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Tax Residence in the sun!

Updated: 09 Oct 2017

At a recent IBSA conference, advisers from Spain, Portugal, Italy, Cyprus, Switzerland and Dubai were vying with each other to demonstrate how their countries were offering better tax incentives than the UK’s non-domicile legislation - plus sunshine, or in the case of Switzerland, glistening ski slopes.

The Swiss lump sum tax regime, or ‘forfait’ as it is known in the French speaking part, has been in existence for decades, and used to be the best alternative to the non-dom regime of the UK. However, left wing pressure in certain cantons like Zurich led to a withdrawal of the cantonal regime (although noticeably not in Geneva and Vaud), and to an anticipated cliff edge vote at a federal referendum which retained it at federal level with a 60% vote. Nevertheless, one wonders how long the regime will continue.  In any event, it isn’t cheap! Although foreign source income may be exempt, the ‘forfait’ calculates tax on a figure of seven times the rental value of Swiss property (itself not cheap) and according to one’s level of expenditure to support their lifestyle. In other words, one should reckon on the annual tax exposure of between CHF 125,000 to CHF 250,000 depending upon which canton is chosen.

Off to warmer climes in Spain, its ‘impatriate’ regime offers a six-year tax free period in respect of foreign source income and gains, charging just 24% tax on the first €600,000 of Spanish source income. This was known as the Beckham rule, introduced by the government in 2003 at the same time as Real Madrid were incentivising David Beckham to sign for Real Madrid from Manchester United. Were members of the government Real Madrid supporters?!! But the beneficial legislation has now been withdrawn for sportsmen (but not entertainers). The disadvantage of the system is that the ‘impatriate’ must move to Spain as a result of a genuine employment contract, a requirement which is not therefore available to pensioners or those with a high net worth who only wish to enjoy the warmth of the Spanish Riviera.

As an alternative, Cyprus welcomes all sorts, and with its own non-domicile legislation, allows foreign income and gains not only to be untaxed on an arising basis, but allows the income and gains to be remitted to Cyprus without further taxation. There are also significant allowances available in domestic taxation which may benefit those who enjoy the ‘meze’ of the island, as well as an unusual residence programme for individuals carrying on business or who are employed in Cyprus. The programme allows such individuals to become tax resident in Cyprus after only spending 60 days in its territory provided they are not resident elsewhere — a saviour for those who spend their life travelling the world and struggling to meet residence requirements to appease their bankers.

Another alternative, and a country with a history of encouraging foreigners to enjoy the local sunshine, is Portugal. The regime there is called the “Non-Habitual Resident” regime and does not require an employment relationship to exist for those wishing to benefit from this provision. And unlike its Spanish equivalent, the regime lasts for 10 consecutive years. So foreign income, which includes pension income, is exempt from tax, thereby attracting many retirees. However, there is a catch; capital gains on foreign assets will still be taxable at 28% and the benefits do not extend to distributions received from certain offshore territories, so a degree of restructuring of assets will be necessary before taking advantage of this programme (which should not be too difficult to arrange!).

Not wishing to lose out on the beauty parade, Italy is the latest country to introduce beneficial legislation aimed at encouraging foreign individuals to take up Italian residence. Unlike the absence of an annual payment in Portugal, the new Italian legislation does however require a €100,000 tax payment each year to allow foreign income and gains to be exempt from Italian tax – but does so for a 15-year continuous period. There is an anti-avoidance provision in respect of non-portfolio capital gains, allowing exemption only if the individual has been resident in Italy for at least five years, discouraging those wishing to come to Italy just to avoid a capital gains tax charge in their “home” country. For such persons, Portuguese and Spanish regimes may be more appropriate.

Perhaps one should consider a country like the United Arab Emirates, where there is actually no income tax or capital gains tax, and the sun shines for even longer and hotter than the other countries mentioned. And Dubai, part of the UAE, can benefit from over 100 double tax treaties entered into by the country. As a resident of Dubai, an individual may therefore be able to reduce foreign taxation whilst at the same time enjoying zero domestic taxation.

But here’s the rub. As with all the other countries mentioned, yes, the incoming residents may be able to benefit from the double tax treaties entered into by these jurisdictions. So for example, pension income received by a non-habitual resident of Portugal from say the UK may be receivable without UK taxation, since the UK cedes the normal source rules over to the country of residence. Yet the individual doesn’t pay Portuguese tax on the pension income. Or a Dubai resident able to avoid capital gains tax on the sale of shares in say a German company where the treaty cedes taxing rights to the state of residence, will not pay any tax in Dubai.

The relatively recent initiative of the OECD with its Base Erosion and Profit Shifting (BEPS) proposals have recommended in Action 6 that double tax treaties should include a clear statement that they are not designed for double non-taxation or reduction of appropriate taxation through evasion or avoidance. I am not suggesting that the above countries are encouraging any element of evasion or avoidance, but the consequence of these beneficial provisions is that an individual may enjoy double non-taxation as a result of reliance on the relevant treaty provisions. More than 70 countries have signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (known as the MLI) including all of the above countries other than the UAE. When the MLI enters into force, it will be interesting to see if countries like the UK and Germany allow its treaties to be used by non-habitual residents of Portugal, impatriates of Spain, ‘forfait’ beneficiaries in Switzerland (who are already excluded from many of Switzerland’s double tax treaties for this reason), Italian and Cypriot residents enjoying zero taxation, and those resident in Dubai who pay no tax whatsoever. Maybe it won’t be quite so sunny then!