 In an attempt to simplify the rules on the taxation of individuals, HM Treasury has produced two consultation documents: one outlining a statutory definition of tax residence, and the other suggesting potential reforms to the taxation of non-domiciled individuals. Penny Simmons reviews the proposals
On 17 June 2011, HM Treasury published two consultation documents detailing proposals to amend the UK tax rules relating to individuals: the first introduced proposals for a statutory definition of tax residence (the SRT consultation document), while the second contained proposals to reform aspects of the tax legislation relating to non-domiciled individuals (the non-dom consultation document). The publication of these consultation documents follows announcements made at Budget 2011.
This article outlines the main proposals of each of these consultation documents in turn, focusing firstly on the proposals for a statutory residence test (SRT).
Proposals for an SRT
The current residence rules
An individual's residence status for tax purposes will be important when determining that individual's liability for UK tax. In most circumstances, individuals who are resident in the UK for tax purposes are liable to UK tax on some or all of their worldwide income and capital gains, whereas individuals who are not UK resident are generally only liable to UK tax on UK source income and in most circumstances will not be liable to UK tax on capital gains.
Despite the importance of establishing whether an individual is resident in the UK, there is currently no definition for UK tax residence; rather the concept has been developed through case law and guidance from HM Revenue & Customs, previously under the guise of IR20 and more recently in the form of HMRC6 (Residence, domicile and the remittance basis (December 2010)). HMRC6 explains that there are many different factors that will determine an individual's residence status and individuals should always consider the 'pattern' of their lifestyle when deciding whether they are UK resident.
However, it should be noted that HMRC6 is only a form of guidance and may not provide a definitive answer as to whether an individual is resident in the UK for tax purposes. Indeed, the ambiguity surrounding the binding nature of HMRC guidance on residence was illustrated in the recent case of R (Davies, James and Gaines-Cooper) v HMRC [2010], where the court considered whether a taxpayer could rely on IR20 when determining his tax residence status. This case was appealed to the Supreme Court and the hearing took place in July 2011. A Supreme Court ruling is expected in the autumn.
In addition to HMRC guidance, the concept of UK residence has been developed through a wide body of case law. Amongst other things, the courts have held that the question of whether an individual is UK tax resident is a question of degree and fact and, therefore, residence is generally decided on a case-by-case basis. The courts have established that several factors may be relevant when determining an individual's residence status, including: accommodation in the UK; frequency and purpose of visits to the UK; and ties with the UK (for example, family and business links). However, there are no definitive rules prescribing when these factors will be sufficiently strong enough to result in an individual becoming UK tax resident.
The plethora of case law, coupled with HMRC guidance on the issue, has given rise to much uncertainty regarding how UK tax residence is established. Indeed, in the SRT consultation document, the government describes the rules as being 'vague' and 'complicated' and points out that:
'… in certain circumstances it is not possible for a person to be sure whether they are tax resident in the UK or to know what activities or circumstances would make them tax resident'.
The SRT consultation document outlines some of the circumstances under the current law, in which individuals will be treated as being resident in the UK for tax purposes, including where they:
- spend 183 days or more in the UK in any tax year;
- come to the UK with the intention of living here permanently or to work here for an extended period, or with no particular end date;
- come to the UK temporarily and spend 91 days or more per year in the UK on average over a four-year period;
- come to the UK for a purpose, such as employment, that will mean that they remain in the UK for at least two years (whether or not, in a particular year, they spend 183 days or more in the UK); or
- usually live in the UK and go abroad for short periods, for example on business trips or holidays.
However, this list is not exhaustive and the SRT consultation document acknowledges that indecision regarding an individual's residence status may persist in complicated circumstances, for example, where an individual travels to and from the UK on a regular basis or has several connections with the UK (such as family, or employment), while also having connections with other countries. Indeed, the government considers that this prevailing uncertainty is a deterrent to individuals and businesses looking to invest in the UK. Consequently, as part of the government's stated commitment to increasing the international competitiveness of the UK's tax system, the government is now attempting to introduce an SRT.
Proposals for reform
In the SRT consultation document, the government explains that the proposed SRT is designed to provide a:
'… simple process and clear outcome for the vast majority of people whose circumstances are straightforward'.
It should be noted that the purpose of the SRT is essentially to clarify the law and create certainty for individuals. Indeed, the government considers that introduction of an SRT should not affect the residence status of the majority of individuals.
