How to optimize your taxes as a digital nomad in the European Union

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If you’re looking for a place that is legally secure, if you’re tired of living without the advantages of having residence, or if you want to transfer your tax residence and stop suffering from the high tax pressure in your native country, the European Union has various solutions for you.

This article is especially designed for digital nomads who, for one reason or another, aren’t able or willing to live as perpetual travelers without a fiscal domicile.

It’s also suited for business-owners, investors, and perpetual travelers who intend (and have the capacity) to settle down in a country in order to benefit from what I’m going to tell you about in this post.

So let’s get to it. Below, I’ll show you how you can optimize your taxes within the European Union, according to the following points:

1. The advantages and disadvantages of the European Union
2. Minimum stay and accommodation
3. Professional activities and international tax laws
4. Dividends, salaries and social security

Here you have a short video introduction by Christoph:

The advantages and disadvantages of the European Union

As much as the lack of democracy and overregulation in the European Union may annoy us, we should keep in mind the advantages it has.

These arise especially with respect to its fundamental freedoms, like freedom of trade, movement and establishment.  These freedoms form the foundations of how people can avoid the chains that these countries try to put on them.

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.

This is a huge difference between what happens in most other States, including developing countries all over the world, where long-term residence is more difficult to obtain.

In general, it’s relatively easy to get temporary residence permits, although they do require a period in which you stay in that country.  Yet this is precisely what digital nomads don’t want to agree to; they want to remain flexible.

As a digital nomad, your work lets you move around without being tied down. What you will be looking for is a residence permit in a country that does not require you to stay there for six months of the year.

Although many countries like this exist outside the EU, getting these permits is much more complicated and expensive for EU citizens. If the cost of a permanent residence limits you in countries like Paraguay ($6,000) or Panama ($10,000), many other more attractive countries would cost around six figures. Such sums of money can be hard to get together for people who are just starting out.

However, the most wealthy business-owners, those who can afford permanent residence outside the EU, will be subject to the tax on changing domiciles and other laws designed to avoid large-scale capital flight.

For this type of business-owner, it’s not worth the effort of moving to a foreign country outside the EU, even if it is much cheaper from a fiscal point of view.

There is another way, though. 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 and more advantageous.  The tax differences within the EU itself are still enormous.

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 many countries within the EU where tax residence doesn’t depend on the length of your stay.

In the same way, you can maintain your tax residence where you live now (if this is not UK) or many other countries while only spending a few weeks a year in your home. You can do this in multiple EU countries.

But what are the disadvantages of being a resident of an EU country?
From a fiscal point of view, there are three:

You have to pay taxes: It is impossible to live in the EU and not pay taxes. In fact, according to European law, a minimum 10% tax is required (with a few exceptions).

You have to deduct VAT: 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, comfort, 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.

Minimum stay and accommodation

Freedom of movement is essential for many digital nomads. Many of these entrepreneurs aren’t ready to tie themselves down to some place for tax advantages.

Of course, letting the country you were born in exploit you simply because you were born there is not recommended. In fact, there is no need for this.

Numerous countries use residence-based taxation, so in these countries you need to pay taxes on your income from all around the world. The difference here is that the tax rates are much lower.

Tax duty (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.

In other words, if you have a tax residence in an EU country with a low tax burden, you will have to rent or buy a house there. And given that countries with lower taxes are usually also cheaper, this shouldn’t be a big problem. Above all, keep in mind that this base will help you minimize a large part of the disadvantages of being a permanent traveler.

What problems are these?

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.

Or, you might prefer to have the house as your base so that you have a place to come back to after trips around the world, especially if you have kids and do something like homeschooling.

You don’t need a big, luxurious mansion; from an official point of view, a shared room or small apartment is fine.

Professional activities and international tax laws

Before you sign a lease contract or register with the census, you should think about how this will shape your future business. Depending on your country of residence, there are different conditions that give priority to foreign or local business structures.

We’ve already talked about international tax laws in a different post. For the purposes of today’s article, what’s essential to know is that although there are some EU countries that have territorial taxation (the citizens residing there pay taxes on income obtained in any country in the world), they don’t have or don’t apply international tax laws.

In these countries (for example, the Netherlands, Luxembourg, the Czech Republic, Croatia, Bulgaria, and Slovakia), you can manage your foreign companies with no complications, even if these operate tax-free.

This means in practice that if you have a company in a non-EU country without corporate tax, and you reside in one of the countries above, you won’t have to pay tax as a company (unlike local companies, which pay high taxes).

