Working at Home and Abroad

ONE WAY IN which the United Kingdom currently favours those domiciled abroad, but resident and ordinarily resident in the United Kingdom, is to exempt their foreign earnings from tax, provided those earnings are not received in the United Kingdom. A dual contract arrangement is the method by which non-domiciliaries working both in the United Kingdom and abroad may take advantage of this treatment. This article outlines the circumstances in which dual contract arrangements should be considered and assesses two different ways in which they might be structured. Statutory references are to the Taxes Act 1988, unless otherwise specified.

Relief for foreign emoluments

The United Kingdom taxes employment income according to the extent to which the employee has a taxable presence in the United Kingdom. The taxable presence of an employee will depend on that employee’s residence and domicile. In short, the position is this:

• not resident: emoluments from United Kingdom duties are taxed under Case II;

• resident but not ordinarily resident: emoluments from United Kingdom duties are taxed under Case II and other emoluments received in the United Kingdom are taxed under Case III;

• resident, ordinarily resident but non-domiciled: all emoluments taxed under Case I except for foreign emoluments;

• resident, ordinarily resident and domiciled: all emoluments taxed under Case I.

The possibility of using dual contracts arises where the employee is non-domiciled, but both resident and ordinarily resident. Dual contract arrangements seek to ensure that the foreign earnings of the non-domiciled employee do not suffer tax by structuring the overseas employment to take advantage of the relief for foreign emoluments. Dual contracts are strictly unnecessary where the employee is not ordinarily resident (whether or not domiciled), since the earnings of employees not ordinarily resident from duties performed outside the United Kingdom are only taxed to the extent they are received in the United Kingdom. However, ordinary residence depends on the factual question of how long the employee intends to be resident in the United Kingdom. So in the case of non-domiciled employees, the cautious view would be to assume the employee is ordinarily resident and to use dual contracts from the first year of residence in the United Kingdom.

Foreign tax implications

An important question is whether the United Kingdom tax saving achieved by dual contracts also achieves an overall tax saving in any particular case. For example, suppose that the employee is present in the United Kingdom for 200 days in a particular year, but performs duties in Ruritania for an employer resident in a third country. Suppose further that Ruritania has a double tax treaty with the United Kingdom that contains an employment income article similar to that in the Organisation for Economic Co-operation and Development Model, and that the employee is resident in the United Kingdom for the purposes of the treaty. The treaty would prevent Ruritania from taxing the employee’s earnings from duties performed in Ruritania, because the conditions for the exemption in Article 15(1) would be satisfied (Article 15 seeks to prevent the contracting states taxing at source the earnings of non-residents working in a contracting state for only short periods). In consequence, the employee’s world-wide earnings are subject to United Kingdom tax only. So, if dual contracts are used, the Ruritanian earnings will not be taxed at all, provided that they are not received in the United Kingdom. This is an example of the situation in which dual contracts work best.

In contrast, assume the same facts except that the employee is present in Ruritania for 200 days in a particular year. In these circumstances, the treaty would allow Ruritania to tax the employee’s earnings from duties performed in Ruritania since the conditions for the exemption in Article 15(1) would not be satisfied. The United Kingdom uses the credit method to prevent double taxation. However, there would be no credit in the United Kingdom for the Ruritanian tax paid on the employee’s Ruritanian earnings, since credit is restricted to the United Kingdom tax suffered on the income: in this case, nil. Consequently, dual contracts would only produce a tax saving to the extent that Ruritanian income tax is lower than that in the United Kingdom. It is therefore crucial to consider how the foreign earnings would be taxed overseas.

The relief

If dual contracts do offer an advantage, it is necessary to consider how they should be structured. This turns on the terms of the relief for foreign emoluments itself. The relief is set out in section 192, and has three conditions:

• the employee is non-domiciled;

• the employer is neither resident in the United Kingdom nor the Republic of Ireland;

• the duties of the employee are performed wholly outside the United Kingdom.

