Tax Guide for Americans & Expats Living in the United Kingdom
This tax guide aims to supplement and enhance your understanding of the UK income tax laws by providing current insights and practical information. In addition, we have also stressed on valuable tax planning opportunities and tax treaty provisions available to United States citizens, permanent residents, and expatriates residing in the UK.
The United Kingdom is a common law country and constitutional monarchy. The currency is the British Pound (GBP) and the 2015 average exchange rate of the GBP to the US dollar was 0.681. Her Majesty's Revenue and Customs (HMRC) is responsible for the assessment and collection of all direct and indirect taxes, custom and excise duties, national insurance contributions, and for certain other benefits.
The National Insurance Number (NINO) is the British equivalent of a Social Security Number. You will need to prove that you are allowed to work or study in the UK to obtain a NINO. American citizens and expatriates who are physically present in the UK may apply for a National Insurance Number by calling the NINO application line to arrange a face-to-face interview. Plan ahead of time as in some metropolitan regions, such as London for example, the application may take several weeks. At any stage should you have a visa that allows you to work in the UK, you may start employment straight away. Your employer will assign you a temporary reference number while waiting for your NINO.
Unlike the United States, the UK adopted a fiscal year that spans over two calendar years. The fiscal year for individuals runs from April 6th through April 5th of the next calendar year. At the end of the financial year, your employer will provide you with a Form P60 which is the British equivalent of Form W-2. If you separate from your employer prior to the year-end Form P45 will be issued instead. Recall that the United States requires income reported on a calendar year basis. Therefore, US citizens and residents will need to keep copies of pay slips or obtain a calendar year income summary, to adequately reflect UK-source income on the US tax return.
Residency & Tax Liability
Your tax liability in the UK will be limited if you remain non-resident or unlimited if you become a tax resident. Non-residents with limited tax liability will be subject to tax only on UK-source income. Residents with unlimited liability are taxed on worldwide income. In addition, there are certain intermediate categories of residency that provide specific exemptions and limited scope of taxation. The Finance Act of 2013 introduced a Statutory Residency Test (SRT) that is used to determine your tax residency. The SRT is based on 3 automatic residency tests and one UK ties test.
Under the first automatic residency test, a US citizen who is physically present in the UK for 183 days or more during the fiscal year will become UK resident for tax purposes.
If you do not meet the first automatic test, the second automatic test requires you to be present in the UK for at least 91 days during the fiscal year, to keep a home only in the UK and spend at least 30 days in that home.
The third automatic test applies to certain commuters, short-term visitors and individuals seconded to the UK by a foreign employer. A prerequisite for the test is a full-time employment in the UK for a period of at least 365 calendar days with no significant breaks.
The last test looks at the taxpayer's social and business ties to the United Kingdom to determine residency. Therefore, a person whose ties to the UK are stronger might be also considered a resident there.
Any of the above tests is sufficient to establish residency in the UK unless a safe harbor provision applies. The safe harbor rules are summarized in three overseas tests. Moreover, a split-year treatment applies to individuals who had become or lost UK residency during the tax year. You may be also taxed only on income remitted to the UK if certain other conditions are met. More residency specific guidance is available in Publication RDR3 issued by the HMRC.
Allowances & Income Tax Rates
The personal allowance in the UK is fixed at GBP 11,000.00 for 2016/2017 fiscal year regardless of the age of the individual. The personal allowance assures taxpayers with annual taxable income of GBP 11,000.00 or less are exempt from income tax. If you earn more than the personal allowance, income tax is applied at graduated rates. Moreover, the personal allowance phases out if gross income exceeds GBP 122,000.00. Individuals may also benefit from an additional marriage allowance and blind person's allowance. The income tax bands and rates in the UK for 2016/2017 fiscal year are
Up to GBP 11000
GBP 11000-GBP 43000
GBP 43001-GBP 150000
Over GBP 150,000
Income Tax on Employees
The income from employment in the United Kingdom is taxed at source under the PAYE (Pay-As-You-Earn) System. The income tax withheld from your wages will be listed as IncomeTax or PAYE on your pay slips. The tax deducted at source is treated as an advance payment of your prospective tax liability and is remitted to the HMRC by the employer. The amount of tax withholding depends on your "tax code", payment period, and expected gross income.
An employee's tax code is the tax allowance set against that employee's total pay. For example, for 2016/2017 tax year, an employee entitled to the full personal allowance will have a tax code 1100L. This tax code means that the personal allowance of GBP 11,000.00 will be spread across the year before any PAYE is deducted. Tax code information is available in a designated personal tax account. Americans and expatriates may set up a free online personal tax account at any time, and we firmly recommend you to do so. The personal tax account will also help you monitor tax withholding, submit address updates and make claims for tax reliefs. More information is available on the HMRC's website.
Generally, self-employment is any activity that qualifies as a "trade" under the HMRC rules, including regularly selling goods or services to others with the expectation to make a profit. Occasional sales or sporadic activities, such as a garage sale do not qualify. Therefore, sole-traders and partners in a partnership are classified as self-employed individuals.
You will need to formally register for a Self-Assessment with the HMRC as soon as you start your sole-trading activity. Absent indication to the contrary, a new business activity begins when you make your first sale to others. New business registration can be filed online at the HMRC's website. Depending on your business activity a license or permit might be also required.
Deductions & Reliefs
The UK tax system established several above-the-line deductions from income, referred to as tax reliefs. The most common are tax-free contributions to various pension plans, donations to charities, professional fees and dues, alimony, and a limited number of employee business expenses. Further, employees in specified occupations qualify for a statutory flat rate expense deduction from gross income that does not require substantiation.
