Writing for Taxation magazine, BKL consultant David Whiscombe examines tax on employment income for UK residents and non-UK resident taxpayers.
Key points
- Employment income is taxed on UK residents wherever it was earned.
- Non-residents will be taxed on earnings from work performed in the UK.
- The importance of determining when earnings are ‘for’.
- Examples of assessment for resident and non-UK resident taxpayers.
- Although Mr Murphy had to satisfy specific employment conditions over a period of time, the earnings were for the year of payment.
- Was the tribunal’s decision correct? An alternative view might have been taken.
It is reasonably well known that the charge to income tax on employment income extends (broadly speaking) to income that is earned anywhere in the world by someone who is a resident of the UK (ITEPA 2003, s 15). Further, it encompasses income that is earned in the UK regardless of the residence status of the person earning the income (ITEPA 2003, s 7). If that creates a potential double charge to domestic taxes both in the country in which the income is earned and that in which the earner resides (as it often does), a double tax agreement or unilateral relief will almost always sort things out.
By a process of elimination, this means that employment income is wholly outside the charge to UK income tax only if it is earned outside the UK by someone who is not resident in the UK. That is not surprising; it would be startling indeed if HMRC were to claim a right to tax income earned by, say, a resident of France in respect of employment income earned in Paris.
Thus stated, the proposition is obvious. However, it was not so obvious to HMRC in the First-tier Tribunal case of Murphy (TC7224). Let us examine where HMRC went wrong and why.
The Murphy case
Mr Murphy was resident in the UK for 2015-16. It was agreed that, in that year, he received earnings of £30,000. HMRC asserted that was an end to the matter: employment income is subject to tax on the amounts received in the year and because Mr Murphy had received earnings of £30,000 in a year in which he was resident in the UK he must, therefore, be liable to pay tax on the £30,000.
The law, however, is not that simple. Indeed, a moment’s thought shows us that this cannot be right. It cannot possibly be the case that an amount that a Frenchman has earned from an employment performed wholly in France is exposed to UK tax simply because he brings the money to the UK in a year in which he happens to be resident here.
The confusion probably arises because of a change in the law 30 years ago. For the years before 1989-90, the statutory basis for assessing employment income was an ‘earnings basis’. This meant that the amount charged to tax in a year was the amount earned in that year, regardless of the year in which it was received. Since 1989-90, employment income has been taxed on a receipts basis – the amount charged to tax in a year is the amount received in that year, regardless of when it was earned. But it is important to appreciate what HMRC failed to grasp in Murphy; namely that the change of law simply changed the year in which earnings were taxed, it did not alter the earnings that were taxable.
The legislation
The legislative starting point is to determine the taxable earnings ‘for’ a year. ITEPA 2003, s 16 helps as regards ‘general earnings’. These are defined at ITEPA 2003, s 7 to mean earnings within Pt 3 ch 1 (broadly, salaries, wages, fees, gratuities and other emoluments) and anything treated as earnings (including, in particular, benefits). Section 16 tells us that general earnings that are earned in, or otherwise in respect of, a period are to be regarded as general earnings ‘for’ that period. If that period spans two or more tax years, the earnings must be apportioned between the tax years on a just and reasonable basis (s 16(4)).
If general earnings thus computed are found to be ‘for’ a year in which the earner is resident in the UK (or, in the case of a split year, ‘for’ the part of the year in which the earner is treated as resident) they fall within ITEPA 2003, s 15(1) and are taxable. Note, however, that s 15 says nothing about the year in which the earnings are taxable; we shall come to that later.
If the general earnings are not ‘for’ a year (or part year) in which the earner is resident, they do not fall within s 15. That does not necessarily mean that they are not taxable at all. ITEPA 2003, s 27 applies to such earnings if and to the extent that they are ‘in respect of duties performed in the UK’ (or from an overseas crown employment subject to UK tax). To that extent, they are ‘taxable earnings’ (s 27(2)).
The next question is to determine the year in which the earnings are taxed. Section 15(2) provides that general earnings for a tax year (or part tax year) in which the earner is UK resident are to be taxed in the year in which they are received. And s 27 provides that the general earnings to which it applies are also taxed in the year in which they are received.
The term ‘receipt’ is defined in ITEPA 2003, s 18 and s 19. We shall not complicate matters by delving into those sections, which refer to money and non-money earnings respectively. Nor shall we consider the special rules applying to people who are not domiciled in the UK.
We thus arrive at the position that the amount on which an individual is charged to income tax as employment income in any tax year is the aggregate of amounts that are received in the year and which are either:
(a) amounts that have been earned in a year in which the individual was resident in the UK; or
(b) amounts that were earned from duties which were carried out in the UK.
In most cases, of course, employment income is earned and received in the same year and arises to a UK resident from duties carried out in the UK. But that should not mislead the adviser (as it seems to have misled HMRC in Murphy) into taking shortcuts with the legislation.
The point to note is that the individual’s residence status in the year in which the amounts are received is irrelevant. Nor does it matter whether the employment is held in the year in which the earnings are received: all that matters is where the income was earned and where the individual was resident when he earned it.
