United Kingdom: Government Releases Updated Proposals on Statutory Residence Test
On 21 June 2012, HM Treasury released a document1 that summarizes the responses to the consultation on a U.K. statutory residence test, which we reported on in Flash International Executive Alert 2012-116 (20 June 2012). This document will serve as a basis for draft legislation on the Statutory Residence Test and details the reforms to the concept of Ordinary Residence (the government has previously announced that the concept of Ordinarily Residence will be abolished). It will also serve as a basis for additional consultations.
Tax residence in the U.K. is a highly complex matter that can create complications for globally-mobile employees and their multinational employers.
The government has made a number of changes in response to the representations received and the main changes are briefly discussed in this Flash International Executive Alert.
This Flash International Executive Alert also re-examines some of the original proposals2 made by the government, and discusses refinements from the perspectives of globally-mobile employees and their employers. A different perspective applies to individuals who are not employees.
Currently there is no single statutory test for residence in the United Kingdom. The extent of liability to U.K. tax on earnings depends on a person’s residence status in the United Kingdom.
In June 2011, the government originally released a consultation document on a Statutory Residence Test (SRT)3 with detailed consultation and discussion taking place in the intervening period.4
As noted earlier, at the present time there is no single statutory test for residence in the United Kingdom. An individual who is in the U.K. for 183 days or more in a tax year will be U.K. resident. Someone who spends no time in the U.K. in a tax year is unlikely to be resident. In other cases, Her Majesty’s Revenue & Customs (HMRC) – and, if necessary, the courts – determines an individual’s residence status from case law principles. Recent cases have demonstrated the difficulties that can arise from this process (please refer to earlier Flash International Executive Alert newsletters referenced in footnote 2).
Conclusive Non-residence Tests
• Increase in the number of days allowed in the U.K. from fewer than 10 days to fewer than 15 days.
• A further consultation on two alternative options to amend the definition of “full time work abroad”: to increase the number of working days allowed in U.K. from 20 to 25 days or increase the number of hours that constitute a working day from 3 hours to 5 hours – working less than 5 hours not being considered a working day for the purposes of the “full time work abroad” test.
Conclusive Residence Tests
• A further consultation on potentially increasing the qualifying period for the purposes of the “full time work in the U.K.” test from 9 months to 12 months
Other Connection Factors and Reforms
• The “family” connection factor to be amended so that children only in the U.K. to attend an educational establishment who do not board at the establishment are more likely to be excluded. Also, only days spent with children in the U.K. will be counted.
• Definition of “accommodation” simplified.
• Provision for days spent in the U.K. due to exceptional circumstances to be disregarded for ‘day counting’ purposes, up to 60 days maximum in tax year.
• Split-year treatment will be available for “trailing spouses/partners.”
• The consultation document clarifies that post-departure the number of days which can be spent in the U.K. during a full year is apportioned.
• Ordinary residence will be abolished for nearly all tax purposes.
• Overseas Work-days Relief to be restricted to non-domiciled individuals.
• An anti-avoidance rule is being considered to catch individuals who are present in the U.K. on a “large” number of days without ever being in the U.K. at midnight.
The Statutory Residence Test (“SRT”)
The SRT will apply for the purposes of income tax, capital gains tax, and inheritance tax with effect from 6 April 2013. It will not apply for U.K. social security (National Insurance Contributions (NICs)) or other non-tax purposes.
Resident or Not Resident
• the individual was not resident in the U.K. in all of the previous three tax years and is present in the U.K. for fewer than 46 days (45 days in the previous consultation document) in the current tax year; or
• the individual was resident in the U.K. in one or more of the previous three tax years and is present in the U.K. for fewer than 16 days (10 days in the earlier consultation document) in the current tax year; or
• the individual goes to work full-time abroad and he or she is present in the U.K. for fewer than 90 days in the tax year and no more than 25 days are spent working in the United Kingdom. (Note: the original consultation suggested a limit of 20 days – the government is requesting views on its suggestion to increase this to 25 days and we have therefore used 25 days throughout this newsletter.)
