Is a single year of non-residence enough to escape UK tax?

The issue

Years ago some taxpayers would seek to ‘wash’ out dividends from their companies by becoming non-UK tax resident for a single year. If they wanted to do this then the advice would generally be that they should not step foot in the UK for the tax year in question. This was because the rules on residence were very wishy-washy and not as scientific as they are today, where the position is determined by a clearly prescribed set of rules known as the Statutory Residence Test (‘SRT’). There were even some commentators who argued that a full year out of the UK would not constitute non-residence, because it was not impossible to break residence for a single year. When the SRT was introduced in 2013 everything became much more objective and it was relatively easy to understand what you needed to do to break residence. At the same time as the SRT was introduced,  a concept of temporary non-residence was introduced for income tax purposes (which had already existed for capital gains tax purposes). This worked by assessing certain income received by a taxpayer during a period of non-residence in their year of return to the UK. To avoid the temporary non-residence rules the taxpayer would usually have to remain non-resident for at least six years, and so much of the planning mentioned above was completely frustrated.

Example

Ned owns a company which has £5m of distributable reserves. On 5 April 2022 he flew over to the Isle of Man and did not return until 6 April 2023.  Under the SRT he was non-resident throughout the 2022/23 tax year. In June 2022, he paid himself a £5m dividend, happy in the knowledge that he had escaped UK tax. When discussing his 2023/2024 tax return with his accountant, he is dismayed to hear that the £5m dividend needs to be brought into account because of the temporary non-resident rules. To add salt to the wound there was also a 1.25% hike in dividend rates in that year, and so his little foray actually cost him tax!

Pre-departure trade profits

The position in the above example is perhaps oversimplified, because the temporary non-residence rules do not apply to all profits but only pre-departure profits. This means that some dividends could escape UK tax.

Tweaked example

Ned owns a company with £5m of distributable reserves in it. On 5 April 2022 he flew over to the Isle of Man and did not return until 6 April 2023. In March 2023 he paid himself a £1.5m dividend out of profits which had arisen since 6 April 2022 (declared and minuted as such). When discussing his 2023/2024 tax return with his accountant, the accountant confirmed that this dividend would not be caught by the temporary non-residence rules. Ned’s foray had therefore effectively saved tax on a £1.5m dividend.

Our view

Although some commentators suggest that anti-avoidance legislation may apply here, I disagree. The legislation is clearly only seeking to subject profits to tax which were made during the shareholder’s period of UK residence. The position may get a bit more ‘edgy’ where a property development company is involved. For example, I can envisage a scenario where a property development company makes a significant profit in a year of the shareholder’s non-residence and a dividend of supposedly post-departure trade profits is paid in that year. The rules say that pre-departure profits have to be calculated on a ‘just and equitable basis’ but would that give HMRC latitude to allocate profits to a period before that in which they were accounted for?  I think that they would have difficulty in arguing this…

As a final note, it goes without saying that care needs to be taken in any planning of this nature that you do not inadvertently move to an unfriendly tax jurisdiction!

The weekly Tax Bites are not intended to constitute tax advice. The information provided in these articles is based on our understanding of current tax law; however, we do not represent or warrant the accuracy of the information contained therein, and any information provided may be incomplete or condensed. Furthermore, the suggestions contained within these articles are for discussion purposes only and should not be relied on. You should seek formal tax advice before proceeding with any of the suggestions contained in this document.