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The general rule is that if you have UK employment, the earnings from that employment are subject to UK income tax, irrespective of your residence status. However, the terms of a UK double tax treaty will impact this, and in many cases, can be used to exempt any UK salary from UK income tax.
Understanding the OECD Model Article: The Organisation for Economic Co-operation and Development (OECD) Model Article sets out the general principle that salaries may be taxed in the country where employment is carried out. It follows that an individual can be taxed on the income arising from duties performed in the UK, whether or not they are resident in the UK under domestic law. This is in accordance with the UK’s domestic provisions.
However, tax treaties go one step further, providing that UK employment income can be exempted from UK tax in certain circumstances. Paragraph (2) of the OECD Model Article outlines the conditions that, if fulfilled, allow employment income to be exempt from tax in the country where the employment is exercised. This article forms the basis of most claims for exemption from UK tax for employees.
Qualifying for Exemption: To qualify for an exemption, the employee must show that they are a resident of the other country for the purposes of the agreement. If they could be classed as UK resident and resident abroad, they would need to look at the tiebreaker rules and ensure they are treaty resident abroad. Additionally, several other conditions must be satisfied:
- In the UK for less than 183 days: The employee must not be present in the UK for more than 183 days either ‘in the tax year concerned’ or ‘in any period of 12 months’. These two tests are different and are used in various treaties. The second test is more difficult to satisfy than the first one. The agreements with numerous countries use the wording of the second agreement (i.e., in any period of 12 months), while most of the UK’s other agreements use the other test.
- Salary not paid by a UK employer: The salary must be paid by, or on behalf of, an employer not a UK resident. The fact that an individual remains an employee of an overseas company does not satisfy the test. The salary for which the exemption is claimed must be paid by the overseas employer and not, for example, by a UK subsidiary company to whom the employee may have been seconded.
- Salary not borne by a permanent establishment in the UK: The employee’s salary must not be borne by a permanent establishment or fixed base that the employer has in the UK. This must be considered if an employee works for a non-resident company in the UK.
If the employee meets these requirements, they can claim an exemption from UK income tax on the UK salary earned. The type of individual most likely to be affected by this is the foreign executive employed by a multinational group who is seconded to the UK. If the UK secondment is relatively short, the individual may still be regarded as a resident in their home state under its tax laws while acquiring UK residence status under the domestic rules. However, they would need to show treaty residence abroad and meet the other conditions outlined above before claiming exemption of employment income from UK tax in accordance with the tax treaty.
Real-Life Examples: Let’s take a look at two examples to understand better how these conditions apply:
Example 1: A US resident is seconded to work in the UK for a two-year assignment, arriving on 15 October 2020 and leaving the UK on 1 October 2022. Depending on all the circumstances, they could be taxable in the UK only for 2021/2022. However, they could meet the condition for the years 2020/2021 and 2022/2023 because, in both periods, they were not present in the UK for 183 days ‘in the tax year concerned’.
Example 2: By contrast, a Norwegian resident working in the UK would be taxable here from 15 October 2020 to 1 October 2022 under the test in the agreement with Norway.
Understanding the intricacies of double tax treaties and how they impact non-UK residents working in the UK is crucial for both employees and employers. It is essential to be aware of the conditions for exemption and how they apply in various scenarios. Individuals who meet the requirements can often claim an exemption from UK income tax on their UK salary earned. You can contact our specialist tax advisors to review specific facts and circumstances to ensure proper tax treatment and compliance with UK tax laws.