BRIEFING USE OF DUAL CONTRACTS BY FOREIGN DOMICILIARIES. September 2014

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1 USE OF DUAL CONTRACTS BY FOREIGN DOMICILIARIES Overview UK resident foreign domiciliaries ( RFD s ) are entitled, subject to payment of the Remittance Basis charge where applicable, to claim the Remittance Basis, whereby most categories of foreign income and gains are subject to UK tax only to the extent that these are remitted (or deemed remitted) to the UK. The Remittance Basis can apply to foreign employment income, but for this purpose the general definition of what constitutes foreign earnings is tightly drawn making it difficult to qualify. There are special provisions, referred to collectively as Overseas Workday Relief (OWR) for short-term UK residents (broadly those newly arrived in the UK during their first three tax years of residence), which mitigate the restrictions of the general rule. OWR allows a straightforward apportionment of employment income between UK and non-uk duties with the Remittance Basis being applicable to foreign earnings. When OWR is no longer available, the Remittance Basis can only apply to employment income where: (i) the employment is with an overseas employer; and (ii) the employment duties are wholly performed outside of the UK (with the exception only of those duties considered as purely incidental which is a term that is interpreted narrowly). RFDs, claiming the Remittance Basis on foreign employment income outside OWR, have come under increasingly sceptical enquiry from HMRC as to the extent to which it is possible to demonstrate that all duties under a foreign contract have been performed wholly outside the UK. It appears that many such enquiries have been successful in HMRC s eyes: with many taxpayers having had to concede settlements; and many multinational groups refraining from offering dual contract arrangements. HMRC s position was set out as far back as April 2005 (an article in Tax Bulletin 76, April 2005, which is now reproduced at EIM77030 of the HMRC Employment Income Manual). If anything between then and the 2014 Finance Act, it might have been felt that the pendulum had swung too far in HMRC s direction: rather than taxpayers exploiting dual contract arrangements artificially to attempt a separation of foreign and UK emoluments (where the duties of related employments cannot truly be segregated), our experience has been that HMRC officials take an overly restrictive line, and pursue enquiries with the aim of exhausting the taxpayer. Many officers seem to start from the conviction that UK residents cannot possibly have an employment that is carried out wholly abroad, regardless of the evidence adduced or the specific facts of the case. It is this stance that seems to have informed the 2014 Finance Act changes rather than purely artificial arrangements. BRIEFING September 2014 CONTENTS 1. Two sets of provisions relating to the Remittance Basis and overseas earnings 2. The older legislation 3. The legislation enacted by the 2014 Finance Act

2 The changes have the potential to impact on all grades of employees, but it is clear that they were specifically targeted at senior employees. Broadly, from 2014/15, once the OWR period is over, the ability to claim the Remittance Basis on foreign earnings will be denied to senior employees having dual contracts with associated companies, unless either the foreign tax on the overseas contract is at least 65% of the additional (or highest) UK income tax rate (so, for 2014/15, the foreign tax will need to be at least 29.25%) or regulatory requirements necessitate the use of dual contracts. 1. Two sets of provisions relating to the Remittance Basis and overseas earnings The 2014 Finance Act changes are wholly disadvantageous to Remittance Basis taxpayers, as a new set of provisions that is additional to (rather than replacing) the older legislation with respect to the Remittance Basis and overseas earnings, has been enacted. Strictly, the new legislation applies only in cases where the old legislation would not disallow the Remittance Basis (so only in cases when ALL the duties of the employment - apart from incidental duties - are performed outside of the UK). Practically, where the new legislation can be applied (so where there is sufficient connection with the UK and foreign employment and the foreign tax suffered is insufficient) HMRC are likely to apply it. This is because doing so is easier since there is no need to show that substantive duties are performed in the UK. OWR provides relief from both the old and the new legislation but only for a maximum of three years. 2. The older legislation As explained above, the older legislation remains in place and in many cases (such as where the foreign tax credit is sufficiently high that the new dual contract anti-avoidance provisions cannot apply), these provisions will determine whether foreign employment income is chargeable on the Remittance Basis. 2.1 The strict definition of chargeable overseas earnings Under the general rules (that is before one even starts to consider the anti-avoidance provisions) earnings from a foreign employer will not automatically qualify for the Remittance Basis. Foreign employment income will only qualify for the Remittance Basis where it comes within the definition of chargeable overseas earnings, which is tightly defined. Foreign employment income will only be chargeable overseas earnings where: the employment is with an overseas employer; and the employment duties are wholly performed outside of the UK (with the exception of purely incidental duties). The first condition may be easy to satisfy. It is the second condition that causes the difficulties. Even though an individual may have two very different roles, and the duties of the foreign employment may be almost entirely performed abroad, it may be difficult to show that no substantive duties are performed here, particularly where the role is senior and involves