There were attention grabbing headlines recently about British business magnate Lord Sugar. It appears that he tried to utilise rules to prevent UK tax on substantial dividend payments by moving to Australia and becoming non-UK tax resident.
The story attracted attention, apart from the celebrity connection, because of the amount of tax at stake and the niche legislation which deems members of the House of Commons and House of Lords as being within the scope of UK tax regardless of their residence status.
Most people will not need to concern themselves with the legislation that stumped Lord Sugar and his advisers but the headline does segue into wider issues and misconceptions around the taxation of non-residents.
Given the complexity of UK tax legislation, many are left bewildered about the basics such as who is required to pay UK tax and what taxes are they required to pay?
The tax system considers both an individual’s tax residence and their “domicile” as relevant factors in assessing their exposure to tax. These are two very different concepts, domicile being a status in common law comprising a person’s “place of belonging”.
Tax residence, on the other hand, is determined under the statutory residence test, which is mechanically set out in legislation and considers days of presence in the UK and other connecting factors.
It is a common misconception that individuals present in the UK for less than 183 days are non-UK tax resident. Unfortunately, this is rarely true and the provisions are much more nuanced.
Once the initial scoping of an individual’s residence and domicile status has been established, the standard position is that UK residents are subject to UK tax on their worldwide income and gains. Non-residents, on the other hand, are only subject to income tax and capital gains tax on very limited UK sources - the majority fall outside the scope of UK tax.
Individuals who are not domiciled in the UK can benefit from the non-dom regime which relieves certain foreign income and gains from UK tax. This favourable regime is a hotly debated issue; the Labour Party has announced an intention to withdraw it if they win the next general election.
These basic principles suggest that UK income tax and capital gains tax can, in theory, be avoided by an individual becoming non-UK tax resident for short periods of time, such as a single tax year, and later returning after having realised significant tax-free income and gains abroad. Whilst this is partly true there are rules which militate against this outcome.
These temporary non-residence rules can apply when someone is returning to the UK after a period of non-residence lasting less than five years. The effect is that certain income and gains arising during that non-resident period are taxed in the year of their return to the UK. If the individual is non-resident for more than five years, the rules do not apply. The position can be further complicated where an individual leaves the UK or returns part way through a tax year.
These rules are complex but there are some commonly misunderstood issues here. For capital gains tax purposes, the rules only apply to assets held before the individual’s departure from the UK. UK residential property remains within the scope of UK capital gains tax regardless of the individual’s residence status.
Regarding income tax only certain income is caught, mainly that arising from substantial draw-down events such as pension payments, distributions from closely controlled companies, chargeable event gains, and offshore income gains. Most other income, such as dividends from non-closed companies, foreign employment income, and various types of investment income will not be taxed upon the individual’s return.
It is important to understand before embarking on a period of non-residence exactly what income and gains would, and would not, be brought within the rules.
The tax system is an outlier in having temporary non-residence provisions to the exclusion of an “exit tax”. Many jurisdictions, such as France and Germany, currently have exit regimes whereby individuals are taxed on any unrealised gains on assets when they move abroad. Anglo-Saxon nations such as the US, Australia, and Canada impose similar charges.
Whether these exit charges are more effective is open for debate but some argue that the current temporary non-residence rules are insufficient to protect the UK tax base.
Under the current rules, there are both opportunities and pitfalls to consider when an individual leaves the UK. It is always advisable that such individuals seek specialist advice, regardless of how long they intend to stay abroad, to ensure that their tax position is appropriately considered and reported.