Expatriate taxation - CIOT - The Chartered Institute of Taxation

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CIOT RESEARCH PROJECT ON EXPATRIATE TAXATION 2 Issue 2: Bonuses: when earned 2.1 The issue is over what time period a bonus is earned. This is not an issue for a domestic employee, as he is taxable on 100% of his lifetime earnings on a receipts basis. For expatriates, the issue is more complex, as employer and employee have to decide which period the bonus relates to and what the residence status was at the time the bonus was earned to determine how much PAYE is deducted, and what is actually chargeable as earnings on the tax return of the employee. 2.2 The problem has been exacerbated by employer long-term incentive plans where the bonus may be earned over three, four or five years, which may be considerably longer than the assignment. 2.3 For employers (or, more precisely, deemed employers for PAYE purposes), there is often no mechanism for capturing either the tax or the information needed to tax bonuses paid post-departure. Applicable law 2.4 ITEPA section 16 provides the only reference to determining when general earnings are to be taxed by relation to particular periods. 2.5 Section 16(2) applies the logical explanation that earnings for a particular period are to be earned in that period. This clarifies earnings that are specifically related to periods of time. It does not apply to bonuses that are discretionary, except that, where there is a bonus pool for a particular period of time, then that period of time can reasonably be expected to be “the period”. 2.6 The law is silent where it is not possible to determine the period other than to say that the apportionment of the bonus to particular tax years is to be on a just and reasonable basis. 2.7 ITEPA section 17 does provide that, where the employment has ceased to be held, then the earnings period is deemed to be earnings for the last year in which the employment is held. 2.8 Two main problems arise. First, what is “the employment” which is the source of the bonus Second, to which period does it relate (covered more fully in Issue 3 below) 2.9 The first problem is of critical importance in determining the source of the bonus. It is also an area of debate in other areas of difficulty in expatriate taxation, as will be discussed in Issue 3 (pages 13-15) and Issue 6 (pages 24- 26). 2.10 With every expatriate employment, there are two possible employers. The home country employer is usually “the legal employer”, and the host country employer may well be “the de facto employer”. Peter Ashby 16 6.2.07
CIOT RESEARCH PROJECT ON EXPATRIATE TAXATION 2.11 It seems logical to assume that, in respect of a bonus, there is only one employment giving rise to the bonus. However, it is possible for two or more bonus payments to be “lumped together” so that, although there is only a single payment to the employee, there may well be two bonuses from two employments being paid as the single sum. If this is the case, the bonuses need to be split apart and each component separately considered. 2.12 “An employment” is defined as any employment under a contract of service in ITEPA section 4(1). The issue for all expatriates is therefore whether there is “an employment” under a contract of service with the host location. The expression is not defined any further in the legislation. 2.13 Case law precedent is missing as far as the tax Courts are concerned, but there is some guidance in the employment law arena. Recent employment law cases of Brook St Bureau v Dacas (2004 Court of Appeal) and Cable & Wireless v Muscat (2006 Court of Appeal) have been decided on the basis that an existing contract of employment can be ignored, and an implied contract of employment can be deduced where a person does, in fact, work for a UK entity in the de facto role as an employee. 2.14 The issue for expatriates is therefore whether the UK entity has become the employer for the purposes of UK tax law. If the answer is yes, then any bonus that relates in part to the UK employment will have to be apportioned to the UK on a just and reasonable basis. 2.15 At the moment, there is no tax definition of employment and, as employment law is still young and developing, it is impossible to say where this will end up. However, there are so many factors that may be taken into account that the employee may be unable to determine who his employer is as regards his bonus payment. Factors that appear to be relevant are: a) Whether there is a legal contract of employment; b) Whether there is an assignment letter that is written in terms that make it clear that it is subsidiary to a pre-existing contract of employment; c) Whether the bonuses that are awarded to the employee are determined in the home or host country; d) Whether the bonus is linked to any duties performed in the UK; e) Which accounting entity bears the cost of the bonus payment; and f) Which tax jurisdiction the bonus payment is deductible in as regards the payer. Proposals 2.16 The definition of employment needs to be given in tax law, as the absence of a definition may be, giving rise to potentially significant tax errors. A proposal for the second problem with this issue is suggested after the next issue, which is closely related. Peter Ashby 17 6.2.07
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Expatriate taxation - CIOT - The Chartered Institute of Taxation

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