Living in a Tax Haven
Possibly the easiest way to escape tax in one country is to move to another!
With more and more people 'telecommuting' (working from remote mobile offices), doing your job or running your business in another country may not prove such a problem.
While most countries, such as the UK, tax the worldwide income of their residents, they do not tax citizens who leave the country and become non-resident.
So a UK a citizen can escape high UK tax bills simply by moving to a low-tax country.
Most countries treat you as non-resident if you are absent for six to nine months.
However this is not always the case. The US, for example, taxes its citizens, no matter where they live.
So if you're a US citizen and go and live in the Bahamas for 10 years you'll still have to pay US tax on all your income (subject to a limited exemption for overseas earned income).
To escape the US tax net completely you would have to relinquish your citizenship and acquire another one.
Citizens of most other countries, such as the UK, can escape the taxman's clutches by becoming non-resident.
However, certain countries make it more difficult than others to lose your resident status.
For example, in Sweden you are regarded as resident if:
• Your 'real home and dwelling' is in Sweden, or
• Your 'habitual abode' is in Sweden, or
• You previously had a 'real home and dwelling' there and you have an 'essential connection' with Sweden.
'Essential connection' means, for instance, that you had Swedish property or family in Sweden.
Another big stumbling block is that anyone who has spent more then 10 years in Sweden is deemed to remain resident for five years after leaving, unless they can prove that they have no 'essential connection' with the country.
Similar rules apply in Holland. The factors that determine your residence status include the number of days you spend in Holland during the tax year, whether you own Dutch property and whether you have any family there.
This shows how easy it is to come within the scope of two countries' tax regimes. A Swedish person emigrating to the US could easily be classed as both Swedish resident, as well as US resident (if they actually live in the US). In this case, though, the US-Sweden tax treaty would come into play to decide in which of the two countries the individual is resident.
The Dutch sometimes also levy an 'exit' tax on residents and inheritance tax applies for up to 10 years after your residence has ceased. So avoiding Dutch tax is a long-term process.
However, the EU Commission has been looking at a number of 'exit taxes' in France, Germany and the Netherlands on the grounds that they prevent free movement of people within the EU. In March 2010 the EU requested some countries such as Belgium and Denmark remove the exit tax regime for companies and has referred some countries to the EU Court of Justice.
Following a ruling by the European Court of Justice the Dutch exit tax regime has been changed. Tax can be deferred until capital gains are actually realized. The US has also implemented an exit tax regime for some individuals who want to give up their citizenship. Other countries also have an 'emigration tax'.
For example, let's say you have UK investment property and become Australian resident. When you eventually sell the property you will only pay Australian capital gains tax on profits made after entering the country. All your profits made prior to becoming an Australian resident will be tax free.
In tax speak we say there is an 'uplift' in the asset's base cost: the cost of the asset is no longer what you paid for it but is deemed to be its market value when you entered the country. A higher cost means less profit and therefore less tax.
The drawback is that if you cease to be Australian resident your investments are deemed to have been sold (even if they haven't) which means that emigrants can end up with hefty capital gains tax bills when they leave the country.
There is fortunately a concession (known as the '5-in-10' concession) which exempts assets held by anyone who has lived in Australia for less than five out of the previous 10 years. As a result many expat workers are not trapped by this piece of tax law.
In summary, moving overseas can be an effective way to drastically cut your tax bill. Some countries like the UK will largely stop taxing you when you leave while others, like the US, will tax you wherever you go.
The Source Basis vs The Residence Basis
It's important to distinguish between the 'source' basis of taxation and the 'residence' basis. Most countries use one or the other.
Under the source basis it doesn't matter what your residence status is: your income is taxed if it arises within the country's borders. So if you are a resident of Atlantis and emigrate to Narnia, you will still have to pay tax in Atlantis on the investments you left behind. By contrast, under the residence basis, Atlantis will stop taxing you once you become non-resident.