If you live in a country without international tax laws, you only have to register and pay tax on the salaries of natural persons or the distribution of their dividends (more on this in the next section).

In the Czech Republic, for instance, corporate tax is 19%, while income and dividends are assessed at a fixed rate of 15%. The smart business-owner can take advantage of the lack of CFC rules and establish a company in the United Arab Emirates or any other tax-free country. That way, he will only pay 15% income tax or withholding tax in the Czech Republic.

Of course, this only works if your business model allows it. If, for example, production requires you to stay in the EU, your only option is to set up a company locally.

With this structure, 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).

In the end, even EU countries with international tax laws can be an interesting option. The important thing is 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.).

Digital nomads of all kinds are always able to go freelance or set up a company in their new country of residence.

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.

In many cases, digital nomads have no reason to set up a company.

They can easily become sole proprietors in their new countries of residence, and in many cases benefit from much better advantages for small businesses.

The tax on sales volume only applies from a considerably high threshold, and normal income tax is replaced by special taxes on sales volume.

Let’s take the example of Hungary, which due to its strict international tax laws, is hardly an attractive option if you have foreign companies.

Besides normal corporate tax, Hungary has three special regimes for small businesses, which are all available up to a certain sales threshold: the simplified entrepreneurial tax (EVA), the combined tax on small taxpayers (KATA), and a tax on small businesses (KIVA).

There are two levels to normal corporate tax in Hungary. Up to a sales volume of 500m Hungarian forints (around €170,000), Hungarian companies pay 10%, and 19% if they exceed this figure. An additional 16% is paid on distributed dividends and income.

The simplified entrepreneurial tax (EVA), which reaches 37%, is an alternative tax system for small business with a maximum sales volume of 30 million Hungarian forints a year. This tax rate replaces the tax on sales volume, corporate tax, and the tax on dividends. Since Hungary has a very high sales tax, at 27%, the simplified entrepreneurial tax can be a very appealing option, as well as being simple to administrate. 30 million forints corresponds to over €90,000, which makes Hungary an attractive country with freelancers with a good income. Bearing in mind that sales taxi s already included, this represents an enormous saving.

For small taxpayers (KATA), there is a monthly combined duty for income up to 6 million forints a year (around €20,000). With taxes combined into a 50,000 HUF sum, small taxpayers can cancel out corporate tax, income tax, social security, all contributions to health services, tax on dividends, and contributions to professional training. This means that on an annual income of €20,000, only around €170 a month has to be paid in taxes.

Finally, the tax on small businesses (KIVA) is special tax rate for companies with less than 25 employees and a sales volume that doesn’t exceed 500m forints (around €170,000). This tax substitutes corporate tax, social security, and contributions to professional training. It can reach 16%, but is clearly a better option than the standard 10% corporate tax plus 27% social security.

This more detailed example serves to illustrate that each country in the EU has different regulations for small businesses. Transferring your domicile can be an especially beneficial decision for those with lower income.

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.

In practice, knowing how to distinguish between dividends, income and contributions to social security is extremely important; however, my consultations have shown me that even entrepreneurs with lucrative, advanced businesses don’t always understand their significance, or confuse all three.

Distribution of dividends has two advantages. As a general rule, they aren’t subject to social security, and in certain countries, they’re treated as a special type of income. In other words, instead of being subject to income tax and raising the tax base, there is sometimes a special, lower tax on dividends.

The reason for this difference is that dividends originate as profits, and these have already been assessed for corporate tax.

This is where foreign companies, double taxation agreements and tax at source all come in, therefore complicating the situation.

Imagine that if your country of residence doesn’t have international tax laws, you can manage foreign companies tax-free. All of a sudden, profits can be transferred to partners via dividends, without paying corporate tax, and at a lower tax rate.

If only it were that simple.

It turns out that both the country where the company is domiciled and the country of residence can impose tax at source on dividends that enter and leave the country.

Usually, but not always, tax at source on foreign dividends is higher than the rate paid on the dividends of local companies. In the same way, it’s possible that the country that houses the company headquarters also wants its share, and may impose a certain tax rate on outgoing dividends.

Moreover, these dividends may be subject to double taxation (meaning that you pay taxes both at your company headquarters and your tax residence).

To avoid this, countries sign double taxation agreements in certain circumstances in order to reduce or eliminate tax at source. This opens up a world of possibilities for legal tax avoidance, of the kind we often talk about at Tax Free Today.

