For many years, the law regarding UK tax residence has been largely subjective with the only definitive rule being that a person is resident in the UK if they spend more than 183 days in the UK in a tax year. However, proposed changes to the residency rules could affect the tax status of many individuals and have a knock-on effect on their companies or trusts.

‘Home’ is an emotive word with a variety of connotations. For Pliney the Elder it was where the heart is while in Douglas Adams’ The Hitchhiker’s Guide to the Galaxy, it’s wherever you happen to park your bath towel. For some people though, where they live can make a significant difference to how, and more importantly how much, they are taxed.

There have long been calls for a statutory residence test even as far back as 1936. At that time the committee on Codification of Income Tax law declared the situation ‘intolerable’ whereby “...an enquirer can only be told that the question whether he is resident or not is a question of fact for the Commissioners but that by the study of the effect of a large body of cases he may be able to make an intelligent forecast of their decision ...”

Disputes over residence began to decrease with the publication by HMRC of their guidance and practice, embodied in booklet IR20. However, in recent years the application of this guidance too has caused some uncertainty and problems, leading the Chartered Institute of Taxation to conclude recently that the law determining whether an individual is resident in the UK or not ‘is a mess.’

Against this backdrop the Government released proposals for a new statutory residence test in June 2011. It was originally proposed that the new test would be applicable from 6 April 2012, but already this target date has been delayed and the new rules are now only expected to be introduced with effect from 6 April 2013.

The test will provide a statutory definition of residency for individuals for the first time and will supersede all existing legislation, case law and guidance for the tax years following its introduction.

Nevertheless, the way in which the proposals are intended to operate will, in some cases, mean that current and past presence in the UK could determine whether a person is resident, or not resident, after 5 April 2013. This in effect means that determination of residency status under the current law, may remain relevant and necessary for the tax years 2010/11, 2011/12 and 2012/13.

New Rules

The consultation paper proposes a three-part test. The first two parts will point automatically to conclusive non-residence or conclusive residence if any of the three factors in each test are present. The third part is essentially a ‘tie breaker’ test which will apply where an individual’s residence status cannot be decided by any of the conditions in part A or B.

Part A: Non-Residence

If an individual has satisfied any of the following conditions for a tax year, it will be accepted that they will not be resident in that tax year if they:

• are not resident in the UK in all of the previous three tax years and are present in the UK fewer than 45 days in the current tax year;
• are resident in the UK for one or more of the previous three tax years and present in the UK fewer than 10 days in the current tax year; or
• have left the UK to carry out full-time work abroad (based on a 35 hour working week) and are present in the UK for fewer than 90 days in the tax year with no more than 20 of these days spent working in the UK in the tax year.

A person will be treated as being in the UK on any day where they are in the country at midnight at the end of the day. Where full-time work abroad is relevant this work must be carried out for at least one full tax year. And the definition of a ‘working day’ is any day on which three hours or more of work is carried out.

The inclusion of this type of criteria does leave scope for uncertainty and dispute with HMRC particularly given modern flexible working practices where people have constant access to emails and mobile phones.

Part B: Residence

If Part A does not apply but the individual satisfies any of the following conditions, they will definitely be resident in that tax year if they:

• are present in the UK for 183 days or more in a tax year;
• have only one home and that home is in the UK (or have two or more homes all of which are in the UK);
• carry out full-time work in the UK over a continuous period of nine months with no more than 25 per cent of the relevant duties being undertaken outside the UK within that period.

‘Home’ is not defined in much detail in the paper, other than to say that residential accommodation is not treated as an individual’s home if that accommodation is being advertised for sale and the individual lives in another residence. Presumably a common sense approach will be adopted similar to the ‘accessible accommodation’ concept in Part C. Again full- time work in the UK requires an individual to work 35 hours per week.

Part C: Connections and Day Counting

If an individual does not fall into part A or B, then a ‘tie breaker’ test, part C, will be applied. This operates on a sliding scale so that the more time someone spends in the UK, the fewer connections they can have with the UK if they want to be regarded as a non-UK resident.

What is proposed is that the time that can be spent in the UK is reduced depending on how many of the following five connecting factors are present:

• Family – the individual’s spouse or civil partner or common law equivalent (provided the individual is not separated from them) or minor children are resident in the UK;
• Accommodation - the individual involved has ‘accessible accommodation’ in the UK and makes use of it during the tax year (subject to exclusions for some types of accommodation, for example, temporary lodgings with relatives, hotel stays or accommodation that is made available by the employer);
• Substantive work in the UK – the individual does substantive work in the UK but does not work in the UK full time;
• UK presence in the previous year – the individual spent 90 days or more in the UK in either of the previous two tax years;
• More time is spent in the UK than in any other country – the individual spends more days in the UK in the tax year than in any other single country, but this only applies to ‘leavers’.

The way that the proposed new rules work is to characterise everyone as either an ‘arriver’ or a ‘leaver’. Care is needed here as an ‘arriver’ is someone who has not been UK resident in any of the previous three years and a ‘leaver’ is anyone else.

The connection factors are therefore combined with days spent in the UK to determine residence status as follows:

Individuals who know how many days they spend in the UK and how many relevant connection factors they have should find it relatively straightforward to assess their residency status. For example, a person who normally works outside of the UK but whose family live in the UK would therefore probably be UK resident under the proposed rules if they had spent 90 days in the UK in either of the previous two years. This is because they would have three connecting factors: family in the UK, accessible accommodation with their family and they would have spent more than 90 days in the UK in either of the previous two years.

The circumstances in which split-year treatment currently applies will be put onto a statutory footing under the new proposals. Split-year treatment will not apply where an individual’s residence status changes only as a result of changes in the number of connecting factors under part C.

An anti-avoidance rule for some forms of investment income, along the lines of the existing five year Capital Gains Tax rule, will be introduced. This will apply mainly to dividends paid by closely- controlled companies based on profits that have built up during a period of residence and which are then taken out during a short period of non- residence.

The rule would not apply to earnings from employment or self-employment or to normal types of regular investment income, such as income from bank interest or dividends from listed companies.

The proposed legislation will apply only to individuals, however it could also have an unexpected impact on the residency status of other entities such as companies or trusts. For example, the residency status of a trust is ordinarily based on the residency status of the individual trustees. If any of those individual trustees find that their own residency status changes as a result of tougher tests, this could render a previously non-resident trust a UK resident potentially exposing the trust income to an income tax rate of 50 per cent.

Therefore, it is crucial that not only individuals, but those entities whose residency status is determined by the status of the individuals who have control, give consideration to the impact of the new rules and where necessary consider taking steps to reduce the number of connecting factors that may apply.