Worldwide vs territorial taxation: key differences and their impact on international tax planning

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🌍 What truly differentiates worldwide income taxation from territorial taxation?

International taxation is built on two fundamental approaches to determine how individuals and companies should be taxed: worldwide income taxation and territorial taxation.

Although these may sound like technical concepts, they actually determine how a country attracts investment, what kind of tax revenue it collects, and which incentives it offers to those who choose to live or invest there. Understanding the distinction is essential for anyone operating across multiple jurisdictions or considering a change in tax residency.

➤ If you want to understand how tax residency works in general, you may find the article Tax residency in Andorra: real requirements and actual advantages (2025) useful.

🌐 Worldwide taxation: how it works and why so many countries rely on it

💼 A system designed to tax all the resident’s income

Under the worldwide taxation principle, a country taxes all income earned by its tax residents, regardless of where it is generated. A resident individual or company must declare and pay tax both on income earned domestically and on income earned abroad.

This model is grounded in the idea that tax residency creates a sufficient fiscal nexus to require a contribution on the entirety of one’s income, irrespective of its source.

🎯 Why countries adopt it

There are several reasons, and some of the most important include:

• Ensuring that residents contribute based on all their income, preventing artificial relocation to low-tax jurisdictions.
• It is the standard model among developed economies and OECD member states.
• It facilitates smoother tax cooperation through Double Taxation Agreements (DTAs), helping prevent the same income from being taxed twice.

🌎 Countries applying worldwide taxation

Most countries worldwide operate under this system. Notable examples include:

• United States: taxes citizens and residents on their worldwide income.
• European Union and United Kingdom: apply worldwide taxation to their tax residents, with local variations between national systems.

🏝️ Territorial taxation: a different approach to attract investment

📌 What it means to tax only income generated within the country

Under the territorial taxation principle, only income earned within the country is taxed, regardless of the taxpayer’s residency status. Foreign-source income falls completely outside the scope of the local tax system.

This model is used by certain emerging economies and smaller states seeking to stimulate investment, attract capital, or facilitate business establishment.

In such jurisdictions, there is often no fundamental distinction between residents and non-residents regarding the taxation of foreign income.

🎯 Common motivations behind territorial systems

Historically, this system has been used by several Caribbean countries that also had limited capacity for tax control and collection. More generally, the main motivations include:

• Encouraging foreign investment by reducing the tax burden on income earned abroad.
• Improving the competitiveness of local businesses by avoiding duplicated tax on foreign revenue.
• Attracting individuals and companies looking to optimise their global tax burden.

🌍 Countries applying territorial taxation

Representative examples include:

• Panama: taxes only income generated within the country (PIT and Corporate Income Tax).
• Paraguay: taxes exclusively Paraguayan-source income.
• Uruguay: applies territoriality with certain exceptions for foreign passive income.
• Honduras: territorial system for both individuals and companies.
• Costa Rica: historically territorial, though reforms have been debated.

➤ If you want to compare different tax models, you may find the article Paying fewer taxes in Europe without giving up security and quality of life: the Andorran model helpful.

🧾 Non-Resident Income Tax (NRIT): the territorial exception within worldwide systems

Although most countries apply worldwide taxation to their residents, almost all use a strictly territorial system for taxing non-residents: the Non-Resident Income Tax (NRIT).

If you want to understand how NRIT works in Andorra, you can read the article Non-Resident Income Tax (NRIT) in Andorra.

🌐 Why NRIT follows a territorial criterion

Unlike ordinary direct taxes — such as Corporate Tax or Personal Income Tax — which are generally worldwide in nature, NRIT is the exception for very specific reasons:

• Non-residents do not have a sufficient fiscal nexus to justify taxation on their global income.
• States consider it fair to tax only the income generated within their territory: rents, salaries, local economic activities, or gains derived from assets located in the country.

This approach coexists naturally with worldwide taxation: someone may be tax resident in one country and, at the same time, non-resident in others where they obtain isolated income.

🤝 The essential role of Double Taxation Agreements (DTAs)

DTAs exist to prevent the same income from being taxed twice, a common issue when a person resides in one country but earns income in another — or to limit taxation in the state of source.

In territorial tax systems, their impact may be more limited — since the country does not tax foreign income — but they remain fundamental for regulating the taxation of:

• dividends
• interest
• royalties
• business profits with cross-border activity

A properly applied DTA prevents conflicts and provides legal certainty for international operations.

If you want to learn more, you can consult the article Double Taxation Agreements (DTAs) in Andorra.

🏛️ OECD recommendations and the position of international institutions

The OECD, through the BEPS Project, has introduced measures to combat base erosion and profit shifting towards low-tax jurisdictions. While it does not explicitly prohibit territorial taxation, it has warned about the risks when such systems lack proper safeguards.

Key recommendations include:

• minimum taxation on foreign income earned by large multinational groups
• transfer pricing rules to prevent artificial profit manipulation ( see our article Related-party transactions: concept, scope and how to register them correctly)
• automatic exchange of information between tax authorities ( expanded in Common Reporting Standard (CRS) and FATCA)

The IMF and the World Bank have also warned about the potential misuse of territoriality in the absence of adequate control mechanisms.

➤ To learn how Andorra has aligned itself with these international standards, you can read the article Evolution of Andorra’s tax framework.

🧭 Conclusion: two different models for different objectives

There is no universally superior system. Worldwide taxation dominates in developed economies, where fiscal equity and stable revenue are priorities, while territorial taxation is more common in jurisdictions seeking to attract foreign capital, offering lighter taxation for income generated abroad.

Both models have advantages and risks. The ideal balance depends on:

• the level of foreign investment a country aims to attract
• its internal tax policy
• its alignment with international standards
• its need to maintain strong tax bases
• and its commitment to preserving a solid international reputation

Tax legislation evolves constantly: political changes, multilateral agreements and international pressure all play a role. This is why anyone or any company with activities in multiple countries should analyse their situation strategically, especially if they are considering improving their tax position or changing residency.

📞 Do you need personalised tax guidance?

If you want to assess how these principles apply to your specific case, you can book a personal and confidential meeting using the button below this article, or write to us through the contact form. We will be pleased to help you with your international planning.

Last updated: December 2025