27 Apr 2017

Readers' forum : Disregarded income

18 April 2017

Entitlement of non-residents to personal allowance on UK rental income.

A husband and wife are non-resident and live in France. For about 30 days in each year, the husband visits the UK to work for a company in which he is director and 50% shareholder with his wife. At the end of the year, they draw dividends of £50,000 each. They also receive a salary of £11,000. I understand that the dividends are classed as disregarded income and do not have to be entered on their UK self-assessment tax returns.

The couple now intend to buy a property in the UK and rent it out. They already own and let out a holiday caravan through the site owner. They use the caravan as a base when they are visiting the UK or working here. Given there are new sources of income, could Taxation readers advise me on whether are they entitled to a personal allowance? Further, does this affect the tax treatment of the dividends?

Query 18,957 – Frank.

 

Reply by  Birdy

I assume that the client meets the non-resident criteria under the statutory residence test. However, given that he works in the UK for a UK company, this is unlikely to be a straightforward ‘automatically not resident’ situation, so Frank would be well advised to review residence status.
 
The query states that dividends ‘do not have to be entered on their UK self-assessment tax returns’. This is on the basis that dividends are ‘disregarded income’. Unfortunately, the disregard relates only to the alternative calculation of UK tax for a non-resident, which in effect caps the tax that a non-resident pays in the UK, so the dividends do have to be included in any UK returns.
 
The starting point for preparation of a UK tax return is that all the income is reported as normal. Once the tax position is established, a relieving provision can then be applied to reduce the tax to be paid by non-residents. This involves a recalculation without ‘excluded income’ such as dividends, but removing the personal allowance. Thus, the disregard of dividend income will apply only if there is a tax saving for the non-resident. It is a cap on the UK tax payable. The loss of the personal allowance for an EU resident will arise only when losing it reduces UK tax liabilities.
 
On the basis of the information provided, the client would lose their personal allowance, but the tax payable by an individual with a salary of £11,000 and dividends of £50,000 would be £7,875. For a non-resident, this is reduced to £2,200 by the cap on tax for non-residents which takes away the personal allowance in return for ignoring dividends.
 
It is not clear from the query whether the salary that is being taken is considered to be a UK salary or is paid as earnings in France. On the basis that it is included in the query, I am assuming that it is indeed taxed as salary in the UK.
 
Given that it is at the personal allowance level, I am guessing that it will have gone through PAYE with a code that gives personal allowances, so that no tax is deducted at source. However, the dividends create a tax liability, either through self-assessment or through PAYE by the loss of the personal allowance. So in this case the acquisition of a new source of income is not itself the trigger for a tax problem; the problem already exists.
 
The final part of the double taxation jigsaw in the UK is relief that may be claimed through the double tax agreement with France, which limits the tax payable on dividends to 15% of the gross. In this case, that restriction is of little help because the tax rate on dividends within the basic rate band is substantially lower than 15%, but it could provide relief if the rental income means that the cap on income tax for non-residents is higher than the actual liability.
 
The fact that we refer to ‘double taxation agreements’ should remind us that there are two parts to this equation. As UK advisers we concentrate on the tax payable here but, for the client, they will also be exposed to tax in the other jurisdiction, France in this case. For a client who is not resident here, the UK position is only ever a ‘payment on account’ for their tax liability in their home country. Therefore, unless the client lives in a very low tax rate country (which France most definitely is not), saving UK tax does not generally reduce the overall liability of the client.

 

Reply by George Attazder

It is not correct that, because dividend income falls within the definition of disregarded income in ITA 2007, s 813, it can be omitted from the individual’s UK tax returns. First, assuming that the company is UK resident, the dividends are UK source income, and, subject to the terms of the treaty with France, are taxable in both countries, with credit being given in France, where the couple live, for any UK tax suffered on the income.

Under the terms of the treaty the UK tax on the dividends is limited to 15%, and non-UK residents are entitled to a non-repayable tax credit of 7.5% under ITTOIA 2005, s 399.

The salaries are taxable only in the UK to the extent that the duties are carried out here, or are otherwise taxable only in France. I assume that all the duties are performed on the visits to the UK, such that they are taxable here.

That being the case, each of the individuals has an £11,000 salary covered by their personal allowance and dividend income of £50,000. Tax on the dividend income is £6,625 (£5,000 at 0%, £32,000 at 7.5%, £13,000 at 32.5%), which does not exceed the 15% (£7,500) limit in the treaty. After deducting the 7.5% (£3,750) credit, this leaves a liability of £2,875.

This UK tax liability is then automatically limited by ITA 2007, s 811 to that which would arise if the individual had no personal allowance and the disregarded income suffered no further tax. This gives rise to a liability of £2,200.

In consequence of s 811, the credit available against the tax on the dividend income reduces from £6,625 to £3,750, giving rise to a potential increase in the net tax liability in France on the dividend income of £2,875. Therefore, the UK and French liabilities might have increased by a net £2,200.

The position may differ if not all the salary is taxable in the UK because some (or all) of the duties are performed in France. The property income will also affect the analysis.

 

Reply by Nenthead

Non-UK resident individuals will be eligible for a personal allowance if granted by a specific double tax treaty or by ITA 2007, s 56. Frank’s clients are resident in France and the UK/France double tax treaty does not specifically grant a UK personal allowance to a French resident and they will only receive a UK personal allowance if they are meet the conditions in s 56. Most commonly, non-UK resident individuals are given a personal allowance by s 56 because they are a national of a state within the European Economic Area (EEA), which comprises the EU, Norway, Iceland and Liechtenstein.

Non-UK resident individuals are subject to UK tax only on their UK sourced income, however their income tax liability cannot be more than:

 

  • the amount of tax that would be chargeable on income, other than the individual’s ‘disregarded income’, but before the deduction of any personal allowances due;
  • plus the amount of tax deducted at source from the ‘disregarded income’.

