Deferred remuneration and treaty residence

HMRC has published new guidance on the tax treatment of deferred remuneration, such as bonuses and long-term incentive payments, under the terms of employment income articles based on Article 15 of the OECD Model Tax Treaty. The guidance, contained in its International Manual at INTM163155, confirms that when considering treaty residence for the purpose of applying the article, it is the individual's treaty residence when the payment is made that determines the application of the provision.

The new guidance provides welcome clarification on the tax treatment of deferred payments of employment income to internationally mobile employees. In essence, it means that the UK will only claim taxing rights over deferred remuneration payments made when an individual is no longer UK tax resident where the payment relates to UK duties. The guidance should also provide much needed certainty for employers going forwards. However, it will still be important to check the wording of applicable tax treaties in all cases to ensure that they follow the wording of the OECD Model.

Background

Issues can arise when a person has changed their State of residence before they receive remuneration from employment earned in relation to duties performed in an earlier period. In broad terms, ITEPA 2003 s.15 brings all general earnings for a tax year in which an employee is a UK resident (under UK domestic law) within the scope of the charge to UK income tax. Section 16 explains when earnings are "for" a tax year and sections 18 and 19 explain when general earnings are treated as "received" for tax purposes: for money earnings this is generally the earlier of when the employee becomes entitled to the remuneration, and when it is paid.

When applying this legislation in situations where at least some of the income is from employment carried out abroad, regard must be had to the tax treaty between the UK and the country where the employment activity occurs. Where there is a change in residence prior to remuneration relating to a period of UK residence being received, it is also necessary to have regard to the treaty between the UK and the new State of residence, if there is one.

Article 15(1) of the OECD Model Tax Convention (income from employment) provides that "salaries, wages and other similar remuneration derived by a resident of a Contracting State" will be taxable only in the State of residence unless they have carried out duties in another State. Where a person has carried out their employment in another State, that other State may also be able to tax the employment income. The interpretation of the term "derived by a resident of a contracting state" in Article 15(1) therefore determines the question where deferred remuneration is taxable. Article 15 of the OECD Model Tax Convention is broadly replicated in the majority of the UK's tax treaties.

HMRC guidance

Uncertainty has existed in applying these provisions, in particular concerning whether it is treaty residence at the time of payment that is relevant or whether it is treaty residence when the duties of the employment are performed that is relevant. This can make a significant difference in terms of taxing rights.

The new guidance provides an example of a person, G, who was UK-resident for all of 2023/24. He exercised his employment in both the UK and Country A. G became resident in Country B for all of 2024/25, and was no longer resident in the UK under domestic rules. In December 2024, G received deferred remuneration relating to his employment duties performed in 2023/24, such that it was taxable under section 15 ITEPA 2003.

Assuming that the UK has tax treaties with Countries A and B that include Articles equivalent to Article 15 of the OECD Model Treaty, then the guidance considers the tax treatment of the employment income that relates to G's empolyment exercised in Country A. As the UK is not the State of source for that deferred income, the UK will therefore only be able to tax this income if it is the State of residence, under the treaty definition. In order to determine whether the UK is the State of residence, it is necessary to determine when that question is to be answered.

Under ITEPA 2003 s.15, it is only at the point the earnings are received that they become taxable, and so can be charged to tax under section 6. The deferred remuneration was money earnings, so that the charge arises in the tax year of the receipt, rather than the tax year in which the income was earned. In this situation, G is resident in Country B in December 2024 when the UK would apply the tax charge. This means that at the time of the tax charge, the UK is neither the State of residence nor the State of source for the portion of the deferred income that relates to employment exercised in Country A. The UK is therefore prevented from taxing this income by the tax treaty with Country B.

As a result of this guidance:

• Where an individual is treaty non-UK resident at the time of payment, the UK would no longer be the State of residence on payment and would only retain treaty taxing rights to the extent it is the source State for the employment income. Therefore, even where an employee was UK resident at the time of performance of the employment (giving domestic taxing rights), the UK would only have the right to tax the portion that relates to UK workdays under the terms of the tax treaty.

• Where an individual is treaty resident in the UK at the time of payment, under the treaty the UK would have the right to tax the full payment as the individual's State of residence. However, in the case of internationally mobile employees, UK domestic provisions only tax the portion that relates to UK workdays (in periods of non-residence) and the full amount for periods of tax residence. As such, the UK would only seek to tax amounts to the extent they are taxable under UK domestic law in this scenario.

Comment

The new guidance provides much needed clarification of HMRC's position. The guidance confirms that where a payment is made when an individual is not tax resident in the UK, the UK only has taxing rights under the treaty to the extent that the payment relates to UK duties, even if the individual was tax resident in the UK when the duties were performed. Accordingly, where an individual performed duties outside the UK (even during a period of UK residence), the UK will not have taxing rights where deferred remuneration is paid in respect of those duties at a time when the individual is no longer UK tax resident.

Affected employees who have previously paid UK tax on deferred employment income when no longer UK tax resident should consider whether they can make a claim to obtain overpaid tax. This may be via an amended self-assessment return when in time or otherwise it may be necessary to invoke the Mutual Agreement Procedure under the relevant tax treaty.