Does UK tax apply?
For an internationally mobile employee, establishing whether income from employment is subject to UK income tax is by no means straightforward. It requires an understanding of the rules under UK law and how these rules may then be overridden in any given case by a double tax treaty.
Even UK law has one set of rules for "general" earnings and another set of rules for "specific employment income" such as income relating to shares and share options acquired by employees.
Under UK law, three central concepts govern liability to UK tax on general earnings from an employment: residence, domicile and source.
UK resident and domiciled persons are liable to UK tax on their earnings for any given year regardless of where they are employed. It makes no difference if the employee only receives the earnings in a subsequent year in which they are no longer resident in the UK. The meaning of receiving payment includes entitlement to payment and is extended still further for company directors.
However, if a UK resident is not domiciled in the UK, they may be able to access a preferential tax regime (remittance basis taxation) for foreign employment income. Under this regime, the income from the foreign employment is not taxed if the income is left overseas and not "remitted" or brought back to the UK. This regime may be available to a non-domiciled employee in two cases:
- the first case is that the employee has a period of 3 years of non-residence in the last 5 years; and
- the second case is that the employment is with a foreign employer and the duties are all performed abroad. The second case gives rise to dual contract arrangements for non-domiciled individuals: one contract for foreign work and one for UK work. Anti-avoidance rules now prevent too much of the salary being attributed to the contract for foreign work.
In general, non-UK residents are only liable to UK taxes in respect of UK-source income – in the case of employment income that means that the income is derived from work physically done in the UK. For non-residents, there is no UK tax liability on income from their work done abroad even if they receive the earnings in a subsequent year when they have become UK resident. However, military personnel, civil servants and diplomats continue to be liable to UK tax. For both this rule and the rule for non-domiciled individuals working abroad, incidental work in the UK is disregarded.
An individual may be resident in one part of a tax year and not in another part of the tax year; in that case the rules above need to be applied separately to each part of the tax year.
Employee shares and share options
Employees may receive shares or share options because of their employment. Some or all of the return on the shares or share options may be deemed to be employment income under provisions in the tax code. These provisions are mainly directed at counteracting tax avoidance.
Special rules then apply to this deemed income if the employee has not been domiciled or resident in the UK in either one of two periods depending on the provision under which the income is deemed to arise. The first period is the period during which the shares or share options are held. The second period is the tax year in which the income is deemed to arise. The rules refer to this as the relevant period.
As with general earnings, the effect of these rules is that a proportion of the income may not be liable to UK tax or may only be taxed if the income is brought into the UK.
The calculation of this proportion involves treating the income as accruing on a daily basis over the relevant period. For each day, you need to see if the employee is resident in the UK or not resident in the UK.
- If the employee is resident in the UK but has a period of 3 years of non-residence in the last 5 tax years, the deemed income has to be apportioned between UK and non-UK work and the amount apportioned to non-UK duties is not taxable in the UK if left overseas.
- If the employee is resident in the UK but the employment is with a foreign employer and the duties are all performed outside the UK, the deemed income is also not taxable in the UK if left overseas.
- If the employee is not resident in the UK and the duties are all performed outside the UK, the deemed income is not taxable in the UK regardless of whether it is left overseas or brought into the UK.
- If the employee is not resident in the UK and the duties are performed partly in the UK and partly outside the UK, the deemed income has to be apportioned between UK and non-UK work. The amount apportioned to the non-UK work is also not taxable in the UK regardless of whether it is left overseas or brought into the UK.
- If the employee is resident in one part of a tax year and not in another part of the tax year, then the rules above need to be applied separately to each part of the year.
The rules incorporate similar anti-avoidance rules to deal with dual contract arrangements and also treat military personnel, civil servants and diplomats as continuing to be liable to UK tax.
Double Tax Treaties
The UK has double tax treaties with more than 130 other countries and most of those are based on the OECD Model agreements. Most of these treaties provide that an employee who comes to work in the UK on a short-term basis is taxed only in their home country. This generally means less than 183 days in the tax year or any period of 12 months.
Two further conditions typically need to be satisfied. The first condition is that the employee's remuneration is paid on behalf of an employer who is not resident in the UK. The second condition is that the remuneration is not borne by a UK permanent establishment of the overseas employer.
The special rules for deemed employment income arising on shares or share options are intended to limit the proportion of income which is taxable in the UK. However, there could still be mismatches between the UK tax system and a foreign tax system in relation to the timing or amount of a tax liability
There are some specific provisions in double tax treaties which help protect an internationally mobile employee against this potential double taxation and there are others which aim to prevent the employee from avoiding taxation by exploiting differences between the tax systems.
The UK special rules are intended to tax only an amount which equates to the amount earned in the UK. However, there may still be circumstances in which the taxpayer may need to claim relief under a double tax agreement. For example, the exchange of notes to the UK/USA double taxation convention provides for the taxable gain on a share option to be apportioned between the two countries based on residence in the period between grant and exercise. This may be different from the UK rules because the UK rules look at the period from to the earlier of exercise or vesting. The taxpayer may be in a better position by claiming relief under the double tax treaty.
Employees sometimes consider that they are entitled to double tax relief against income tax and therefore ask the employer to anticipate the relief by applying payroll taxes only to the amount actually taxable in the UK. If the employee is resident in the UK for the purposes of the double tax agreement, the UK will give relief for foreign tax by way of a credit. In these circumstances, it is not possible for the employer to anticipate the double tax relief except by making a special agreement with HMRC. If the double tax relief is given by way of exemption, payroll taxes do not need to be applied to the exempt amount. However, it would still be sensible for the employer to agree such an approach with HMRC because the employer will be at risk if the exemption was not available.
National Insurance contributions (NICs)
The general rule is that employees pay social security charges in the country where they work. Unlike double tax treaties, international social security agreements do not allow for apportionment of income.
Income from shares and share options is generally subject to NICs. However there are special rules that grant internationally mobile employees some relief from a double charge to NICs on this income. The first step is to identify the relevant period in accordance with the income tax rules. The income is then treated as if it had accrued evenly over the relevant period. NICs are not charged in respect of any days in the relevant period which meet one of three conditions. The first condition is that the employee did not meet conditions of residence or presence in the UK. The second condition is that the employee was subject to the social security system of another European Economic Area (EEA) member state or Switzerland. The third condition was that the employee was subject to the social security system of a country with which the UK has a reciprocal social security agreement.