Tax rules Britannia

 This article seeks to present some of the UK taxation and financial issues that Israelis – and not only UK expats – may face.

As is well known, the tax years in Israel and the UK are not concurrent with each other; Israel's tax year runs from 1 January – 31 December, whereas the tax year in the UK, for historic reasons, runs from 6 April – 5 April.

Residency definition

Until April 2013, the UK residency laws were fairly similar to those of Israel. There was a "centre of life" test, with assumed residency for someone who was present in the UK for either 183 days in a given UK tax year, or averaged at least 90 days in the UK over a period of four UK tax years.

As the "centre of life" was never fully defined by law, HMRC (Her Majesty's Revenue & Customs – the UK tax authorities) have made the criteria far easier to check by issuing a number of identifiable tests:

Step 1: Automatic tests

*You are automatically considered resident in the UK for a given tax year if you do not meet any of the automatic overseas tests, and you meet at least one of the following tests:

1. You were in the UK for at least 183 days, OR

2. You owned a UK home for at least 90 days and were present in it for at least 30 days. It is also required that you were present in your non-UK home (if any) for less than 30 days, OR

3. You were considered to be working full time in the UK, and 75% of your work days were done in the UK.

*You are automatically considered resident outside the UK for a given tax year if:

1. You were present in the UK for less than 16 days (if you were resident in the UK for at least 1 of the last three tax years), OR

2. You were present in the UK for less than 46 days (if you were not resident in the UK for all of the last three tax years), OR

3. You were working full-time outside of the UK, spending less than 91 days in the UK and fewer than 31 work days in the UK.

For these purposes, a work-day is any day where at least 3 hours of work were done.

Step 2: Sufficient ties test

If you don't meet either automatic residency rule, your UK residency status is based on how many of the following ties you had to the UK during the tax year, combined with the number of days that you were in the UK.

This table summarizes how many ties you need to have in order to be considered a UK resident. The fifth tie is relevant only if you were resident in the UK for at least one of the last three tax years.

The ties are as follows:

(1) Family tie: Spouse/partner or children (aged up to 18) resident in UK

(2) Accommodation tie: Your own home or that of close relatives (parents, grandparents, siblings, children or grandchildren) available at least 91 days, and used at least 16 days (or just 1 day if it is your own property)

(3) Work tie: at least 40 works days done in the UK

(4) 90-day tie: present in the UK for 90 days or more in either of the previous two UK tax years

(5) Country tie: you spent more midnights in the year in the UK than in any other country.

Implications of being resident

Anyone who is a UK resident is required to report and pay taxes on their worldwide income and capital gains, wherever these arise.

On the other hand – and significantly, unlike the US – a non-UK resident is liable to pay UK taxes only on income arising in the UK; and even this is subject to Double Taxation Agreements that the UK has entered into with various other countries. At present, non-residents are also exempt from UK tax on capital gains arising worldwide, including those from the UK. However, see further on for details of forthcoming changes in this regard.

Inheritance tax

It is well known that the UK taxes the estate of a deceased individual at a whopping 40%, after deducting the nil-rate band of just £325,000 (or £650,000 for a married couple).

If the deceased was considered UK domicile, the worldwide estate is subject to UK IHT (Inheritance tax). However, if the deceased was non-domiciled in the UK, only UK assets are subject to IHT.

The concept of domicile is not defined in the law, and is only ever assessed upon death (i.e. you cannot get a pre-ruling on such matters). But, based on case law, the concept applies to where a person sees themselves settling long term. It is difficult to change your domicile, but those of you who are planning on living (and dying) in Israel can take various steps in order to move their domicile from the UK to Israel. Such steps would include giving up UK shul and other cultural club memberships, giving up UK burial spots and keeping UK visits to a minimum (in terms of days visited) – and doing the opposite in Israel. It may also be advisable to have an Israeli will made.

It should be noted that you are automatically considered UK-domiciled for IHT purposes if you were UK resident for at least 17 of the last 20 UK tax years. As such, it is required for you to be non-resident for 3 full UK tax years in order to (potentially) avoid IHT on non-UK assets.

Property investment

I will not be addressing Israeli tax consequences of owning UK property – you should seek advice as to how best to proceed.

