This guide considers the UK income tax implications for employers when overseas employees come to work in the UK or UK employees go to work abroad. It also considers the social security implications for employees moving within the EU.
The rules on residence and ordinary residence are due to change on 6 April 2013 and so this guide only relates to the 2012–2013 tax year.
INBOUND EMPLOYEES – INCOME TAX
This section of the guide focuses on UK income tax liabilities for 'inbound' employees coming to the UK from overseas. It should be read in conjunction with the final section of this guide which considers the social security implications of UK assignments.
Residence status – why it matters
The first and most important question when a foreign employee comes to the UK is whether that person will acquire UK residence status. An employee's UK residence status is crucial because, broadly speaking, an individual who is UK resident will be liable for UK income tax on all his worldwide income whereas a non-resident will only be liable on earnings in respect of duties performed in the UK. In practice, this liability for non-residents can sometimes be avoided entirely on a short assignment.
An unexpected liability for UK tax could therefore prove very expensive for employers. As the highest rate of UK income tax is now 50% (45% from 6 April 2013), this can especially be the case if there is an 'equalisation' policy in place where the employee is effectively guaranteed net benefits equivalent to those in his home country. Even if the UK employer does not bear the costs of remunerating an inbound employee, whether directly or indirectly, it will invariably be responsible for ensuring that the correct tax is deducted and paid over to HM Revenue and Customs (HMRC). Funding allocated to the secondment may not cover unexpected excess tax liabilities.
'Ordinary residence' status is also important for inbound employees who do become UK resident, as this governs whether or not they are able to shelter their overseas income and gains from UK tax. However, this concept is due to be abolished from 6 April 2013.
Determining when individuals are, and are not, UK resident has long been something of a headache for employers. These difficulties have worsened in recent years, following apparent shifts in HMRC's position and question marks over what reliance can be placed on its published guidance.
The government has therefore decided to introduce a statutory test of tax residence with effect from 6 April 2013. This flowchart summarises the new test (although note that this is not yet in final form and may be subject to further amendment).
Under the current law, determining residence status is notoriously complex. Very broadly, however, an inbound employee will always become UK resident if he is present in the UK for 182 days or more in any tax year.
An employee may also become UK resident – and professional advice should always be sought – if:
- his visits average 91 days or more per tax year;
- he intends to stay for two years or more at the point of arrival – if this intention is formed later, then residence will commence from the start of the tax year when it is formed;
- he purchases a property in the UK or takes out a lease for three years or more; or
- the pattern of the employee's lifestyle, such as family and social connection, suggests that he has a stronger connection to the UK than simply making a temporary visit.
In the case of short-term regular assignments, where day counting becomes relevant, it is important to remember that a day is now counted if the individual is present in the UK at midnight. You can no longer ignore days of arrival and departure.
Until 6 April 2013, where an individual becomes, or is likely to become, UK resident, attention should also be paid to his 'ordinary residence' status. In particular where an employee is non-ordinarily resident, he may well be able to avoid UK income tax on that part of his earnings which relate to duties performed overseas - provided that this is paid overseas and the income is not remitted to the UK (known as "overseas workday relief").
Recent case law has also highlighted how quickly an individual can become ordinarily resident in the UK. HMRC's previous guidance suggested that ordinary residence would not normally be acquired until three years had elapsed from the individual's arrival, unless they had previously formed the intention to stay for three years or more, and this had also been supported by case law. This guidance has now been withdrawn.
However, there is no minimum period for which an individual must be present in the UK before becoming ordinarily resident. Rather, what matters is the shift in the pattern of the individual's life: has he come to the UK voluntarily and for a 'settled purpose', and established a degree of continuity in his presence here? If he has, then he may well become ordinarily resident despite having no intention to stay for more than three years and leaving before that time. This was what happened to entrepreneur Robert Gaines-Cooper, who was liable to pay UK tax despite spending fewer than 91 days a year in the country as England had remained "the centre of gravity of his life and interests". Clearly this 'pattern of living' test is not an easy one to apply, and it will be important to take proper advice on employees' likely status before the assignment starts, and ensuring that their status is regularly reviewed.
The government intends to abolish the concept of ordinary residence from 6 April 2013. However, transitional rules will mean that where an individual is not ordinarily resident on 5 April 2013, certain reliefs will continue to apply to that individual for a limited period as if ordinary residence had not been abolished. In addition, some new statutory provisions are to be introduced which will preserve the concept of overseas workday relief, although subject to somewhat more restrictive conditions.
Where the employee is not UK-resident, it will sometimes be possible for the UK employer to completely eliminate UK tax liability by virtue of the relevant double tax treaty.
