Key Takeaways
1. Digital nomads are location-independent workers who can work from anywhere, by utilizing technology to communicate and collaborate with clients or employers remotely.
2. Digital nomads’ tax obligations are primarily determined by three main tax systems: residential, citizenship, and territorial.
3. As well as the tax system, each country imposes other rules and criteria that affect tax obligations. These include factors like domicile status, the existence of tax treaties, and the concept of ‘substance’ or significant ties to a country.
4. Digital nomads are in a unique position to maximize their tax efficiency. They can take various approaches, from establishing residency in favorable tax environments, to claiming deductions and expenses, or by establishing an alternative business structure.
5. To avoid immigration issues and financial penalties, it’s important that digital nomads or the employers of fully remote employees understand their tax obligations. It makes good sense to consult a tax advisor or global EOR for advice on compliance and international tax.
Over the past decade, there has been a steady growth in the number of digital nomads working and traveling in foreign countries. This trend has been driven by advancements in technology and a desire for greater work-life balance, particularly amongst millennials.
Although the digital nomad lifestyle affords plenty of opportunities, it does present certain challenges, especially around complying with tax rules. Being a relatively nascent trend in work culture, digital nomad taxes are still a gray area and tax authorities around the world are working to simplify and harmonize their rules.
In this article, we give a top-level overview of digital nomad taxes, covering the topic for the benefit of nomads and the employers of location-independent employees.
What is a digital nomad?
Digital nomads are location independent workers who are not tied to any specific place or country of work. This includes freelancers, independent contractors, entrepreneurs, or employees with the freedom to work from a foreign location of their choice.
Typically, digital nomads work in tech-related professions that don’t require intensive team work and physical/face-to-face meetings. Instead, digital nomads utilize videotelephony software to communicate with their clients and collaborative working tools to deliver their services from anywhere in the world.
Digital nomad vs remote employee
For employers, it’s important to highlight the difference between a digital nomad and a remote employee. Whereas digital nomads work from anywhere; a remote employee is usually someone who works from a specified or pre-agreed location.
Read more about this distinction in our complete digital nomad guide.
How to determine tax obligations for digital nomads?
Whether they are employed, self-employed or operating their own company digital nomads must meet their tax obligations. Unlike traditional employees who have a fixed place of work in their country of residence, digital nomads tend to have no fixed address and often move between countries. This movement between different legal jurisdictions can lead to a complicated tax situation.
There are three tax systems that broadly determine a digital nomad’s tax obligations; Residential, Citizenship; and Territorial.
1. Residential
The residential tax system imposes taxes on individuals classed as residents in the country. For nomads who don’t have formal or legal ties to a particular country, their residence status is based on the amount of time they spend in a particular country.
For example, in the UK those who reside in the country for more than 183 days over the course of one tax year may be classed as a UK resident and therefore be obligated to pay income tax in the UK.
183 days over the course of the tax year or a 12 month period is used by multiple countries when classifying tax resident status.
2. Citizenship
The citizenship tax system imposes tax obligations on citizens’ worldwide income, no matter where they reside. Citizenship status is determined by the place of birth or the citizenship status of the parents. Only two countries (the USA and Eritrea) impose this tax system, making it the rarest of the three tax systems.
US citizens living outside the country do have the opportunity to exclude some of their foreign income from their IRS tax filing. Should a US citizen decide to renounce their citizenship, they cannot regain citizenship status.
3. Territorial
The territorial tax system only imposes taxes on income that is earned within a country’s borders, i.e. income earned from clients based in the country. Countries using a territorial tax system can be particularly advantageous to digital nomads looking to reduce their tax burden.
Other factors affecting digital nomad tax obligations
As well as the tax system of a country, there are a number of other factors that can affect digital nomads’ tax obligations.
1. Domicile status
It’s important to understand the difference between residency and domicile. Residency refers to the country or countries where a digital nomad spends time, whereas domicile refers to the nomad’s permanent home.
In other words, the domicile is the long-term home or the place that the nomad maintains ties to and intends to return to in the future. For example, being listed on the title deeds of a residential property or being on the electoral register.
So, although a nomad may be classed as a resident in a foreign country they may be classed as a tax resident in their country of domicile.
2. Tax treaties
The key tax treaty to look for is known as a double taxation avoidance agreement or ‘DTAAs’. These are designed to reduce or eliminate instances of double taxation, where individuals are classed as tax residents in both their home country and host country.
