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CPD technical article
An individual's liability to UK income tax and capital gains tax is determined by their residence, ordinary residence and domicile status, together with the location of their assets and the sources of their income, writes Rory Fish.
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Someone's residence, ordinary residence and domicile status depends on the time spent in the UK and the intention of the person concerned.
The basic rule is that someone who is in the UK for 183 days or more in any tax year is resident for that tax year. An individual who is resident in the UK from year to year is regarded as ordinarily resident.
Someone who moves to the UK with the intention of staying for at least two years will be regarded as a UK resident from the date of arrival. Where there is an intention to stay for at least three years, they will also be regarded as ordinarily resident from that date.
An individual who makes regular trips to the UK will be regarded as resident and ordinarily resident from the year of arrival if present in the UK for an average of 91 days or more for four tax years, provided such an intention was clear at the outset. Where there is no such initial intention, someone who makes such regular trips will become resident and ordinarily resident from the start of the fifth year.
Someone who leaves the UK will become non-resident once they have been outside the UK for a complete tax year and non-ordinarily resident once outside the UK for at least three years. They will become non-resident and non-ordinarily resident from the date of departure from the UK under a full-time contract of employment, where the period of absence includes a complete tax year. They will also become non-resident and non-ordinarily resident from the date of departure if there is an intention to be absent from the UK for a period of at least three years.
An individual normally assumes the domicile of his or her father. A change of domicile is effected by moving to a new country with the intention of remaining there permanently while, at the same time, severing all links with the old country.
Liability fundamentals
Generally, the UK tax position of someone who has always lived and worked in the UK (i.e. someone who is resident, ordinarily resident and domiciled in the UK) is that they pay income tax (IT) on worldwide income and capital gains tax (CGT) on worldwide assets.
Similarly, the UK tax position of someone who has always lived and worked outside of the UK (i.e. someone who is not resident, ordinarily resident or domiciled in the UK) is that they pay IT on UK source income only and no CGT (unless the asset sold is used in a UK trade).
Therefore, UK source income is always subject to UK IT, regardless of the status of the individual and there is no UK CGT, even on (most) UK assets, where they are based outside of the UK.
UK assets include land, buildings and chattels in the UK, cash in UK bank accounts, and UK-registered securities. UK source income consists of income in respect of UK assets, employment income in respect of duties performed in the UK, and trading income in respect of trades carried on in the UK.
The complete picture
The rules set out above raise two fundamental questions. At what point does foreign income become subject to UK IT? And when are gains on UK and foreign assets subject to UK CGT?
1. Foreign income
The key factor when considering the taxation of foreign income is the individual's residence position. Figure 1 indicates the liability of foreign investment income and trading income to UK IT.
Figure 1 relates to the taxation of foreign investment income and trading income only. It has already been recognised that UK source income is always subject to UK IT regardless of someone's tax status. Foreign employment income is considered below, following example 1 (below).
Note the following:
- Where an individual is non-UK resident, foreign income is not subject to UK IT. There is no need to consider the person's ordinary residence or domicile status. This is true even if they bring the income into the UK.
- Where someone is UK resident, foreign income is subject to UK IT. The manner in which it is taxed depends on their ordinary residence and domicile status. Foreign income may be taxed on the remittance status if they are non-ordinarily resident or non-domiciled.
- From 2008/09, where someone is non-ordinarily resident or non-domiciled but has been resident in the UK for seven of the nine years prior to the year in question, the remittance basis is only available on payment of a fee of £30,000. Individuals can choose each year whether to pay the £30,000 charge and claim the remittance basis, or pay tax on their worldwide income and capital gains (subject to a de minimis of £2,000 in respect of unremitted income and capital gains). Individuals who claim the remittance basis are not entitled to the income tax personal allowances.
- Under the remittance basis, income is subject to UK IT only if it is brought into the UK. Someone with foreign bank interest will not pay UK IT on that interest if they can show that it has not been brought into the UK. This could be achieved by, for example, showing that it has not been removed from the foreign bank account.