The rule cuts both ways: an individual may be taxable on income received in a year in which he is neither resident nor working in the UK and even has no employment; and he may escape liability on earnings received in a year in which he is both resident and working in the UK.
Smith and Jones
Let’s consider the example of Mr Smith. He has been working and residing overseas for many years. He returns to the UK (though continuing with the same employment under the same employer) on 6 April 2020.
On 6 July 2020 Mr Smith is paid (into his UK bank account) a bonus relating to his overseas work. He has no liability to UK tax on the bonus because it was neither earned while he was UK resident nor earned in respect of duties performed in the UK. Of course, it may in practice be difficult to persuade HMRC that the bonus relates to overseas work, but this is purely a question of fact.
By contrast, consider Mr Jones. After working and residing in the UK for many years he finally retires overseas. He is delighted to receive, six months after retiring and after ceasing to be resident in the UK, a discretionary bonus that is calculated by reference to the results of the company’s previous accounting year, for the whole of which he was resident in the UK. Even though the bonus is paid into an overseas bank account, in foreign currency, during a period of non-residence, after the employment has ceased and is never remitted to the UK, it remains subject to UK tax. Indeed, this would be the case even if it related to an earlier period of temporary overseas work throughout which Mr Jones remained UK resident.
Back to Murphy
Let us apply the legislation to the Murphy case.
Mr Murphy’s £30,000 was paid to him under a ‘staff retention programme’ associated with the merger or takeover of his employer’s business. The criteria under which he was entitled to the payment were that he was, on 31 December 2013, an ‘active permanent employee in good standing’ who had not announced his resignation, and that he had continued to be such throughout the period ending on the payment date (which was 28 April 2015). However, Mr Murphy had been working abroad for his employer from February 2011. The case report confirms: ‘For UK tax purposes he was taxed as a non-resident in the tax year 2013-14, returned during the tax year 2014-15 and was resident in the UK for the tax year in issue, 2015-16.’
HMRC put forward the following arguments.
(1) ‘There is no requirement in ITEPA 2003, s 62 that an amount is earned over a period.’ Exactly what HMRC meant by that is obscure. Plainly, all earnings relate to a period because that is what s 16 is all about.
(2) ‘Section 15(1) applies to general earnings for a tax year for which an employee is UK resident except that, in the case of a split year, it does not apply to any part of the earnings that are excluded. The tax year 2015-16 was not a split year so no amount is excluded.’ This statement is correct, but HMRC failed to appreciate the significance of the phrase ‘earnings for a tax year’.
(3) ‘Section 15(2) states that the full amount of any general earnings within s 15(1) which are “received” in a tax year is an amount of taxable earnings from the employment in that year.’ This is wrong. As we have seen, earnings fall within s 15 only if they are ‘for’ a year in which the individual is resident in the UK. This was HMRC’s fundamental error.
(4) ‘Section 18 sets out the rules for determining when earnings are received for this purpose, and in the present instance that is the earlier of the date when it is paid and the date when the person becomes entitled to it.’ Correct.
(5) ‘Mr Murphy was paid the retention payment on 28 April 2015. This is also the date he became entitled to it – he only became so entitled once he had met the conditions which included that he was still actively employed by Booz or PwC at the payment date.’ Correct, the amount was received in 2015-16.
(6) ‘ITEPA 2003, s 16 does not apply. The question of the year that earnings are “for” is only relevant where earnings are chargeable on an earnings basis, and this only applies to certain individuals who are not UK resident or domiciled when amounts are earned.’ This is wrong. Section 16 is the key provision on which all else depends and it is of general application.
Nonetheless, HMRC did win the case. Why? Because of the department’s final argument.
(7) ‘Even if s 16 did apply, the retention payment was not earned over the period from December 2013 to April 2015. It was a one-off payment, and if at any time in that period Mr Murphy had ceased to meet the eligibility criteria he would not have been entitled thereto.’ The tribunal held that this meant that the money was earned only when it was paid. It was earnings ‘for’ 2015-16 when Mr Murphy was UK resident and therefore it was taxable in full.
The correct conclusion?
Was this correct? It is plainly true that Mr Murphy did not become entitled to the money until April 2015 and, if things had turned out differently, he might not have become entitled to it at all. But, arguably, that is relevant to when it was received and not to the crucial question of when it was earned.
In the writer’s view, the tribunal could equally (and perhaps more correctly) have concluded that what Mr Murphy had to do to become entitled to the money (namely, remain an employee in good standing) he did continuously throughout the period from 31 December 2013 until the date of payment. He had therefore ‘earned’ the money over that period as a whole and, to the extent that he was not resident in that period, the £30,000 did not fall either within s 15 or s 27 and was not taxable.
But, right or wrong, this neatly underlines one final point. Difficult though it may be to wrestle with the legislation and extract its meaning, that is only half the job: applying it to the facts may be equally challenging.
This article was first published by Taxation magazine (Issue 4720) and is also available on the Taxation website.
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Read our earlier article about this case here.
