New rules on residence and domicile

07 April 2008

We look at the new rules for non-ordinarily resident and non-domiciled individuals and ask how they affect employee incentives.

Background

The rules on whether someone is resident, ordinarily resident, and/or domiciled in the UK are largely based on case law and reflect the development of the income tax system from its introduction in 1799. This area is increasingly important as workforces become more mobile. The new rules do not override much of the existing common law and so to some extent may be viewed as yet another development in a legal argument that has lasted over 200 years!

Unfortunately, since the consultation period for the new legislation ended on 28 February 2008, there has not been a great deal of time for these sections of the Finance Bill to be finalised before their publication on 27 March 2008 (bearing in mind two centuries have not been long enough) and worries about lack of clarity therefore remain.

HMRC will publish a full replacement for their booklet IR20 on the liability to tax in the UK for residents and non-residents, but this is not expected until this Autumn.

Counting days of presence – where are you at the end of the day?

The starting point is to ask whether an employee is resident in the UK.

From 6 April 2008, where you are at the end of the day is not a figure of speech favoured by football commentators, but the new legislative test for UK tax residence purposes.

If an individual is present in the UK at the end of the day (i.e. midnight), that day will count as a day of UK residence for tax purposes regardless of the reason for being in the UK, so days of arrival that are workdays or holidays will count equally. This is a climbdown from the position previously stated in the Budget Notes published by HMRC prior to the publication of the bill, which stated that both days of arrivals and days of departure would count as days of presence for residence purposes.

There is a limited exception for transit passengers, provided that anyone arriving in the UK as a passenger departs from the UK on the next day and that the individual does not engage to any substantial extent in activities that do not relate to travel during the time between arrival and departure. This means, for example, a proper business meeting would be out of the question, but it is not clear what view HMRC would take on an employee meeting a business contact while passing through the UK.

We assume that HMRC will also seek to use this basis of counting days when considering the (non-statutory) test as to whether an employee claiming non-residence has in fact visited the UK for less than an average of 91 days in a tax year (over a period of up to four years).

What does this mean for employers?

Employers should review their UK work and travel expectations for employees carefully in the light of the new rules, in particular for:

  • any individual leaving the UK for a period of envisaged non-residence such as an overseas secondment; and

  • any resident but not ordinarily resident individual who wishes to claim the remittance basis of taxation - since claiming the remittance basis comes with a £30,000 charge (see below), it is high earners, such as commuting bankers, who are particularly targeted by the new legislation.

Remittance basis

Need to claim to benefit if unremitted income and gains > £2,000

UK residents who are not UK domiciled or who are not ordinarily resident in the UK continue to be able to use the remittance basis of taxation, that is, any income and capital gains arising overseas are only taxed in the UK when that income or gain is remitted to the UK. This is now only possible, however, by making a claim on the Self Assessment tax return.

A claim applies to the particular tax year for which it is made, so it is not a permanent decision. There is a catch in that if an individual chooses not to claim the remittance basis for a particular year and during that year remits income from a previous year when the remittance basis applied, he will be taxed on those remittances.

There is an exception to the general rule: the remittance basis remains automatic for individuals with unremitted income and gains in a tax year of less than £2,000.

£30,000 charge

Individuals entitled to claim the remittance basis who have been UK resident for at least 7 out of the last 9 tax years (including years prior to 08/09) preceding the relevant tax year will be liable to pay an annual charge of £30,000 in addition to tax on remittances made, in order to claim the remittance basis. Money remitted to the UK to pay the £30,000 charge will not be taxable.

This annual charge will be a tax rather than a levy, as originally proposed, which means that it can be taken into account for double taxation relief purposes and it can also be used to cover gift aid donations.

The £30,000 only applies to individuals who have unremitted foreign income and gains in excess of £2,000 a year.

Loss of individual allowances

Individuals claiming the remittance basis lose their entitlement to income tax personal allowances (£5,435 for individuals aged under 65 in tax year 2008/09) and to the capital gains annual exemption (£9,600 for individuals in tax year 2008/09).

Again, there is an exception for individuals with unremitted income and gains in a tax year of less than £2,000, who continue to benefit from personal and annual allowances.

