Taxes are a necessary part of living in a structured society, but not all tax systems are created equal. Globally, countries adopt one of four main types of income tax systems: Residence-Based, Citizenship-Based, Territorial-Based, and Zero Taxation. This article delves into the intricacies of each type and uses real-world examples to illustrate how they operate.
Tax System followed by Different Countries
There are four types of income tax system followed by Worldwide.
(1) Residence Based tax System and
(2) Citizenship based taxation
(3) Territorial Based taxation
(4) Zero Taxation
Page Contents
Residence-Based Tax System
- In a residence-based tax system, a country taxes individuals on their global income
- This means that if you live and work in a country with a residence-based tax system, you are required to report and pay taxes on your income earned both domestically and abroad.
- Countries like ; India, Australia, Canada, the United Kingdom, South Africa, Japan, Germany, Russia, France ,Ireland and European countries, use a residence-based tax system
Citizenship based Tax System
- In a citizenship-based tax system, a country taxes its citizens on their worldwide income, regardless of where they reside. This means that even if you live and work in another country, you are still required to report and potentially pay taxes to your home country.
- The United States and Eritrea used citizenship-based taxation.
Territorial based Taxation
- In a territorial tax system, a country taxes individuals and businesses based on income generated within its own borders not on worldwide income regardless of their citizenship or residence status.
- In other words, only income earned within country’s territory is subject to taxation, Income earned outside of country’s territory is not taxed.
- Countries Like; Singapore, Malaysia, China, Hongkong, Thailand used Territorial taxed system.
ZERO Taxation countries
Some Countries don’t charge income tax Like ; The Bahamas, The Cayman Islands, Monaco ,Brunei , Bahrain
Middle East Countries (UAE, Kuwait, Saudi Arabia, Dubai, Oman), etc don’t charge income tax on individual but they levied corporate tax
Tax law of every country specify rules for compute Residential Status of person .However citizenship status govern as per Country and their law regulation ,Citizenship not define by Tax law of the country.
Like An individual is said to be resident in India in any Previous year if he satisfies any one of the following conditions.
1. He has been in India during the Previous year for a total period of 182 days or more or;
2. He has been in India during 4 immediately preceding the year for total 365 days or more and has been in India for at least 60 days in the previous Year.
If the individual does not satisfy both the conditions he is said to be Non – Resident.
Similarly, An Individual is said to be tax resident of Australia if he meets any of the following criteria:
1. You reside in Australia permanently.
2. You are in Australia for 183 days or more in an income year (July 1 to June 30).
3. You have established a domicile in Australia.
4. Your usual place of abode is in Australia.
If the individual does not satisfy all the condition above, he is said to be Non – Resident
Let’s Understand the Whole concept with Certain examples.
Example 1
Priya is a U.S. citizen and a resident of the United States. She is an IT consultant employed by Tech Solutions, a U.S. software company with its headquarters in the United States. Tech Solutions has won a project in Frankfurt, Germany, and they’ve selected Priya for a short-term, three-month on-site assignment to contribute to this project. Throughout her assignment in Germany, Priya’s salary will be paid by Tech Solutions, her U.S. employer, and deposited into her German bank account.
Answer:
US Tax obligations
Priya is considered a U.S. tax resident due to her U.S. citizenship and residency status. As a U.S. tax resident, she is required to report her worldwide income to the U.S. Internal Revenue Service (IRS).
Priya’s salary, paid by a U.S. company (Tech Solutions), is considered U.S.-sourced income. Therefore, it is subject to U.S. income tax laws, and Tech Solutions will withhold taxes in accordance with U.S. tax regulations.
Germany Tax obligations
Priya’s three-month assignment in Germany is relatively short. Since Priya Stay in Germany for less than 183 days during a tax year are not considered tax residents. So, Priya has not German tax obligations for this short period.
Example -2
Mr. Patel is of Indian origin, but he has been living and working in the United States for the past several years. He is a lawful permanent resident (green card holder) in the United States and has established a life there. He has investments and financial assets both in India and the United States.
What tax treatment if MR Patel become Tax resident of India in the tax year
Answer:
US Tax obligations
Mr. Patel is considered a U.S. tax resident based on his green card status or substantial presence in the United States. As a U.S. tax resident, he is required to report his worldwide income to the U.S. Internal Revenue Service (IRS).
Mr. Patel must file a U.S. tax return and report all of his income, including income earned in India through financial assets investment income such as interest, dividends, or rental income.
Indian Tax Obligations:
If Mr. Patel become tax Resident of India in the tax year he would be considered a “Resident and Ordinarily Resident” (ROR) for tax purpose then his worldwide income taxed in India. He must have to report his global income in India, including income earned in the United States.
Double Taxation Avoidance Agreement (DTAA):
To avoid double taxation on the same income in both countries, the U.S. and India have a Double Taxation Avoidance Agreement (DTAA) in place. Under the DTAA, Mr. Patel may be eligible for tax credits or exemptions in one country for taxes paid in the other country, depending on the specific income types and the terms of the DTAA.
Example -3
Mr. Prince is of Indian origin and is working for a multinational corporation based in Germany, XYZ GmbH. He has been assigned to work in the company’s office in Frankfurt, Germany, for an extended period of time, expected to be several years. During his assignment, Mr. Prince will receive his salary from XYZ GmbH and have a German bank account for managing his finances.
Answer:
German tax Obligation
Mr. Prince’s stays in Germany for more than 183 days in a tax year, he may be considered a German tax resident.
Since Mr. Prince becomes a German tax resident, he will be subject to German income tax on his worldwide income, including the salary he earns from XYZ GmbH. Germany has a progressive income tax system, which means that the tax rate increases as income rises.
Indian Tax Obligations:
Mr. Prince is Indian origin but not stay in India more than 182 days in tax year So he is not Tax resident for India and also he has not earned any income which source in India So he has no tax obligation in India .
Conclusion:
Tax systems vary from one country to another, affecting individuals based on various factors such as residency, citizenship, income source, and even absence of taxation. Understanding the type of tax system in a country can significantly impact financial planning and obligations. While residence-based systems are more prevalent, each system has its pros and cons that can influence global mobility, investments, and income reporting. It is crucial to be aware of your tax obligations, especially when dealing with international income, to avoid legal complications and ensure financial well-being.
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Disclaimer: The views and analyses in this article are the personal perspectives of the author and do not constitute legal advice. Always consult with a tax advisor for personalized guidance.
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