For example, a digital nomad may hold domicile status in their home country but meet the criteria for resident status in a host country. If there is a DTAA in-place between these countries, the nomad pays a reduced rate of personal income tax in each country.
3. Substance
‘Substance’ is another concept used to determine an individual’s tax residency and the extent of their tax obligations. Substance refers to the ties, interests and overall connection an individual has to a country. Another way to think of substance is the extent to which the nomad takes advantage of the resources and infrastructure of the host country.
Various factors are considered when assessing substance and the criteria vary from one country to the next. Typically, substance considers factors such as; property ownership, familial ties, financial investments, banking, and the use of healthcare services and local utilities.
How can digital nomads maximize their tax efficiency?
As well as the ability to take advantage of geographic arbitrage, digital nomads are well placed to maximize their tax efficiency. The following strategies can be used to maximize tax efficiency and stay compliant with local tax rules.
1. Look for countries with favorable tax environments
Before committing to any country, be sure to research its tax system and criteria for qualifying as a tax resident. You’ll want to know how long you have to live in the country to qualify for tax residency, the types of income subject to local taxes, and any tax incentives or exemptions available to foreign residents.
Becoming a tax resident in a country with a favorable tax environment can lead to significant tax savings. Digital nomads interested in maximizing their tax efficiency can realize significant tax advantages by establishing themselves in countries that implement a territorial tax system.
For example, countries such as Singapore, Malaysia, and Costa Rica only tax economic activity within the country. This makes these countries particularly attractive for nomads with clients in their native or other countries.
2. Check for tax treaties
If you are domiciled or plan on remaining a tax resident in your home country, look for host countries that have tax treaties in place. By familiarizing yourself with the tax treaties between your home country and the host countries you plan to work in, particularly DTAAs, you can effectively minimize your tax obligations.
Understanding the provisions of these treaties can also help you avoid conflicts and ensure compliance with both jurisdictions. Many tax treaties are publicly available, but interpreting them correctly may require advice from a professional tax advisor.
3. Utilize tax credits
Many countries offer tax credits that are designed to lessen the impact of double taxation. Digital nomads can utilize such credits to offset certain taxes paid to the tax authority in a foreign country against their tax obligations in their home country.
Taking advantage of foreign tax credits relies on meeting specific rules in both the home and host country, including keeping accurate records of any taxes paid. Some countries have implemented straightforward processes for claiming foreign tax credits, while others may have more complex requirements.
Again, it makes good sense to consult a tax professional who can give accurate advice on the best way to approach claiming tax credits.
4. Deductions and expenses
Where operating as self-employed workers, digital nomads can take advantage of various deductions and qualifying expenses to reduce their taxable income. These include expenses related to business-related costs such as workspaces, equipment, and travel.
For example, digital nomads might be able to deduct the cost of phones, computers, or coworking spaces that are necessary for the completion of their work. A tax professional can help identify the deductions and expenses you qualify for and advise on how to claim them.
Full and proper records and supporting documentation such as receipts are essential to support your claims if your tax authority decides to carry out an audit.
Consider alternative business structures
Many digital nomads operate as sole proprietorships/traders for simplicity, but establishing an alternative business structure can bring considerable tax advantages. Setting up as a company or establishing an offshore company in a country with favorable tax rules makes sense in certain situations.
Furthermore, forward-thinking nations are making it easier to file taxes and maintain compliance. For example, Estonia’s e-Business Register allows individuals to register a new company online as part of the country’s e-Residency programme.
If you are considering establishing a new business structure, especially in a foreign country, you’ll want to speak to global expansion experts. Global EORs specialize in compliant international expansion, business structuring, and taxation.
Clarify your digital nomad tax situation
Taxes as a digital nomad are a tricky issue. It’s often not clear which country the individual owes taxes to and can create a headache for both employers/clients and digital nomads. To get expert advice on the tax situation, consider consulting a global expansion company like Horizons, who can advise on the best next steps.
Frequently asked questions
Digital nomads’ tax obligations are primarily determined by the three main tax systems: residential, citizenship, and territorial. Understanding these tax systems and how they apply to their situation (home country vs host country) is crucial for digital nomads to remain compliant and avoid double taxation.
Working with a tax professional or global EOR that specializes in compliance and taxation is a surefire way to ensure compliance whilst also maximizing tax efficiency.
Digital nomads are in a unique position to optimize their tax situation and reduce their overall tax burden. There are various approaches nomads can take, including; utilizing deductions and expenses to reduce their taxable income; establishing residency in countries with favorable tax environments; and considering alternative business structures.
