Some recent changes to the rules on residence and domicile in the UK may have significant UK tax implications for UK expats and regular visitors to the UK. This article considers the new rules by looking at the case of (the fictional) John and Amy.
John is a 42-year-old partner in a law firm in the Cayman Islands. He was born in the UK and after university; John worked in the city for a few years before finding Amy, a charming, but feisty, red headed Irish girl whom he married in 1994. John and Amy decided to leave the UK in 1997 to work in Cayman. Two delightful children followed, Felix, 11, and Gemma, 9, both born in Cayman.
John and Amy retained their flat in South Kensington ‘just in case’, but subsequently decided to hold on to this, after transferring it to a BVI company, as an investment and a base for them when visiting London.
John's parents are in the UK; Amy's parents are in Ireland. John travels extensively, sometimes with Amy, and spends around 85 days a year in, or passing through, the UK en route to the international offices of his law firm, staying at the London apartment.
The children will board in the UK in the next few years and Amy would like to spend more time in London. John and Amy have a lovely beachfront five bedroom house in Cayman and are looking at buying a holiday home in Europe. John is actively involved in the Cayman community and now regards Cayman as his home. He enjoys travelling around the world but welcomes his return to the island.
Since they left the UK in 1997, John and Amy have probably given very little thought to UK tax but recent cases and changes to HM Revenue practice suggest that they may need to think again.
The starting point to determine John and Amy's UK tax exposure is to consider their residence and domicile position carefully.
Let's start with residence. The law on residence is a bit of a mess. For years this did not matter – HM Revenue & Customs published practical rules in its booklet IR20. Most tax advisers proceeded on the basis that if an individual was UK resident or non-UK resident on the basis of IR20 that was the end of the matter. However, this relative certainty has been thrown into doubt by recent cases where HM Revenue have successfully challenged taxpayers who have claimed to be not resident or domiciled in the UK and the production of new guidance from HM Revenue in its booklet HMRC6, which took effect on 6 April, 2009. IR20 still applies for the period before 6 April, 2009, so it cannot be ignored completely.
There are essentially two key tests for residence set out in IR20 and HMRC6. The first is the 183 day test. If you are physically present in the UK for 183 days or more in a given tax year then you are UK tax resident for that year.
The second test is the 91 day test. If you are physically present in the UK for 91 days or more in any given tax year, when averaged over a period of up to four years, then you are also tax resident.
Before 6 April, 2008, HM Revenue practice was, in most cases, to ignore days of arrival and departure when counting days. However, since 6 April, 2008, days of arrival in the UK will now be counted if the individual is in the UK at midnight, usually ignoring days of transit through the UK.
What is the position for John who is in the UK for less than 91 days on average?
HMRC6 makes it clear that the number of days spent in the UK is only one factor to take into account, albeit an important factor.
HMRC6 also states that: "Just because you leave the UK to live or work abroad does not necessarily prove that you are no longer resident in the UK if, for example, you keep connections in the UK such as property, economic interests, available accommodation and social activities or if you have children in education here. If you are someone who comes to the UK on a regular basis and have a settled lifestyle pattern connecting you to this country, you are likely to be resident here."
So applying these principles, is there a danger that John could still be regarded as UK resident? Well yes there is. Although John does not satisfy the 91 day count test he is still spending a significant number of days in the UK, he has retained a UK house and his parents are in the UK. He comes to the UK on a regular basis and there is a possibility that he could be said to have a settled lifestyle pattern connecting him to the UK.
He would argue that John made a distinct break with the UK when he moved to Cayman and that his settled and usual abode is in Cayman but there is a potential battle with HM Revenue.
Alternatively, even if John has ceased to be resident in the UK, there is a danger that he will be regarded as acquiring UK tax residence going forward. If his children go to school in the UK and his wife spends more time in the UK, the UK-connecting factors increase as does the risk of a challenge.
HMRC6 is untested so we will have to wait and see what happens but for now expats like John need to be extremely cautious. It seems clear that the new HM Revenue approach will make it harder for individuals leaving the UK to lose UK residence and easier for individuals visiting the UK to become UK resident.
The other key factor in determining UK tax exposure is domicile.
When John was born he acquired a UK domicile of origin from his father who was UK domiciled. John will only lose that domicile of origin in favour of a new domicile of choice if he satisfies two conditions: (1) he is physically present in another jurisdiction and (2) he has the intention to remain in that jurisdiction permanently or indefinitely.