Remittances and assets

The scope of remittances has also been extended so that, in particular, the following now constitute remittances to the UK:

  • assets which have been purchased with unremitted income or gains are brought in to the UK and then sold (or otherwise turned into cash in the UK);

  • money, property or services derived from unremitted income or gains brought into the UK; and

  • the payment of interest out of offshore income on loans made outside the UK which is advanced into the UK, for example a loan to fund the purchase of UK located assets, such as houses.

There are exemptions for personal effects, assets costing less than £1,000, assets brought to the UK for short-term repair and artwork brought to the UK for public display or for educational purposes.

Effect on employee shares and options

The taxation of employment-related securities is complicated, in part because share-based awards generally have a life span of several years, so it is not unusual for the residence status of employees, and therefore their basis of taxation, to change during the life of the award.

The reform of the taxation of individuals who are non-UK domiciled and not ordinarily resident in the UK (“NOR”) has had a knock-on effect on this area of taxation that has in many respects made the rules clearer, however some issues remain to be clarified. Overall, employees who are NOR at the time awards are made, will in general have to pay more tax.

The main issue for employers is that they need to make sure they are tracking, reporting and, where relevant, operating PAYE and NIC correctly on employee share awards according to the new rules. The difficulty here is that under the new legislation it will be more common for a tax charge on employment-related shares to occur when the employee is no longer resident in the UK.

Employers already need to ensure that they can keep track of UK tax compliance and withholding obligations in respect of share awards to internationally mobile employees, but this is now more important under the new regime. Share plan administrators may need to review their systems in order to fully support their clients.

Any standard employer communications (such as employee booklets, letters or other guides) to employees on the grant of employment-related securities and options will also need to be updated to reflect the new rules.

Employers should also review any tax planning or agreements they may have with HMRC in respect of mobile employees, particularly where there are senior / highly paid NOR employees with ongoing UK and non-UK duties.

HMRC has confirmed in its Budget Notes (BN106) that the intention is to change the law only for securities and options granted after 5 April 2008, i.e. the changes will not have retrospective effect.

Options

Previously, in a typical example of securities options granted to NOR employees, there would be a notional loan charge under the rules for securities acquired for less than market value. Although this charge often came within the £5,000 de minimis exemption for loans from employers, employers found it hard to keep track and report it correctly. Particular problems arose where an employee remained in the UK and sold the shares, since the employer had a PAYE liability on the deemed write-off of the notional loan at that time.

After the changes to the law take effect, the notional loan will generally no longer apply to option shares acquired by NOR optionholders, and they will instead be taxed on the spread at exercise in the same way as ordinarily resident employees.

Restricted securities

Previously, in a typical example of restricted securities awarded to NOR employees, there would be an income tax charge on the market value of the securities on acquisition taking into account the effect the restrictions would have on that value, and no further income tax charge after that point.

After the changes to the law take effect, the more flexible treatment on restricted securities available to ordinarily resident employees will also be available to NOR employees, which in many cases allows the employee and employer to jointly elect for certain types of treatment although again it will probably mean that NOR employees will pay more tax in most circumstances.

UK securities will always be within the UK

Most importantly, if the employment-related securities are issued by a UK company, taxable amounts will always be treated as remitted, so apportionment will not apply. This is because the securities are by definition already within the UK when issued.

Apportionment between UK and non-UK duties

Under the new rules as they apply to securities issued by non-UK companies, it will be possible to apportion potentially taxable unremitted income from securities and options between UK and non-UK duties for NOR taxpayers who

  • have both UK and non-UK duties under the relevant employment; and

  • elect for the remittance basis of taxation under the new regime.

This means that:

  • the portion of any relevant amount relating to UK duties would be taxable whether or nor remitted; and

  • the remainder would not be taxable unless remitted.

However, it is not entirely clear how the apportionment will be done. The Finance Bill 2008 explains that it will be accrued “on a daily basis over the relevant period”, but leaves scope for HMRC to change the result in various circumstances provided the final apportionment is “just and reasonable” (this last phrase is used repeatedly).

Apportionment for non-domiciled taxpayers

Apportionment will also be available to non-domiciled taxpayers who are ordinarily resident if they have elected to keep the remittance basis of taxation. However, in such cases, as for general earnings, the taxpayer will only be able to keep gains from employment-related securities out of the UK tax net if they relate to non-UK duties of a non-UK employment.

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