UNITED KINGDOM: SPECIAL EXPATRIATE FISCAL REGIME

The UK is no tax haven, but it does have relatively low tax rates compared with some other European countries, and it offers exemption from tax for income from foreign investments for people who are resident but not domiciled in the UK. For expatriate executives with assets to invest, a UK posting or residential base therefore offers very good tax planning opportunities.

The concept of domicile, which is unique to the English-speaking common law jurisdictions, attaches to a person's original home country, and cannot be changed unless the person moves their whole life, family and base to another country, with the intention of remaining there permanently. Few 'visiting' residents will therefore have a UK domicile.

Foreign investment income is exempt from tax for such individuals as long as the income is not remitted to the UK. Therefore they can safely make offshore investments knowing that the income will be reinvested without deduction - the ideal way of turning income into capital without taxation. Note however that capital gains crystallised abroad during a period of residence are deemed to be remitted to the UK, and are then taxed. Some types of mutual or hedge fund impose capital gains unilaterally on members.

American citizens, and nationals of the very few other countries that tax world-wide income on the basis of citizenship, won't be able to take advantage of this UK possibility, but for all other nationals, it is available. This rule has led to many foreign celebrities making the UK their home for tax purposes.

For the last few years, the Treasury has been making threatening noises about the tax privileges of the 'non-doms'. In the 2003 budget a more formal period of consultation was launched over proposed changes.

The most likely reform, according to experts, would be to impose a limit on the number of years that an individual could remain resident in the United Kingdom but not domiciled there for tax purposes. After the expiry of that period, they would be obliged to pay tax in the UK on their overseas income.

Perhaps surprisingly, there was some support for Gordon Brown's plans from some in the accounting and tax consulting professions. Many organisations supported the prospect of reform in this area of tax law, in the hope that new legislation would make the domicile rules simpler. Also, by taking a proactive approach to the reforms, they were hoping to stave off more radical proposals that Gordon Brown may be considering.

It has been estimated by the Treasury that the government would gain between GBP1 billion and GBP1.5 billion from a tightening of the domicile rules. However, some experts contend that the government could actually lose revenue if changes prompt an exodus of wealthy foreigners from the UK.

In September 2003 the Paymaster-General, Dawn Primarolo, a known tax 'hawk', said she was increasingly hard pressed to justify the current state of affairs to her constituents. Primarolo told the FT: "There seems to be quite a lot of agreement it is not fair...People pay tax...and they want to ensure they are paying a fair amount compared to anybody else. What I am hoping this time is we will actually get to the bottom of it," said Primarolo.

Michael Caden, Tax Partner at the London office of Hacker Young however said that the government simply "wants to have its cake and eat it." Responding to Treasury and Inland Revenue proposals on the issue, Mr Caden has formulated a five pronged plan of action for non-domiciled residents seeking to escape the clutches of the UK tax man: invest for growth rather than income; look for assets that attract taper relief on sales; transfer foreign income and gains abroad as gifts to family members who can import them into the UK tax free; establish a foreign trust to shelter non-UK assets from inheritance tax; and re-invest overseas assets to establish a new/higher base cost.

In January, 2004, the government dropped a further strong hint that the current non-dom rules would be scrapped with the news that the Inland Revenue (now HMRC) was building a new database of expatriate workers living in the country. The Revenue was said to have set up five regional offices to collect personal details of non-domiciled workers, including names and national insurance numbers. It also began to send out letters to around 6,500 employees asking for information on “inward expatriate employees who are non-domiciled”.

The tax authorities have no accurate way of assessing how many expatriate workers are resident in the United Kingdom under current rules. A Treasury paper published in the April 2003 budget revealed that the Inland Revenue had 16,000 individuals on its database who declared a total income of GBP800 million which stayed out of the Revenue's clutches by being remitted overseas. However, the accounting profession believes the figure is in reality much higher.

Then in May of that year, perhaps the most famous, now ex-non dom was in the news when permission for a full-scale investigation into the tax affairs of Harrods owner, Mohamed al Fayed was granted at the Court of Session. Lord Reed rejected claims that a tax investigation initiated following the ending of the 'forward contracts' tax break for super-wealthy foreign-domiciled UK residents, constituted an abuse of power on the part of the Inland Revenue.

