No. It’s a terrible idea. Here’s why.
How the UK system currently works
The UK taxes individuals based on their residence. If you live in the UK for 183 days in one tax year (or more than 90 days if you have a home here)1 then you are “resident” in the UK, and subject to UK tax on all of your income and gains for that year.2
The problem with this from some people’s perspective is that it becomes remarkably easy to stop being subject to UK tax. Simply quit the UK. Plenty of wealthy people skip the UK to move to tax havens, often just before making large capital gains.3 You can be sure we’d see more of that if the UK was about to introduce a hefty wealth tax
Whether you call this “tax avoidance” and/or think it’s immoral is a personal question on which different people will have different views. But – as long as they are really spending 270 days abroad every year, and don’t come back within five, then leaving the UK is absolutely a proper, legal and 100% effective way to escape UK tax.
The US alternative
The US does things differently – it has “citizenship-based taxation”.
The way this works is that US citizens (and green card holders) are fully subject to US tax on their worldwide income and gains, no matter where they live. So you cannot escape US tax by moving to Panama. You can escape US tax by surrendering your citizenship – but that comes at the price of a hefty exit tax (which broadly eliminates all the immediate benefit of escaping US taxation).
Interestingly there is almost no other country that does this.4
But, on the face of it, if you want to stop billionaires from leaving the UK and escaping UK tax, this is the approach to adopt.
(You may, alternatively, regard such an approach as immoral, and think that no country has the right to tax people who want to leave – but I’m going to park such political questions and look at the practicalities)
Where citizenship-based taxation goes wrong
The problem is that you would be paying tax in two places. A Brit living in France would pay UK tax (because they are a British citizen) tax plus French tax (because they are resident in France).
On the face of it, this shouldn’t be a problem, because the UK has double tax treaties with France and most other countries which in principle stop you from being taxed twice on the same income. And certainty in a simple case where you have £100 of income then the US and UK won’t both apply their full rate of tax to that income. But the problems go beyond simple double taxation.
We can get a sense of the issues by looking at the difficulties currently faced by US citizens (subject to US worldwide taxation) resident in the UK (and subject to UK worldwide taxation).
Here’s how it goes:
- The US has the “foreign earned income exclusion” for the first $107,000 of income for citizens living abroad. But it doesn’t protect the self-employed, who still have to pay US self-employment tax on their income. If you’re a plumber or an IT contractor, you have to file two complete tax returns in two countries. Those tax returns have different rules for e.g. what is deductible and what isn’t. Nightmare.
- To make life more fun, those tax returns will often cover a different period – for example the UK tax year runs from April 6th, but the US tax return runs from January 1st. Even if you’re employed, and all your income is exempt in the US under the foreign earned income exclusion, you still have to file.
- Filing tax returns in two countries is complicated, because of the interactions between the two sets of returns. I know someone who had a $5k capital gain – filing US taxes for that year cost them $3k.
- Capital gains are a problem, because the US taxes you on your US dollar gains. For example: say you buy a house in the UK for £300k and sell it a few years later for the same price. No UK capital gain. But if Sterling appreciated over that period, so that the dollar purchase price was $380k but the dollar sale price was $450k, then you have a $70k US capital gain, but no cash proceeds to fund it. And the UK will do the same to your US assets.
- If you make a capital gain then the different filing and payment timetables mean that you’ll sometimes have to pay the full US tax, then the full UK tax, then claim a refund of the US tax.
- It’s a nightmare for the spouse. If a couple have a joint account, and one is a US citizen and the other is not, then the joint account becomes subject to U.S. tax. Married couples can normally not worry about the tax treatments of their family finances – but where one of the couple is a US citizen then even simple arrangements like joint accounts become very complicated.
- Many people in the UK have an ISA, where you can put cash or shares into an account and the return is exempt from tax. But it’s not exempt from U.S. tax. So a U.S. citizen living in the UK cannot use an ISA (or, to be more accurate, if they use an ISA they get no benefit from it). Some US advisers think it’s worse than that, and an ISA has a particularly awful US tax treatment: that’s a whole other class of problems that arises when one country’s tax system has to characterise the tax effect of another country’s legal and tax system.