day-to-day responsibilities. It will all depend on what is expected of the individual in the specific role. For example, if an individual heads up the UK subsidiary of a multinational foreign parent company, and also has a contract governing his or her position as director on the board of the foreign parent, it might be possible to meet the condition but only if: all the board meetings take place outside of the UK; all the preparation for the board meetings takes place outside of the UK; and any follow up work takes place outside of the UK. If the meetings are held once a quarter and the individual flies out of the UK a few days before to prepare and stays outside of the UK for a few days after for follow up work, then the conditions could be met. If, however, the individual reads the board papers in the UK beforehand, flies out to the meeting and immediately flies back performing any follow up work in the UK, then it is clear that the conditions would not be met, as preparation and follow-up would each be considered as substantive duties of the role. 2.2 Limit on level of chargeable overseas earning where duties of an associated employment are performed in the UK In addition to the strict definition of chargeable overseas earnings there is a specific anti-avoidance provision that will imposes a limit on how much of an employee s earnings can be classified as chargeable overseas earnings where: in addition to the foreign employment that gives rise to the chargeable overseas earnings (the relevant employment ) an employee holds one or more associated employments ; and 2

3 the duties of the associated employment(s) are not performed wholly outside of the UK. In such cases the legislation specifies that the chargeable overseas earnings figure cannot be higher than the proportion of the aggregate earnings for the tax year from all the employment concerns (that is the relevant employment and all associated employments ), which can be considered reasonable having regard to the nature and time devoted to each of the following: the duties performed outside the UK; the duties performed in the UK; and all other relevant circumstances. Associated employments are defined as employments with the same employer or with associated employers. There are three rules (A, B and C), which are used to determine whether, for these purposes, employers are associated: Rule A an employer (who is an individual) will be associated with other employers (these being partnerships or companies) where he or she controls them. This means that an employee of Mr X will have an associated employment if he or she also works for a company controlled by Mr X. Rule B an employer (which is a partnership) will be associated with other employers (these being other partnerships or companies) if one has control of the other or both are under the control of the same person or persons. For example if Nettles LLP holds subsidiary companies, an employee of Nettles LLP will have associated employments if he or she works for the partnership and one of the subsidiary companies. Rule C an employer (which is a company) will be associated with other employers (these being other companies) if one has control of the other or both are under the control of the same person or persons. For example, an individual working for two wholly owned subsidiaries of a parent company would have associated employments. Control, in relation to a body corporate means the power to ensure that the affairs of the company are conducted in accordance with one s wishes either: (i) by the holding of shares; (ii) by the possession of voting rights; or (iii) as a result of powers conferred by the articles of association or conferred by some other governing document relating to the entity. In relation to a partnership, control means the right to a share of more than half the assets, or more than half the income or the partnership. 3. The legislation enacted by the 2014 Finance Act 3.1 Introduction The 2014 legislation applies to earnings from an employment for 2014/15 or a subsequent tax year. The provisions deny the Remittance Basis to income from a relevant employment where: the income would otherwise have qualified as chargeable overseas earnings (defined at 2.1 above); the income falls within one of the four specified categories, being: (i) general foreign earnings; (ii) deemed income from the receipt of foreign employment securities; (iii) deemed income from options on foreign employment securities; and (iv) employment income provided through third parties; conditions 1 to 4 are met; and condition 5 is NOT met. Conditions 1 to 4 are discussed in section 3.2 below and condition 5 is discussed in section 3.3. The definitions are discussed in section 3.4. Income caught by the legislation will be taxed on the Arising Basis in the same way as UK employment income but it is not subject to Pay As You Earn (PAYE) requirements. The legislation does not cover National Insurance and there are no plans to introduce corresponding National Insurance regulations. UK National Insurance may, however, be due under the terms of the coordination of social security agreements across the EU, EEA and Switzerland. These operate regardless of the domicile status of the individual. Generally such agreements provide that where someone works (either as an employee, as a selfemployed person or in both capacities) in more than one relevant State and/or in a relevant State other than the one in which he or she is resident, only one State will have the right to levy social security contributions on all the earnings. 3.2 The conditions that must be met The four conditions that must be met for the legislation to apply are as follows: Condition 1 is that in the relevant tax year the taxpayer qualifies as a relevant employee at a time when he or she also holds a UK employment. Where the relevant employee arrives in or leaves the UK in a relevant tax year, and meets one or more of the statutory conditions such that split year treatment applies, the 3

