Escape Income Tax: Central America

How would you like to stop paying any income tax for the rest of your life? In this short series, I'm going to explain how this is done 100% legally by moving to Central America, South America, Europe & Africa, and Asia.

I'm not talking the crap you read about in the media where every year at tax time the Globe or National Post does a story of how you can get up to $45,000 in dividend income and not pay taxes. I've covered simple tax structuring extensively on this blog. If you are a retiree, it's quite easy to have a net personal tax rate around 10% on a moderate level of income.

Unlike our American friends who must file and pay applicable income taxes based on citizenship regardless of where they live, there is an easy way for Canadian citizens to legally avoid paying income tax forever.

All you have to do is move to another country where they do not tax worldwide investment income for residents. It's important to understand that the vast majority of countries do tax residents based on worldwide investment income. The countries which don't generally have less developed tax systems and often have small governments. But if you are interested in avoiding tax, this might not be an issue for you.

Getting Out

The first step in this process is getting your funds out of the country. There are illegal ways of doing this such as tax flight. However, I'm going to explain the legal way so you can actually come back and visit your family and friends in Canada without getting arrested at the airport.

Becoming a Non-Resident

To stop paying income tax in Canada, you must become a non-resident for tax purposes. This doesn't affect your citizenship. You only need to cut resident ties to Canada.

While it's not 100% clear and straightforward (nothing in Canadian tax law is), generally if you reside outside of Canada for more than 183 days a year, you don't own or rent a home in Canada, don't have a spouse or dependent children in Canada, don't have a Canadian driver's license, and don't have active Canadian bank accounts, you can be declared a non-resident.

Liquidating Assets

To become a non-resident, you will generally have to liquidate your assets at fair value and pay any applicable tax on those investment gains. It also includes most private business holdings plus any real estate holdings you have outside of Canada. For this reason, it's generally best to take this step in a new tax year where you earned no other income to keep your tax bill to a minimum.

You may retain your RRSP accounts while you are a non-resident. But you cannot make new contributions with this status. It often pays to use existing RRSP room to offset your taxable income that results from required property dispositions.

It is not advisable to make withdrawals from your RRSP while you are a non-resident because you will pay a withholding tax of 25% on withdrawals. You might be able to get around this by filing a Section 217 claim under the Tax Act, but it can cost you more money if your other investments are profitable.

I would generally plan on keeping your RRSP intact and letting it grow while you're gone so you have access to that money if you move back to Canada. Same goes for the TFSA. But you can always liquidate the TFSA tax-free and use it if you wish.

Do not wait to sell your home. If you sell while you are a non-resident, you will pay the standard 25% withholding tax on the entire value of the sale!

Open an Investment Account for Non-Residents

To continue investing your wealth, you will need an overseas investment account. Don't try continue using your Canadian broker! Overseas brokerage accounts are often called expat accounts and they are offered by several brokerages around the world. The best one for you depends on your investment style and your overall wealth.

Some of the most common options are Interactive Brokers, Internaxx, Saxo Brokers, or DBS Vickers. (Let me know via comment if these links die). Interactive has the lowest costs, especially currency transactions, but they're based in the U.S. so you could be liable for U.S. estate taxes when you die. The other options are a bit more expensive, but they're based in Luxembourg, Hong Kong, and Singapore so estate taxes are not an issue unless you hold U.S.-listed stocks or funds.

Your investment account will be a regular investment account with no embedded tax privilege in any country you reside. If you live in a country which charges taxes on investment income, you will be required to pay those taxes.

Countries with No Tax on Investment Income

There are a significant number of countries around the world which do not tax investment income on money located outside of the country you reside in. Other countries do not charge capital gains taxes on worldwide income. Both of these are countries I will focus on where you can legally not pay a dime in income tax for the rest of your life!

My picks include countries which have more stable governments, are known to be friendly to expats, and are quite safe for foreigners. I'm also only considering options which have a moderate cost of living. Some of the better known micro-states or islands with huge tax advantages are prohibitively expensive and only an option for the super-rich.

My Picks in Central America

1. Costa Rica

Edited Photo. Source: Flickr - Christian Haugen

Top of the list for me in this region is Costa Rica. Costa Rica is safe, has an effective and stable government, is relatively affordable, has a nice variety of climates, and is expat friendly. Costa Rica is a biodiversity and Eco-sustainability hot spot. As well, Costa Rica is the most "Free" country in this region.

Income Tax:  Low - No tax on any overseas income. Low tax on local income. Import taxes on personal belongings applies.

