What is Flag Theory?
And why does it matter?
Note: For information purposes only. Not intended as personalized advice of any sort. Please consult a qualified professional.
This article is part of a series on Escaping The West. Part One, “Escape From The West,” is available here. Part Two, on “Citizenship By Investment,” is available here. Part Three, on “Why Escape From The West Is Different,” is available here.
You’ve probably never given it much thought, but your whole life has been centered around just one country. You were born in one country, went to school in one country, lived in one country, worked in one country, invested in one country, and had citizenship in one country.
Flag Theory inverts this idea to achieve the complete opposite outcome. Utilizing Flag Theory, you may have been born in one country, but you have jobs/businesses, investments, bank accounts, residences, and citizenship in multiple other countries.
The concept of Flag Theory, as the folks at Far Horizon Capital write, "was first mentioned in 1964 by Harry D. Schultz in his novel 'How to Keep Your Money and Your Freedom.' The original Flag Theory was comprised of the following 3 flags: (1) a second passport, (2) a safe location for your assets outside your own country and (3) a legal address in a tax haven."
Later, this would be expanded by W.G. Hill, who coined the term "Flag Theory," as well as "refined the idea that a person could be a 'PT' – a permanent [or perpetual] traveler – also known as a perpetual tourist or just passing through, and he added an additional 2 flags: (4) where the millionaire invests his money and (5) living in the playgrounds."
The world has changed, though, since the 1960’s, and what was once a strategy exclusively for millionaires and billionaires can now be utilized by practically anyone in today’s information age. Others contend that the original Five Flag Theory has become outdated, despite the soundness of the basic principles, and is in need of expansion.
Because I like lists, let’s put the original Five Flags in a numerical list, with help from Andrew Henderson, the Nomad Capitalist:
Second Passport: “Besides acting as a backup plan, [W.G.] Hill added that the second citizenship should be from a country that does not tax non-resident income.”
Business Haven: “Set up your business in a stable tax haven.”
Playgrounds: “Spend your time and money in places with no sales tax or VAT.”
Legal Residence: “Obtain a second residence in a tax haven to get all the benefits of living in a place without all the tax obligations of citizenship.”
Asset Haven: “Store your assets offshore and get an offshore bank account in a country with stable banking.”
Now, let’s dispel some myths. You may have it in your head that you’re going to be the next "James Bond and sipping Martini’s somewhere in Monaco with a bag full of passports and cash. Numbered bank accounts and private jets. Helipads and stacks of gold in Switzerland. Different countries every day and paying 0% tax... Rest assured — none of that is the case (anymore)."
Instead, modern Flag Theory needs to achieve six objectives:
"Be able to tell your government which country you live in.
"Be prepared to show them your permanent residence card.
"Be ready to share information about rent or home ownership in your new country of residence.
"Be willing to show them what tax you’ve paid in your new tax home.
"Be able to detail where your family lives, where your children go to school, and where you’ve moved your ‘center of life.’
"Be able to demonstrate active bank accounts in your new residence.”
"In other words, the burden of proof is on you," says Nomad Capitalist's Andrew Henderson. "If you cannot prove that you no longer live in or have substantial connections to your home country, you will remain tied to its tax system. If they wanted, and especially if they saw gaps in your financial planning, the government could hit you with a massive tax bill and potentially a fine, as well."
So what is Henderson’s and Nomad Capitalist’s take on modern Flag Theory? A more holistic approach, as they call it:
Second Passport(s)/Second Citizenship(s): Having a second citizenship and passport can "weaken the grip that any one country has on you, your money, and your freedom," meaning that "you’re never a slave to one country." Keep in mind that "every citizenship comes with rights and responsibilities," and "the key is to find the country that offers you the rights you’re looking for with the responsibilities you’re willing to shoulder." For example, maybe you didn't have a choice concerning "the responsibility of paying 40% or more in taxes to your home country," because "that decision was [likely] made for you the moment you were born. But maybe you’re okay with paying 10%, instead." The beauty of Flag Theory is that "you can decide where to plant your citizenship flag and choose to accept the obligations that come with it." It's not a "get-out-of-jail-free card for paying taxes," especially if you're a U.S. citizen, because "you have to pay taxes no matter where you live and no matter how many other citizenships you acquire." You'll have to "take a good look at your first citizenship and understand what it means and if you want the obligations that go along with it," and decide accordingly whether "renouncing your U.S. citizenship [would] be beneficial in your specific situation" or "hold on to that citizenship and find a way to work within those limitations."