4 condition will be met if at a time in the UK part of the relevant tax year the UK employment and a relevant employment are held. Condition 2 is that the UK employer is the same as or associated with the relevant employer. Condition 3 is that the UK employment and the relevant employment are related to each other. Condition 4 is that the 65% test is met. 3.3 The condition that must NOT be met For the legislation to apply, the fifth condition must NOT be met. It will be met if the two employment contracts are required because it would not, by virtue of a relevant regulatory requirement, be lawful for: all or substantially all of the duties of the relevant employment to be duties of the UK employment and performed in the relevant territory (that is the territory where the duties of the relevant employment are performed); and all or substantially all of the duties of the UK employment to be duties of the relevant employment and performed in the part of the UK where they are performed. The relevant regulatory requirements are those applying in the jurisdiction where the duties are performed. The HMRC Guidance provides the following examples of regulatory requirements: in order to get a work permit in some countries, you have to have an employment contract in that country; in order to provide certain types of financial services in the UK, you have to be employed by a person authorised by the Financial Conduct Authority. 3.4 Definitions Relevant employment, relevant employee and the relevant employer To be a relevant employee an individual must have a relevant employment. A relevant employment is one which gives rise to the income that may be denied the Remittance Basis as a result of the legislation. It is, therefore, an employment where all the duties (barring incidental duties) are performed outside of the UK. The relevant employer is the entity that employs the individual in connection with the relevant employment UK employment and UK employer UK employment is defined as an employment the duties of, which are not performed wholly outside the United Kingdom. This is a very broad definition and means that for the purposes of this legislation: a UK employment can be with a UK based employer or a foreign based employer; and an employment will come within this definition even if 99% of the substantive duties are performed outside of the UK. As such, an employment where the earnings previously have qualified for OWR (as it covered UK and foreign duties) would be a UK employment. The UK employer is the entity that employs the person in connection with his or her UK employment Associated employments The legislation uses the same definition of associated employments as is found in the current anti-avoidance provision (see sub-section 2.2). Broadly, that means that one has control over the over or both are under the control of the same person or persons Related The term related is not specifically defined in the 2014 legislation. However, without prejudice to the wider scope of the provisions, it is specified that a UK employment and a relevant employment are to be assumed to be related if one or more of the following applies: It is reasonable to suppose that: the relevant employee would not hold one employment without holding the other employment; or the employments will cease at the same time or one employment will cease in consequence of the other employment ceasing. The terms of one employment operate to any extent by reference to the other employment. HMRC Guidance provides as an example a case where one contract may take into account hours worked or leave taken under the other contract or may refer directly to duties performed under the other contract. The performance of duties of one employment is (wholly or partly) dependent upon, or otherwise linked (directly or indirectly) to, the performance of duties of the other employment. HMRC Guidance provides the example of a case where an 4

5 individual carries out research under one employment, and under their other employment carries out marketing work made possible by the research. The duties of the employments are wholly or mainly of the same type (ignoring the fact that they may be performed (wholly or partly) in different locations). The duties of the employments involve (wholly or partly) the provision of goods or services to the same customers or clients. The relevant employee is: a director (or shadow director) of the UK employer or the relevant employer and has a material interest" in the UK employer or the relevant employer ; a senior employee of the UK employer or the relevant employer ; or one of the employees of the UK employer or the relevant employer who receives the higher or highest levels of remuneration. A director (or shadow director) will have a material interest in either the UK employer or the relevant employer if either or both of the following conditions is met: The individual alone or with any associates is: the beneficial owner of; or able to control, directly or through the medium of other companies or by any other indirect means more than 5% of the ordinary share capital of the company. If either the UK employer or the relevant employer is a close company, the individual alone or with any associates possesses or is entitled to acquire, such rights as would: in the event of the winding-up of the company; or in any other circumstances give an entitlement to receive more than 5% of the assets that would then be available for distribution among the participators. In deciding whether the individual is a senior employee the explanatory notes state that HMRC will have regard to the level of seniority as compared to other employees in the organisation, and that to hold a senior position the individual must either: be a director who owns or controls more than 5% of either the UK employer or the relevant employer ; or be in the highest tiers of seniority or remuneration compared to other employees. The HMRC Guidance states that HMRC