A Cautionary Tale About Tax Residence

Expat Briefing Editorial Team, 28 February, 2014

From New Zealand, a cautionary tale for those expats who might think that they have fulfilled the last of their obligations to the tax man in their country of origin once emigrated.

New Zealand, like the vast majority of other countries in the world, considers you a resident for tax purposes if you spend more than 183 days there in any 12 month period. Where New Zealand differs from a lot of places though, is that you are still tax resident if you considered to have an “enduring relationship” with the country, a test that usually hinges on whether you maintain a permanent place of abode there. However, this does not just involve ownership of a property in New Zealand as it might suggest, but includes all of a person’s ties and links in the country.

To decide whether there is an enduring relationship with New Zealand, factors to be considered include whether a person has access to property in New Zealand; a person’s social ties, including where an individual’s immediate family lives; and what economic ties a person has in New Zealand, including an individual’s business and employment situation.

Usually, a person only becomes a non-resident if he or she is away from New Zealand for more than 325 days in any 12-month period, and no longer has an enduring relationship with New Zealand.

The concept of the enduring relationship was tested recently in a challenge to a New Zealand tax authority decision that a citizen who left the country permanently in 2003 remained resident for tax purposes for several years due to continuing family links and the ownership of property.

The Taxation Review Authority took the view that the disputant had retained "a permanent place of abode" in New Zealand, in the form of a property that was being rented out to tenants. The disputant argued that the way that the property was owned meant that it was not available for him to live in during the relevant tax years, but the TRA judged that, had he so wanted, he could have served notice to the tenants under the terms of the Residential Tenancies Act 1986. The TRA further noted that the property was in a location where the disputant had family and economic ties.

The TRA also took into consideration the fact that the disputant had not put down roots overseas during the relevant years, and that his intention to leave New Zealand permanently in 2003 was not documented prior to 2006. It was also noted that he had made frequent visits to New Zealand to see family.

The TRA imposed a shortfall penalty "for taking an unacceptable tax position in each of the relevant tax years," reduced by 50 percent in view of "previous behaviour”.

Rebecca Armour, who is head of the International Expatriate Services tax team at KPMG, described the decision as "very disappointing."

She added that the pessimistic interpretation of the ruling was that expatriates had to break all ties with New Zealand when they move overseas to escape tax liability, and that this was particularly relevant for expats residing in locations without a Double Taxation Agreement with New Zealand.

New Zealand is not the only country where pretty much all links must be broken before a person can be considered to be truly non-resident. In fact, concepts similar to New Zealand’s “enduring relationship” exist in common law countries in particular. In the United Kingdom, expats have traditionally had to grapple with ideas of ‘domicile’, ‘residence’ and ‘ordinary residence’, and the New Zealand example has striking similarities with a long-running legal battle in the UK courts settled in favour of HM Revenue and Customs, which disputed an expat’s claim that he had severed all ties with the UK for tax purposes.

The case concerned Robert Gaines-Cooper who migrated to the Seychelles in 1976. However, although he spent less than 91 days each year in the UK in accordance with non-domicile residency rules, at the time his position was challenged he owned a house in England, occupied by his second wife and son. He also kept classic cars and a collection of paintings at the property, and sent his son to a British public school. He also had his will drawn up under English law.

It was Gaines-Cooper's links with England that led the Court of Appeal to find that the UK remained Gaines-Cooper’s “center of gravity of his life and interests”, a decision upheld by the Supreme Court in 2011.

Explaining the reasoning behind its 4-1 majority decision, the Supreme Court said that while guidance on how to achieve non-residence "should have been much clearer", the guidance, when taken as a whole, informed taxpayers that one would need to leave the UK permanently, indefinitely or for full-time employment, and do more than to take up residence abroad and relinquish ‘usual residence’ in the UK. Information was also provided that subsequent returns to the UK had to be no more than ‘visits’ and that any ‘property’ retained in the UK by the taxpayer for their use could not be used as a place of residence.

The Gaines-Cooper case, and a number of others like it, was a factor behind the British Government’s decision to create a statutory residence test (SRT) to clear up a very confusing picture laid down by decades of case law and confusing HMRC guidance on the matter. Effective April 6, 2013, the SRT uses three tests to determine whether an individual is a UK resident for tax purposes.

