Dual employment contracts have hit the headlines in recent months. Often reserved for internationally mobile senior executives, one high profile financial services institution announced earlier this summer that it was ending a dual employment contract arrangement for one of its most senior employees. And from 6 April 2014, the Treasury has put in place measures to tackle the artificial use of dual employment contract arrangements. The new provisions will apply to general earnings from overseas employment, income from overseas employment-related securities and overseas employment income provided through third parties on and after 6 April 2014.
What are dual employment contracts?
Dual contract arrangements arise when an individual enters into an employment contract with two employers: typically, one contract is entered into in relation to UK duties, and another for international duties. The arrangements can give tax advantages to a UK resident non- domiciled employee who works partly inside and partly outside the UK and perhaps unsurprisingly they are popular with this group. In addition, depending on the jurisdiction, there can be employment law benefits to employers of using this type of arrangement.
On a basic level, the structure is intended to take advantage of the fact that overseas earnings of a non-domiciled employee are taxable on something called the “remittance basis”, which means that tax is paid on foreign earnings only to the extent that the foreign earnings are brought, used or enjoyed in the UK. Alternatively, a UK resident non-domiciled individual can elect annually to pay tax on their foreign earnings as they arise, the so-called “arising basis”. Whilst there is nothing illegal about such arrangements, HMRC have long attacked dual employment contract arrangements on the basis that they do not work - HMRC believing that in the real world the employee has only one employment, not two, with duties inside and outside the UK. One of the key areas of concern for HMRC has been where the split in duties has been geographical; classically the type of situations where say an employee performs marketing duties to prospective clients in the UK under a UK employment contract and the same duties to international clients under a non-UK employment contract. In this type of situation HMRC has generally sought to prove that substantive duties covered by the non-UK employment contract were actually performed while the employee was in the UK.
Why all the fuss now?
In the Autumn Statement in 2013, it was announced that the artificial use of dual contracts by non-domiciles was to be attacked, so it has been an agenda item for some time. And, as matters have developed, HMRC’s view appears to have hardened with the preface to their explanatory notes saying that in most cases separate contracts will have been artificially arranged in order to obtain a tax advantage. The crackdown aligns with the spirit of the Coalition Government’s wider aim to make the tax system fairer and to prevent contrived arrangements by high earning individuals to avoid tax, so there is clearly the political will to impose change and enforce it in this area. HMRC predicts that the new rules will impact approximately 350 non- domiciled individuals and, reassuringly, they say there will be no effect on compliant employers!
What does it mean?
Essentially, employment income caught by the new rules will be taxable on the “arising basis” rather than the “remittance basis” if, broadly, all of the following conditions are met:
- an individual has a UK employment and one or more foreign employments;
- the UK employer and the foreign employer are the same or associated with one another;
- the UK and the foreign employment are related to each other; and
- the foreign tax rate that applies to the income of the overseas employment is less than 65% of the UK’s additional rate of tax (which is currently 45%).
So, if an employee pays tax at 0% on his overseas earnings, this is less than 65% of 45%. This means tax will be payable on those earnings in the UK. The additional income tax will be payable under self-assessment if the overseas employer does not have a tax presence in the UK. As for employers’ national insurance contributions (NIC), the starting point is that no employers’ NIC would be due unless the overseas employer has a place of business in the UK. This could be an issue where the individual has separate employment contracts with an overseas head office and the London branch of, say, a bank. If employers’ NIC are due, the new rules will mean an additional cost of 13.8% of the employee’s overseas earnings.
Importantly, there is no general exclusion from the new rules for dual employment contracts that are not motivated by tax avoidance. However, the new rules will exclude directors who own less than 5% of their employer, exclude income earned before 6 April 2014 and take account of employments held for “legal” or “regulatory” reasons, albeit that the accompanying guidance to the legislation suggests that a narrow interpretation will be applied to the scope of these two reasons.
In light of the new rules, we are seeing organisations review the dual employment contract arrangements they have in place and, in the context of transactions, we are seeing them used considerably less frequently.