The Internal Revenue Service recently issued Revenue Ruling 2011-19,1 which provides good news for many United States taxpayers who are long term residents of the United Kingdom. The ruling concludes that the current £30,000 Remittance Basis Charge (“RBC”) is eligible for the credit against foreign taxes under section 901 of the Internal Revenue Code.
Historically, the income and capital gains of individuals who were resident in the United Kingdom but who were not classified as “domiciled” in the UK under UK law were taxed based on where the income or gains were generated. Generally, such “resident non-doms” were taxed on UK source income and gains as such income was recognized and such gains were realized. This scheme is referred to as the “arising basis” of taxation. In contrast, non-UK source income and gains became liable to UK tax only when the income or gain was remitted to the UK. This scheme, known as the “remittance basis” of taxation, could be quite favorable for many individuals who reside in the UK and have significant non-UK source income.
Starting in 2008, the tax system changed for long-time resident non-doms. Now a non-dom who is eighteen years of age or older and who has been resident in the UK for at least seven of the prior nine years must pay the RBC of £30,000 in order to take advantage of remittance basis taxation. Resident non-doms who do not choose to pay the RBC must instead report and pay tax on worldwide income and gains on an arising basis.
Although the system is complex, the £30,000 RBC formally is treated in the UK as a tax on the unremitted non-UK income and gains of these resident non-doms in the year in which such income and gains are recognized or realized. That treatment notwithstanding, US tax practitioners have been concerned that the charge may not be treated in the US as a direct tax on income and gains, and therefore may not be eligible for a credit against US tax with respect to the foreign tax paid on current income.
Every US citizen or resident is subject to tax on his or her worldwide income, regardless of where the individual resides or where the income is earned. Absent some form of relief, a US taxpayer who pays both US income tax and the £30,000 RBC on non-UK source income could be subject to double tax on that income. Given the magnitude of the RBC this was a very significant issue for many UK resident non-doms who also are US taxpayers. Many such taxpayers have voluntarily subjected their worldwide income and gains to the currently higher UK tax rates (and to UK reporting) in order to avoid the possibility that the RBC would not be creditable for US tax purposes.
Happily, Revenue Ruling 2011-19 concludes that US taxpayers who pay the RBC may credit it against their US income taxes. This will simplify significantly the analysis of whether a US taxpayer should choose to pay the RBC or instead to submit to UK taxation on an arising basis.
Revenue Ruling 2011-19 specifically examines whether the RBC qualifies for the credit allowed for foreign taxes under section 901 of the Internal Revenue Code. This section allows a credit for the amount of any income, war profits or excess profits tax (collectively, an “income tax”) paid or accrued during the taxable year to any foreign country or to a possession of the United States. A foreign levy is an “income tax” for purposes of section 901 only if (i) it is a tax and (ii) the predominant character of that tax is that of an income tax in the U.S. sense. The Internal Revenue Service concluded that the RBC is a “tax” because it is a compulsory payment pursuant to the authority of the government of the United Kingdom to levy taxes. The Service also concluded that the RBC, in combination with the remittance basis tax system for resident non-domiciliaries, is a single levy that is an income tax in the US sense. Accordingly, the £30,000 RBC is a foreign tax that may be credited against federal income tax by U.S. taxpayer. 2
The taxpayer-friendly guidance provided by this Revenue Ruling may be very beneficial to the many US taxpayers who are long term residents of the United Kingdom and who have non-UK source income. Remittance basis taxation in the UK will be an even more attractive option for these individuals, as the availability of the foreign tax credit means that payment of the RBC will not increase their overall income tax liability.