In December 2013, HMRC launched a new online Tax Residence Indicator to help people determine whether they should be paying tax in the UK. HMRC says that the tool, which replaced a pilot version released earlier that year, will be of use to groups such as expatriates, aircraft and liner crews, rig workers, foreign students, health workers and seasonal workers.

However, it is important for British expats to note that residence status is still assessed according to time spent in the UK, in conjunction with their other ties to the country. Indeed, HMRC expects that the residence status of most people is likely to remain the same under the new test. So to avoid falling into the same trap as other expats, it is essential that people who enter and leave the UK keep clear and accessible records in case their residential status is challenged by the tax man.

It remains to be seen whether the UK SRT results in a more consistent application of the residence rules. However, in places where these tests have applied for a number of years they may still be open to interpretation by revenue authorities and courts, especially in cases where property is involved. For example, the New York Court of Appeals, the highest court in the state, recently decided that – contrary to New York's current statutory resident test – there must be evidence that a property has been used as a taxpayer's residence for that individual to qualify as a statutory resident of the state.

In Gaied v New York, the State Tax Appeals Tribunal decided on February 18, 2014, to side with the appellant Mr Gaied's argument that the standard to be applied when determining whether a person "maintains a permanent place of abode," for the purposes of determining residency in New York, should "turn on whether he maintained living arrangements for himself to reside at the dwelling."

During the relevant time period, Gaied lived in New Jersey. He owned an automotive service and repair business on Staten Island, New York, and commuted daily to work. In 1999, he purchased an apartment building on Staten Island. It was his parents who lived in the building, and Gaied only stayed in their apartment on occasion to attend to their medical needs. He leased the other two apartments in the building to tenants.

For each of the tax years in question, 2001 to 2003, Gaied filed non-resident income tax returns in New York. The New York Department of Taxation and Finance later issued a notice of deficiency for an additional USD253,062 in state and city income taxes, plus interest, determining that the petitioner owed New York taxes.

In an earlier ruling, the Tax Appeals Tribunal had sustained the deficiency, concluding that in order to qualify as a statutory resident under the New York tax code, a taxpayer need not actually dwell in the permanent place of abode but need only maintain it.

As we explained in a previous Expat Briefing, Americans are in the unenviable situation of being taxed on the basis of their citizenship, rather than on the basis of residence, so their relationship with the Internal Revenue Service (IRS) tends to endure no matter what.

Thanks to fairly generous income and property exclusions, the vast majority of US expats (about 88%) don’t actually owe any tax in the US. Nevertheless, most must still file tax forms and other income declarations, and there are growing calls for the US expats’ tax situation to be reviewed.

American Citizens Abroad (ACA) proposes that, as part of a general tax reform package, an election should be provided to citizens who are long-term non-resident citizens to be taxed as non-resident aliens if they meet certain conditions – for example, a minimum period of residence abroad, and an exit tax imposed on electing taxpayers where they are deemed to sell all assets at the time of election. The exit tax on deemed dispositions would, it is said, "be designed to address Congress' concern that the few extremely wealthy Americans who may choose to move abroad should pay their fair share on capital gains.”

ACA believes that administration costs for IRS would be significantly lower under a residence-based tax system than it currently is for the citizenship-based tax system. However, no matter how logical ACA’s proposals might sound, there are no signs currently to suggest that they will be taken up by the US Treasury or Congress. Indeed, extra-territorial tax compliance initiatives like FATCA only seem to be making US expats lives harder on the tax front.

As for expats from other countries, with governments under continuing pressure to raise revenue from every avenue possible, they are more likely to challenge one’s tax status these days than they were a few years ago. Expats are therefore advised to tread very carefully through the tax residence minefield.

Tags: compliance | business | interest | Tax | Expats | FATCA | Finance | expatriates | Seychelles | New Zealand | Jersey | United Kingdom | court | law | Internal Revenue Service (IRS) | tax authority | mining | tax compliance | tax | tax reform | exit tax |


Features Archive