Getting the message

In the culmination of a 13-year residency dispute between Seychelles-based British millionaire Mr Gaines-Cooper and HMRC, Mr Gaines-Cooper’s appeal has been dismissed by the Supreme Court, opening the floodgates for HMRC to pursue retrospectively the large number of UK citizens living overseas for unpaid UK tax.

Residency status is important when determining a person’s liability to UK tax. Generally, individuals who are resident in the UK and domiciled in England and Wales are liable to UK tax on all of their worldwide income and capital gains; UK residents who are not domiciled in England and Wales may elect to be taxed only on overseas income and gains brought to the UK (and may have to pay £30,000 – soon to be £50,000 – for the privilege). However, non-residents are normally only liable for tax on UK-source income.

Staying put

Given that the concept of residence is fundamental to the limitations of income tax and capital gains tax, it is surprising that the word ‘residence’ has not been defined in tax legislation. Without a definition, we have to look to decided case law, but, what is interesting is that, save for the series of Gaines-Cooper cases, there has been no decided case law on the subject for decades. So, taxpayers and their professional advisers have had to look to HMRC guidance for direction which, since 1973 (until recently), was contained in a booklet known as ‘IR20’.

Mr Gaines-Cooper’s case concerned the interpretation of HMRC’s guidance in IR20, which outlines the circumstances in which an individual becomes non-resident and not ordinarily resident in the UK. Mr Gaines-Cooper, who migrated to the Seychelles in 1976 (but remains a British citizen), contended that IR20 contained a more benevolent interpretation of those circumstances than was reflected in the ordinary law: therefore, a legitimate expectation arose that this interpretation would be applied by HMRC to the determination of his residency status. He also contended that, in any event, even if the court were to find that IR20 did not contain a more benevolent interpretation, it was nevertheless HMRC’s settled practice to adopt it.

Mr Gaines-Cooper argued that, despite retaining a number of links with the UK (including owning a house in Henley-on-Thames occupied by his wife and son and sending his son to an English public school), by spending less than 91 days each year in the UK he had satisfied the requirements of HMRC published practice and had shed his residency status.

However, the Supreme Court held that a proper construction of IR20 did not support Mr Gaines-Cooper’s contentions. Although IR20 “should have been much clearer”, it nevertheless provided sufficient information to a sophisticated taxpayer to allow him to summarise what the booklet required in just three words: “A distinct break.” As the UK remained “the centre of gravity of his life and interests”, Mr Gaines-Cooper had not demonstrated such a break in the pattern of his life in the UK.

Lowering expectations

While the outcome is disappointing, Lord Wilson clarified the tests to be applied by holding that the judgment in the decision under appeal, which stated the need for a ‘severance’ of social and family ties, pitched the requirements at too high a level. He held, rather, that a distinct break required only a ‘loosening’ of such ties.

Mr Gaines-Cooper is now left to decide whether to embark on the arduous journey of taking his case to the European Court of Justice.

The Gaines-Cooper series of cases has been described as the catalyst for a much-needed statutory definition of ‘residence’, and a statutory residence test is expected to be introduced from April 2012 (outlined by HM Treasury in a consultation document published on 17 June this year). HM Treasury describes the existing law, governed largely by case law and HMRC guidance, as being “vague” and “complicated” and highlights the fact that, in certain circumstances under existing law, “it is not possible for a person to be sure whether they are tax resident in the UK or to know what activities or circumstances would make them tax resident”. The statutory residence test, which is intended to bring clarity and certainty to this area, will be based on a combination of time spent in the UK and ‘connection factors’, such as family, accommodation and work in the UK.

Although the test should bring clarity and certainty in the long term, it may not be appreciated fully that a taxpayer will not, in fact, be free from the effects of existing case law and HMRC guidance for many years to come. This is because the existing law and practice will continue to be relevant in determining under which part of the statutory residence test a taxpayer will fall.

Looking more closely at the proposed test, ?the residency status of a taxpayer in a particular tax year will be determined by reference to their residency status in the three previous tax years. In other words, the existing case law and guidance ?will be directly relevant up to and including tax ?year 2014/15 and, by virtue of the perpetual examination required of the three preceding years to any one tax year, will continue to be indirectly relevant for decades to come.

Numbers game

To illustrate, let’s take the tax year 2024/25 as ?an example: in order to determine the residency ?status of a taxpayer, it will be necessary to examine their status in the three previous tax years, i.e starting in 2021/22. In order to determine the residency ?status of the taxpayer in that year, it follows that ?one will have to look back three further tax years ?to 2018/19. To determine the status of the taxpayer ?in that year, one will be required to look back a further three years to 2015/16, then a further three ?to 2012/13 and finally, a further three to 2009/10, thus eventually requiring an analysis of the law applicable before the introduction of the statutory residence test.

Although such an examination will become less and less likely as the years go on, it is not inconceivable that a set of circumstances will arise with a wealthy globe-trotting individual, testing the boundaries of the residency test.

In summary, while the introduction of a statutory residence test is welcome news for taxpayers and ?their advisers, and the proposed test, albeit complex, should offer a degree of clarity, this only goes so far, ?as consideration will still need to be given to the ?effect of existing law and practice going forward.

With HM Treasury indicating that the existing ?law is “vague” and “complicated”, tax residency ?will have a degree of uncertainty for years to ?come. The practical effect is that this may continue ?to inhibit financial activity for ‘UK PLC’ by preventing individuals from doing business in the ?UK for fear of being tax resident; or wealthy would-be migrants leaving the UK but retaining connections and valuable investments here which ?may benefit all.

Unless Mr Gaines-Cooper successfully appeals ?his case at the European Court of Justice, taxpayers will be subject to the effects of this unwelcome Supreme Court decision and, without transitional rules, following HM Treasury’s consultation, the uncertainty will continue. n