- You always get the worst of both worlds. For example, the US and UK take the opposite approach to the taxation of your house. The UK gives you no tax relief on your mortgage payments, but exempts you from capital gain on the value of the house. The US gives you tax relief on mortgage payments, but then taxes the capital gain. Both are somewhat balanced results. A U.S. citizen living in the UK gets the worst of both worlds. They get no tax relief on the mortgage for their UK tax, but have to pay US capital gains when they sell. That’s an unbalanced result.
- It becomes impossible to buy investment funds. The UK has rules that in practice mean no UK residents can buy an investment fund unless it is either established in the UK, or foreign but an “approved offshore reporting fund”. The US has rules that in practise mean it is very disadvantageous for a US citizen to invest into a non-US fund (the PFIC rules). The poor U.S. citizen living in the UK is subject to both sets of rules, and therefore cannot realistically invest in any funds.
- There’s an obvious incentive for US citizens abroad to simply not declare or pay their US taxes. That’s a criminal offence, but historically it was very hard for the IRS to spot. A whole international reporting regime – FATCA – was introduced to stop this. But that imposes a significant admin burden on non-US financial institutions with US citizen clients and, as a result, some banks don’t allow US citizens to open accounts.
- I could go on. The impact on minors. “Accidental Americans”. Retirement account taxation. Inheritance/estate tax interaction. Complexity when couples divorce. Social security/national insurance interaction. You don’t need to be wealthy, or to have complex personal finances, to have a horrible time navigating the US and UK tax systems at the same time.
These are unfair outcomes for normal people, particularly people who can’t afford lots of tax advice. Billionaires can cope with it; doctors and IT workers, not so much.
So if the UK adopted citizenship-based taxation then you might regard that as a “win” for taxing the very wealthy. But it would hurt many ordinary people who choose to live abroad.
That’s why the US is the only developed country that taxes on the basis of citizenship. Why does it do that? Some combination of: changing the US tax system is very hard, US expats don’t have valuable votes and so the campaign to change the law gets nowhere, and the US is big enough and bad enough to get away with things that other countries can’t.
Surely there’s a way to do the good stuff and not the bad stuff?
One idea would be to keep citizenship-based taxation, but only for people who move to tax havens.
The problem with this is that there are many countries that behave exactly like tax havens for Brits who move there. Singapore, Israel, Portugal, even Italy, don’t tax, or barely tax, the income of a wealthy Brit who moves there. So our list of “tax havens” would have to either be very long, or full of holes.
And if the UK introduced a wealth tax, then almost every other country would be a “tax haven” from that wealth tax, because only a handful of countries these days impose a wealth tax.
So what’s the answer?
I think there are two.
One is to have no problem with people leaving the UK if they choose, and escaping UK tax. You can justify this on the principled grounds that everyone has a right to vote with their feet, or the pragmatic grounds that people may be less likely to come here, and entrepreneurs less likely to stay, if we hit them with a large tax bill when they leave.5
The other is to say that in some cases, where a person has accrued lots of untaxed capital gain during their time in the UK, the UK should have a right to tax it if they leave. I think that’s worth more thought, and will be writing more about it soon.
But citizenship-based taxation is unfair and unjust.
Photo by James Giddins on Unsplash
Footnotes
It’s a bit more complicated than that, but these days the rules are fairly clear and sensible ↩︎
Unless you are a “non-dom”, which is a whole other story ↩︎
It’s occasionally claimed that people don’t move in response to higher tax rates. Most of this is based on studies of people moving from relatively highly taxed US States to relatively lowly taxed states. It’s not applicable to the very wealthy moving to tax havens, which is hard to study statistically (too few people) but very easy to assess empirically (there’s no other reason a Brit would choose to live in Monaco ↩︎
People sometimes cite Eritrea, but that looks more like gangsterism than tax. ↩︎
The US doesn’t have an obvious problem with that, but this arguably goes back to the US being uniquely big and bad enough to have a citizenship-based taxation system. ↩︎
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