Draft legislation in the United Kingdom will significantly change the method by which individuals resident but not domiciled in the UK will be taxed on income realised from outside the UK. Under current law individuals not domiciled in the UK are taxed more leniently than individuals domiciled in the UK.

Domicile

As defined under UK law, domicile usually is based on a person's nationality as well as the country in which the individual has their permanent home, regardless as to where they are living at the current time. So if you were born in the UK and have lived in the UK all your life, and you are now living in Bermuda while you are on a six-year, work-related assignment, and you intend to return to the UK after the assignment ends, you are likely to be considered a UK domicile under UK law.

Ordinarily Residence

A United States citizen who goes to work in the UK for less than three years will be considered "not ordinarily resident" under current UK tax law.

Residence

If a United States citizen goes to work in the UK for at least two years, but less than three years, or is present in the UK for more than 183 days in the UK fiscal year that runs from April 6 to April 5, or visits the UK for more than 90 days a year over a four-year period, the individual may be deemed to be resident in the UK.

Taxation

Under current law, which of the above categories you fall into determine how income is taxed in the UK. For example, if you are resident in the UK but are not a UK domicile, investment income coming from sources outside the UK are not subject to income tax unless the investment income is "remitted" to the UK.

United States citizens who temporarily reside in the UK while on assignment and whose work typically calls for travel to Europe, usually have a dual employment contract, one for services rendered in the UK and one for services rendered outside the UK. Compensation with respect to the latter contract is paid outside the UK and this compensation will not be subject to UK income tax unless the individual "remits" these funds into the UK.

The net result under current law is that if you are deemed to be both UK-domiciled and resident, you are subject to UK income tax on your global income. If you are resident in the UK, but not domiciled in the UK, you are only subject to tax on income derived from the UK and on foreign source income "remitted" to the UK.

The current law is of significant benefit to US citizens who live and work in the UK on short term assignments. For example, suppose the UK employment contract is for £140,000 sterling and the non-UK employment contract is for $120,000. And also suppose that the individual realised interest income, dividends and capital gains from the sale of stock in the US of $100,000. If the $120,000 salary and the $100,000 of investment income are not "remitted" to the UK, they are not subject to income tax in the UK. The tax savings is $88,000.

Proposed Changes

The primary change to the tax law, effective for the upcoming April 6, 2008 to April 5, 2009 tax year is a new concept called the "arising basis" of taxation. Under the "arising basis" an individual who is resident but not domiciled in the UK will pay UK income tax on their global income in the year in which the income is earned and/or the year in which dividends and interest are paid and capital gains realised.

Opt Out

The proposed legislation will allow an individual who is resident but not domiciled in the UK to "opt out" and continue to be taxed on the "remittance basis", but to do so they must now pay a £30,000 sterling annual "charge". The annual £30,000 sterling "charge" is applicable to an individual who is resident, but not domiciled in the UK, who makes a claim to continue to be taxed on the remittance basis, who has unremitted foreign income and gains of £1,000 sterling or more arising in the year of claim, and who has been resident in the UK for at least 7 of the 9 years immediately preceding the tax year.

An individual who chooses to use the remittance basis of taxation will not be allowed to claim the personal allowance that will be £5,435 sterling in 08/09 and the individual will also lose their annual capital gains exemption of about £9,600 sterling per year.

As the £30,000 sterling "charge" is not a tax on income, it is doubtful that it can be claimed as a foreign tax credit on a US citizen's US tax return.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com