Broadly, the proposed SRT will involve reviewing the activities and circumstances of an individual during a three-year period. The government considers that an SRT should take into account both the amount of time that individuals spend in the UK and their other connections with the UK. On this basis, the government is proposing that the SRT will have three distinct parts:
- Part A, which will contain conclusive non-residence factors that would be sufficient in themselves to make an individual not a UK resident;
- Part B, which will contain conclusive residence factors that would be sufficient in themselves to make an individual UK resident; and
- Part C, which will contain connection factors and day-counting rules which will only need to be considered by those whose residence status is not determined by Part A or Part B.
So, under the SRT, if individuals satisfy any of the conditions of Part A for a tax year, they will definitely be not resident in that tax year. If Part A does not apply, individuals must consider Part B and if such individuals satisfy any of the conditions in Part B, they will definitely be UK resident in that tax year. If none of the conditions in Part A or Part B are satisfied, individuals should consider Part C.
The SRT consultation document explains that in the rare circumstances where an individual satisfies one of the conditions in both Part A and Part B, Part A will take precedence and the individual will definitely not be UK resident in that tax year.
In addition, the proposed SRT will distinguish between 'arrivers', those individuals not UK resident in all of the previous three tax years and 'leavers', those individuals who have been resident for one or more of the previous tax years. The government believes that it should be harder for leavers to become non-UK resident than for arrivers to become UK resident and therefore, the SRT has been designed accordingly.
Part A
Under Part A, it is proposed that individuals will not be UK resident in a tax year if they satisfy any of the following conditions:
- they were not resident in the UK in all of the previous three tax years and they are present in the UK for fewer than 45 days in the current tax year;
- they were resident in the UK in one or more of the previous three tax years and they are present in the UK for fewer than 10 days in the current tax year; or
- they leave the UK to carry out full-time work abroad, provided they are present in the UK for fewer than 90 days in the tax year and no more than 20 days are spent working in the UK in the tax year.
Individuals will be considered to be working full-time abroad if they are working at least 35 hours a week. For the purposes of the SRT, a 'working day' is defined as being any day during which at least three hours of work is undertaken. The SRT consultation document clarifies that even if an individual is not present in the UK at the end of the day, such an individual will still be treated as working in the UK on that day, if they have worked in the UK for at least three hours. This is a particularly onerous test and guidance will be required to address whether checking and responding to e-mails on a BlackBerry and taking phone calls while travelling would constitute 'work' for these purposes.
The SRT consultation document explains that, if individuals do not satisfy Part A, this does not mean that they are definitely UK resident; rather that they need to consider Part B of the SRT.
Part B
The SRT consultation document clarifies that Part B is intended to provide certainty for particular individuals that they are UK resident. It is proposed that under Part B, individuals will be conclusively resident for the tax year if any of the following conditions are satisfied, they:
- are present in the UK for 183 days or more in a tax year;
- have only one home and that home is in the UK (or have two or more homes and all of these are in the UK); or
- carry out full-time work in the UK.
Individuals who do not meet any of the conditions in Part B would not necessarily be non-UK resident; rather they would need to consider Part C of the SRT.
Part C
Part C would only apply to those individuals whose residence status is not determined by Part A or Part B. The SRT consultation document explains that Part C is intended to reflect the principle that, as the length of time that an individual spends in the UK increases, fewer connections with the UK will be permissible if that individual wants to maintain a non-resident status.
Part C specifies five 'connection' factors that may need to be considered when determining such an individual's residence status:
- whether an individual has a UK-resident family;
- substantive UK employment (including self-employment);
- accessible accommodation in the UK;
- whether an individual has spent 90 days or more in the UK in either of the previous two tax years; and
- whether an individual spends more days in the UK than in any other single country.
It should be noted that individuals will be deemed to have a UK-resident family, where their spouse, civil partner or common law equivalent is resident in the UK (unless they are separated permanently) or where they have UK-resident children under the age of 18 and that individual spends at least 60 days during the tax year with those children, whether or not that time is spent in the UK. It seems totally unreasonable to suggest that the time that an individual spends with children outside the UK could still be included in the 60-day count. Indeed, this may dissuade non-residents from spending time with their UK-resident children and therefore, may give rise to public policy concerns.
The SRT consultation document defines substantive employment as being where an individual works in the UK for at least 40 days in the relevant tax year.
The first four connection factors would be relevant to arrivers and leavers, while the fifth connection factor would only be applicable to leavers. Having established which of the connection factors are relevant, individuals would then need to combine these factors with the number of days that they spend in the UK into a 'scale', through which they would be able to determine their UK residence status. There will be different 'scales' for arrivers and leavers, to reflect the government's stated belief that it should be harder for individuals to relinquish their UK residence status than for individuals to become UK resident.