Explaining the reasoning behind his decision, the judge observed that: "Mr al Fayed works as a director of major companies, but does not appear to be paid a salary. He lives in expensive accommodation, but he does not appear to own or rent it."

"The natural inference from the evidence is that a great deal of effort and ingenuity has gone into creating networks of offshore companies, trusts and other entities in order to minimise liability to tax." He concluded: "In the face of such opaque and sophisticated arrangements, it is important the Revenue should be able to ensure UK tax liabilities are accurately assessed."

However, the 'pre-budget' statement in late 2004 contained no proposals for any change to the non-dom regime, and it may be that the Treasury has been unable to find a satisfactory way of 'improving' it which doesn't also disadvantage the economy.

When the Budget arrived in March, 2005, this view was confirmed as for yet a further year the Chancellor put off any change to the highly favourable tax regime they enjoy.

The Treasury said: "The Government is continuing to review the residence and domicile rules as they affect the taxation of individuals and will proceed on the basis of evidence and in keeping with its principles. It would welcome further contributions to the debate, which will then be taken forward by the publication of a consultation paper setting out possible approaches to reform.

Delivering his 2006 budget speech, Mr Brown repeated his 'holding statement' of the previous year with regard to the taxation of non-doms.

Rumblings from both sides of the debate continued throughout the year, but still no concrete action had been taken by the government by the beginning of January 2007.

Later that month HM Revenue and Customs felt the need to clarify its position on the issue of tax residence in light of the most recent court case on the matter, and issued the following statement:

"The recently published decision of the Special Commissioners in Robert Gaines-Cooper v HMRC (SpC 568) has attracted some attention from tax practitioners and their clients. In particular, some commentators have suggested that the decision in Gaines-Cooper means that HMRC has changed the basis on which it calculates the ‘91-day test’. This is incorrect."

"The ‘91-day test’ is set out in Chapters 2 & 3 (‘Leaving the UK’ and ‘Coming to the UK – Short term visitors’) of the booklet IR20: Residents and non-residents. This guidance is clear that the ‘91-day test’ applies only to individuals who have either left the UK and live elsewhere or who visit the UK on a regular basis. Where an individual has lived in the UK, the question of whether he has left the UK has to be decided first."

"Individuals who have left the UK will continue to be regarded as UK-resident if their visits to the UK average 91 days or more a tax year, taken over a maximum of up to 4 tax years. HMRC’s normal practice, as set out in booklet IR20, is to disregard days of arrival and departure in calculating days under the ’91-day test’."

It continued:

"In considering the issues of residence, ordinary residence and domicile in the Gaines-Cooper case, the Commissioners needed to build up a full picture of Mr Gaines-Cooper’s life. A very important element of the picture was the pattern of his presence in the UK compared to the pattern of his presence overseas. The Commissioners decided that, in looking at these patterns, it would be misleading to wholly disregard days of arrival and departure."

"They used Mr Gaines-Cooper’s patterns of presence in the UK as part of the evidence of his lifestyle and habits during the years in question. Based on this, and a wide range of other evidence, the Commissioners found that he had been continuously resident in the UK. From HMRC’s perspective, therefore, the ’91-day test’ was not relevant to the Gaines-Cooper case since Mr Gaines-Cooper did not leave the UK."

• "HMRC can confirm that there has been no change to its practice in relation to residence and the ‘91-day test’. HMRC will continue to:
• Follow its published guidance on residence issues, and apply this guidance fairly and consistently;
• Treat an individual who has not left the UK as remaining resident here;
• Consider all the relevant evidence, including the pattern of presence in the UK and elsewhere, in deciding whether or not an individual has left the UK;
• Apply the ‘91-day test’ (where HMRC is satisfied that an individual has actually left the UK) as outlined in booklet IR20, normally disregarding days of arrival and departure in calculating days under this ‘test’. "

The HMRC Brief concluded:

"The guidance provided by booklet IR20 is general in nature. If, on the facts of the matter, a dispute arises over the application of this general guidance and the parties cannot resolve their dispute by agreement, the Commissioners will determine any appeals. The Commissioners are bound to decide the legal issues by reference to statute and case law principles rather than HMRC guidance. Where a dispute relates to particular facts the Commissioners will consider the evidence and make findings of fact to which they will apply the law."