Since time immemorial it has been accepted that taxpayers with a close connection with a jurisdiction should pay tax on their income in that jurisdiction. This norm informs the taxing rights of countries – literally, their right to impose tax. This means that countries will generally have the right to tax people on their income in the place where they are based – their country of residence. But this would obviously not satisfy countries – referred to as source countries – where operations and customers might be based and hence where income is generated. Both countries will have a legitimate claim to tax the income, but allowing double taxation of this sort would hinder cross border trade. As a result, taxing rights in international tax law are allocated on the basis that source countries have the “right” to tax active income – such as trading and employment income – whilst residence countries have the right to tax passive income – such as dividends, interest and royalties. For these “rights” to have any practical effect for taxpayers, both source and residence countries must have signed a double tax treaty to reflect the allocation of taxing rights.
The injustice of the non-dom rules is that they unilaterally grant relief from tax on income (and gains) without asking whether the income (or gain) has already been subject to tax and irrespective of what any double tax treaty provisions might say. How does this work?
Let’s just work with the rules on income to illustrate the point. The non-dom rules allow somebody who is resident in the UK but is domiciled abroad to only pay tax on income sourced in the UK. Meanwhile anything generated outside the UK, so long as the money is not brought in to the UK, is not taxed in the UK. A person’s “Domicile” is generally the country where a person (or their father) is born or where a person plans on returning.
Here the distinction is made not between source and residence, but rather between source and domicile. That might be justifiable if every other country adopted the same approach – meaning that the income would be taxed in either the domicile or source country, and crucially somewhere – but of course that is not the case. Instead, countries adopt the source/residence distinction and that distinction is enshrined in double tax treaties.
Let’s take an example: if we look at the India/UK double tax treaty, we see that passive income in the form of dividends, interest and royalties will be taxed in the country of residence (save for withholding taxes at either 10% or 15%; see Articles 11, 12 and 13). This means that if an Indian domiciled person were to take up residence in the UK, then the double tax treaty dictates that India cannot tax that person on their passive income derived from Indian sources (except in respect of withholding tax). Instead, the UK has the “right” to tax that person. But the UK does not do so (so long as the money is not brought into the UK). This means the UK non-dom resident does not pay tax in the UK – owing to the non-dom rules – and does not pay tax in India (save for the withholding taxes at low rates).
That is the injustice of the non-dom rules – they unilaterally exempt from tax where there is no risk of full double taxation. This is how the rules generate a tax break for rich people with a foreign connection who have accumulated wealth in another country. Not only should the less well-off be upset by having to pay marginal rates of tax much higher than the non-doms, but even rich people who have had the misfortune of being born in the UK should feel aggrieved!
Is that tax break justified? It seems that few still think so. Many that do are harbouring a misconception that the non-dom rules somehow encourage investment. But that cannot be right, given that the rules only work where the non-dom individual does not bring their foreign sourced income or gains into the UK. So the non-dom cannot invest in the UK without having to pay lots of tax. As Arun Advani has argued, the rules actually discourage investment.
The point of this post is not to suggest that there should no rules to prevent double taxation, even on the rich. That’s what double tax treaties are for. The non-dom rules however go far further than is necessary to achieve that aim. All that can be said for the rules is that they encourage non-doms to come to the UK and spend some money consuming goods and services. This generates some taxation receipts for the State and some employment no doubt. But how much, and at what cost…
taxatlincolnox 