ABB 2006/7 | Practical Advice | Taxation

For mobile employees, tax can be a daunting and confusing subject. Generally, at least two jurisdictions may require tax return filings and ensuring that appropriate tax returns are filed in the correct country, state, city and local jurisdictions can be a challenge.

To be tax compliant, but also to ensure that you are not paying double tax (or no tax when you should be!), it is important to seek advice from experts in the tax rules of the countries in question. Here are some key concepts to give basic guidelines on what to think about when you are no longer dealing with just your home country under “domestic” rules.

Residence

The concept of residence is usually centred on how much time you spend in a country and each country has its own rules. In the US, for example, there are detailed day-counting requirements under what is known as the “Substantial Presence Test”; the test reviews days over a cumulative three-year period and once you are classified as a resident under this test, you are subject to tax on worldwide income. In the UK, there are also day-counting tests, but your intention at the outset of arriving in the UK can also play a part in determining your UK residency status.

Domicile

Some countries have a concept of “domicile” which tends to be a longer term concept of where your permanent home is or where your “roots” are. In the US, some States have the concept of domicile. Retaining your US property while you live outside the US can lead to a State considering you domiciled there and so that State may require you to continue to pay tax on your worldwide income. Each State has its own rules and these rules are separate from the US Federal rules. The UK also has this concept and your domicile status there will determine how your investment income is taxed. For a non-UK domiciled person, it may be possible to limit or avoid UK tax on your investment income by generating and keeping that income outside the UK (this is referred to as the “remittance” basis of taxation).

Citizenship

US citizens and Lawful Permanent Residents (usually Green Card Holders) are subject to US tax on worldwide income no matter where they reside, so even after leaving the US, a US citizen or Lawful Permanent Resident will be required to continue filing US tax returns. This can lead to the potential for double taxation so US tax law allows certain exclusions and foreign tax credits to help the US taxpayer avoid double taxation. If a US taxpayer resides in a country where there is no tax or low tax, US tax could still be due. In short, if you haven’t paid tax in the host location, the US could tax you on the income.

Double Tax Treaties

There are double tax treaties between many countries and these are in place to ensure double taxation is avoided, and in many cases, a double tax treaty will guide the decision as to where you are considered resident for tax purposes, and therefore which country has the right to tax income. There is a common misconception that treaties have a “183 day rule” and if you spend fewer than 183 days in a country, you do not have pay income tax. Double tax treaties are not aiming to help individuals avoid tax altogether. They are in place to help individuals avoid paying tax in two countries on the same income. Whenever there is potential for double taxation, it is vital to review the country-specific treaty, since no two are the same.

Tax Planning

The length of an assignment can significantly affect an individual’s tax liability as can the timing of the move and the timing of recognizing income. In some countries, such as the US and UK, arriving towards the end of a tax year (December 31 for the US and April 5 for the UK) can result in that first or last “stub” year being a year in which you may be considered nonresident.

This can lead to opportunities to minimize tax by reducing the amount of income actually subject to tax, or by taking advantage of a full tax year’s lower tax brackets and exemptions or allowances even though a full year of income is not included. Tax issues can also be complex when it comes to selling real estate and often timing of the sale can play a key part in minimizing tax.

For example, the UK may treat the sale of your principal private residence as non-taxable and although the US has tax beneficial rules when it comes to the sale of your home you do need to meet specific requirements including set periods of occupancy in order to qualify for the tax breaks.

Gift, estate, and wealth taxes and social security

In addition to income tax considerations, many countries have gift taxes, estate taxes and wealth taxes and each country has its own rules about these. Social security also varies by country and each country’s social security rules should be consulted to determine where social security should be paid.

A rule of thumb is that you pay where you work but for relatively temporary moves, it is often possible to remain in your home country system. For moves between the US and UK, coverage under the home country can generally continue for five years.

What’s New?

In the US in May 2006, a key change impacting on US citizens or Green Card Holders living abroad was a change to the calculation of exclusion allowed for foreign earned income and housing costs. The outcome is that there is a potential for significant increases in US tax for US tax filers residing outside the US since the exclusion for foreign housing costs is limited substantially, and the excluded income must be added back to taxable income for the purposes of determining the marginal tax rate applicable to non-excluded income. Those most affected are likely to be US filers living in low-tax countries where housing costs are high.

In the past, many US expatriates living overseas – particularly those living the UK – were subject to Alternative Minimum Tax (AMT) because they were restricted on their foreign tax credits. However, from 1 January 2005 this restriction has been lifted. For 2005 onwards, many US expatriates may no longer have to pay AMT, a “tax” which was usually not creditable and therefore an additional cost.

In the UK, new pensions legislation came into force from 6 April 2006, or “A-Day”, such that there is no restriction on the level of pension contributions that can be made each year. There is a restriction on how much tax relief is allowable; for 2006/07, tax relief on these contributions is the lower of an individual’s taxable employment income and £215,000. A further test is applied to the value of an individual’s total pension savings at the time they draw their benefits. If the total value exceeds the “Lifetime Allowance” at that time (£1.5M in 2006/07), the excess will be subject to tax at an effective rate of 55%.

Tax for mobile employees is complex and each situation must be reviewed on its own merits. Professional advice should be sought in most cases and pre-planning before you leave, return home or take on your next new move will stand you in good stead.

For more information, contact:
Sean Trotman
Director in Deloitte Tax
Tel: 212-436-2211
E-mail: strotman@deloitte.com
Or
Nicky Holt
Principal, Deloitte Tax
Tel: 212-436-2351
E-mail: nicholt@deloitte.com

Website: www.deloitte.com

Copyright© 2006 Deloitte Development LLC. All rights reserved. This article does not constitute tax, legal or other advice from Deloitte Tax LLP, which assumes no responsibility with respect to assessing or advising the reader as to tax, legal, or other consequences arising from the reader’s particular situation.

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