An individual who does not meet any of the above tests will be regarded as resident in the U.K. when:
• the individual is in the United Kingdom for 183 days in a U.K. tax year (a U.K. tax year is from 6 April to the following 5 April) – a day in the U.K. for this test is a day where the individual is present in the U.K. at midnight; or
• the individual only has one home and that home is in the U.K. (or two or more homes and they are all in the U.K.) for a period in excess of 90 days (if the individual is in the process of selling a home, it will not count as a home for the purposes of the test after he or she has moved out of the property); or
• works full-time in the United Kingdom.
If these tests are not conclusive, the connections an individual has with the U.K. and the number of days that the individual spends in the U.K. have to be considered.
If an individual is regarded as not resident in the U.K. for all of the three previous U.K. tax years, the connections to be considered are whether the individual has:
• a U.K. resident family;
• a substantive U.K. employment (including self-employment);
• accessible accommodation in the U.K.;
• spent 90 days or more in the U.K. in the previous two tax years.
If the individual has been resident in the U.K. in any of the previous three tax years, it is proposed that the individual’s residence status for the current year is to be determined as explained below.
Determining Residence for Individuals Resident in One or More of the Previous Three Tax Years
When an individual has been resident in one or more of the previous three U.K. tax years, the connection tests are as outlined below. (Please note that these tests are only relevant if the individual has not been deemed to be nonresident by virtue of being in full-time employment abroad and spending fewer than 90 days in the United Kingdom. Please see below for a discussion on the meaning of “full-time employment abroad.”)
The connection tests are as outlined above, namely:
• individual has a U.K. resident family;
• individual has a substantive U.K. employment (including self-employment);
• individual has available accommodation in the U.K.;
• individual spent 90 days or more in the U.K. in either of the two previous tax years with an additional connection because resident in any one of the previous three years:
• individual spends more days in the U.K. in the current tax year than in any other single country.
Full-Time Work Abroad
The government intends to further consult on two alternative options to amend the definition of “full time work abroad” (FTWA):
• Increasing the number of working days allowed in the U.K. from 20 to 25 working days, or
• Increasing the number of hours that constitute a working day from 3 to 5 hours.
It was confirmed at a meeting with HMRC attended by KPMG LLP (U.K.) on 21 June 2012, that the above are alternatives. In other words, the intention will not be to accept both of the proposed changes.
FTWA is defined as employment under one or more contracts of employment for 35 hours per week or more or a trade or profession carried out wholly abroad. The work must be carried out for a complete U.K. tax year and the government is now inviting comments on its suggestion that no more than 25 days of work can be carried out in the United Kingdom (previously 20 days).
A working day is a day on which more than potentially five hours of work (previously three) are carried out. If the employee carries out less than five hours work in a day, then this will not count towards the 20-day limit. If the individual is not in the U.K. at midnight, but has worked for 5 hours in the U.K. on that day, then that day will count towards the 20-day limit. If the day limit is increased to 25 days then it is proposed that a working day will be 3 hours or more.
In addition, the person must not be present in the U.K. for more than 90 days in the tax year.
If an individual changes employment during the tax year, it will be possible to remain regarded as FTWA provided that the 35 hour per week average is met over the full year – where there is a gap between employments, a maximum of 15 weeks will be discounted for the purposes of calculating the average as long as no work is undertaken throughout the gap period.
Full-Time Work in the U.K.
The original consultation document proposed that an individual should be treated as working full-time in the U.K. if he or she were employed in the U.K. over a continuous period of 9 months, and no more than 25 percent of his or her duties were carried on outside of the United Kingdom. The government is inviting views on increasing the qualifying period from 9 months to 12 months.