The different scales for arrivers and leavers are illustrated in the table below.
The government is specifically requesting feedback from interested parties regarding whether the connection factors listed above are appropriate and whether there are any other connection factors that should be included.
To further simplify the process of determining an individual's residence status, the government is proposing to introduce an interactive online tool, which would allow individuals to self-assess their residence status.
It should also be noted that under the current residence rules, an individual will be considered as either UK resident or non-UK resident for the whole of a tax year. However, in certain circumstances the tax year can be split into periods of residence and non-residence by virtue of HMRC's Extra Statutory Concession (ESC) A11. As part of the consultation process, the government is also proposing to replace ESC A11 with statutory provisions on split years, which will have broadly the same effect, although the rules will be linked to the conditions of the SRT.
The government is also proposing to introduce anti-avoidance provisions to prevent taxpayers creating short artificial periods of non-residence, during which they receive substantial amounts of income that may not be liable to UK tax.
On the basis that the government considers that the new SRT should not affect the residence status of the majority of individuals, transitional rules are not currently being proposed. When implemented, it also intended that the SRT will not apply retrospectively. This may cause some difficulty for individuals who need to determine their residence status in previous years to establish their current residence status, for example, where Part C is applicable. However, the government is specifically consulting on whether interested parties agree that transitional rules are unnecessary.
Ordinary residence
Under the UK tax residence rules there is also a concept of 'ordinary residence', which is currently distinct from the concept of 'residence' and is broadly based on whether UK residence is typical or usual for an individual. Ordinary residence status may affect an individual's liability to UK tax; in certain circumstances, individuals who are not ordinarily resident in the UK may be able to claim the 'remittance basis' of taxation (outlined below).
Akin to the tax rules on residence, there is currently no clear definition of ordinary residence. Consequently, the government is also reviewing whether the rules relating to ordinary residence should be amended. The SRT consultation document explains that the government considers that the concept of ordinary residence should be retained at least for the purposes of overseas workday relief and that a statutory definition of ordinary residence should be devised. Under the proposed statutory definition, individuals would be ordinarily UK resident where they are UK resident, unless they have not been UK resident in all of the previous five tax years.
The government is specifically asking for comments on how the concept of ordinary residence should be retained and how a statutory definition should be introduced.
Comments were accepted on the SRT consultation document until 9 September 2011 and it is currently intended that a summary of responses and draft legislation will be published later this year, with a view to legislation being included in the Finance Bill 2012 and being effective from 6 April 2012.
The introduction of an SRT is a welcome development, on the basis that it should increase certainty for individuals when determining their UK tax residence status. However, it is questionable whether the distinction between arrivers and leavers will in fact alter the current residence status of certain individuals and consequently, whether transitional provisions may be useful to remove any prevailing uncertainty in this area.
Proposals for the reform of the taxation on non-domiciled individuals
The current law on domicile
For UK tax purposes, the concept of domicile is distinct from residence. Under UK tax law, there is no statutory definition of domicile; rather a person's tax domicile is determined by reference to a number of common law rules. Broadly, an individual's domicile is often that of origin at birth (primarily being that individual's father's domicile at that time).
As explained above, in most circumstances, individuals who are UK tax resident are liable to UK tax on some or all of their non-UK worldwide income and capital gains. However, individuals who are resident but not domiciled in the UK for tax purposes may be able to benefit from the remittance basis of taxation, which prescribes that such individuals are only liable to UK tax on their worldwide income and gains to the extent that they are remitted to the UK. In 2008, the government introduced an annual tax charge of £30,000 for non-domiciled individuals who want to benefit from the remittance basis of taxation and have been resident in the UK for at least seven of the previous nine tax years. If individuals do not want to pay the £30,000 charge, they will be taxed on their worldwide income and gains, whenever arising.
Proposals for reform
The non-dom consultation document provides details on the package of reforms that were announced at Budget 2011 and specifically includes proposals to:
- increase the annual tax charge for certain non-domiciled individuals who wish to benefit from the 'remittance basis' of taxation from £30,000 to £50,000;
- enable non-domiciles to remit overseas income and gains tax-free to the UK for the purposes of commercial investment in UK businesses; and
- simplify some technical aspects of the current rules to reduce administrative burdens.
