“If you can’t stand the heat, get out of the kitchen” so said Harry S Truman, ex-President of the United States in 1942. I would say the same nowadays as regards tax. “If you can’t stand the tax laws, emigrate”. And, as I have clearly described in earlier Newsletters, this applies both to individuals and also corporate entities (see the February Newsletter). In this month’s Newsletter, we describe the issues relating to personal tax residence and those considerations which apply when thinking about emigrating.
Regular readers will know that personal and corporate migration is, in my opinion, the theme of international tax planning in the 2010s. I gave a lecture on corporate migration at the recent ITPA conference in Montreux, and was very pleased to see the interest it generated with the numbers coming to the afternoon discussion periods. One of the most interesting aspects was the ‘step up in basis’ of asset values on corporate migration within a newly created merged company in certain jurisdictions, (eg Austria, Malta). What was also interesting was that Delaware companies, long known for their flexible company law provisions, can easily migrate from one jurisdiction to another, outside of the US.
Since this is such an important area of future international tax planning, I intend to devote the entire second annual ITSAPT Conference this year to the subject of corporate and personal migration. Following on from the success of the first annual conference held last year, the 2011 conference will take place again at The Landmark Hotel on 3 November 2011, and will feature the same respected speakers from the US, Canada, Singapore, Israel, Switzerland and many EU countries who will examine the relevant issues from their perspective. Philip Baker QC will chair the conference as he so expertly did last year, and will also participate in the conference giving the OECD and EU views on corporate migration. I will introduce the concepts and be the moderator on the panel discussions during the morning in respect of corporate migration, and in the afternoon on personal migration.
As for last year, we will hold a cocktail party in the Gazebo at The Landmark Hotel after the conference, so that delegates and speakers can discuss matters of mutual interest. Please make a note of the date, and if you would like to register your interest in attending and secure your place, please click here. We will be sending out full marketing material relating to this conference in the May newsletter together with relevant booking forms, but you can view the draft conference programme by clicking on the ‘ITSAPT’ link.
Personal migration as an international tax planning toolMoving to a different country often constitutes the ultimate form of individual tax planning. Indeed changing one’s place of living may uproot the person’s entire life, put relationships at strain and cause substantial expenses. This may not be appreciated fully by some high net worth individuals, who have the liberty to choose between destinations that offer optimal tax benefits but perhaps at the expense of their quality of life.
Nevertheless, many individuals want to emigrate in order to lose their residence status and achieve tax benefits. For example, death of a person who is not domiciled in the UK but who has resided here for at least 17 out of 20 continuous years will trigger a substantial UK inheritance tax charge. This is because such prolonged residence period makes the person “deemed domiciled” in the UK with the resulting inheritance tax liability. A common planning strategy involves periodic loss of UK residence—in any 20-year period there must be at least four full tax years of non-residence. Conversely, one may want to immigrate to obtain favourable treatment only available to residents. The Chelsea-dwelling ex-wife of a Russian oligarch may receive her ex-husband’s share of their Moscow flat and shares in a Russian company as a part of their divorce settlement. A non-resident—she belongs to the London’s beau-monde and has not set foot in Moscow in the past ten years—if she decides to sell the flat and the shares, she will pay Russian income tax on gross proceeds at more than twice the rate available to residents (and without the ability to deduct initial acquisition costs of the property!). Depending on circumstances, she may be advised to become a Russian tax resident in the year of the subsequent post-divorce sale; she may well tell the tax adviser what to do with his advice, but the tax benefits are indisputable.
Residence is universally regarded as the primary connecting factor that links an individual to a State and usually gives the State jurisdiction to tax that person’s worldwide income and gains. Whether a person is resident in a particular country or not, tax liability may also be affected by their ordinary residence, citizenship, domicile or deemed domicile. Depending on the direction which the individual’s tax planning strategy takes, the combined effect of these factors must be considered. For example, a resident alien who moves out of the US but keeps their Green Card pays tax on their worldwide income. As a countermeasure they may seek to establish a permanent home in a country with which the US has a double tax treaty and become resident there. They may also want to relinquish their US citizenship; however such person must be aware of a quasi-“toll charge,” imposed on wealthy individuals who have in the past ten years relinquished their US citizenship or given up “long term” US residence.
