⚠️ Please note that sometimes links from this website will go directly to our main Low Incomes Tax Reform Group’s (LITRG) website.
Many countries have laws which mean that 'tax residents' of that country pay tax on all income, irrespective of where it arises (this is broadly the case in the UK – if you remain UK tax resident, you continue to be subject to UK tax on worldwide income). Many countries in the world also have laws that state that income which arises in that country is taxed in that territory, irrespective of whether the taxpayer is tax resident there.
This means that if you are a UK tax resident working overseas, a UK tax liability may arise on your foreign employment payments. Since you may also have to pay tax in the other location (due to the fact that it arises there), this may lead to double taxation implications. This is a situation that students who have temporarily left the UK to work overseas may find themselves in.
Granted, this sounds fairly horrendous, but don’t panic just yet – the UK has an extensive network of double tax treaties with other countries. One of the functions of these treaties is to prevent double taxation by ultimately allowing only one country to tax your earnings (if you are a UK national, this will typically be the UK) or by allowing a credit for the foreign tax paid when calculating the UK tax liability on the foreign income.
The method of double taxation ‘relief’ will depend on your exact circumstances, the nature of the income and the specific wording of the treaty between the countries involved. You should also be aware that some countries do not have a double tax treaty with the UK. If that is the case, you may still be able to claim unilateral tax relief in respect of the foreign tax you have paid. Unfortunately there are no hard and fast rules and you will probably need to seek some professional advice if you find yourself in a ‘double taxation’ situation.
Here we look at two examples. Please note that the foreign tax rules have been discussed for the purpose of the illustrations only and should not be taken as reflective of the true New Zealand or Australian tax positions.
Mary is on a gap year and leaves the UK to go to New Zealand for around four months on 1 July 2020 after her exams. She does not earn any money in New Zealand – instead she volunteers in an animal sanctuary. She returns to the UK on 1 November 2020 but already knows that she wants to go back to New Zealand as soon as possible. She works hard over the Christmas period and by 15 January 2021 has saved up enough money to return to New Zealand, where she stays, travelling around, until May 2021.
⚠️ Note that a person’s residence status (elsewhere under foreign country rules) is irrelevant in determining their UK tax residence status (under UK rules), as it is possible to be resident for tax purposes in two countries simultaneously.
Under UK rules, Mary remains UK tax resident for 2020/21 under the Statutory Residency Test even though she has less than 183 days of physical presence in the UK as she has her only home in the UK (albeit her parent's home) for all or part of the year. She is therefore taxable in the UK on her worldwide income. Under New Zealand's rules, Mary is tax resident there from the date of her first arrival in July 2020 until May 2021 (due to being there for more than 183 days in a 12 month period) and so they may want to tax her worldwide income in this period too. This leaves her Christmas job income potentially subject to both UK and New Zealand tax, due to her being treated as tax resident in both countries.
Mary can look at the double tax treaty to see if it can help avoid this double taxation situation. Where it is a ‘dual residency’ situation that is causing the double tax issue, most treaties contain a series of ‘tie breaker’ tests to help determine which country’s residence takes precedence. They generally say the ‘winner’ country is:
- The country where the individual has a permanent home available to them
If the individual has a permanent home in both countries, the country where the individual's personal/economic ties are closer (this is known as the ‘centre of vital interests’)
If it is not possible to determine at which permanent home the centre of vital interests lies, or if the individual does not have a permanent home, the country where the individual has a habitual abode
Where the habitual abode test is not decisive, the country where the individual is a national
If the individual is a national of both country (or of neither), then the countries must settle the matter by mutual agreement.
The answer to the first test for Mary is the ‘UK’ as this is where her family home is. As she meets the first test she doesn’t have to look at the remaining tests. It is unlikely that she will be considered to have a permanent home in New Zealand – but even if this is the case, her centre of vital interests appears to be in the UK and therefore we arrive at the same outcome. This means that Mary is treated as 'treaty resident' in the UK and 'treaty non-resident' in New Zealand – these special treaty rules override the actual position as regards the income covered under the treaty.
As non-residents in New Zealand (including those that are only non-resident by virtue of the treaty tie breaker tests) are only taxable on employment income sourced there, New Zealand will give up its right to tax Mary on her UK employment income and it will be taxed in the UK only (which is probably what we would have expected to happen in the first place).
It is worth noting that had Mary worked in a restaurant (say) in New Zealand, rather than travelled there when she returned in January 2021, then this income could give rise to another double taxation situation for her to tackle. However New Zealand would not give up its right to tax Mary on her restaurant income due to it being sourced there. Double taxation would have to be avoided on this particular source of income in the manner described in example 2 below.
Mark is on a gap year and leaves the UK in August 2020 for a five-month working holiday to Australia. He works in various bars, earns the equivalent of £5,000 and pays Australian tax at the non-resident tax rate of 32.5% (£1,625). Mark also earned £1,200 a month (no tax deducted) from a casual job he had in the UK for the other 7 months of that tax year.
Under UK rules, he remains UK tax resident due to the 183 day rule, so he is taxable in the UK on his worldwide income. Mark is not resident in Australia, but the employment income is Australian ‘source’ so it is also correctly taxable there. In this scenario, instead of just being able to exclude the income from one of the countries’ remits, the double tax treaty tells Mark that Australia has the main right to tax the income and that if the UK also wants to tax it (under its own rules) then the foreign tax credit method should be used to avoid double taxation.
You should note at this stage, that a foreign tax credit will be limited to the UK tax liability on the foreign income, meaning that you will always end up paying at the higher of the two rates.
Mark’s 2020/21 UK tax calculation looks like this:
|Income £8,400 (£1,200 x 7 months) + £5,000||£13,400|
|Less personal allowance||£(12,500)|
|UK tax thereon @ 20%||£180|
|Foreign tax credit £1,625||(£180) * limited to the amount of UK tax charged|
We can see here that there is no UK tax ultimately due on the Australian income. The foreign tax credit means that Mark only ends up paying Australian tax on his Australian income at the Australian rates. It is a different method of preventing double taxation. This is the method of double tax relief that you will come across most often where you have remained tax resident in the UK but have employment income arising in another country.
We know this is very complex, but there are two things to remember before you get too concerned with double taxation:
1. Anyone who is classed as a tax resident of the UK can normally earn a certain amount of money each year, without paying any UK income tax. This tax-free amount is called the ‘personal allowance’ (some non-residents can have it too – for example, if you are a UK or European Economic Area (EEA) national). As the personal allowance is so generous (for 2020/21 it is £12,500) it is possible that your total income for the year (including any overseas employment income) will fall within it, meaning that there will not be any tax to pay in the UK.
2. Whilst you will normally have tax deducted by your foreign employer, you may be entitled to reclaim some or all of this back from the foreign tax authorities, meaning that, overall, there may not be any foreign tax. Perhaps they have an amount that you can earn tax free like in the UK or there are some other special exemptions or deductions that you can claim in a tax return. This is an important point because foreign withholding tax amounts may not represent the true final tax liability. You should also remember that every country has its own rules and so the tax position will depend on the country you work in.
Our Examples section also looks at double taxation in the context of several other typical ‘students leaving the UK’ scenarios.