This is going to be one of those articles that I start with a disclaimer about how irresponsible you would be to take my word as gospel. I talk about complex subjects on a high level, sweeping manner. As always when discussing legal concepts across jurisdictions and even legal systems, oversimplifications will occur and can be misleading or confusing.
The principle is simple: tax residents and tax non-residents are only taxed on locally-sourced income.
This is different from what is otherwise the norm: residents are taxed on their worldwide income and non-residents are taxed on locally-sourced income.
Incorporating in a territorial taxation jurisdiction as a non-resident creates an essentially tax free entity very easily, except it’s probably not actually tax free where you live.
Remember Tax Residence? That will trip things up for you. Even thought your Hong Kong company might not owe tax in Hong Kong, you are likely still liable for tax where the company is effectively controlled and managed (which can be multiple jurisdictions).
The advantages are most apparent to companies actually run from these jurisdictions, as foreign-sourced income can be earned with zero tax burden.
As a natural person, the only way to make use of TT is by living in the jurisdiction.
How does territorial taxation actually work?
A lot can be said about territorial taxation. Below are some questions I see come up frequently.
How useful is it really?
This is the real question, isn’t it? What good can territorial taxation do for you?
First of all, when we get down to the nitty-gritty, variances between jurisdictions start to emerge.
Second, it really is only useful if you are present in the jurisdiction. In order to take advantage of territorial taxation, an entity needs to be tax resident in that jurisdiction (and only that jurisdiction).
What about pass-through entities?
How are for example LLCs and other pass-through entities treated under TT?
As a non-taxable or disregarded entity, it is simply not at all in scope for corporate taxation, whether it’s a territorial, remittance, or worldwide taxation system.
The income is instead in scope for personal taxation.
Can you move to Costa Rica and run a business there without paying corporate tax as long as you don’t trade with locals?
In most cases, yes.
Can you do the same in Hong Kong?
Well, it’s not so clear cut. There is a lot more nuance in Hong Kong.
Can I incorporate in Panama and not pay tax where I live?
Not unless you live in another tax haven, and oftentimes not even then.
See above regarding Tax Residence.
Can you move to a TT jurisdiction and and live tax free?
Depends on how you earn your money.
If it’s doing freelance or remote work for a foreign business, different regulations will apply across different jurisdictions. Some will consider it as income generated locally and thereby taxable, whereas others will not consider it in scope.
You’re not helping! How can I know for sure?
Friends don’t give friends tax advice.
Lists out there vary. Below is a fairly conservative gathering of jurisdictions with territorial taxation systems (for corporations, natural persons, or both).
- Costa Rica
- Democratic Republic of the Congo
- Dominican Republic
- El Salvador
- Hong Kong
- Marshall Islands
Some will argue whether for example Singapore fits the bill. It often would but I’m trying to take a very cautious approach to this list. There are special circumstances, which I will save for another day, under which even Denmark and France would qualify.