As the result of a recent and long-awaited IRS ruling, U.S. domiciliaries resident in the UK have a useful tool at their disposal to minimize their overall U.S. and UK income tax liability. In accordance with IRS Revenue Ruling 2011-19, the UK £30,000 remittance basis charge (RBC) is fully creditable against U.S. income tax liability. Therefore, for U.S. persons who are resident but not domiciled in the UK, it may now be advantageous to elect to be (or remain) taxable pursuant to the UK’s alternative “remittance basis” system of taxation for non-domiciliary UK residents.
Residence currently has no statutory definition for UK purposes, but generally looks at the number of days spent in the UK as well as other social and economic connections to the UK. A statutory residence test is currently being considered in the UK and practitioners are hopeful that this will be finalized by the next tax year beginning April 6, 2012. UK residence is a complex area and advice should always be sought in this regard. Domicile is a separate concept from residence under UK law, and is relevant both for income and capital gains tax purposes as well as for UK inheritance tax purposes.
In general, the default basis of taxation for persons resident but not domiciled in the UK (broadly, persons who do not intend to live in the UK permanently) is the same as for any UK resident, namely, worldwide income and capital gains are taxed during the year that they arise (the “arising basis”). The alternate method of taxation available for non-domiciliary UK residents is the remittance basis of taxation (the “remittance basis”). Under the remittance basis, non-domiciliary UK residents can elect to be taxed on their non-UK source income and capital gains only when they remit the income and gains to the UK. Remittance basis taxpayers are also subject to UK tax on their UK-source income and gains, which are taxed in the year in which they arise.
In April 2008, the UK enacted a new rule applicable to long-term non-domiciliary UK residents (i.e., a non-domiciliary who was resident in the UK in at least seven of the prior nine tax years) that elect the remittance basis of taxation. Under this rule, unless unremitted non-UK income and gains are less than £2,000 for the year, a long-term non-domiciliary UK resident who elects the remittance method must pay the £30,000 RBC (scheduled to increase to £50,000 beginning April 6, 2012, for taxpayers who have been UK residents for 12 of the previous 14 tax years). The RBC constitutes a tax on the unremitted non-UK source income or gains of the individual. Since the enactment of the RBC, it has been unclear whether the RBC constitutes a fully creditable income tax for U.S. tax purposes. As such, non-domiciliary UK residents that are subject to U.S. income tax have been at a disadvantage in determining whether to elect to be subject to remittance basis of UK taxation or the arising basis.
In Revenue Ruling 2011-19, the IRS determined that the RBC and remittance basis of taxation constitute a single levy (Long-Term Non-Domiciliary Levy). For U.S. income tax purposes, a foreign levy is an income tax (and thus creditable against a U.S. person’s U.S. income tax liability) only if it is a tax and the predominant character of an income tax in the U.S. sense. In this new ruling, the IRS determined that the RBC has the predominant character of an income tax in the U.S. sense because the tax is likely to reach net gain in the normal circumstances in which it applies. As a result, the IRS ruled that the payment of such levy is fully creditable against U.S. income taxes.
Notwithstanding the foregoing, the IRS noted that a credit for the RBC will be available only if all other requirements for obtaining a foreign tax credit are satisfied. In particular, the RBC will not be creditable for U.S. tax purposes if the levy is considered a noncompulsory payment of UK tax. In Rev. Rul. 2011-19, the IRS noted that an amount paid to satisfy the RBC will be treated as a compulsory payment of income tax only to the extent that the taxpayer applies the substantive and procedural provisions of UK law, including elective provisions available under UK law relating to the remittance basis, in such a way as to reduce, over time, the taxpayer’s reasonably expected liability under UK law for income tax.
With confirmation from the IRS that the RBC is fully creditable against U.S. income tax, long-term non-domiciliary residents of the UK now have the benefit of greater clarity in determining whether to elect to be taxed in the UK on the remittance basis or the arising basis.
For more information relating to Rev. Rul. 2011-19 or cross-border UK/U.S. income tax issues, please contact any member of the McGuireWoods Tax Team.