Offshore Business Incorporation(s) in Stable Tax Havens: Incorporating your business offshore is "not as simple as setting up a company in a low- or zero-tax country like the Cayman Islands, Nevis, the [British Virgin Islands], or even Hong Kong and then heading back to the United States where you live full time... Because in places like the US, Australia, and Canada, your business will always be tied to you no matter where you set it up." Western governments have enacted what are known as "Controlled Foreign Corporation (CFC) laws, mind and management stipulations, and other regulations that basically dictate that if you want to live somewhere, you have to pay tax there too." In order to "effectively lower your tax burden [with your business flag], you will need to plant other flags on this list as well or you’ll merely end up with more paperwork and the same tax rate." Therefore, "the best asset protection strategy is a running business that’s able to operate and collect money," as well as give you more than just asset protection and lower taxes. This includes the ability to "set up in a country with great laws for hiring, accompanied by affordable wages, where you can build a great team of people to work for you," establish "an operating business base" or even numerous bases, and perhaps even act as a "licensing company to hold intellectual property."
Living/Spending Playgrounds: While it is possible to "live in a country with no income tax and... set up your business in a tax haven, you could still end up paying high [sales tax] rates," especially if the countries you live in and do business in have a Value Added Tax, or VAT. Thus "you would need to have a playground where you shop for goods at lower sales tax levels," and "selecting the right playgrounds can make your dollar go much further," as well as "simply [be] where you like to spend your time."
Tax Residence in Zero-Tax Countries: "By obtaining tax residence in a country that does not tax overseas income (or any income at all), you can establish a base of operations for your life without having to pay taxes to the local government." Here, we should take a moment to break down the four different types of taxation used around the world:
Territorial taxation — "You only pay taxes on income earned within the country’s territory. Even if you live there, income earned outside of the country is not taxable locally."
Residential Taxation — "You pay taxes based on where you live; many countries use a version of the ‘183 days’ principle, which means that you have to spend at least half [the year] living in the country to be taxed on your worldwide income. Of course, it’s rarely that simple. Most countries have criteria you need to fulfill in order to prove you no longer have ties to that country."
Citizenship-Based Taxation — "Only the United States and Eritrea use this system; it means that your income is taxable no matter where in the world you live or how long you live there. So long as you hold citizenship in that country, you must pay taxes."
Zero Tax — "These countries do not have an income tax. In many cases, they have absolutely zero taxes: no capital gains tax, no inheritance tax, no withholding tax, no estate tax, etc. In other cases, however, they may have high VAT rates or stamp duties, so be aware."
Asset Havens: "You can plant flags all around the world to protect your assets... from offshore gold storage to offshore trusts, and from foreign real estate investments to offshore banks." One of your first (and potentially easiest) steps could be opening an offshore bank account somewhere for "increased asset protection, greater stability, and much higher interest rates. The trick is knowing where to set it up." Furthermore, "your banking country may be different from your business base for [reasons of] stability. You want your assets stored in countries with efficient judicial systems, good interest rates, and stable banking conditions," because "all of these are essential to protect your assets and grow your wealth while giving you the peace of mind that your strategy will work long-term." Just so we're perfectly clear, "you can’t simply stash and hide your money... There are plenty of people who ended up in jail for using some pretty low-rent methods to hide their money overseas. It’s not worth it." With that being said, "you [can] still legally move your assets around the world and benefit" in several ways. For example, offshore banks and trusts can protect you if you ever get sued, "offshore gold storage can protect you from robbery and government gold confiscation," owning "foreign real estate can allow you to invest your wealth in a non-reportable asset," and having accounts with "offshore banks can [potentially] give you higher interest rates."
Digital Privacy and Freedom Protection: "Have [your website hosting, email hosting, and] files stored in a country where there’s higher data privacy and they’re going to be more protective. If you run a business that is controversial – not illegal, just controversial – go to a place... where they’re really into freedom of speech and they’re not going to take you down with the drop of a hat. In today’s world, people just don’t like controversy. And most value security over freedom. So, for your own protection and for your own redundancies, having digital flags is very important."