In addition, it is essential that the employee does not receive the foreign earnings in the United Kingdom. This is not a condition of the relief for foreign emoluments, but emoluments not otherwise subject to income tax are taxed on the Case III remittance basis. In consequence, dual contracts only succeed where the foreign earnings both qualify for the foreign emoluments relief and avoid being taxed because they are remitted to the United Kingdom.

The condition that causes a problem in practice is the requirement that the duties of the employee are performed wholly outside the United Kingdom. The scope of this requirement is reduced by section 132(2), which provides that duties performed inside the United Kingdom, which are merely incidental to duties performed outside, are regarded as performed outside the United Kingdom. However, this is a very narrow concession: in Robson v Dixon 48 TC 527, the judge confirmed that:

‘the words "merely incidental to" are upon that ordinary use apt to denote an activity (here the performance of duties) which does not serve any independent purpose but is carried out in order to further some other purpose.’

Thus, duties performed in the United Kingdom of the same type as those performed overseas are not merely incidental, even if performed for only a very short period. It is this requirement of the relief that duties are performed only outside the United Kingdom that drives the structuring of dual contracts.

Duties where employed

The duties-where-employed approach structures dual contracts so that the employee’s United Kingdom duties are those performed for his United Kingdom employer and the non-United Kingdom duties are those performed for his overseas employer. For example, a non-domiciliary employed by a European venture capitalist to identify investment opportunities in the United Kingdom and France might have dual contracts: the first contract with a United Kingdom subsidiary of the group stating that he is required to identify United Kingdom investments and that these duties should be performed in the United Kingdom; and a second contract with a French subsidiary of the group stating that he is required to identify French investment opportunities and that these duties should be performed outside the United Kingdom.

This sort of arrangement is effective, provided that the executive does not in fact perform duties under the overseas contract while in the United Kingdom. This is the problem: the likelihood of the executive (notwithstanding any amount of assurances to the contrary) never making a telephone call or sending e-mails concerning possible French investments while in the United Kingdom is nil. In consequence, the Revenue may successfully challenge the relief provided that it asks the right questions. This is particularly likely if the dual contracts are being used provocatively in circumstances where there is in reality one job split into two employments for the purposes of obtaining the relief.

Duties where performed

The duties-where-performed approach defines the duties required under each contract according to where those duties are performed. This time, the executive’s United Kingdom contract would state that the duties of the United Kingdom employment are all those duties performed in the United Kingdom defined by reference to section 192(2); similarly, the overseas contract would state that the overseas duties are all those duties wholly performed overseas, again defined by reference to section 192(2).

The practical upshot of this arrangement is that overseas duties must be performed overseas and United Kingdom duties must be performed in the United Kingdom. Suppose that the executive is travelling from Paris to London by Eurostar and is preparing for a meeting on the way. As the train enters the tunnel at Calais, the executive will be performing duties overseas and so under the overseas contract. However, as the train enters the United Kingdom, the executive’s duties are performed in the United Kingdom and thus automatically performed under the United Kingdom contract; this is so regardless of whether the duties being performed relate to potential United Kingdom or French investments. In consequence, the executive can never perform United Kingdom duties under the overseas contract because, according to its terms, only overseas duties may be performed under the overseas contract. The duties-where-performed approach therefore overcomes the problem that the executive cannot, in practice, avoid taking calls or answering e-mails in the United Kingdom that relate to overseas duties.

A possible objection to the duties-where-performed approach is that it requires the employee’s duties to be artificially split under the United Kingdom and overseas contracts. No doubt this would be the basis of any Revenue attack, since paragraph SE40103 of the Schedule E Manual states that there must be ‘two (or more) employments in reality and not one employment that has been artificially divided to exploit the provisions of section 192(2)’. Presumably this means that the Revenue only regards dual contracts as effective where the duties performed under each contract constitute the sort of job that each employer might realistically offer to different people. The Revenue might attack the artificial split in two ways.

Real or otherwise?