Conversely, if a person moves to the UK and becomes resident there, they can avoid paying tax on foreign income and gains for as long as they are not remitted to the UK. This is however only available to persons, who are not ordinarily resident in the UK or who remain domiciled outside the UK. After residing in the UK for seven out of nine years they can only continue with this regime subject to paying an annual £30,000 charge (potentially increased to £50,000 for individuals who have been UK resident for twelve or more years if the 2011 Budget becomes law), unless the individual goes abroad temporarily to make a break in their residence period.
Tax-driven migration therefore primarily depends on how a person acquires or loses residence under the laws of a particular jurisdiction. Each tax system is unique, however there is a remarkable similarity in approaches to determination of the concept of residence. Notably, a mechanical residence-defining factor is seldom considered by itself and often there are several alternative or complementing tests. Some are hard and fast and look at exact facts, such as the length of a person’s stay in a country or whether they have a house and family there. Others are nebulous, looking at the person’s state of mind and future intentions. The following is an attempt to split these factors into several broad categories—these are merely examples of different approaches and they must not be considered in isolation.
Mechanical Residence Test
Many States deem resident a person who physically spends some time within their borders during a certain period, and this is where the first difference lies. In the US, for example, the relevant time frame is any consecutive 12 months; in Russia it is the tax year—the same as the calendar year; in Australia it is the tax year, which runs from July 1st to June 30th; in the UK it is also the tax year, running from April 6th to April 5th.
In some places simple day counting constitutes the sole method of residence determination. Cyprus and Russia, for instance, deem resident a person who stays there for 183 days in any year. Notably, Cyprus allows an individual to be treated as a resident only following their arrival; conversely in Russia the person will be deemed resident during the whole year in which they acquired such status. This is a subtle yet an important difference. Seeing that a resident pays taxes on their worldwide income and gains, they may want to receive earnings before coming within reach of tax authorities of their destination State. A Monaco resident executive may wish to receive their annual bonus, say, on March 1st and pay no taxes at all before arriving in Cyprus on April 1st with a view to staying there for the remaining part of the tax year, only during which they will incur a worldwide tax liability. In Russia such executive’s tax liability would extend to the entire year.
Compare this with a rather Jesuitical approach practiced by, for example, the US, which also counts days of presence, although with a twist. An individual should be treated as a resident of the US for any calendar year or part of a calendar year if he meets the “substantial presence” test, i.e. if the number of days such individual was present in the US (provided it is more than 31 days) during the calendar year, plus 1/3 of the days he was present in the preceding tax year, plus 1/6 of the days the individual was present during the second preceding year, exceeds or is equal to a total of 183 days. Similarly, an individual will always be resident in the UK in a tax year if they are physically present there for more than 182 days in that tax year. If, however, after three complete tax years it appears that a person’s annual visits to the UK total more than 91 days on average and their visits continue, then that person will become resident in the UK from the start of the fourth tax year (this is the rule in the new HMRC6). Other common law States, including Ireland, the Isle of Man, Guernsey and India follow the similar approach and look at the aggregate number of days of presence over the course of several tax years.
Switzerland demonstrates an interesting modification to the above rules. It deems resident a person who stays there for at least 30 days per year and engages in a gainful activity which generates income from Swiss sources. This period is increased to 90 days where no such activity is performed. Conversely, China requires a person to spend at least 365 days on its soil in a tax year, of which a maximum 90 days may be spent abroad, before they become resident there.
Permanent Home Test
Other States deem resident a person who keeps a living place on their soil – this used to be the case in the UK prior to 1993. For example a person will be resident in Austria if they either own or are entitled to use a living place, such as an apartment or a hotel room for over six months in a year. If the person permanently resides outside Austria for more than five years but also keeps an apartment in Austria, they will be under an unlimited tax liability in those years in which they used this apartment for more than 70 days. Conversely, a person who owns or occupies a house in Portugal on December 31st may be found resident during the same year regardless of the number of days spent in the country, provided that the tax authorities can demonstrate that person’s intention to reside in that house permanently. Jersey even deems resident a person who acquires accommodation there and visits the island for even a single day during a year, irrespective of their intentions.
It is noteworthy that in some States, such as Belgium and Italy, entering the civil registry also renders the person resident there, until proven otherwise.