Social/Personal Life: "Where are your friends? Where do you want to hang out with people? Where are they from? If you’re dating, where are you dating? And where are the people you’re dating from? If you’re married, what does your spouse want? If you have kids, how will you accommodate their needs and educate them? Where do you feel comfortable?... Plant flags in the places where you can easily connect with other like-minded individuals. Create and contribute to [those] communities. It won’t matter how many flags you plant if you forget the human element that makes life worth living."
That’s the Nomad Capitalist revision, and in my view, it’s a good one. Another good revision comes from Far Horizon Capital:
Citizenship and Residency: "The flags you place for citizenship or permanent residency can have a dramatic effect on all the other flags," and "a second passport is widely recognized as a critical step you can take to reduce your sovereign risk," because it "facilitates worldwide movement and travel." Citizenship is "a social contract maintained with a government," and that has inherent "benefits and sometimes drawbacks. It's up to you to determine whether you want to continue to be a citizen of your country of birth – or if another option is more beneficial to your current situation." Timelines and costs vary, but "a person can achieve a legitimate citizenship by naturalization for about $5,000 and 3 years with a re-domiciliation process. For a quicker timeline, an investment of $100,000 and a background check can get you a new citizenship in just 6 months."
Residency Taxation: "Citizens are taxed in a number of different ways. We are taxed when we earn. We are taxed when we spend. We are taxed when we die... Courts have repeatedly ruled that tax evasion is a crime, but that tax avoidance [or minimization is completely legal]. It’s well within your rights to pay only the amounts required by law, and nothing more. Many individuals and companies currently legally minimize their taxes by intelligently making use of international corporations offshore. In fact the largest companies in the United States use offshore companies to legally defer taxes, sometimes indefinitely. The growing number of entrepreneurs with a worldwide focus, or location independent operations, are looking for answers. The day of the micro-multinational is upon us."
Offshore Companies and Trusts: International/offshore legal entities like companies or trusts are important as a "primary method of asset protection" that can potentially "protect your wealth and your business and save dramatically on taxes. Companies can buy property, buy assets, carry liabilities, carry debts, and transact business. They "can also be used to open [offshore] bank accounts, gain citizenship, establish privacy, gift assets, set up a tax base, extend beyond your lifetime, protect and grow wealth and accomplish many other goals." For tax purposes and liability protection, your business can maintain "a registered office [in] the place where your company’s articles of incorporation are filed," while your actual office and operations are located elsewhere. For example, "you can sometimes objectively state that setting up a company in [Country A] might be better than [Country B] because there are less reporting requirements and you don’t face a yearly audit. Alternatively, you could state that [Country B] is more reputable and won’t send up a ‘red flag’ to the authorities." Overall, "it’s quite easy to find a jurisdiction for a business entity which has no tax, or territorial tax rules. Planned properly with the guidance of a professional, tax can be deferred indefinitely, or eliminated completely."
"A trust is comprised of 2 essential, basic parts; (1) a trustee, and (2) a beneficiary. The trustee is the person who you trust to keep assets held in the trust safe for the benefit of the beneficiaries. The founder is the person who creates the trust and a protector is a person who can veto or remove the trustee. A trust can be the owner of a business entity and create an additional level of protection. This is because a court order cannot compel a person located outside their jurisdiction to take action. A trust is an efficient way to place assets outside your ownership, but somewhat within your control – as the trustee has a fiduciary duty to protect the assets for your benefit."
Offshore Bank and Investment Accounts: "The countries where you hold your assets and wealth should be in another jurisdiction from where your money is actually earned or spent. Ideally, these jurisdictions have a reputation for privacy, professionalism and stability... What country you bank in is almost as relevant as the bank itself. A systemic collapse could wipe away your liquid assets. Obviously this is a long shot, but we should prepare for the worst, and hope for the best." With that said, don't place "all of [your] money in one bank," and don't keep all of your money in "all of the banks within one country." You can open an offshore bank account "under [your] personal name, or through a corporate account [that is] controlled and owned by a legal entity."
