits. There are ways to structure your business and accounting so that you can minimize the amount of taxes you pay on your business income, and that depends on the jurisdiction your business is registered in and the jurisdiction in which you reside personally.

In most countries there is also a tax on all capital gains. Capital gains refer to growth from capital, so for example profits from stock trading, buying and selling real estate, and so on. If you are someone who invests and trades stocks (or even crypto), you are liable to paying taxes on your capital gains each year. The same goes for a house you sold from which you made a profit.

Just like income tax, corporate and capital gains taxes also vary depending on jurisdiction. A company registered in Delaware or Nevada doesn’t pay the same amount of taxes as a company registered in California or New York – and now you understand why people register companies in Delaware (even giants like Apple!).

How to Leverage Geoarbitrage to Optimize Taxation

If you are living a global lifestyle, then you have many options and strategies to legally minimize the amount of taxes you have to pay. I won’t go into too much detail here but rather give some examples so you can understand how it generally works.

Let’s say again you are a Canadian citizen legally residing in Hong Kong, and you run your business through a Hong Kong registered LLC that sells products to North American customers via Shopify. In Hong Kong’s case, you actually pay 0% corporate tax on your business income, because your business’ earnings come from non-Hong Kong sources.

As owner of the company, you can pay yourself a small salary each month to take care of living expenses, etc., and the individual income tax rate is very low in Hong Kong (ranging between 2% and 17% depending on income level). Since you are legally a resident of Hong Kong, you do not need to pay any taxes to Canada. This gives you massive savings because paying something like 10% individual income tax (on a small salary you pay yourself) is significantly better than paying the standard 30-40% individual income tax (provincial + federal) in your home country.

The same case can be applied if your main source of income is from trading stocks or other financial instruments. You can shop around and choose to live in a jurisdiction that has a low tax rate on capital gains, and keep A LOT MORE of your income as supposed to living in your home country.

In conclusion, as our world has evolved into such an information-driven society where countries are increasingly competing with each other for talented individuals, it makes a whole lot of sense to take advantage of better offers in countries other than your home one. If you are a smart individual who likes to live a global lifestyle, 10-20% in tax savings per year coupled with compound interest can make a huge difference for your personal finances.

Would you like to learn more on the topic of taxation? What kind of topics would you like to read about? Let me know in the comments.

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