Centre of Vital Interests Test (Economic and Social)
It is not uncommon for residence to be based on whether a person maintains their centre of vital interests in a State, although there is a marked difference in interpretation of what constitutes “vital interests”—these can be economic or social. Normally the latter are attached greater importance, although in their absence the former will often be considered.
France, for example, deems resident a person whose centre of economic interests is in France. This includes managing their investment activity from France or having French headquarters for their personal business activities, or earning the majority of their income in French soil. Similarly, Belgium defines economic nexus as the location from where the person’s property is administered, regardless of the location of this property. Spain also looks at where a person has their main centre of business or professional activities or economic interests—the authorities interpret it as the location where the taxpayer obtains the majority of their income.
Conversely, the Netherlands looks at whether the person’s centre of personal interests is situated, which includes a permanent home, family and economic ties. Unlike other countries the Netherlands dispenses with counting a person’s days of presence altogether. Switzerland also looks at the evidence of a person’s centre of vital interests i.e. a place where the taxpayer actually stays and intends to dwell. This includes where the individual’s family lives, the children go to school, a political affiliation is demonstrated, etc. Belgium also looks at where the taxpayer in fact has their centre of social and professional interests regardless of any minimum duration.
“Intention to Settle” Test
These factors may seem to demonstrate that residence planning is objective, that it is enough to stay in or, conversely, out of the jurisdiction, to buy or sell a house there or to enter or to remove oneself from the official records in order to acquire or lose residence. It could not be further from the truth—the majority of States in deciding on the person’s residence status also look at their subjective intentions. These may tip the balance towards finding the person resident, even if their period of physical stay in the jurisdiction is insubstantial.
For example the UK has a very broad definition of residence, which is a combination of statutory provisions and case law. The latter gives “residence” its usual meaning: to dwell in one jurisdiction permanently or for a considerable time; to have one’s settled or usual abode in one jurisdiction; to live in a particular place. The oft-cited example is that of a Mr Shepherd, a professional pilot, spending 180 days in the tax year out of the UK on flights, 77 days in Cyprus where he rented a furnished flat and 80 days in the UK in the family home. The following factors would, following reported cases, point towards a person being resident in the UK:
- physically being present in the UK;
- visiting the UK frequently and for long periods;
- having links with the UK, such as available accommodation, friends and family;
- retaining UK possessions and bank accounts;
- keeping UK subscriptions to UK newspapers, parties and clubs memberships;
- demonstrating the intention to reside in the UK in letters, diaries, emails.
Her Majesty’s Revenue and Customs (HMRC)—UK’s tax authority—has published its views on the interpretation of statutory and case law principles of residence in its publication HMRC6. HMRC impresses in no uncertain terms, however, that they are not bound by any precedents in determining a person’s status and each case is decided upon its facts. Following the recent decision of the Court of Appeal on Gaines-Cooper v HMRC, this is no longer true—provided the taxpayer falls within the exact terms of HMRC6, HMRC is bound to apply it. Happily for tax practitioners, the 2011 Budget statement brought promises of a statutory residence test in the UK, which may become law in 2012. At the moment, however, its exact scope is unclear.
The UK is not unique, and a similar approach is followed across the world with slight modifications. For example a person settling in Australia or France with their family (spouse and children) may be regarded as residing there from the date of their arrival regardless of whether that person may be subsequently absent from either country for extended periods (this goes hand in hand with the above discussion of what constitutes the centre of vital interests).
Factors affecting loss of residence
The above discussion mostly addresses the issue of acquiring residence, but what of those wanting to lose theirs? Here approaches differ. It is easy to depart from the State that solely looks at the days of presence—one just must avoid setting foot on its territory during the requisite period. Others, especially common law jurisdictions, bring memories of a Hotel California—one can physically go at any time they like, but they may never be able leave the grip of that State’s tax authorities. The best advice in that case is to make a “clean break”, i.e. severe all connections with the former homeland. This may include selling or leasing out available accommodation, closing bank accounts, terminating subscriptions and memberships, removing oneself from civil registers, gathering personal evidences from friends and neighbours about one’s intentions to leave and, most importantly, physically moving abroad with one’s family. In short, no appropriate measure will be deemed too excessive.