A lot of countries tax income that arises within their borders by default. For example, tax is deducted in the UK from interest earned by non-residents. However, someone who is not 'ordinarily' resident in the UK can apply to have interest paid gross (without tax deducted).
You have to be careful if you plan to move to a tax haven and continue running a business in your home country. Most countries tax trading income arising within their boundaries.
There are, however, two exceptions to this rule:
• If you go and live in a country that has a double tax treaty with the country where your business is based. In this case you will probably only pay local tax on profits arising from a permanent establishment (in other words, a business with a physical presence in the country, such as offices).
The problem is finding a country that has a good double tax treaty network AND a low domestic tax regime. This is why Cyprus and Ireland are popular tax havens.
• If your business is based in a genuine 'no tax' haven. There would then be no local taxes on your trading profits.
Becoming a UK Non-Resident
There is no formal legal definition of 'residence'. The UK Revenue's practice -- based on a mixture of statute and court decisions -- is to regard you as UK resident during a tax year if:
• You spend 183 days or more in the UK during the tax year, or
• Although here for less than 183 days, you have spent more than 90 days per year in the country over the past three years (taken as an average). You will then be classed as UK resident from the fourth year.
The 90 day rule should be treated as guidance only. For example, an individual who regularly returns to the UK for 87 days per tax year may still be regarded as UK resident.
A person can also be resident in two countries at the same time. It is therefore not possible to escape UK residence by arguing that you are resident elsewhere. It is important to note that UK residence is a question of fact and not intention. Therefore although you may intend to leave before the 183-day limit, if you are forced to remain in the UK as a result of exceptional circumstances you will nevertheless be regarded as UK resident.
The UK authorities have, however, tightened up on the concept of non-residence. Recent decisions by the Tax Tribunal and UK courts, as well as revised guidance issued by the UK authorities, have made it clear that they look much more at the actual facts of a claimant's life. There's a lot more information on this in our Non-Resident department.
Essentially, though, they're looking to clamp down on people who aim to avoid spending more than 90 days in the UK but who still regard the UK as their main home (eg by having family, business and other social interests here).
In the 2011 Budget, HMRC announced that it will be consulting on a new Statutory Residence Test which will provide clearer guidance on exactly when individuals will and won't be classed as UK resident. This was planned to be introduced from April 2012 but has been delayed until April 2013 to allow further time for consultation.
Even if you qualify as non-resident you may still fall into the taxman's clutches by being classified as UK ordinarily resident. There is also no statutory test of ordinary residence. You will be classified as a UK ordinary resident if the UK is your 'normal place of residence'.
On leaving the country you will continue to be regarded as ordinarily resident unless you go abroad with the intention of taking up permanent residence overseas. Revenue and Customs normally interprets 'permanent' to mean three years or more.
It is therefore possible to be non-UK resident but UK ordinarily resident. This would occur, for example, where you go abroad for a long holiday and do not return to the UK during a particular tax year. You will continue to be classed as UK ordinarily resident until you can show that you have taken up a permanent residence elsewhere.
The consequence of being classed as UK ordinarily resident is that you will still have to pay UK capital gains tax on your worldwide capital gains.
A person who is UK resident under the 183-day test may not necessarily be UK ordinarily resident. Such a person would then have to pay tax on overseas income that is brought into the UK.
However, the 2008 Finance Act introduced provisions so that from April 2008 non-UK ordinarily residents who have lived in the UK for several years will only be able to claim this remittance basis of tax if they pay an annual £30,000 tax charge. After April 2012 this is increased to £50,000 for non-doms or non-ordinarily residents who have been UK resident for twelve or more tax years.
However, a person who is UK resident as a result of the 90-day test would find it difficult to argue that he or she is not also UK ordinarily resident and therefore worldwide income and gains would be taxed as they arise, not just when brought into the UK.
One factor that is likely to be taken into account in assessing ordinary residence is whether you continue to own and occupy property in the UK -- in particular, where the use or occupation of the property is combined with other factors, such as regular visits to the UK only slightly below the 90-day average. This will be persuasive evidence that you have not taken up a permanent residence elsewhere.