 

Disregarded income includes, but is not limited to, interest from UK banks, dividends from UK companies and certain UK social security benefits, such as the state pension. From 6 April 2016, the notional tax credit on dividends was abolished and therefore a dividend from a UK company will not be treated as having any tax deducted at source.

An income tax computation based on the normal principles should be undertaken and compared with the alternative calculation under the disregarded income rules. It is important to note that the disregarded income rules are not an election and they must be used to compute an individual’s tax liability if they are more favourable.

Frank’s clients have UK salaries, UK rental income and UK dividends. Of these sources, only the clients’ UK dividends will be considered disregarded income. The income tax liability of Frank’s respective clients will therefore be limited to the tax due on the salary/rental income (for 2016-17 a rate of 20% applies to the first £32,000, 40% on the next £118,000 and 45% on any excess) without a deduction of a UK personal allowance plus the tax deducted at source on the UK dividends (nil).

If Frank’s clients are not entitled to a personal allowance, the income tax liability restriction under the disregarded income rules will certainly limit their liabilities and the UK dividends can be left out of account in computing their respective tax liabilities.

Even if Frank’s clients are entitled to a personal allowance, given the level of dividend income his clients receive (£50,000 per each in 2016-17), the limitation under the disregarded income tax rules will apply and his clients’ income tax liabilities will be limited to the tax due on their salaries/rental income without deduction for a personal allowance. This is because the tax due on the dividends that are being left out of the computation under the disregarded income rules would far outweigh the tax saving from the personal allowance.

 

Reply by IS

From 2016-17, non-UK resident individuals with UK source income can be taxed in two ways. Under the normal rules, they are subject to income tax on dividends in the same way as UK residents. The first £5,000 of dividends is tax free. For basic rate taxpayers, the income tax liability is covered by the deemed tax credit at the ‘dividend ordinary rate’ of 7.5%. However, higher and additional rate taxpayers will have additional liabilities because their tax liabilities will not be covered by the deemed credit. Non UK residents can claim personal allowances if they fall into one of the categories listed in ITA 2007, s 56 which includes EEA nationals (see s 56(3)(za)) or if they can make a claim under a tax treaty. A full list of eligible claimants in included in HMRC’s Residence, Domicile and Remittance Basis Manual at RDR10340.

Alternatively, non-UK residents can use the special rules in ITA 2007, s 811 to s 814. These limit the non-resident’s UK income tax liability to tax paid at source on investment and pension income. In particular, no UK tax is payable on dividends from UK companies because the tax credit is treated as paid at source. All other UK income, such as employment income, is taxed in full, but no personal allowance can be claimed.

The non-resident can choose whether to be taxed under the normal rules or the special rules for each tax year. There is no requirement for consistency, the special rules are usually more beneficial for higher or additional rate taxpayers with significant investment income. Frank will need to prepare calculations for his clients on both bases and submit the claim on the more favourable basis. If the special rules are used, he should include a note in the white space to this effect.

 

Reply by PS

Frank’s client is being treated as not resident in the UK and I am answering on the assumption that he meets the non-resident criteria under the statutory residence test. However, given that he works in the UK for a UK company, this is unlikely to be a straightforward ‘automatically not resident’ situation, so Frank would be well advised to review residence status sooner rather than later.

The query states that dividends ‘do not have to be entered on their UK self-assessment tax returns’. This is on the basis that dividends are ‘disregarded income’. Unfortunately, the disregard relates only to the alternative calculation of UK tax for a non-resident, which effectively caps the tax that a non-resident pays in the UK, so that the dividends do have to be included in any UK returns.

The starting point for preparation of a UK tax return is that all the income is reported as normal. Once the tax position is established, a relieving provision can then be applied to reduce the tax to be paid by non-residents which involves recalculating the tax position without ‘excluded income’ such as dividends, but also removing the personal allowance from the calculation. Therefore, the disregard of dividend income will only apply in situations where there is a tax saving for the non-resident. It is a cap on the UK tax payable. The loss of the personal allowance for an EU resident will only ever arise when losing it reduces UK tax liabilities.

On the basis of the information provided, yes the client would lose their personal allowance, but the tax payable by an individual with a salary of £11,000 and dividends of £50,000 would be £7,875. For a non-resident, this is reduced to £2,200 by the cap on tax for non-residents which takes away the personal allowance in return for ignoring dividends.

It is not clear from the query whether the salary that is being taken is considered to be a UK salary or is paid as earnings in France. On the basis that it is included in the query, so is relevant, I am assuming that it is indeed taxed as salary in the UK. Given that it is at the personal allowance level, I am guessing that it will have gone through PAYE with a code that gives personal allowances, so that no tax is deducted at source. However, the dividends create a tax liability, either through self-assessment or through PAYE by the loss of the personal allowance, so in this case the acquisition of a new source of income is not itself the trigger for a tax problem; the problem already exists.

The final part of the double taxation jigsaw in the UK is relief that may be claimed through the double tax agreement with France, which limits the tax payable on dividends to 15% of the gross. In this case, that restriction is of little help because the tax rate on dividends within the basic rate band is substantially lower than 15%, but could provide relief if the rental income means that the cap on income tax for non-residents is higher than the actual liability.

The fact that we refer to ‘double taxation agreements’ should remind us that there are two parts to this equation. As UK advisers we concentrate on the tax payable here, but for the client, they will also be exposed to tax in the other jurisdiction, France in this case. For a client who is not resident here, the UK position is only ever a ‘payment on account’ for their tax liability in their home country. Therefore, unless the client lives in a very low tax rate country (which France most definitely is not) saving UK tax does not generally reduce the overall tax liability of the client.

 

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