First, the Revenue might claim that employment in section 192(1) means real employment (and similarly ‘office’ means real office). However, this is a difficult argument for two reasons:

• There is no such qualification in the legislation, it merely says ‘employment’. Moreover, the defining quality of an employment must be the relationship of the employee and employer (as demonstrated by the case law distinguishing Schedule D and Schedule E) and not the nature of the services that constitute the employment.

• It would have the absurd result that artificial employments would escape Schedule E. Employment must have the same meaning in section 19(1) as in section 192(1) and if employment means real employment, section 19(1) would not catch artificial employments. The requirement that each employment must be real is therefore not supported by the legislation, but is an additional condition of the relief illegitimately imposed by the Revenue.

One mixed employment?

The Revenue’s second challenge to the duties-where-performed approach might be to claim that the overseas and United Kingdom employments are in fact a single employment not performed wholly outside the United Kingdom, so that the conditions of the relief for foreign emoluments are not satisfied. However, this argument must fail since there is a real employment relationship with each employer, and there can be no question of the arrangement being a sham since it is intended by both parties. It is true that the United Kingdom and overseas employments are connected but, nevertheless, they are real and distinct.

Points for the taxpayer

In addition, there are two arguments that dual contracts based on the duties-where-performed approach should be effective. First, the artificial split is necessary to give the relief practical effect. As explained, the duties-where-performed approach is necessary to avoid the problem that an executive cannot realistically avoid taking phone calls and answering e-mails while in the United Kingdom. In this respect, the Revenue’s view that there must be two real employments is outdated and the duties-where-performed approach is needed to make the relief useful, otherwise its purpose of attracting non-domiciliaries to the United Kingdom is frustrated. In short, the splitting of employments on the basis of where the duties under each contract are performed is necessary if the legislation is to achieve its purpose.

Second, the duties-where-performed approach accords with the policy of the relief in exempting the income of non-domiciliaries that arises abroad and is not remitted to the United Kingdom. It is true that there is no relief where the duties are not wholly performed outside the United Kingdom, but this is unsurprising since any employment which has in part a source in the United Kingdom cannot be expected to escape United Kingdom tax. However, in contrast, the duties-where-performed approach ensures that the duties performed under the overseas contract have no United Kingdom source and, to that extent, qualify for the relief. This is how the relief works and there is no mischief in the perhaps artificial splitting of employments, especially given the Revenue’s powers under paragraph 2 of Schedule 12 to apportion remuneration between the contracts so as to ensure the remuneration for United Kingdom duties fairly reflects the extent of the duties actually performed.

A final argument against the artificial split is that the duties-where-performed approach simulates a Case II treatment for non-domiciliaries where the legislation requires Case I subject to the relief for foreign emoluments. The argument is that non-domiciliaries should not benefit from the same treatment as those not ordinarily resident, since the former have more of a taxable presence in the United Kingdom than the latter. However, this argument is misguided: the treatment of those not ordinarily resident is different in kind, since it does not require an overseas employer and is intended to tax United Kingdom source employment income only. In contrast, under dual contracts based on the duties-where-performed approach, the employee is resident in the United Kingdom and so, in principle, his world-wide income is within the scope of United Kingdom tax. The tax advantage simply flows from the existence of the relief for foreign emoluments.

Overall

The duties-where-employed approach will generally be ineffective since an employee will find it impossible to avoid performing overseas duties in the United Kingdom. However, that approach may accord with the Revenue’s view that there should be two real employments, and so in exceptional cases it may be worthwhile; perhaps where the overseas and United Kingdom duties follow each other rather than are concurrent so that there is no danger of performing overseas duties in the United Kingdom. In contrast, the duties-where-performed approach, although apparently inconsistent with current Revenue practice, will generally be the more suitable.

It must be better to have an argument with the Revenue that should be won on the law, rather than an argument which is bound to be lost on the facts.

Alastair Ladkin is in the tax department at Ashurst Morris Crisp.

Issue: 3900 / Categories: Comment & Analysis