UK: The UK – a Tax Haven Without Palm Trees?

Last Updated: 30 November 2005
Article by Andrew Goldstone and Kamal Rahman

If you are planning to come to the UK, whether short-term or permanently, you will discover a fiscal regime that can be as welcoming as any tax haven. But beware, you must plan carefully if you are to make the most of the available tax advantages. Organising your tax affairs after you arrive may be too late.

This Briefing Note sets out some of the main tax issues affecting new arrivals to the UK, and offers some possible tax planning ideas.

Residence, ordinary residence and domicile

These are terms you will hear frequently, whether you are speaking to the taxman or other expats. That is because your UK tax liability is dependant on whether you are UK resident, UK ordinarily resident or UK domiciled. Unhelpfully, none of the terms are defined. They do not necessarily run together and nor are they mutually exclusive – you can be all three or any combination. Depending on the combination you will be liable for certain UK taxes but not others. It's a legal minefield and a trap for the unwary.

What is UK residence?

Your residence for tax purposes is based on your circumstances from year to year. It depends on how long you are in the UK, your reasons for being here and how long you intend to stay. The main criterion is how long you spend in the UK each tax year, which runs from 6 April to 5 April.

If you come for a temporary purpose, you will not normally be treated as UK resident unless you spend at least 6 months here during the tax year. However, if you come for substantial periods on a regular basis then you will still be treated as UK resident even if you spend less than 6 months here each year. In practice, spending an average of at least 3 months in the UK each year over a 4 year period will trigger your UK tax residence.

Normally you are treated as UK resident for complete tax years. For a new arrival, that could be up to 11 months before you actually arrive and might leave you with a large unexpected tax bill. However, in some cases you will only be treated as UK resident from the day you actually arrive. It all depends on how long you intended to stay when you arrived.

You should note that you can be resident in more than one country at once.

What is ordinary residence?

Ordinary residence is a form of "super-residence". If your residence here is short term and casual, you will not be ordinarily resident. But if you arrive with the intention of taking up permanent residence or you end up living here medium or long term (in practice for more than 2 complete tax years) then you will be treated as ordinarily resident.

What is domicile?

Domicile is the country you consider to be home. It is not the same as nationality or residence though they will often coincide. It is a very uncertain concept and is difficult to change once established. Everyone starts with a domicile of origin at birth, which is usually based on their father's domicile. It can be displaced by a new domicile of choice but that will only happen if you abandon your domicile of origin. Not only does that mean moving to another country but you also have to intend to live there permanently and sever most of your links with your original country of domicile. For most new arrivals they will not acquire a UK domicile when they arrive (and that is generally a good thing for tax purposes). However, the longer you live in the UK the harder it is to sustain your foreign domicile.

Unlike residence, you cannot have more than one domicile at the same time.

The importance of residence and domicile for tax purposes

Income Tax (IT)

In principle UK residents are liable for IT on their global income. However, if you are non-UK domiciled then you can at least avoid IT on overseas income provided the income is not brought into the UK. This applies to both overseas investment income and, in most cases, foreign earnings. However this "remittance" basis of taxation raises various issues:

  • Where does the income arise? Often it's obvious but not always - you can encounter difficulties with global investment portfolios or if your job requires you to work in several countries.
  • What counts as bringing in income? Unfortunately the rules are complicated and can easily catch an indirect remittance of foreign income to the UK. The consequences of getting it wrong can be significant.
  • What happens when your capital and income are mixed up? In that case any money you bring in is treated first as a remittance of income until the income is all "used up" and only then are you treated as bringing in capital. But this can be avoided with careful planning.
  • What if you have existing pre-arrival overseas income? Usually it can be reclassified as capital and can therefore be brought to the UK tax-free. But be careful to keep it separate from future income.

Capital Gains Tax (CGT)

When you dispose of an asset at a profit, CGT is payable on the gain. The rate can be as high as 40%. UK residents are, in principle, liable for CGT on their global capital gains. However, if you are non-UK domiciled then you can at least avoid CGT on overseas capital gains provided the gains are not brought into the UK. However this "remittance" basis of taxation raises various issues depending on where the gains arise and whether they were made before or after you arrive in the UK.

It is sometimes possible to avoid CGT altogether, even if the gains are remitted to the UK, if you transfer the assets into an offshore trust. However, you should seek professional advice before doing so and prior to entering the UK.

Inheritance Tax (IHT)

IHT is a tax on the value of your estate when you die. Unlike Income Tax and Capital Gains Tax, your IHT liability is not based on your residence status. For IHT purposes, your domicile as well as the location of your assets are what's crucial. If you are UK domiciled at your death, IHT is payable on your worldwide estate. But if you are non-UK domiciled then IHT only applies to your assets situated within the UK. Since the tax rate is 40% on everything above £275,000 (for the 2005/06 tax year), the potential tax savings can be enormous.

Despite the generous tax haven nature of this much-criticised rule, you need to plan your affairs carefully to ensure you will benefit.

There is one specific trap to be aware of for married couples. Transfers between spouses are normally exempt from IHT without limit. However, if your spouse is UK domiciled and you are not, and he or she leaves everything to you, the spouse exemption is restricted to just £55,000. Your spouse should therefore consider transferring valuable assets to you now, since your own spouse exemption will be unlimited. You would therefore be able to leave those same assets back to your spouse tax-free if you die first. Ideally your wills should be reviewed at the same time and you may need separate wills to cover assets in the UK and assets in your home country.

What should you do before you arrive?

The UK tax regime for foreign domiciled individuals living in the UK can be generous. However, in many cases the rules are very complicated and you should take specific tax and estate planning advice. We have extensive experience providing tax advice to senior executives and other high earners moving to the UK. Ideally we would review your case as long as possible before you arrive so that appropriate structures can be set up in advance to minimise the risk. Our tax advisers also work closely with our immigration team, to ensure all your advice is fully co-ordinated.

This article is only intended as a general statement and no action should be taken in reliance on it without specific legal advice.

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