Obtaining Residency:  Easy - Pensionado visa allows easy renewable residency to persons receiving a pension payment more than $1,000 USD monthly. Rentista visa allows easy renewable residency with a $60,000 USD deposit in a Costa Rican bank with each renewal (every two years). You can become a permanent resident after three years.

Climate:  Appealing - The coast offers a tropical, humid climate with beautiful beaches. The central highlands offer a stable climate with daily highs in the mid-20C range year round, moderate rainfall, and over 2,000 hours of sunshine each year in most places.

Cost of Living:  Moderate - The cost of living is approximately 30 - 40% cheaper than a large city in Canada. This varies by area with real estate costs.

English Speakers:  Low - Just 10% of the population can speak a passable amount of English. This means you should commit to learning the local language, Spanish, to have a good experience. There are numerous language schools and Spanish is a relatively easy language to learn quickly.

Freedom: High - Costa Rica has high rankings in personal freedom. The court system is quite effective and government corruption is low for a developing country. It also scores well in property rights and trade freedom.

2. Panama

Edited Photo. Source: Flickr - Juan Cruz Soares Gache

Panama is also a very appealing pick in this region. The government has been stable the last few decades and the economy is growing quickly. Panama is also safe and very expat friendly. Panama is famous for banking secrecy, but this is likely to change over the years as international pressure increases. If you're a city lover and crave the hustle and bustle of a cosmopolitan city, Panama City is the only real option in Central America.

Income Tax:  Low - No tax on any overseas income. Low tax on local income. One-time exemption on import duties for personal belongings (up to $10,000).

Obtaining Residency:  Easy - The Pensionado visa allows renewable residency to persons of any age receiving a pension payment more than $1,000 USD monthly for life. There is also an Economic Solvency visa for individuals who can invest more than $300,000 USD in Panama real estate or a GIC at a Panamanian bank.

Climate:  Moderate - The coast has a hot tropical, humid climate with beaches. Temperatures here often go into the mid-30C range. The central highlands offer a more stable climate with temperatures around 25C year round, high rainfall, and moderate sunshine hours. Generally speaking there is quite a bit of cloud cover throughout Panama.

Cost of Living:  Moderate - The cost of living is approximately 20 - 30% cheaper than a large city in Canada. This varies by area with real estate costs.

English Speakers:  Low - Just 10% of the population can speak a passable amount of English. This means you should commit to learning the local language, Spanish, to have a good experience. There are numerous language schools and Spanish is a relatively easy language to learn quickly.

Freedom: Moderately High - Panama scores very well with property rights compared to many other developing countries. However, government integrity and the court system score only in the moderate range. Panama scores well with economic freedom.

3. Nicaragua

Edited Photo. Source: Flickr - Ken Mayer

Nicaragua used to be a basket-case country rife with civil wars between communists and capitalists while ruled by a dictator. However, it has come a long way in recent years. Nicaragua is now as safe as Costa Rica and Panama in most places, although it is definitely not as prosperous. It offers good climates and a low cost of living with a lot of potential as reforms continue.

Income Tax:  Low - No tax on any overseas income. Moderate tax on local income. Exemption on import taxes for personal belongings up to $20,000.

Obtaining Residency:  Easy - A Pensionado program allows renewable residency to persons over 45 years old receiving a pension payment more than $600 USD monthly. There is a Rentista visa for individuals of any age who can demonstrate a secure income of at least $750 USD per month.

Climate:  Appealing - The coastal and lowland areas have a hot tropical, humid climate. The temperatures often climb into the high-30sC with moderate rainfall and lots of sunshine. The beaches in Nicaragua are known for their beauty. The central highlands offer a more moderate climate with temperatures rarely going above 30C, moderate rainfall, and still lots of sun.

Cost of Living:  Low - The cost of living is approximately 40 - 50% lower than a large city in Canada. This varies somewhat by area.

English Speakers:  Low - Very few locals can speak a passable amount of English. It is very important to learn the local language, Spanish, to get by well in Nicaragua. There are numerous language schools and Spanish is a relatively easy language to learn quickly.

Freedom: Moderately Low - Nicaragua is the least free of these countries. Personal freedom is moderate, but the court system is not very effective and government corruption is somewhat high. Economic freedom is also middling. Residents must obtain a permit to exit the country; while easy to obtain at the airport, this is somewhat concerning.

Have you considered moving overseas on a more permanent basis? What would be your priorities in choosing a place to live?

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.

The Everything Bubble

As I've suggested in some previous posts, assets in developed countries are currently very expensive relative to historical norms by almost any measure. This includes stocks, government bonds, corporate bonds, high risk debt, and real estate.

We know from historical investment return data that it's better to buy things when they are cheap on both relative and absolute terms. For example, if you are looking at U.S. stocks, you would have been much better over long time periods buying the cheapest stocks (value investing) than expensive stocks (growth investing).