Employees whose deductions amount to less than GBP 2,500.00 for the entire fiscal year may file a claim for tax relief on Form P87. The form could be submitted electronically through your personal tax account. Self-employed individuals are allowed to deduct a wider range of common and necessary business expenses.
Tax Assessment, Collection & Refunds
Ordinarily, employees in the UK are not required to file a tax return. Instead, the tax office will automatically calculate your liability and a tax assessment notice P800 will be mailed to your address on record. The P800 notice is issued by the end of July if you are due a refund or by the end of September if you have to pay more tax.
If a refund is due, you will typically receive a check or payment order within 14 days following the P800 notice. If you have to pay additional tax, the notice will provide instructions that vary depending on the amount of the additional tax liability. In an event, you receive no notice or you need to claim a tax rebate for a previous fiscal year, you may file a claim through your personal tax account. You can apply for a tax refund for the past four fiscal years.
In certain situations, a Self-Assessment tax return is required, including claims of more than GBP 2,500.00 in tax reliefs, reporting foreign income, high rental or capital gains income, and the like. Self-employed individuals are also required to file a Self-Assessment tax return on an annual basis. Moreover, individuals registered for Self-Assessment will not receive P800 notice from the HMRC.
You may file a Self-Assessment tax return online or on paper Form SA100. Supplementary schedules are attached to reflect various sources of income. The Self-Assessment tax return is due October 31st for paper and January 31st of the next calendar year for electronically filed returns. If a return results in a balance due, you will need to cover it by January 31st of the following calendar year to avoid penalties and interest.
Finally, if you are dissatisfied with the assessment, you may object to the inspector within 30 days. You may also file a formal appeal. Appeals are usually heard by the First-tier Tribunal except for certain more complex legal matters that are referred to the Upper Tribunal.
Capital Gains Tax
A separate Capital Gains Tax is applied on gains derived from the sale or other disposition of capital assets. An exemption applies to assets with a fair market value of less than GBP 6,000.00 as well as to your personal car and home. In addition, there is a separate capital gain tax-free allowance of GBP 11,100.00 for 2016/2017 fiscal year. Taxpayers in the basic rate band pay 10% capital gains tax on profits from most assets and 18% capital gains tax on profits from a sale of a residential property. Taxpayers in the higher and additional brackets pay 20% or 28% respectively.
National Insurance Contributions
Both employees and self-employed individuals pay National Insurance (NI) Contributions. There are different classes of NI Contributions depending on employment status and income. Most employees fall in Class 1 NI and are required to pay 12% of their earnings towards national insurance. Additional 13.8% are covered by the employer. Class 2 and Class 4 NI with various rates apply to self-employed individuals. Class 3 NI is a voluntary insurance for persons who have no coverage due to a low income exemption, unemployment or otherwise.
Individuals also pay Council tax on living and business quarters. The Council tax rates vary between municipalities. Value-Added Tax (VAT) is an indirect tax applied on goods and services.
The UK has various private pension schemes that qualify for a tax relief. A pension scheme available through an employer is referred to as a workplace pension. Most employer-sponsored pension schemes are defined contribution plans, similar to the 401(k) in the United States. A defined contribution plan that accepts elective deferrals from you, your employer or both qualifies for a tax relief at source. Some examples of approved employer-sponsored plans include Contracted-out money purchase scheme (COMPS) and Contracted-in money purchase scheme (CIMPS).
Pension schemes that you arrange yourself are called personal and stakeholder pensions. Some of them are available through an employer, but because of their structure, they are closer to the US Traditional IRA. Some examples include Group Personal Pensions (GPPs) and Group Stakeholder Pensions (GSPs). Also, some self-invested plans are similar to a self-directed IRA. These are the Self-Invested Pension Plans (SIPPs) and the Group Self-Invested Pension Plans (GSIPPs).
Taxpayers in the UK are allowed to contribute up to 100% of their annual income to a qualified pension scheme. However, to obtain a tax relief the combined contributions to all pension plans must not exceed GBP 40,000.00 per year.
Tax Planning for Americans in the United Kingdom
American citizens and residents living in the United Kingdom are still required to file US income tax return. Therefore an on-time tax planning is a key to elimination of double tax exposure. We have presented several impressive tax planning strategies that are tax efficient and easy to implement.
US tax deduction for the UK pension contributions
Yes, you got it right. Americans in the UK may get a tax deduction on their US tax return for the pension contributions made to a qualified UK pension scheme. Under Article 18 (5) of the USA-UK Income Tax Treaty contributions paid by or on behalf of a US citizen or resident to a pension scheme organized in the United Kingdom are deductible in computing taxable income in the United States.
Transfer of the UK pension contributions to the United States
Subject to a set of eligibility rules, a US citizen, resident or expat living in the United Kingdom may roll-over benefits accumulated in a UK pension scheme to a qualified pension plan abroad. If eligible, the transfer will not be subject to tax in the United Kingdom. Many IRA plans qualify!
Social security coverage exemption for self-employed individuals
Self-employed persons residing in the UK are required to pay NI contributions. Simultaneously, US citizens and residents also pay self-employment (SE) taxes in the United States. To eliminate double coverage and ensure equal treatment, the United States has signed a Social Security (Totalization) Agreement with the United Kingdom. The agreement exempts US citizens and residents from the self-employment taxes in the USA.
Many other tax treaty provisions effectively eliminate double taxation. Feel free to contact us should you need a personalized tax planning strategy. Our US-International tax experts will be happy to answer all your questions and to offer you the best possible solution.