With the aim of making the United Kingdom more attractive to foreign investors, the 2011 Budget announced two consultations: one on the introduction of a statutory residence test and the other on changes to the remittance basis rules. The consultations have been published and are open for responses until September 9 2011. The changes will take effect from April 6 2012. This update considers the consultation on the proposed statutory residence test.
The rules for determining whether an individual is resident in the United Kingdom for tax purposes consist of a mixture of case law (some dating back to the 19th century), guidance of questionable assistance from Her Majesty's Revenue and Customs (HMRC) and a few broad statutory provisions. This often makes it difficult to advise with confidence as to whether someone is a UK resident. As such, the proposed introduction of a statutory residence test is to be welcomed.
The proposed test combines a presence test and a connections test. It will apply only to individuals and will cover income tax, capital gains tax and inheritance tax. It will supersede all existing legislation, case law and guidance for tax years following its introduction.
'Day of presence'
For the purposes of the test, the definition of a 'day of presence in the United Kingdom' will be the same as that which applies for the remittance basis for taxation (ie, a day on which an individual is in the United Kingdom at midnight at the end of the day). A day spent in transit, where the individual arrives in the United Kingdom as a passenger, departs on the next day and does not engage in activity that is substantially unrelated to his or her passage through the United Kingdom will not count as a day of presence.
The proposed residence test is divided into three parts.
Part A sets out conclusive non-residence factors. An individual will be non-resident in a tax year if he or she:
- was not resident in the United Kingdom in all of the previous three tax years - such an individual is defined in the consultation as an 'arriver' - and is present in the United Kingdom for fewer than 45 days in the current tax year;
- was resident in the United Kingdom in one or more of the previous three tax years - such an individual is defined in the consultation as a 'leaver' - and is present in the United Kingdom for fewer than 10 days in the current tax year; or
- leaves the United Kingdom to carry out full-time work abroad, provided that he or she is present in the United Kingdom for fewer than 90 days in the tax year and no more than 20 days are spent working in the United Kingdom in the tax year.
Part B sets out conclusive residence factors. An individual is resident in the United Kingdom in a tax year if he or she:
- is present in the United Kingdom for 183 days or more in a tax year (ie, the equivalent of the old statutory test);
- has only one home, which is in the United Kingdom (or has two or more homes, both or all of which are in the United Kingdom); or
- carries out full-time work in the United Kingdom.
If an individual satisfies a condition in both Part A and Part B, Part A will prevail and the individual will be non-resident in the tax year in question.
Part C acts as a tie-breaker where neither Part A nor Part B determines the position. It looks at four or five relevant UK 'connection factors' and compares them with the number of days that the individual spends in the United Kingdom in a tax year. The factors are as follows:
- Family - the individual's spouse or civil partner or 'common law equivalent'(1) (unless they are separated) or minor children are resident in the United Kingdom.
- Accommodation - the individual has accommodation in the United Kingdom which is accessible to him or her as a place of residence and is so used by the individual or his or her family during the tax year (subject to exclusions for some types of accommodation).
- Substantive work in the United Kingdom - the individual does 'substantive' (but not full-time) work in the United Kingdom, defined as 40 days or more in a tax year on which more than three hours of work are undertaken during the day.
- UK presence in a previous year - the individual spent 90 days or more in the United Kingdom in either of the previous two tax years.
- More time in the United Kingdom than in other countries - a leaver spends more days in the United Kingdom in the tax year than in any other single country.
For an arriver, the test will work as follows in any tax year using the first four of the five Part C factors. Where he or she spends:
- fewer than 45 days in the United Kingdom, he or she is always non-resident (under Part A);
- 45 to 89 days in the United Kingdom, he or she is resident only if four factors apply;
- 90 to 119 days in the United Kingdom, he or she is resident only if three or more factors apply;
- 120 to 182 days in the United Kingdom, he or she is resident only if two or more factors apply; and
- 183 days or more in the United Kingdom, he or she is always resident (under Part B).
For a leaver, the test will work as follows in any tax year using the five Part C factors. Where he or she spends:
- fewer than 10 days in the United Kingdom, he or she is always non-resident (under Part A);
- 10 to 44 days in the United Kingdom, he or she is resident only if four or more factors apply;
- 45 to 89 days in the United Kingdom, he or she is resident only if three or more factors apply;
- 90 to 119 days in the United Kingdom, he or she is resident only if two or more factors apply;
- 120 to 182 days in the United Kingdom, he or she is resident only if one or more factors apply; and
- 183 days or more in the United Kingdom, he or she is always resident (under Part B).