However, value stocks were also more volatile and had larger drawdowns. This is why there has been an advantage to value stocks. Larger drawdowns scare investors and drive down the value of those stocks (risk vs. reward). If you're disciplined, you can pick up the pieces and do well.

Bonds are no different. In the 32 years before 1985, an investor in 10 Year Treasuries would have achieved an inflation adjusted return of just 1.65% per year. From 1985 (when yields were in the double digits) to now, the annual inflation adjusted return was almost double at 3.09%. Again, it's better to buy cheap bonds than expensive bonds.

Real estate will be a very interesting tell in the coming decades as the value of real estate is correlated to the inverse yield of bonds (bond yields determine mortgage rates). In 1953, the average house in the U.S. cost $17,000 and $82,000 in 1985. This results in an inflation-adjusted return of approximately 0.5%. Makes sense because interest rates climbed substantially during this period.

However, from 1985 until today, house prices have climbed to $310,000 for an annualized return of 1.6% after inflation. More than double the pre-1985 thirty-two year return. But interest rates fell after 1985. These stats also demonstrate the pathetic returns offered by residential real estate even with an interest rate tailwind.

Future Return Expectations

History can be a great guide to the future. History might not repeat itself per se, but markets work in cycles and are remarkably similar over and over. We can use this knowledge to serve as a guide with some degree of accuracy.

Developed Country Stocks

Stocks are currently valued at some of the highest historical levels ever. By most measures (CAPE and Cap/GDP), it is at or near the market peaks of 2000 when stocks had two 40% crashes in the next 10 years taking values back by a decade.

John Hussman uses a unique market cap tracker measuring non-financial equities to GDP. This metric—which has remarkable accuracy going back to the 1920s—predicts a future twelve-year return of 0% as of last month.

Source: John Hussman - Hussman Funds

If you don't like Hussman, or his metrics, look at Shiller CAPE for U.S. stocks. Developed market stocks led by the U.S. are expensive and there is no denying that.

Shiller PE Ratio - Source: Multpl.com

However, there are deals out there based on fundamental evaluation. Emerging markets are pretty reasonable led by Russia and Brazil which are cheap. Australia, the U.K., and China are also quite reasonable relative to historic norms and comparable countries.

Bonds

Currently, bond yields are as low as they've ever been in modern history. In some countries they are less than the current rate of inflation. It's pretty reasonable to believe that in the coming decades interest rates will go up. This means a typical mid-to-long term government bond bought today in a developed country will provide a return that's roughly equal to inflation.

10-Year Treasury Yield - Source: Multpl.com

Will yields go even lower? Will they go negative? They might, but not for long. Investors and those who provide capital want a return on their money. Smart people don't want to keep cash in peanut butter jars in the backyard for long.

Corporate bonds provide slightly higher returns than government bonds over time. They are also more risky because corporations go bankrupt and fade into nonexistence. Corporate bonds are more correlated to stock returns than government bonds, so they are not as effective buffering your portfolio from stock market crashes.

Real Estate

In Canada residential real estate is priced at nosebleed levels in most major cities compared to the historical norm. In many places rental properties don't provide positive cash flow at current valuations.

If an investment doesn't cash flow after accounting for all costs, it's a crappy investment and you should stay away. Don't let the successes of real estate investors who got in the game a decade or more before you make you delusional. They have benefited from a huge bull market.

At current prices investing in residential real estate sucks. You are likely to face higher costs (particularly taxes and interest rates) while holding a declining value asset over the coming decade.

Portfolio Strategies

Every investor should be very aware of these valuation problems; that's why I'm sharing with you. Returns in a passive portfolio strategy are likely to be quite low going forward in the short-to-medium term.

If history is any guide, sometime in the coming years we are likely to see another 40%+ drop in the stock market. In the past, when we have reached these types of valuations, markets crashed. Wishful slow melts don't happen when markets are richly priced.

That doesn't mean you should sell your stocks and go hide, waiting for the next crash. But it does mean you should mentally prepare yourself for a big crash.

History shows that market crashes can be great buying opportunities. With the exception of 1931-1932, whenever stocks drop more than 20% for the year, they pop up more than 20% the following year. This is why re-balancing with bonds, gold, and new contributions works so well over the long run.

Another option is to follow a market timing investment strategy. Dual Momentum has shown fantastic results over whole market cycles because it does so well reducing losses during a market downturn.

A great advantage with Dual Momentum is you only need to look at your brokerage account once a month and most months you make no trades. It's about as easy as active investing gets and simplicity works well for most people if they can trust the system.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.