Many taxpayers dream of retiring to the sun and leaving “it” all behind. “It” being rainy weather, strikes and UK taxes. Unfortunately for many, they are not escaping the attentions of HMRC.
Residence
The first step that people consider is becoming non-resident in the UK. Since 2013, the Statutory Residence Test has given greater certainty in terms of residence tests. The test relies on looking at the number of days spent in the UK and the number of factors which link the individual to the UK. So those individuals who spend more than 182 days in the UK are automatically resident in the UK for that tax year. On the other hand, if an individual spends less than 16 days in the UK in a tax year, they are automatically not resident in the UK. Between these two positions there are a number of thresholds for residence which depend on how many links one has to the UK.
The links are a main residence, family, children, job, pattern of residence in the previous three years, whether one has spent more days in the UK than any other country and available accommodation. Broadly speaking, the more links one has to the UK, the less time one can spend in the UK without retaining one’s UK tax residence. There is also another complication in that the tests for leaving the UK and establishing non-residence if one has been resident in the UK in any of the three previous tax years are more stringent than if one has not had recent residence in the UK. In that sense, the UK is a bit like “Hotel California” which is difficult to check-out from.
Even if an individual successfully establishes non-residence one needs to bear in mind three important facts. The first is that a non-UK resident is still liable to UK tax on their UK-source income. That would include earnings from employment, self-employment income, certain investments and, of most relevance to expats, income from UK rental properties.
The reduction in the tax relief available for interest paid to acquire or improve properties means that more individuals have taxable rental income that they need to declare.
The second point is that if an individual resumes UK residence within five years, then the temporary residence rules apply which may tax capital gains made in the temporary period of absence.
The third point is that a non-resident is subject to Capital Gains Tax on gains made on UK residential property and UK commercial property. Where the property has been at some point their principal private residence, then some relief from CGT is available. However, the relief has been eroded for non-residents in two important ways.
First of all, it used to be that the last 18 months of ownership was classified as deemed occupation and therefore relief was available on a time apportioned basis. This has been reduced to nine months.
Secondly, non-residents who let out a property which had been their main residence were able to take advantage of lettings relief which was worth up to £40,000 per owner. In 2020 the Government restricted this relief to circumstances where the landlord actually lived in the same property as the tenant. These two changes have increased the chances that non-residents will have to pay substantial CGT on the sale of properties in the UK.
Non-residents will also need to file one of the new HMRC property gains returns and pay the tax within 60 days of the completion of sale of the property, irrespective of whether any CGT is payable or indeed if there has been any gain on the property.
If this form is not completed by the deadline, then HMRC can and will issue penalties even if there is no tax to pay.
Out of the frying pan into the fire
The non-resident also needs to consider whether they will have acquired new tax reporting and paying obligations by becoming resident in another country. You might think that the UK is a highly taxed country but there are some which make the UK look like a tax haven!
Domicile
Once the individual has established non-UK residence, they may reduce their income tax and CGT liabilities to gains and income earnt or crystallised in the UK. They do not escape Inheritance Tax (IHT) so easily. Individuals who are domiciled in the UK will be subject to UK IHT on their worldwide assets. Individuals who are not domiciled in the UK are only subject to UK IHT on their assets situated in the UK.
Establishing a non-UK domicile
Establishing a non-UK domicile, particularly for someone who has been born and brought up in the UK, is not straightforward. To abandon one’s Domicile of Origin, one would need to establish a Domicile of Choice elsewhere. Broadly speaking, this means reducing one’s connection to the UK and increasing them elsewhere. The burden of proof rests on the party trying to show that the domicile has changed. Domicile takes a longer term view on an individual’s centre of vital interests looking at not only where their residence is but where their family is, business connections are, social connections, club memberships and activities as well as, in the final resort, where a burial plot is reserved.
As one might expect in tax, nothing is completely straightforward and it is not possible to look at one factor overriding anything else. It has also been possible since 1974 for a husband and wife to have different domiciles.
The case of Sir Charles Clore is instructive in that he moved to Monaco in order to try and escape death duties in the UK and become non-UK resident. However, friends testified that he was never very happy in Monaco and felt somewhat homesick. On that basis, the courts ruled that he had not acquired a domicile of choice in Monaco.
Double tax treaties
It is also possible to be resident under domestic law in two countries. To work out which country has primary taxing rights, one has to look at the relevant double-tax treaty. Double-tax treaties vary from country to country and have important differences in the treatment of, for example, pensions. It is therefore important when looking at the treatment of income that one looks at the relevant treaty to see whether it is taxed in the country where the taxpayer is resident or in the country where the pension is situated. This is of particular interest to UK individuals retiring to sunnier climes.
How do they know?
It is not unusual for clients to ask how HMRC knows about a mobile individual’s movements, assets, and sources of income. Recent cases in the courts have demonstrated the breadth of HMRC’s knowledge. Every time an individual comes into the UK and leaves the UK, the Border Force obtains the details. These details are available to HMRC. So, unless one swims the channel, they are likely to know about an individual’s entrance and exit from the UK.
Secondly, they have access to third party financial details such as bank accounts, credit cards, debit cards and other records kept by third parties. In a recent case, HMRC were able to prove that an individual had spent longer in the UK than they claimed by looking at their record of expenditure in the UK as well as details of their drawings from UK ATMs.
Third, under the automatic exchange of information protocols, HMRC is receiving a wealth of information from foreign tax authorities. The way the system works is that the bank or other financial institution or land registry in the foreign country will send details to the foreign tax authority. The foreign tax authority will then send details to HMRC and they can compare that to the relevant self-assessment return if it has been filed. This of course works the other way in that if an individual is claiming to be resident in a foreign country, HMRC will obtain information from third parties in the UK and send that over to the foreign tax jurisdiction.
The penalties for making mistakes have certainly got greater. HMRC can in extreme circumstances charge a penalty of up to 300% of the tax not paid. In addition, they can also charge penalties based on the capital value of the asset, in addition to the tax that has been avoided or evaded. Normally taxpayers get a discount on the penalties if they cooperate with HMRC in producing the figures for an investigation. However, HMRC tends to press for higher penalties when the evasion is related to foreign income or gains.
In conclusion, escaping the clutches of HMRC is not as simple as buying a plane ticket and going somewhere far away from the UK. The world has got smaller and more interconnected. Individuals who leave the UK, should take advice about how their wealth and income will be taxed in their new circumstances. Early advice can avoid unpleasant and costly shocks later.