Exit taxes and residual taxation rights
Some jurisdictions impose exit taxes on persons who become non-resident under domestic laws. Israel, for example, treats departing individuals as if they sold their worldwide assets and realised employees’ share options at market value one day before they ceased to be residents. The resulting deemed gain is liable to capital gains tax, and this often justifies implementing an arrangement that permits a “step up” in the asset’s base value. Alternatively, pension income may be taxed at an increased rate. Exit taxes are becoming increasingly rare and are often disapplied altogether under non-discrimination provisions of applicable tax treaties or under EU jurisprudence.
Some States, however, retain residual taxation rights towards their departing citizens or former long-term residents. Germany, for example, retains for ten years limited taxation rights vis-à-vis worldwide income of its citizens who were resident there for five out of ten years immediately preceding departure and who have moved to a low tax country, having retained economic ties with Germany (e.g. a shareholding in a Germany company). Italian citizens who have been removed from the Resident Population Registry and have moved to a State or territory not included in a published “white list” remain Italian residents unless proof to the contrary is provided. Similar lists are maintained by Portugal and Spain. The US is also famous for taxing its departing Green Card holders as described in the beginning of this article.
Resolving conflicting residence claims
A person may unwittingly satisfy residence conditions of more than one State. Consequently, the individual may be liable to tax on the same items of income in more than one jurisdiction, incurring double (or in extreme cases—triple) taxation. Conflicting residence claims are settled under double tax treaties—most of these contain a tie breaker provision that gives the attachment of an individual to one State a preference over the attachment to the other State. This is achieved through applying a series of the preference criteria that the individual concerned will satisfy in one State only. The first preference is given to the State in which the individual has a permanent home available to them—the home, which the individual owns or possesses and where they stay permanently and not for short durations only.
If the individual has permanent homes in both States (or indeed in neither State), preference is given to the State where that person has their centre of vital interests—the State with which the personal and economic relations of the individual are closer. This is a rather subjective factor and requires examination of all circumstances, including the personal acts of the individual, location of their family, social relations, occupations, political, cultural and other activities, place of business, etc. Even if the person establishes a second home abroad, the fact that they retain the first home in the place where they have always lived, worked and have their family connections can demonstrate that their centre of vital interests remains in the first State.
The next criterion is the length and frequency of the person’s stay in each State—their habitual abode. It applies if either (i) the person has permanent homes in both States, and it is impossible to determine where their centre of vital interests lies; or (ii) they don’t have a permanent home in either State, and it is impossible to determine where their centre of vital interests lies. Regard is given to the sum of visits to the territory of a particular jurisdiction, including stays in hotels. There is no stipulation over what length of time the comparison must be made, although it is commonly required to be reasonably sufficient to establish patterns in the person’s behaviour.
If none of the above factors demonstrate the person’s closer connection to a particular State, they will be deemed resident in the jurisdiction of which they are a national. If they are a national of both or neither State, the conflict must be resolved through the jurisdictions entering into negotiations—the mutual agreement procedure.
It can be seen that the tie breaker clause to a large extent repeats and brings to the common denominator residence criteria found in different jurisdictions. It establishes a clear hierarchy of succeeding residence tests and brings certainty to individual tax planning—this is in view of the fact that usually tax treaties take precedence over domestic laws. Unfortunately tax treaties are not always a panacea for the problem of double taxation. Some like the treaties between the UK and Jersey and Guernsey do not contain tie breaker clauses—the person seeking to lose UK residence must satisfy requirements of the UK law. In other cases domestic courts in each state may interpret terms of the tie breaker clause differently, resulting in double taxation.
There are numerous examples showing that moving from one State to another or, conversely, staying out of a particular jurisdiction in preparation to a transaction or as a means of life-time financial planning constitute an important tool in the international tax planning arsenal. Unfortunately the boat of an elaborate strategy may run aground amidst the sands of uncertainty sometimes surrounding residence criteria of jurisdictions involved in the move. This is especially true in circumstances where a person wants to lose their residence, or, conversely, not to acquire it, especially once it has been lost. In this case only a tax treaty can provide certainty; its tie breaker clause, if it exists, regulating conflicting residence claims. This just goes to demonstrate the complex nature of residence planning, and that’s just the tax planning side. How many divorce lawyers relish the social issues arising from the departure of a wealthy spouse from the marital home; divorce settlements can prove far more expensive than the tax saved by a tax residence move! And a final word of warning – the grass may seem greener in a far off land, but it is often rather brown and sparse; the final recommendation before departure must be to test the water first.