"Other relevant flags within this sector include: brokerage accounts, investment advisors, private funds, opportunities for business, and essentially anything that makes you money. While legal entities provide the vehicle for investment and business, business markets are the highway upon which we drive."
"Once you have protected your assets within a legal entity, its important to invest your liquid assets in an intelligent fashion. This is highly contingent upon your individual circumstances and risk profile. One thing should be clear, your financial planning should not be restricted to just plopping cash in a bank account and watching it dissolve slowly over time due to inflation. We need to be personally responsible for the growth of our wealth, and how we protect and manage our assets."
Physical Assets: "This can be gold, other precious metals, but most commonly it is land... Productive land is one of the most valuable appreciating assets in the world. There is a limited amount – and it can be strongly held with a freehold deed. If the land is arable or has potable water, the price [may] increase accordingly... Whoever controls the supply of clean food and water will be able to dictate pricing to the increasing demand... Always get YOUR OWN private lawyer (not one recommended by the real estate agent and especially not the buyer) and make absolutely certain that you perform due diligence... Performing due diligence is a key step to this process. The more you know, the less chance of someone 'pulling the wool over your eyes'... If you are going to buy some investment property overseas, you would be very wise to use a property management company."
"This was 'playgrounds' in the original Five Flag Theory but physical assets such as land and gold are much more strategic... Lifestyle is not a flag, [but a] fluid experience, a journey. Flag Theory assumes that the lifestyle is a given, but won’t dedicate significant forethought to the subjectivity inherent in lifestyle choices... The elimination of the playgrounds flag does not mean that you can’t build a recording studio at your buddy’s resort, or a house on a secretive island in South East Asia... It shouldn’t be considered a flag that’s used for a strategic advancement of solving your privacy and freedom issues. Further, your playgrounds as a [Perpetual Traveler] are highly mobile, and can effectively be anywhere you enjoy spending time."
Digital Security: "The internet has changed the face of business and commerce forever. Now that businesses can operate without an established base, from the internet – the locations where our infrastructure flags are planted becomes important. Further, our intellectual property and intangible assets are more at risk than ever before. You need to be hyper vigilant about the security of your financial information, passwords, national identification number and even digital currency... Your security, your identity, and your website need to be protected at all times. Not knowing is no longer an excuse. Sensitive information should be sent via encrypted email. Firewalls, VPN access and virus software are a must. It’s not about being paranoid, it’s about being prepared. Your merchant account is the point of sale for your business if you operate an internet business. Merchant accounts have altered the landscape of business and commerce forever. For the very first time, a teenager in Wisconsin can pay a programmer in Russia to build a website and start accepting payments from a buyer in Brazil. With a website and a merchant account, you have instant access to the world’s largest marketplace – the world wide web. Overnight, your business can be a micro-multinational."
"Other Infrastructure and Intangible Assets flags: Important documents, servers, merchant accounts, processes, server farms, domain registration[s], encrypted communication[s], patents, passwords, [and] industrial design[s]."
Digital Assets: "In the same way the internet changed communication, blockchain is changing the world of finance and banking. Everything from currency used to pay for goods and services, holding these in a digital wallet fully under your own control, or even utilizing blockchain for payment systems and smart contracts... A digital asset strategy makes sense to any modern Flag Theory strategy. Whether you choose Bitcoin, or one of the multitude of other alternative coins, the autonomous nature of many of these systems can allow you to fully control your wealth and transfer it across borders without restriction or need to gain permission. These systems aren’t for everyone yet, but worth building into your strategy for future utilization, much like the Internet in the mid-90s."
Some noticeable differences, especially concerning lifestyle, but fundamentally in agreement. It reminds me of that old saying about not putting all of your eggs in one basket. Whether that basket is a country or an asset class, diversification is an important consideration.
Failing to geographically diversify is like having only one big target on your back, which makes it easier for the bad guys (whoever they may be) to "take you out." With Flag Theory, you have a better Escape Plan, because you make it harder to be "taken out" - if the worst case scenario does occur for you, you’ll have created multiple targets, and spread them across the globe, meaning the bad guys have to work harder to hit them all. Statistically speaking, the odds of the bad guys hitting all of those targets may be substantially reduced, giving you the ability to recover.
It’s why Flag Theory is an important pillar for anyone desiring to Escape From The West.