Navigating tax compliance challenges for UK non-resident directors

As the UK tax authorities continue their focus on employer compliance checks, many UK companies with non-resident directors are in danger of failing to comply with their obligations.

Where NRDs of UK companies spend time working in the UK, the UK entity will have an obligation to operate payroll reporting and withholding – whether or not it pays the NRD. UK companies often inadvertently fail to do this, risking penalties.

It is easy for the UK tax authority, HM Revenue and Customs (HMRC), to check this. HMRC will review Companies House, the UK’s company register, to identify NRDs and request copies of the UK payroll records relating to them. For impacted companies this can be the first time they are aware of their failure.

Given that HMRC remains vigilant in enforcing employer compliance obligations, it is imperative that employers act.

Under the UK’s domestic legislation, an individual who is not tax resident in the UK is subject to income tax on income relating to UK workdays.

This can be overruled by a double taxation agreement (DTA), under which income relating to employment duties performed in the UK by an overseas tax resident individual can be exempt from tax in the UK.

However, DTAs do not provide this relief for income relating to UK workdays of directors (or other employees) of a UK company. An NRD who spends any time working in the UK will be subject to income tax on the income relating to UK workdays. The UK entity will have an obligation to operate UK payroll reporting and withholding.

The UK has a statutory residence test that determines tax residence, based on time spent in the UK and personal connections. If a director is UK resident, there are additional tax implications for both the director and the employer.

An NRD is subject to income tax on the income relating to the work they perform in the UK.

Generally accepted practice is to apportion the total earnings (including any linked employments, such as other positions with a group of companies) across total workdays to determine the amount relating to UK workdays.

It is important to remember that earnings includes both cash and non-cash earnings (such as benefits in kind and share based remuneration). This can make the calculation complex.

The NRD will have an obligation to file a UK self-assessment tax return and report the amount of earnings relating to their UK workdays.

They should be able to receive relief from double taxation in their home country (this could be a reduction in their home country tax on the same income, or an exemption with progression whereby the income is exempt from tax in their home country, but the amount exempted is still considered when determining the tax rates applying to their other income).

This obligation applies even where the UK entity is operating payroll reporting and withholding which is likely to be on a ‘best estimate’ basis.

Under the UK’s pay as you earn (PAYE) payroll withholding regime, the entity an individual is working ‘for’ (which will usually include an entity that an individual is a director of) is obliged to withhold income tax even if it doesn’t pay them.

The default position is that 100% of an NRD’s earnings be subject to income tax withholding. A UK entity can obtain a direction from HMRC (a ‘section 690 direction’) allowing PAYE income tax withholding to be reduced to the best estimate of the percentage of workdays performed in the UK.

Where the NRD is paid by an overseas entity (perhaps a group company) it will likely be necessary to set up a ‘shadow’ payroll in the UK. This is a payroll that reports the income for UK PAYE purposes to allow the calculation and remittance of the necessary income tax without paying the NRD.

The tax remitted to HMRC under a shadow payroll arrangement will then need to be recouped from the NRD via their (overseas) paying payroll. Failure to do this could result in the need to ‘gross up’ the UK tax liability (given that paying the tax on behalf of a director is itself taxable earnings) or consider the implications of having made interest free loans to the director.

The social security position for NRDs can be complex, especially where the NRD resides within the European Economic Area (EEA).

Within the EEA and the UK, an individual can only be subject to social security contributions in one member state (or in the UK).

If a UK entity has an NRD who is subject to social security contributions in an EEA member state, the UK entity will automatically be deemed to have a place of business in that EEA member state for social security purposes.

The UK entity will also be obliged to register as a foreign employer to operate payroll reporting, withholding and payment of both employee and employer social security contributions. It is likely to be necessary to obtain a ‘portable document A1’ from the relevant authority to confirm the correct country in which social security contributions are payable.

In addition, and often relevant for NRDs residing outside of the EEA, the UK has a specific administrative exemption from national insurance contributions for NRDs who travel infrequently to the UK.

This means that an NRD and the UK entity of which they are a director will be exempt from national insurance if they come to the UK only for board meetings, and either come for a maximum of ten meetings in a tax year (with each visit lasting no more than two nights), or come for a single meeting in a tax year which lasts no more than two weeks.

Some of the other common tax issues arising with NRDs include:

• Non-cash earnings: it is necessary to ensure that any relevant non-cash benefits and share based remuneration are considered;

• Travel expenses: reimbursement of travel and subsistence expenses to that workplace are likely to create further UK tax liabilities, a point that is often forgotten. A limited exemption may be available for NRDs who are not domiciled in the UK, however with the upcoming proposed removal of ‘non-dom’ status it is unclear how this will be impacted;

• Permanent establishment: if NRDs perform their work remotely from abroad there is a risk that the UK entity could create a permanent establishment for corporate tax purposes in the location where the NRD lives.

With the current deficit in the UK’s finances, HMRC is under continuous pressure to ‘close the tax gap’ and enforce the collection of taxes wherever possible.

Given the relative ease with which HMRC can identify potential compliance failures relating to NRDs, and HMRC’s ability to use this as a starting point for a wider employer compliance check (potentially covering a multitude of awkward employment tax rules) this area remains a key focus.

HMRC employer compliance checks normally go back over the prior four tax years, potentially leading to significant liabilities.

Any UK companies with NRDs should carefully review their position now, making sure that they are compliant and, if necessary, act to disclose and rectify any historic areas of issue.