Case law has shown that it is difficult to lose a domicile of origin – it has been said to have an "enduring quality" and "cannot easily be shaken off". The burden of proof is on the person asserting the change. So John with a domicile of origin in the UK needs to prove that he has acquired a Cayman domicile of choice.
Although John must show that a domicile of choice has been acquired on the balance of probabilities, case law has indicated that the acquisition of a domicile of choice is "a serious matter" and is "not to be lightly inferred from slight indications or casual words".
It is very important for John to have strong evidence to support a change. The weight to be attached to the evidence and the inferences to be drawn will be particular to John's case.
HM Revenue are looking very closely at claims to be non-UK domiciled and will challenge them. A domicile dispute is best avoided. To determine domicile the Court will look back at the whole of your life in minute detail. Those details will be included in a publicly available judgement – all privacy goes out of the window. If you think paying tax is the worst that can happen, think again!
What factors are relevant in determining domicile? Recent HM Revenue guidance refers amongst others to nationality, places of residence, location of family members, exercise of voting rights, membership of clubs and professional bodies, location of personal papers and items of financial or sentimental value, where wills have been prepared, religious, cultural and social connections, charitable and voluntary activities and intentions for the future. No one factor is conclusive – they all need to be taken together to form the whole picture.
It is important to have a full domicile review with an experienced tax adviser if you are uncertain about your domicile status. Documenting your domicile privately identifies weaknesses that can be corrected to prevent a dispute in the first place or puts you on the front foot if a challenge is made.
So John has a UK domicile of origin, because his father was UK domiciled. Has he acquired a Cayman domicile of choice? He needs to weigh his Cayman connections against his UK connections. On the Cayman side he has a substantial Cayman house, he spends most of his time in Cayman, his wife and children are in Cayman, he has a Cayman will, he is involved in Cayman charitable activities, his personal papers are in Cayman and he regards Cayman as his permanent home and wants to retire in Cayman. On the UK side his parents are in the UK, he has retained a valuable property in the UK and still spends a good number of days in the UK.
There is a good argument, based on these facts, that John has acquired a domicile in Cayman but by no means is it a certainty that John has shed his UK domicile of origin and a challenge is possible. This is also something that can change on a year by year basis. If John starts to spend more time in the UK or his wife and children live in the UK the balance of the domicile scales starts to shift and John may face a challenge in a later year.
Amy has an Irish domicile of origin, so she is in a better position from a UK tax perspective, because, even if she has not acquired a Cayman domicile, her fallback position is her Irish domicile. Has she acquired a Cayman domicile of choice? She probably has for the same reasons as John.
What happens if Amy moves to the UK? It would be for HM Revenue to prove that she has acquired a UK domicile of choice. While Amy has limited UK connecting factors, HM Revenue would have an uphill battle to show that she has lost her Irish domicile of origin.
UK tax implications
How important is it to establish residence and domicile outside of the UK?
If John and Amy are not UK resident, then they have no exposure to UK income tax and capital gains tax. If they are non-UK domiciled, they only have an exposure to UK inheritance tax on directly held UK assets. The Kensington flat is held through a BVI company, so John and Amy do not own a UK asset directly.
In contrast, if John and Amy are UK resident and domiciled, then all of their worldwide income and capital gains are subject to UK taxes and all of their worldwide assets exposed to UK inheritance tax -with the added difficulty of only a limited spouse exemption if John dies first and Amy retains her Irish domicile.
If John and Amy are UK resident but can remain non-UK domiciled, then they are in a better position. They are taxed on the “remittance basis”, which means that their non-UK income and non-UK capital gains are only taxed, if that income or those gains are remitted or brought into the UK either directly or indirectly.
However, since 6 April, 2008, the definition of “remittance” has been widened and tax planning “loopholes” removed. The remittance basis must also be formally claimed and once John and Amy have been UK resident for seven tax years out of the last nine tax years, then they must each pay a remittance basis charge of £30,000 for the privilege of claiming that basis of taxation.
Expats and visitors who regularly spend time in the UK will need to carefully consider their residence and domicile position to determine if the recent changes have an impact. However, with careful and early planning it may be possible to reduce any potential UK tax exposure.