Definition of Work
The government proposes that an individual will be treated as working if he or she is performing the duties of the office or employment, including:
• any days spent training or reporting on progress;
• travel undertaken in the performance of duties, to the extent that it would be tax deductible for the individual.
Currently, training within limits where no productive work performed and reporting on progress are considered incidental and do not preclude being regarded as in full-time employment abroad.
Under current U.K. tax rules, an individual is either resident or not resident in the U.K. for the whole tax year. However, by Extra Statutory Concession (ESC) A11, the tax year can be split into periods of residence and non-residence in certain circumstances when an individual comes to or leaves the U.K. part way through the year. As part of the SRT, the intention is to place the split-year basis on a statutory footing.
The tax year will be split when a person:
• becomes resident in the U.K. by virtue of his or her only home being in the U.K.;
• becomes resident by starting full-time employment in the U.K.;
• establishes his or her only home in a country outside the U.K. and satisfies the condition that within 6 months of departure the individual’s normal home is overseas and does not come back to the U.K. for more than 15 days in that tax year;
• loses U.K. residence by virtue of working full-time abroad;
• returns to the U.K. following a period of working full-time abroad and either starts work in the U.K. or has his or her only home in the United Kingdom.
In the year of departure, the number of working days permitted will be pro-rated from the 25 (or 20) days permitted for a full tax year. Similarly, the number of days of presence will be pro-rated from the 90 days for a full tax year.
A new anti-avoidance rule will be introduced to counteract the risk of individuals creating artificial, short periods of non-residence to avoid U.K. tax. The government will introduce a new rule to tax certain types of income in the year of returning to the U.K. and becoming U.K. resident where this occurs within five years of leaving.
As noted earlier, the government is also considering a supplementary anti-avoidance rule which would apply only to those who are present in the U.K. on a large number of days without ever being in the U.K. at midnight.
In addition to the concept of residence for tax purposes, the U.K. has a separate concept of ordinary residence. Again, there is no statutory definition of this for tax purposes. Currently, ordinary residence signifies that residence in the U.K. is:
• for a settled purpose;
• forms part of the regular and habitual mode of the individual’s life;
• when an individual has come to the U.K. voluntarily (the fact that an individual has been sent to the U.K. by his/her employer does not make the individual’s presence involuntary).
Individuals can be regarded as U.K. resident and ordinarily resident (ROR) or resident but not ordinarily resident (RNOR). The distinction is important because, with one exception (non-U.K.-domiciled employees of a non-U.K.-resident employer where there are no U.K. duties), ROR employees are taxable on their worldwide earnings whether remitted to the U.K. or not. RNOR employees are taxable on their earnings for U.K. duties whether the employee’s earnings are paid in the U.K. or not. Such employees, however, can elect for the remittance basis, and then their earnings for non-U.K. duties are only taxed in the U.K. if remitted to the United Kingdom. This is commonly referred to as “overseas work-days relief.”
The government has confirmed its intention to abolish the concept of ordinary residence for tax purposes but will introduce an “overseas work-days relief.”
Overseas Work-days Relief
The government recognizes the benefits of relief for overseas work-days for short-term secondees and their employers and has, therefore, confirmed that Overseas Work-days Relief (OWR) will be retained and placed on a statutory footing, but restricted to non-domiciled individuals only.
The calculation of work-day relief can be very complex and HMRC had previously introduced a Statement of Practice (SP) 1/09 which relaxed the strict mixed-fund rules and allowed RNOR employees to calculate their U.K. tax liability by apportioning the total income received in the tax year by looking at the number of U.K. work-days and number of non-U.K. work-days over the U.K. tax year.
Foreign Service Relief on Termination Payments
The abolition of ordinary residence is likely to have a significant effect on the availability of foreign service relief in respect of termination payments. This will be the subject of a later Flash International Executive Alert.
The government welcomes views on the issues raised in this further consultation document by 13 September 2012.
Following this consultation a further draft of the legislation will be published in a draft Finance Bill 2012 later this year.