(1) Non-Resident Landlord's (NRL) Scheme

UK law requires that a tenant or letting agent deduct basic rate (20%) tax from the rent paid to a UK property owner (before the deduction of expenses). One way to stop this is to enter the NRL Scheme. Entering the scheme allows the owner to receive rent without the deduction of tax at source, but also requires them to then file annual tax returns in order to report the income and pay any taxes due via the self-assessment system. This is a fairly straightforward process, and the relevant forms can be found on HMRC's website.

(2) Capital Gains Tax (CGT)

From April 2015, non-residents will be required to pay UK CGT when a UK-based property is sold – until now non-residents have never been required to pay capital gains tax when a UK asset is sold. At present the law is at the consultation stage, and the final draft is likely to appear during the winter. At this stage, what is fairly clear is that the tax will come into effect in one way or another, seemingly only for residential properties. As such, if you are thinking of selling an existing property, it may be wise to try to do so within the next few months.

(3) Annual Tax on Enveloped Dwellings (ATED)

UK residential properties owned by non-individuals (e.g. companies, trusts etc.) are potentially liable to pay ATED. The tax is due to be paid on all such properties valued at £2,000,000 or more. However, properties valued £1,000,000 or more will become liable to ATED from 1 April 2015, and properties valued £500,000 or more will become liable to ATED from 1 April 2016.

For ATED purposes, the value is based on the value of the property on 1 April 2012, or the date of purchase, if later. All properties will need to be revalued on 1 April 2017 for ATED purposes, and every five years thereafter.

UK pensions

The Double Tax Treaty between Israeli and the UK says that since Israeli residents are required to report and pay taxes on their foreign pensions, a UK pension received by an Israeli resident is taxable only in Israel. There is a formal procedure to go through to ensure that HMRC does not tax the pensions in such cases

There are two exceptions:

(1) Government (i.e. Civil Service) pensions. HMRC have confirmed that NHS, Judicial, Teacher's pensions etc. do not fall into this category.

(2) Anyone claiming exemption from Israeli tax on the pension due to the 10-year foreign income exemption rule for new olim (i.e. anyone who made aliyah in 2007 or later). That being said, one is allowed – despite the exemption – to elect to tax some/all of their foreign income in Israel should they so wish. Doing so with a UK pension will grant the elector an exemption from tax on the pension in the UK. For many pensioners making aliyah, this is most often an excellent strategy to take advantage of saving UK taxes at the highest marginal rates, and making use of the Israeli allowances and lower rates of tax – thereby saving significantly on the worldwide tax bill.

QROPS

Another option to protect pensions from being taxed is to move the pension fund into a QROPS – an offshore fund, approved by HMRC. These are expensive to run, and not all funds can be transferred. However, there can be significant tax advantages as any withdrawals would not be subject to UK tax or to Israeli tax within your first 10 years after aliyah.

Pension withdrawals

From April 2015, the government is overhauling the way one can withdraw funds from a (UK-based) private pension fund. Under the new laws, once you reach age 55, you will be able to make withdrawals from the fund, including the whole pot should you so wish. Twenty five per cent (25%) of the overall pot will be available as a tax-free lump sum, but anything else will be taxed at your marginal rate. Of course, if you are paying tax in Israel on this income, you will be exempt in the UK (see above). It goes without saying that you should consider how much you will be giving to the tax-man (either Israeli or UK) before making any decisions.

National Insurance voluntary contributions

Your eligibility to a state pension depends on your contributions towards National Insurance in the years prior to your retirement; similar to the criteria for being eligible to a Bituach Leumi pension.

The full state pension is based on 30 qualifying years (rising to 35 years for those who reach pension age after April 2016), and you are eligible for a pro-rated pension if you have at least 3 qualifying years (rising to 10 years for those who reach pension age after April 2016).

If you have less than the full amount, you are allowed to make voluntary contributions in order to increase the number of qualifying years. In essence, this is a one-off payment that will increase your weekly pension from retirement age and until you pass away.

The nature of the payments at present mean that even if you have to pay the more expensive Class 3 contributions (as opposed to Class 2), you need only live 4 years past UK retirement age in order to break even (before taking inflation into account).