Increase to the remittance basis charge
The government explains that the increase to the annual remittance basis charge from £30,000 to £50,000 is intended to ensure that non-domiciled individuals who have been resident in the UK for many years make a fair tax contribution. It is intended that the increased charge will only apply to non-domiciled individuals who have been resident in the UK for at least 12 out of the last 14 tax years. The existing charge will be retained for those individuals who have been resident in the UK for at least seven out of the last nine tax years.
Tax relief for investment in UK business
It is intended that proposals to enable non-domiciles to remit overseas income and gains tax free for the purposes of commercial investment in UK business will encourage such individuals to invest in the UK and is in line with the government's stated intention of making the UK an attractive location for investment.
Individuals will only be able to benefit from these proposals where they invest in a 'qualifying business'. It is currently proposed that a 'qualifying business' will be one that carries out a trading activity or a business that is involved in the development or letting of commercial property. However, businesses that are involved in holding and letting residential property, or are engaged in leasing will be specifically excluded from the definition of a 'qualifying business'.
The government contends that including businesses involved in the holding and letting of residential property would introduce an unacceptable risk of the exemption being used for non-commercial purposes, such as an individual using a business to acquire a residential property in which they live. However, the non-dom consultation document clarifies that some types of investment in residential property will not be excluded, such as an investment in a trading business that builds and develops residential property and an investment in certain types of residential property (such as nursing homes and hospitals).
It should be noted that under the current proposals, tax-free remittances will only be permitted where the UK business is structured as a company. The government considers that extending the relief to other forms of business, such as partnerships, trusts and sole traders would create an unacceptable tax avoidance risk. However, the non-dom consultation document notes that the government is considering whether the relief should apply to companies that are listed on a recognised stock exchange and companies quoted on exchange-regulated markets, such as AIM.
Although the relief will only apply to investments structured as companies, it is intended that there will not be a restriction on non-domiciled individuals investing in UK businesses by using funds held in offshore companies and trusts. Furthermore, relief will still be available where funds are being remitted to the UK for investment in a non-UK resident company that has a permanent establishment in the UK.
The government also proposes that the new tax relief for investment in UK business should apply to investments in companies that hold shares in other companies, provided that the holding company only holds shares in companies that undertake a 'qualifying business' and are resident in the UK, or have a permanent establishment in the UK.
It is currently intended that there will be no limit on the level of tax-free remittances permitted for investment in UK business. However, when an investment that has benefited from this relief is disposed of, any overseas income or gains that were originally remitted to the UK must be removed from the UK, or re-invested in another 'qualifying business' within two weeks of the individual receiving the proceeds generated by the disposal. Otherwise, the individual will be treated as making a taxable remittance of the original overseas income or gains used for the investment and will be subject to the usual remittance basis rules. The government is specifically consulting on whether this two-week time limit is appropriate.
It should be noted that this relief will only be available where non-domiciled individuals pay the annual remittance basis charge of either £30,000 or £50,000 as appropriate. This relief cannot be used for those non-domiciled individuals who choose to be taxed on their worldwide income and gains, wherever they arise, rather than under the remittance basis of taxation.
Simplification of the existing remittance basis rules
The government is proposing four amendments to the current remittance rules, with the aim of simplification. This article does not intend to review these measures in any detail, although, broadly, these measures involve:
- changes to the nominated income rules;
- allowing all sums within an individual's foreign currency bank accounts to be removed from the scope of the UK's capital gains tax legislation;
- sales of certain 'exempt assets' in the UK; and
- giving statutory effect to Statement of Practice 1/09, which simplifies the process by which UK-resident but not ordinarily resident employees who undertake duties both in the UK and overseas under a single contract of employment, can calculate their UK tax liability when their employment income is paid into a single overseas bank account.
The proposals to simplify aspects of the current remittance rules should be welcomed, although, it is suggested that further simplification is required to reduce the compliance burden on UK-resident non-domiciled individuals.
Finally, it should be noted that the non-dom consultation document confirms that there will be no further substantive changes to the taxation of non-domiciled individuals for the remainder of this Parliament.
As with the SRT consultation, the consultation on the taxation of non-domiciled individuals was open for comments until 9 September 2011, following which it is intended that legislation will be included in the Finance Bill 2012 and the measures being proposed will take effect from 6 April 2012.
By Penny Simmons, professional support lawyer,Watson, Farley & Williams LLP.
E-mail: psimmons@wfw.com.
R (Davies, James and Gaines-Cooper) v HMRC [2010] EWCA Civ 83