The consultation requests views on, and other suggestions for, the tests in Parts A, B and C.
HMRC's existing concessions, enabling a tax year to be split into periods of residence and non-residence when individuals leave the United Kingdom or arrive there during a tax year, will be replaced by statutory rules. These rules will apply where an individual's arrival in or departure from the United Kingdom relates to full-time employment, or where the individual has his or her only home:
- in the United Kingdom; or
- outside the United Kingdom in a country in which he or she has become tax resident and from which he or she does not return to the United Kingdom in the relevant tax year.
The rules for accompanying spouses or civil partners of individuals who leave the United Kingdom for full-time work abroad will also apply, provided that their sole or main home is outside the United Kingdom.
In order to prevent short periods of non-residence from being used to avoid liability to UK income tax, certain types of investment income that accrue during a period of non-residence of fewer than five tax years to an individual who has been a UK resident in four of the previous seven tax years are likely, for tax purposes, to be deemed to accrue to the individual in the year in which he or she returns to the United Kingdom.
The consultation does not propose transitional rules. Instead, the existing rules should apply for tax years up to and including 2011-2012. However, the consultation invites views on this subject.
Unless transitional rules are introduced, if the Part C test is relevant to an individual, his or her residence status in 2012-2013 and 2013-2014 will depend partly on the number of days spent in the United Kingdom in one or both of tax years 2010-2011 and 2011-2012. If he or she has exceeded 89 days' presence in the United Kingdom in either tax year, this connection factor will be an issue. Although nothing can be done about 2010-2011, individuals may wish to consider arranging their affairs to ensure that they do not exceed 89 days of UK presence in 2011-2012.
As the proposed test is drafted, arrivers will be able to maintain their non-residence status by ensuring that they spend fewer than 90 days in the United Kingdom in every tax year (including 2010-2011 and 2011-2012, if relevant) - this is effectively a pure presence test. However, such individuals must bear in mind that an average of 90 (now 89) days in the United Kingdom over a number of years will no longer be relevant: each year's day count will stand alone.
Ordinary residence is a different concept from residence and is primarily relevant to an individual's liability to tax in two situations. Individuals who are not ordinarily resident may claim or otherwise be entitled to the remittance basis of taxation for:
- foreign investment income; and
- overseas workday relief in relation to income from foreign employment duties paid by a UK employer which is, accordingly, UK source income.
The residence consultation proposes a new statutory definition of 'ordinary residence', according to which an individual who is resident in the United Kingdom should also be treated as ordinarily resident unless he or she has been non-resident in all of the previous five tax years, in which case he or she may be treated as not ordinarily resident. After a maximum of two tax years following the individual's tax year of arrival, he or she would become ordinarily resident in any event. Notwithstanding an individual's residence status in previous years, it is proposed that he or she will be ordinarily resident if the individual:
- is resident in the United Kingdom on the basis that his or her only home is there; or
- has more than one home and all of their homes are in the United Kingdom.
It is also proposed that the concept of ordinary residence could be scrapped other than in relation to overseas workday relief and might be restricted to non-domiciled individuals. The consultation requests views on these proposals, including alternative suggestions for the proposed definition.
The proposed residence test will introduce a welcome level of certainty. The scope of the existing lifestyle connection factors has been narrowed. Social ties have been eliminated from the test, meaning that individuals who seek to leave the United Kingdom will no longer have to consider withdrawing from UK-based clubs and associations; nor will they need to close UK accounts. Equally, individuals coming to the United Kingdom may make such connections without the risk of becoming resident on such basis alone.
Some of the definitions should be clarified - for example, what counts as 'work' for these purposes? However, the consultation requests views on the definitions and it is hoped that such issues will be addressed in the legislation.
A number of the time limits for days that can be spent in the United Kingdom, both working and generally, are tight (eg, the limits of 10 days and 20 working days in Part A). Ideally, these limits should be extended before the test is finalised.
For further information on this topic please contact Anthony Thompson at Lawrence Graham by telephone (+44 20 7379 0000), fax (+44 20 7379 6854) or email ([email protected]).