I previously wrote on the trend towards the EU taxing its non resident citizens –
Similarly, we are frequently approached by location independent international entrepreneurs in the EU who would like to remain in the EU.
To understand the freedom of establishment, we refer to Articles 26 (internal market), 49 to 55 (establishment) and 56 to 62 (services) of the Treaty on the Functioning of the European Union (TFEU)
Thanks to freedom of establishment, any European citizen can come and go from the country they are in, whenever they choose. Within the Schengen Zone, there are practically no requirements to becoming a resident within another EU State besides having valid health insurance, a residence and a minimum income of about €80 a week.
Thanks to EU protection of rights, when it comes to the tax on changing your domicile, transferring your residence within the EU becomes much easier. Unfortunately, countries with non-dom tax programs like Malta, Ireland and Cyprus have minimum stay requirements. While it’s hard to control this in practice, it’s better to be on the safe side.
There are other countries within the EU where tax residence doesn’t depend on the length of your stay.
But what are the disadvantages of being a resident of an EU country?
From a tax point of view, there are three:
- You have to pay taxes: It is nearly impossible for EU citizens to live in the EU and not pay taxes on earned income. In fact, according to European law, a minimum 10% tax is required (with a few exceptions).
- VAT is necessary: If you live in the European Union you will need to pay VAT. If you sell products, this is less important, because you will need to pay VAT in every European country anyway. However, if you work as a consultant or professional coach, this is a little different for you, because you aren’t obligated to add VAT to your prices.
- You have to keep accounts and submit to inspections: You will have to keep accounts and send them to the authorities for inspection and monitoring, which costs you time and money. The severity of the requirements and controls varies between the different EU countries.
Those who don’t want to pay taxes or keep accounts have to live outside the European Union.
Of course, within the EU there are many options that allow you to use different types of taxation in your favor and outsource accounting at a low cost.
Together with the advantages involved, such as
- your proximity to your customers and/or your country of origin (if you’re from Europe),
- the possibility of changing your tax residence,
- good reputation, etc.,
staying in the EU could be a good option for you.
Choosing a European destination as a country of residence outside of your country of origin can let you optimize your taxes legally and much more easily than if you stay in your home country.
Note that tax residence isn’t just linked to the duration of your stay (183 days), but also other factors, such as where your family’s principal base of operations is.
For example, being registered at the census office of the country, having your kids in school, or arranging accommodation for the whole year can justify tax duty in many other countries.
Given that many countries in the EU don’t keep a census, usually renting or buying a dwelling is the determining factor in deciding where you pay taxes. On the one hand, you will have an address that you can use when you need to receive physical mail, and on the other you can give your information (and show invoices) when opening a bank account, starting a business, etc.
What’s important to be able to benefit from these advantages and get a tax residence isn’t that you specifically have to use your home, but that you could use it. This means that you won’t have any problem subletting the house. The reality is that no State wants to lose your tax money.
Before you sign a lease contract or register with the census, you should think about how this will impact your business.
It’s essential to be aware of the treatment afforded to foreign hybrid companies such as North American limited liability companies, which are judged differently in various countries.
Specifically, if the country considers the LLC as a partnership, it will apply income tax on profits in their totality. If it considers it as a standard company, the distribution of dividends will be taxed, bringing you big tax advantages (see below).
It is also important to know how strict these laws are. In many cases, they ignore active companies, companies inside the EU, or small companies that don’t exceed a certain turnover. For example, in Poland, you can manage your foreign company with no complications, as long as your sales volume is below €250,000.
However, remember that the European Union is putting together a Base Erosion and Profit Shifting directive, which will make international tax laws mandatory in all EU countries.
In any case, it remains to be seen whether the typical EU tax havens will bow before these measures and apply them, especially bearing in mind that the EU has other significant problems, both political (Brexit, the US) and economic (Greece, Spain, etc.).
Establishing a company in Slovakia or Estonia, for example, involves paying 19% or 20% corporate tax respectively, but the distribution of dividends is tax-free for local companies. A total tax burden of under 20% is fairly reasonable if we compare Slovakia to its neighbor Austria, or Estonia to neighboring Finland.
The tax on sales volume only applies from a considerably high threshold, and normal income tax is replaced by special taxes on sales volume.
Even for people with very high sales volume, you can still pay very little tax as a self-employed business owner. An example of this is Bulgaria, where there is a fixed rate of 10%.
Since freelancers can deduct a combined sum of 25% on operational expenses, there is an effective 7.5% tax rate for self-employed business owners in Bulgaria. It’s no surprise that Bulgaria has become one of the most popular countries to settle in for people who aren’t tied down to any one place.
Dividends, salaries, and social security
The example of Bulgaria is useful for the next section, since it illustrates the differences in taxation on income, dividends, and additional social security. The types of income for business owners are not all equal, and should be structured in an intelligent way.
If a digital nomad established a Bulgarian company, he would pay 10% corporate tax on the profits this company makes. But he could proportionally reduce his profits before tax with an administrative salary of another 10%. An extra 5% tax would then be applied on the distribution of the dividends that remain after the tax on profits.
This doesn’t mean, however, that it’s convenient to assign yourself a high salary and low dividends. Social security is applied to all salaries, while this isn’t the case for dividends. This factor often isn’t taken into account when calculating tax burdens, nor is the fact that it’s not always necessary to distribute profits, given the opportunity to transfer them beforehand.
Knowing how to distinguish between dividends, income and contributions to social security is extremely important.
Take the example of Luxembourg. A withholding tax of 27% is applied there on dividend distribution for international companies. In certain circumstances, this tax is reduced by half to 13.5%. This is only the case with domestic Luxembourg companies, companies inside the EU, or companies from countries that have double taxation agreements with Luxembourg.
The situation is similar for other countries within the EU. The EU gives you the option of establishing companies inside the EU, despite international tax laws. Moreover, these companies enjoy a privileged tax on dividends as compared to external tax havens.
However, there are also tax havens without tax at source on dividends within the EU, such as Malta, Cyprus, and the UK. We won’t get into the advantages of transferring dividends under the directive concerning EU parent companies and subsidiaries right now.
After this introduction to the theme of dividends, we shouldn’t forget contributions to social security. These are mandatory in many countries for freelancers, and in some cases, for business owners too. For example, in some EU countries, at least one type of contribution must be paid to social security based on the local minimum wage.
They can pay themselves a salary amounting to the maximum tax-exempt sum or to a reduced tax bracket. This will balance out contributions to social security, which are proportionally low with a reduced salary in any case. They can then distribute the profits to themselves as dividends at a favorable rate.
No advice implied. Don’t believe what you read online. See you qualified tax professional instead