International contractors have to manage several items that are unique to working in foreign countries. The obvious tasks include immigration and work permits, banking, language differences and business registration. But one area that is often overlooked or forgotten is that of tax residency. This might seem like an abstract concept and unimportant, but tax residency can have real implications for your income tax status and tax liability.
What is tax residency?
Tax residency is a status given to any individual that meets certain criteria in the host country, which will include international contractors. The most common test is the “183-day rule”, meaning if you are physically present in a country for more than six months, you will be deemed a tax resident. The days might be counted in the calendar year, or a rolling 12-month period.
Some countries have a longer period to meet the tax residency test, for example in Japan where it is one year, and in South Africa which counts the days over five years.
What is my responsibility as a tax resident?
Tax residency is a tax rule, and unrelated to immigration status, so it is not necessarily being monitored. But it is your responsibility to know if you meet the criteria, your tax liability and what is required to comply. In general, as a tax resident, you will naturally pay taxes on earnings inside the host country, but you could also be liable for tax on worldwide earnings during the tax year.
This brings up a very real possibility of double taxation on the same earnings. Here is an example of how that could happen:
- From January to May 2021, you worked in your home country as a contractor.
- In June 2021 you decide to work abroad with a new client in South Korea.
- You stay six months in the tax year in South Korea and become a tax resident.
- It is possible that your home country’s earnings from January to May could be taxed in South Korea as well as having tax liability in your home country.
To avoid this outcome, you would have to rely on a tax treaty between South Korea and the other tax jurisdiction, usually your home country. Some countries like Thailand only tax worldwide income if it is paid into Thailand, so the earnings in this example would not be taxable. This illustrates why a contractor needs a thorough understanding of the tax residency rules.
What is a tax treaty?
A tax treaty is a bilateral agreement between two countries that prevents double taxation of individuals with cross-border earnings. The actual rate applied and the country where it is paid will depend on the treaty. In general, the higher rate will apply, and there will be credits or offsets deducted from the tax return of the amount paid to avoid double taxation.
Is tax residency always a burden for international contractors?
Tax residency in some countries is desirable, such as in the UAE which has no income tax. If you could manage to ‘lose’ your home country’s tax residency, your global tax liability would be zero. For this reason, the UAE tax residency certificate is in high demand by ex-pat workers and is sometimes difficult to obtain.
What is legal residency?
Legal residency sometimes referred to as permanent residency, is an immigration status conferred on any foreign national that meets the criteria for residency in a country. The requirements may include residing a certain number of years, making a significant investment or marrying a citizen. It is unlikely that an ex-pat contractor working in a country would qualify for permanent residency without some other factors. But if you like the country, it is a path that one can pursue while working.
What is my responsibility as a legal resident?
Usually, as a legal resident, you would have similar rights and responsibilities as citizens, with some differences. You would be a tax resident as well. You probably won’t be able to vote, and you will pay taxes at the same rates as citizens. One potential benefit is that many countries don’t allow foreigners to work as self-employed without a visa sponsor, but as a permanent resident you could do so without a work permit.
How does tax residency differ from legal residency?
The primary difference between tax residency and legal residency for international contractors is immigration status. Tax residency has no bearing on your right to stay in a country, it is simply a tax policy. You are taxed like a legal resident but have none of the rights of residency. You will still retain your home country citizenship and privileges while working abroad.
For example, if you are a resident of Finland working in Singapore for several years, you will of course be a tax resident of Singapore. But you won’t become a legal resident automatically by staying. But citizens of Finland can ‘lose’ their home tax residency status (not their citizenship) if they are away for four or more years.
Then you don’t have to worry about double taxation and tax treaties. In contrast, US citizens can never lose their tax residency. They will always pay tax on worldwide income, subject to tax treaties or other tax relief measures. This is true even if a US citizen becomes a legal resident of a foreign country.
How Contractor Taxation can help you with tax residency
If you don’t want to take any chances navigating the tax residency rules and tax liability, Contractor Taxation can be your valuable partner. We have a network of umbrella companies around the world, with local experts who know all of the residency criteria and tax rates. This ensures that you will remain in compliance, and pay the correct tax rates under local criteria.
The umbrella company can also assist with handling client payments, withholding taxes and negotiating any client disputes. Please contact us if you are interested in using an umbrella company for all of your contracting needs.