OF course, this poses a considerable problem not only for company profits, but also for capital yields, which are too complex to begin to explain here.

For the typical perpetual traveler, the problem of tax at source isn’t much of an issue. Tax at source doesn’t apply to incoming dividends for people without a domicile.

Of course, perpetual travelers also don’t have to worry about tax at source on foreign dividends, because they logically choose States for their company headquarters where this doesn’t exist.

When we talk about tax-free areas, most people think about the absence of corporate tax or VAT. However, the lack of tax at source on outgoing dividends is also important.

If a permanent traveler decides to transfer their tax residence to a certain country, they’ll have to pay close attention to tax at source. Given that, as we mentioned, foreign dividends are usually taxed at a higher rate than domestic dividends, it doesn’t always make sense to establish a company abroad, even if the country doesn’t have international tax laws.

Take the example of Luxembourg, which doesn’t have international tax laws. A withholding tax of 27% is applied there on dividend distribution for international companies. In certain circumstances, this taxi s 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.

It’s not my intention to add more detail to what is already a complex topic. If you’re interested in knowing more about how these taxes behave in a specific country, you can read an article about the State in question (there are already several on the blog), or consult me directly.

Ultimately, today’s theme is how small-scale digital nomads can optimize their taxes within the European Union. If this is your case, it should be clear that you can do very well for yourself in countries where there are little to no taxes on dividends.

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.

Contributions to social security also constitute a complex topic that we’ll only briefly go into here. They are often divided equally into the confusing concepts of the employer’s share and the worker’s share, which socialists often channel into propaganda aimed at less economically-minded voters.

Ultimately, a high employer’s share (paid by the owner of the business) and the subsequent reduction of the worker’s share seems to imply a profit for the employee, when in reality it’s the gross salary that is being reduced.

When the company in question is self-owned, the director is responsible for both shares. In general, the employer’s share can be deducted in its entirety from profits made, while the worker’s share is limited to a certain percentage of the salary paid. The regulations of this system vary enormously from country to country, especially with respect to the maximum share.

Depending on the country, digital nomads can optimize their tax burden in the way that suits them best.

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.

Let’s clarify this strategy with two examples:

Under a special program in Cyprus (which we’ll talk about very soon), professional traders don’t pay any kind of corporate tax on capital gains for their limited companies based in Cyprus. Thanks to this Cypriot limited company, they can obtain tax-exemption on domestic and foreign interest and dividends on a personal level, but not on income.

What’s the most intelligent move the trader can make?

The most intelligent solution is to assign himself a totally tax-free salary for a sum of €19,500. This is the tax-exempt sum in Cyprus. The limited company must pay 7.8% of this €19,500 to social security. If it paid corporate tax (12.5% for a regular business), it could then reduce profits before taxes. On a personal level, it would also have to pay another 7.8%.

If you assign yourself a salary amounting to the tax-exempt sum, the minimum payments to social security (as defined by the minimum salary) will be entirely covered and compensated for.

And here’s another example, in this case without the tax-exempt sum.

In Croatia, there is a progressive income tax rate with three quotas: 12% (up to 26,400 HRK), 25% (up to 158,400 HRK), and 40%, which is the maximum tax rate. However, only 12% capital gains tax is applied to both domestic and foreign dividends, independent of the sum paid.

Since Croatia has no international tax laws, you can combine a residence in Croatia with a tax-free company (at source). The total tax burden will therefore only amount to 12% of profits. Contributions to social security, which are compulsory in Croatia too, are balanced out by a salary of 26,400 HRK, which is similarly taxed at 12%.

Ultimately, you pay 12% in taxes and contributions to social security on very reduced salaries in Croatia. Together with the fact that (if you’re inside the EU), there’s an additional stimulus package for investors (which I won’t go into now) and no required minimum stay to obtain residence, this makes Croatia an extremely attractive option as a country of residence, and one that few people take into consideration.

Conclusion

I hope this in-depth article has helped you understand a little better how you can optimize your taxes inside the European Union.

Of course, I’ve only been able to cover a few examples. The EU is made up of 28 States and offers a ton of combinations with respect to personal residence, company residence, and many other factors (double taxation agreements, tax at source, international tax laws, etc.).

If you’re looking for the best combination for you, you can request a consultation, where I’ll be able to consider your preferences and specific situation.

Every digital nomad or entrepreneur should take advantage of the great opportunities offered by his or her way of living and working, not only in a practical sense, but also in a philosophical one.

Because your life belongs is yours!