Changes afoot for working UK residents

Any proposals the UK Chancellormakes for changing residence and domicile rules will be assessed on whether they contribute to the country’s overall economic well-being, writes John Battersby

International relocation is becoming almost standard practice. Whether it is short-term secondment for career development or a considered decision to relocate for personal circumstances, more and more individuals are grappling with unfamiliar tax systems. Some countries have seen the advantages of encouraging inward migration through favourable tax regimes. Internationally mobile professionals add to the economic growth of the country in which they live by spending money on goods and services as well as by paying some taxes. Moreover, multi-national organisations are influenced by the tax regime and thus the costs faced in deciding where to locate their operations and international headquarters. In April’s UK Budget Statement, Chancellor of the Exchequer Gordon Brown announced that the current rules governing residence and domicile would be reviewed with a further announcement at the time of the pre-Budget Report, usually in October or November. There has been no statement on which particular aspects of the rules are thought to be of concern although the government has invited comment from those who might be affected. The UK has various tests to decide whether an individual is to be regarded as resident and thus exposed in full to tax on worldwide income and gains, rather than only on UK source income. One rule is based on a person’s presence in the UK for 183 days or more in the tax year. This test compares reasonably with that used by a number of other countries and there seems no strong reason to change it. But another test regards persons as residents if they average 91 days or more of presence in the UK for a period of four years or more. Current practice is to ignore both days of arrival and departure. It may be that this is seen as being unduly generous. The UK position is actually tougher than that applied by the US. There, an individual will be regarded as a tax resident if they average more than 120 days of presence in any tax year. So if the UK proposes to change its rules, then there would be something to be said for moving to a more generous test of 120 days, but possibly not allowing both the days of arrival and departure to be excluded. The Chancellor’s review may, however, be more concerned with the tax status of domicile. In very broad terms, individuals are domiciled in the country with which they are regarded as having the closest connections. This is sometimes loosely described as their native land. The advantages of becoming resident in the UK but not being domiciled there are well known. Such an individual will not pay UK tax on any income and gains from non-UK sources unless and until those income and gains are remitted to the UK. There are broadly similar advantages for inheritance tax, in that such an individual is generally not taxed on non-UK assets. Intermediate tax status The UK arrangements for domicile allow individuals who are not UK natives, and who do not intend to make it their permanent home, to enjoy a logical halfway house. On the one hand, someone who has always lived in the UK and intends always to do so, is liable to UK tax in full on income and gains no matter where they arise. On the other, an individual who does not live in the UK pays UK tax only on UK source income and not generally on UK capital gains, although the provisions of a double tax treaty may be relevant. Persons resident in the UK for only a few years are allowed an intermediate basis of taxation in order to avoid too abrupt a transition. The theory is probably that if such individuals are not using their non-UK income to support their UK life style, then it is not necessary to tax them on it. The UK is by no means alone in having such special arrangements. Many countries see the advantage of encouraging those individuals with a choice of location to come to their own shores. Belgium does not tax expatriates on foreign source income and the expatriate regime is unlimited in time. The Netherlands provides a 30 per cent deduction for up to 10 years and does not tax foreign income of such expatriates. For obvious historical reasons, both Cyprus and Republic of Ireland have systems somewhat similar to the UK. Switzerland allows each canton to tax separately. It is not, therefore, usually possible to generalise about the Swiss tax position. That said, Switzerland is prepared to allow individuals who come from abroad to negotiate a special tax regime whereby their Swiss tax liability on non-Swiss income is limited to an amount which takes into account the rental value of the property they occupy and any foreign income on which treaty benefits are claimed. Other foreign income is taxed in Switzerland. The economic case for allowing such special tax regimes has been well recognised. This is the issue with which the UK government will have to grapple, and which its predecessors have looked at from time to time. Over the last 20 years, consideration has been given to changing the special tax regime but on each occasion it has been decided that the economic advantages for the UK are best served by encouraging individuals to live in the UK because of the favourable tax regime for non-domiciles. Depending on if and how rules are changed, individuals might choose not to live in the UK but to relocate elsewhere. For multi-national companies, it might be a strong reason why they would want to relocate parts of their business. Expatriates are commonly offered some form of tax protection from their employers, who may be reluctant to pick up additional costs. Possible changes If the UK government does decide to take a different stance from its predecessors and introduce some changes, then there is a whole range of possibilities. Perhaps the obvious starting point is to take the special rule which currently applies for inheritance tax and apply it to income tax and capital gains tax. Under this rule, once individuals have been resident in the UK for more than 16 years in any 20-year period then they are deemed domiciled. Thus, their heirs are exposed to inheritance tax on their worldwide estate. It might be thought appropriate to introduce the same rule for the other taxes. An alternative, which was floated in the late 1980s during the last consideration of the topic, would be to provide a graduated build-up from no liability to full liability on worldwide income and gains after an individual had been resident in the UK for seven out of 10 years. Whatever changes are proposed, hopefully a more formal process of consultation will follow, so that possible difficulties and unanticipated effects can be identified and dealt with. In addition, it would be unreasonable if the changes were to be introduced with immediate effect. The 1988 consultation put forward the proposition that there should be a period of two tax years before the new rules came into operation, to allow taxpayers the opportunity to make necessary administrative arrangements. The extent of such arrangements should not be underestimated, since at present individuals who are non-domiciled are not required to provide details of their overseas income and gains. They may well have investments managed for them outside the UK where there is no need to provide details for UK tax, including the very complicated UK basis for capital gains. As such, enough lead time is needed to provide such information. In conclusion, the UK offers an attractive tax regime for those who are able to achieve non-domiciled status. This is reasonably well known. Any proposal for change needs to be assessed on whether it will contribute to the overall economic well being of the UK and whether the proposed new rules are clear to understand and enable taxpayers to comply with them with minimum administrative costs. There is a danger that the UK may change its rules in the desire for fiscal purity and succeed only in benefiting the tax revenues of its international competitors. John Battersby is a partner in the national private client group of KPMG