However, subject to this, a person who leaves the UK will cease to be UK ordinarily resident if he or she establishes non-UK residence for three consecutive tax years.
It was confirmed in the 2012 Budget that Ordinary residence status will be abolished as from April 2013. Therefore the main determinant of UK tax liability will be residence and domicile.
Capital Gains Tax Planning
One of the main reasons people use tax havens is to escape capital gains tax (CGT).
Individuals with large property or share portfolios or a business to sell often consider moving overseas to a country with low or no capital gains tax.
To do this successfully UK residents must ensure they are not UK resident or UK ordinarily resident.
The good news is that if CGT avoidance is your top priority there are a lot of countries that don't tax capital gains. Cyprus is a popular choice for UK expats because it allows you to avoid CGT on UK land and property disposals and also offers advantageous income tax treatment of pensions.
The Importance of Timing
Timing is crucial in offshore tax planning and should be built into your 'escape plan' from early on.
For example, there's no point moving to a tax haven to sell your investment properties if you still end up paying tax in the country you leave.
This could easily happen if you don't understand your home country's capital gains tax rules for emigrants. For example, it could be the case that you can become non-resident half way through a tax year for income tax purposes. But for capital gains tax purposes you may need to be a non-resident for the entire tax year.
If you leave the UK and sell assets later in the same tax year, you will still have to pay UK capital gains tax.
To avoid capital gains tax you have to sell your assets in the next tax year.
You'll also find similar rules in the US, as well as many other European countries.
Another way you may get caught out is by selling assets en route to another high-tax country. For example, if you emigrate from the UK to Country X and decide to stop off in the Cayman Islands to dispose of your UK properties, any gain could still be subject to tax in Country X if you're classed as resident for that tax year.
Therefore as a general rule you are much safer if you conduct all your dealings in separate tax years:
• Dispose of assets in a separate tax year from the year you emigrate.
• Dispose of assets, if possible, in a separate tax year from the year you acquire residence in your new home country. Clearly it is crucial to understand how different countries apply the definition of residence.
If you can find a country that allows 'split-year' residence you may have nothing to fear. The split-year basis means that you will only pay tax on income or gains that arise after you become a resident in that country.
So if you sell assets early in the tax year and then become resident in another country a few months later, you won't be taxed.
The UK applies such a split-year rule in certain circumstances, as does the US.
You become a US resident for tax purposes as soon as you become a permanent resident. You will then have to declare your worldwide income to the IRS.
Of course lots of immigrants find themselves becoming US resident during a tax year, with part of the tax year having been spent in another country such as the UK.
This is known as a 'dual status' tax year. As a dual-status taxpayer you will be taxed on income and capital gains from all sources for the part of the year you are a US resident.
You will also be taxed on income and gains derived in the US for the entire tax year. Income from a trade or business conducted in the United States will also be taxed.
Note that income and gains you receive from sources outside the US before you become resident is usually not taxable. Therefore if you acquire US residence via a green card you can usually escape US tax by selling any overseas assets prior to actually becoming US resident.
Some people become 'tax nomads' ensuring they are not resident in any country. This is difficult to achieve long term but ideal for a couple of years to shield large capital gains or one-off income payments.
However, if you keep hold of income-producing assets in your home country your options are more limited. UK rental income and trading income, for example, is usually taxed even if you become non-resident.
Most tax treaties between countries state that the country where the property is physically located can tax the rental income. In the UK the Non-resident Landlord Scheme requires letting agent or tenants to withhold tax from the rent paid to an overseas landlord.
In these cases the main focus is on maximizing your tax deductions. Ways you could do this include moving offshore and forming an offshore personal service company that invoices your UK trading company. These amounts would be tax deductible and reduce your taxable profits in the UK. At the same time the payments from the UK company could be received tax free.
As for rental income, obtaining offshore loans and claiming the interest as a tax deduction is a popular technique.
About the Author
The Author of this article is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.
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