Protecting Tax-Free Overseas Salaries from UK Tax - the Tax Treaty Double Whammy

By a recent count, there are currently 23 countries offering a zero rate of income tax.  Of these, maybe a half-dozen are particularly attractive to Brits seeking to spend a few years abroad, with Gulf states such as Saudi Arabia and the UAE often featuring high on this list.

Even before the Covid-19 pandemic, these tax savings were vulnerable to the employee returning to the UK earlier than planned, perhaps because the job, the culture, or the climate were not quite as expected.  In these cases, there is a risk of never having broken UK tax residence and remaining fully liable to UK tax on their overseas earnings - and of course with no foreign tax credit to offset the UK liability.

Assuming then that the employee has remained UK tax resident throughout their overseas assignment - and is therefore facing a huge and unexpected tax bill - as a last resort the UK’s network of  Double Taxation Agreements (DTAs) could come to the rescue.  DTAs mostly have a standard structure (known as the ‘OECD model’) and for the most part the various provisions which assign taxing rights between the participating countries are identical.

In the case of overseas employment income, there are two sets of conditions (‘Articles’) under the treaties which, if applicable, can knock out the UK’s right to tax a single penny of this income.

Step one is to establish if the employee is officially tax resident in the overseas jurisdiction for some or all of the relevant UK tax year.  If this is the case, then Article 4 of the relevant DTA may award overall tax residence to the overseas jurisdiction based a series of four tests.  Broadly, these tests are designed to establish to which country the individual has the closest personal and financial ties.

Step two, under Article 14, is to establish if the time spent in the UK across the relevant tax year is below a certain threshold (183 days within any 12 month period beginning or ending in the UK tax year), and to confirm the overseas employer does not itself have a taxable corporate presence in the UK.

If both steps can be cleared, then a claim can me made on the relevant UK tax return to exclude the income entirely from UK tax, notwithstanding the fact that the taxpayer is UK tax resident under the Statutory Residence Test and would otherwise be fully taxable in the UK on their worldwide income.

If only the first step can be cleared (i.e. awarding overall residence against the UK), then the UK’s taxing rights are restricted to the amount attributable to UK workdays, usually calculated as a fraction of the total workdays across the tax year.

Additional complications can arise where the employee is awarded a cash bonus or equity in the business (e.g. restricted stock units or ‘RSUs’) as the overall accrual period of the award must be considered.

Here at Taxative, we are experts in assessing your circumstances and establishing if you could benefit from the provisions of the DTAs. Given the relatively high rates of UK income tax, the amounts at stake can often be very large and therefore investing in professional assistance is likely to pay off.