will generally consider that employees involved in higher-level management and decision-making will be senior. The following examples are given of activities that might be carried out by senior employees: implementing higher-level or global business strategies; and participating in higher-level decision-making relating to management issues, finance, corporate restructuring or governance. HMRC Guidance sets down how HMRC will interpret higher or highest levels of remuneration. Total pay from the UK and the relevant employment must be taken into account in considering whether the aggregate remuneration is high relative to other employees in the same group of companies. The Guidance states that: There is no absolute level of pay that is relevant rather it is a matter of comparing your overall remuneration from all your related employments to that of your fellow employees. However, rather confusingly after having said that there is no absolute relevant level of pay the Guidance goes on to say: HMRC considers that if you would be liable to tax at the additional rate on your combined pay (ignoring personal reliefs like donations to charities), it will be a good indication of an employee who is higher or highest paid. This would suggest that HMRC would see 150,000 as being indicative of an employee who receives the higher or highest levels of remuneration. The explanatory notes provide the following scenarios, in which HMRC would consider a UK employment and a relevant employment to be related : Where the individual has two employments and undertakes client meetings, entertainment or marketing under the relevant employment and manages investments for the same clients under the UK employment. Where: the individual is employed in the UK and the contract specifies that he or she cannot work outside the UK; the individual is also employed in France, and the contract specifies that he or she can only work in France; and 5

6 the individual does the same type of work under their French contract as under their UK contract, so although these duties are separated geographically, the work is of the same type. Where the individual provides financial advice to a client under both a UK employment and a relevant employment. The Treasury is given powers (subject to the regulations having to be approved by the House of Commons) to add to reduce or modify the cases where the UK employment and the relevant employment are deemed to be related to each other The 65% test Broadly, the 65% test is met where the foreign tax credit that would be available on the aggregate income from the relevant employment if subject to UK tax on the Arising Basis would be less than 65% of the UK additional Income Tax rate for the relevant tax year. The UK additional tax rate for 2014/15 is set at 45%, so this means that for 2014/15: if the foreign tax credit percentage is less than 29.25% the test will be met; and if the foreign tax credit percentage is 29.25% or higher the test will not be met and the legislation cannot apply. Note that the foreign tax credit takes account only of what could be claimed to set against the UK tax liability in accordance with the relevant double tax agreement or (where there is no appropriate double tax treaty) any unilateral relief permitted. This will not necessarily be the same as the total foreign tax suffered on the income. There are significant practical problems with the 65% test. It can be difficult and time consuming to determine the actual tax liability in some foreign jurisdictions and this problem is compounded since the calculation has to be performed on the basis of UK tax years, which is different to that of most other jurisdictions. An individual may not know when they come to submit their UK tax return whether the 65% test is met and may not even have the final information in time to made an amendment to their selfassessment tax return. In the HMRC Guidance this is acknowledged to some degree. The guidance states that the individual may have to file a provisional tax return and submit an amended return within the amendment window (twelve months after 31 January following the end of the relevant tax year). The possibility that the final position may not be known by then is not addressed. 3.5 The commencement provisions and deferred income The 2014 legislation applies to income earned in or after 6 April 2014.The HMRC Guidance accepts that the new rules do not apply to foreign employment income for tax years prior to 2014/15 that is paid after 5 April Deferred foreign employment remuneration part of which relates to tax year 2014/15 or after and part of which relates to tax years prior to 2014/15 should be apportioned on a just and reasonable basis with the 2014 legislation only applying to the element apportioned to tax year 2014/15 or after. Rawlinson & Hunter Chartered Accountants Eighth Floor 6 New Street Square New Fetter Lane London EC4A 3AQ And at Lower Mill Kingston Road Ewell Surrey KT17 2AE T +44 (0) F +44 (0) firstname. lastname@rawlinson-hunter.com Partners Chris Bliss FCA Simon Jennings FCA Philip Prettejohn FCA Mark Harris FCA Frances Jennings ACA David Barker CTA Kulwarn Nagra FCA Paul Baker ACA Sally Ousley CTA Andrew Shilling FCA Craig Davies FCA Graeme Privett CTA Chris Hawley ACA Phil Collington CTA Toby Crooks ACA Directors Lynnette Bober ACA Mark Bonnett CGMA Mike Cunningham ACA Karen Doe Michael Foster CTA Nigel Medhurst AIIT Alex Temlett CA Consultants Bob Drennan FCA Ralph Stockwell FCA The information contained in this briefing does not constitute advice and is intended solely to provide the reader with an outline of the provisions. It is not a substitute for specialist advice in respect of individual situations. Rawlinson & Hunter is a partnership registered to carry on audit work in the UK and Ireland and regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales. Details about our audit registration can be viewed at under reference C for the UK and at under reference EWC for Ireland.