Example 1 - Adele
Adele came to the UK in 2007/08 but did not become resident until 2008/09. She is domiciled outside the UK. Adele has employment income in respect of her job in the UK and interest arising on a foreign bank account. Adele's liability to UK IT is as follows:
Her employment income is in respect of UK duties. Accordingly, it will be subject to UK IT in both 2007/08 and 2008/09.
In 2007/08, the foreign bank interest will not be subject to UK IT as Adele is not resident in the UK.
In 2008/09, Adele is UK resident and will be taxed on her foreign bank interest as well as her UK source employment income. However, the foreign bank interest will be taxed on the remittance basis, as Adele is not domiciled in the UK. There will be no need for Adele to pay the £30,000 charge as she has not been UK resident for seven of the nine years prior to 2008/09.
Figure 2 indicates the liability of foreign employment income, ie income in respect of foreign duties, to UK IT.
Figure 2 relates to the taxation of foreign employment income only and is slightly different from Figure 1. A UK resident and ordinarily resident but non-UK domiciled person is not taxed on the remittance basis unless the employer is foreign and the duties are performed wholly outside the UK.
The rules set out above (in the notes following figure 1) regarding the £30,000 fee and the remittance basis apply equally here.
2. Liability to UK CGT
The key factors in determining someone's liability to UK CGT are residence and ordinary residence. Domicile is only relevant where gains have been realised on foreign assets. Figure 3 indicates the liability of an individual to UK CGT on both UK and foreign assets.
Note the following:
To be outside of UK CGT, an individual must be both non-resident and non-ordinarily resident, and must not be a temporary non-resident.
UK CGT applies to worldwide assets. Once someone is subject to UK CGT it is then necessary to consider their domicile status to determine the treatment of gains on foreign assets.
The rules set out above (in the notes below figure 1) regarding the £30,000 fee and the remittance basis apply to capital gains as well as to income. Note that the de minimis limit of £2,000 applies to the total of unremitted income and gains. Individuals who claim the remittance basis are not entitled to the capital gains tax annual exemption.
The rules for temporary non-residents were introduced in order to prevent people avoiding UK CGT by going abroad for a relatively short period of time, becoming non-resident and non-ordinarily resident, and then selling assets outside of UK CGT. The rules apply to people who have been UK resident for at least four of the seven years prior to the year of departure, and who leave the UK for a period of less than five years.
Gains made on assets owned at the time of leaving the UK, but sold while the individual is outside of the UK, remain subject to UK CGT. Gains on assets purchased after leaving the UK are not subject to UK CGT.
Example 2 - Bosun
Bosun has always been UK resident, ordinarily resident and domiciled. On 1 June 2008 he left the UK and became non-resident and non-ordinarily resident. His intention was to remain outside of the UK for four years. In 2009/10 Bosun sold some shares (acquired in 2001), and a painting (acquired in 2009).
Bosun's liability to UK CGT is as follows:
- Bosun is non-resident and non-ordinarily resident. Accordingly, he will not be subject to UK CGT unless he is caught by the rules for temporary non-residents.
- If Bosun returns to the UK as planned he will have been outside the UK for less than five years and will therefore be a temporary non-resident. The gain on the shares will be taxed in the year he returns.
- If he is non-resident for more than five years, the gain on the shares will not be subject to UK CGT.
- The gain on the painting will not be subject to UK CGT as the painting was acquired after Bosun left the UK.
Double tax relief and treaties
Someone who is liable to UK IT on worldwide income may find that income arising in respect of foreign assets is taxable in two countries - the UK, and the country in which the income arises. A similar situation may arise in respect of CGT. Relief may be available via either a double tax treaty or double tax relief.
A double tax treaty, between the UK and the country in which the income arises, will set out how double taxation is to be avoided or minimised. The treaty could state that the income will only be taxed in one of the countries concerned (for example, the country in which the income arises). Alternatively, it could impose a maximum rate of tax in one of the countries.
UK double tax relief is available where there is no treaty or where an element of double taxation occurs, despite the existence of a treaty. Foreign tax suffered, up to a maximum of the UK tax on the foreign income (or transaction subject to CGT), is deducted from the UK tax liability.
Rory Fisher is an ACCA examiner
The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The author and the ACCA expressly disclaims all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.
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