However, this will never be possible where the UK business employs the person on assignment – so it is worth considering whether this should be avoided, bearing in mind the position in the other jurisdiction. Complex issues can also arise where the UK business could be said to be the 'economic employer', and especially where it effectively bears the cost of the remuneration package. It is always worth taking advice on structuring before putting any arrangements in place.
OUTBOUND EMPLOYEES – INCOME TAX
This section of the guide considers the issues in relation to 'outbound' employees going to work abroad from the UK. This should be read in conjunction with the final section of this guide, which covers the social security issues of international assignments.
The importance of 'breaking' UK residence
The first and most important question when an outbound employee leaves the UK is whether his UK residence has been 'broken'. An employee's UK residence status is crucial, because normally an individual who is UK resident will be liable to UK income tax on all his worldwide income whereas a non-resident will only be liable on earnings in respect of duties performed in the UK. Where an employee is leaving the UK the employer may believe that UK income tax liabilities have ceased on departure, only to later discover that this is not the case - potentially an expensive mistake.
As discussed in relation to inbound employees, there is currently no legislative test to determine when an individual is resident – it is based on case law and HMRC practice. However, the government proposes to introduce a statutory test from 6 April 2013. This flowchart summarises the new test (again note that it is not yet in final form).
Under the current law, determining when UK residence has ceased is not straightforward, and the position has become even more unclear in recent years. Against this background, a series of recent cases has reinforced the difficulties of breaking UK residence when leaving the UK.
Broadly, there are two possible ways in which an outbound employee can cease UK residence. They can:
- work full-time abroad in an employment for at least one complete tax year; or
- leave the UK 'permanently or indefinitely'.
Clearly the latter position will only ever be relevant to longer-term assignments, but a recent high-profile case has restricted its application even there. The case highlighted that employees wishing to rely on the second test must show a 'distinct break' from the UK, and that this may well be prejudiced by continuing social, business and family ties to the UK – which many employees will of course retain.
It is therefore especially important to make sure that the first test is met where it can be, as it has now been established that this is not dependent on the employee severing ties to the UK in the same way. However, retained accommodation can still be an issue as can visits to the UK in excess of 91 days per tax year.
The test contains various traps for the unwary. In particular, it is important to note that the employee does have to be away for a full tax year (April 6 - April 5) so a secondment of almost two years from May 2011 to March 2013 would not break residence. In addition, care is needed where the employee is still performing duties in the UK. Generally, 'incidental' duties do not give rise to any problem, although HMRC interprets this very narrowly. Recent guidance states that, in HMRC's view, an employee can carry out substantive duties in the UK on up to nine days per tax year without affecting his residence status. In practice, therefore, employers should monitor return trips to the UK very carefully or perhaps consider whether the employee can avoid working in the UK at all.
Whichever test employers rely on, it is now established beyond doubt that simple day counting is not enough – and remember that, even if the employee does break his UK residence, duties performed in the UK will still attract a UK income tax liability unless this is relieved through the relevant double tax treaty.
Social security rules for assignments within the EU
The rules governing liability to social security contributions for employees who are assigned in other countries are different to those which apply for income tax. It is entirely possible for an employee to be liable for UK national insurance contributions (NICs) when he has no UK tax liability, or vice versa.
For assignments within the EU, the NICs position is determined by a set of standard rules which override the domestic regimes of member states. After remaining the same for many years, these rules changed on 1 May 2010.
It is important that businesses understand the impact of the rules as the costs of applying the wrong system can be significant – especially as social security costs in some member states are a great deal higher than others, which may cause difficulties with funding the shortfall. For example, employer's liability in the UK is currently 13.8% while it is almost 32% in Sweden.
Under the previous rules, where EU employees were assigned to work in another member state they were, in most circumstances, still covered by their 'home' system for the first year provided that the assignment was not intended to last longer than that. This could be extended to two years where the assignment unexpectedly overran. In practice, however, it was not uncommon for employees to remain insured under the home system for up to five years. Where employees regularly worked in more than one member state, they normally remained insured in their home state so long as they carried out some duties there even if those duties were minimal.
The rules now say that:
- employees on assignments of under two years will normally remain insured under their home system.;
- where the employment is such that the employee works regularly in more than one country, the rules allow continued insurance in the home country - but only if the employee carries out 'substantial' duties there. In practice, HMRC considers that if the employee spends less than 25% of his working time in the UK or earns less than 25% of his remuneration here, then he will probably not meet the 'substantial' test - so therefore he will be liable in the other state even if he does not live there. This test is primarily forward-looking, to the next 12 months, although HMRC states it may also look back.
Note that the above rules only apply to assignments to and from EU countries and certain other jurisdictions such as Switzerland, Iceland, Liechtenstein and Norway. In other cases it is necessary to consider the terms of any specific agreement with the country in question or, where there is none, to apply the UK's own domestic rules.