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KEY POINTS
- A summary of the facts and law.
- The relevance of the Levene and Lysaght cases.
- HMRC’s published guidance.
- The application of Barnet LBC v Shah.
- When does ordinary residence commence?
On 18 March 2009, in the case of Fabio Massimo Genovese v HMRC (SpC 741), the Special Commissioner dismissed the appeal of the taxpayer and held that Mr Genovese was resident and ordinarily resident for the year in which the third anniversary of his arrival fell.
At first glance, this may seem to be another HMRC triumph following on from their string of victories relating to British citizens trying to break residence.
However, a closer study of the decision shows that all HMRC’s arguments which have been the basis of countless challenges under TMA 1970, s 9A were rejected, and while some people may find their period of not ordinary residence ends a year earlier, others may find that they were not ordinarily resident or even not resident all along.
In his decision, the Special Commissioner, John Clark, concluded that Mr Genovese had followed the guidance set out in the IR20 booklet, but that HMRC had decided to ignore this and to apply a non-tax case to overrule its own guidance.
Unfortunately, in our view, Mr Clark may possibly have misdirected himself on the point of law which swung the case HMRC’s way.
This article discusses HMRC’s current challenges to the residence status of foreign nationals in the UK and offers an analysis of what the House of Lords actually said in the case of Barnet LBC v Shah [1983] 2 AC 309, the case on which the department’s arguments increasingly depend.
It will also explain how an even more aggressive HMRC position, which would have made it virtually impossible for anyone working in the UK to be not ordinarily resident, was stopped in its tracks by the Genovese judgment.
Residence, employment and tax
Just to remind ourselves, employees who are resident but not ordinarily resident in the UK are only subject to tax on remuneration earned while working outside the UK to the extent that such earnings are paid in or brought to the UK.
This remittance basis of taxation, now subject to an election, was retained despite the changes introduced by FA 2008.
The relief is not unique to the UK nor is it particularly generous when compared to other countries seeking to attract foreign investment, but it is the cause of regular challenge by HMRC.
The status of ‘resident but not ordinarily resident’ has been on the statute books since 1806 and has given rise to various tax reliefs over the past 200 years. However, it has never been defined by statute.
There were two House of Lords rulings in 1928 which were generally regarded as test cases and they have formed the basis of the accepted rules for tax purposes ever since.
These cases, Levene v CIR [1928] 13 TC 486 and Lysaght v CIR [1928] 13 TC 511 were relied upon by the House of Lords, led by Lord Scarman, in the Shah case.
This was not a tax case, but it was held that the concept of ordinary residence in the UK was the same for all statutory purposes.
Although Lord Scarman said he merely followed the 1928 tax judgments his expanded comments on the concepts of residence have been relied upon increasingly by HMRC to limit their own published guidance.
Taken to the extreme which the department proposed in the Genovese case, the guidance published by the Inland Revenue and HMRC has not been in accordance with common law for the last 25 years.
Levene and Lysaght
The Inland Revenue’s published guidance was contained in the booklet IR20 and in two statements of practice. It is based primarily on the cases of Levene and Lysaght.
Both these gentlemen were British citizens who, having lived all their lives in England claimed to have broken residence and ordinary residence even though they continued to visit the UK on a regular basis.
Mr Levene stayed in Monaco and various other French resorts during the winter, but returned to the UK in the summer to visit friends and family.
Mr Lysaght was semi-retired. He had moved with his family to Ireland, but returned regularly to the UK on business and to visit friends and family.
The House of Lords held that every case had to be decided on its own facts and circumstances and that judges could not overrule a finding of fact by the Special Commissioners if there was sufficient evidence for them to have decided as they did.
They decided that someone was resident in the UK if they were here voluntarily and for a settled purpose.
They reviewed the pattern of visits of Messrs Levene and Lysaght over a four-year period and decided that their visits to the UK were regular enough to constitute residence.
In the case of Mr Lysaght it was held that employment could constitute a settled purpose.
One dissenting judge suggested that the same concept should not apply to a foreigner visiting the UK on business for a temporary period.
The published guidance
From these cases the guidance in IR20 emerged. Unless someone arrived in the UK with the intention of remaining for three years or more they would be regarded as resident but not ordinarily resident until the beginning of the year following the third anniversary of their arrival.
Anyone who had, or intended to visit the UK for more than three months a year on average over four years would also be regarded as resident and ordinarily resident.
Residence status was to be decided by a combination of intention and the actual pattern of previous presence in the UK.
Following other tax cases relating to residence (as opposed to ordinary residence) someone who had available accommodation would be regarded as resident and ordinarily resident.
The guidance in IR20 was extended by two statements of practice. SP 3/1981 stated that someone coming to the UK with no clear intention to remain for three years or more would be regarded as resident but not ordinarily resident ‘for at least three years’ unless they acquired available accommodation (house purchase or purchase of a lease for at least three years).
Even then, someone could revert to being not ordinarily resident if they sold the accommodation and left the country within three years.
SP 17/1991 again confirmed the rule that someone would be not ordinarily resident until the beginning of the year following the third anniversary of arrival unless they purchased accommodation or decided to stay indefinitely before then.
These statements of practice were integrated into later versions of IR20, but remain valid in their own right.
‘The rules’
At the start of a meeting with HMRC officers, including two residence specialists, the Inspector held up a copy of IR20 and explained that it contained ‘the rules’.
If these rules were followed Mr Genovese would be not ordinarily resident. If he did not comply with the rules his claim would fail.
This followed the fairly standard written opening broadside from HMRC’s residency team that diversion from the rules set out in IR20 would mean that a claim to be not ordinarily resident would fail.
It was always explained that the taxpayer had the right to appeal to the Commissioners.
The prospect, not to mention the cost of taking a case to the Special Commissioners is daunting because the cost could easily be greater than the tax at stake.
Mr Genovese was prepared to take his case, supported by Ernst & Young. It was clear from the outset of the process that the arguments rested on the Shah case.
The Shah case
Lord Scarman was regarded as one of the leading judges of the 20th century. The senior judge in the House of Lords and first chairman of the Law Commission, he is usually remembered for enquiries into the Brixton riots, Northern Ireland and the miners’ strike. Some may recall him as the judge who found for Mary Whitehouse in a blasphemy trial.
In 1983, the House of Lords heard an appeal by several students against the refusal of various councils to award them educational grants in accordance with the Education Act 1962.
This stipulated that councils were obliged to award grants to residents in their area who had qualified for a course of study providing they had been resident and ordinarily resident in the UK for the three years immediately prior to the commencement of the course.
The students involved in the case, with one exception, were Commonwealth citizens with leave to remain in the UK only for the purposes of their education. The councils argued that they were not ordinarily resident in the UK.
In the lower courts their argument was that the restrictions on entry to the UK imposed by the Immigration Act 1971 meant that their stay was temporary and, besides, Parliament could not possibly have intended that councils should be obliged to bestow grants on foreign students.
A settled purpose
The other law lords agreed with the judgment delivered by Lord Scarman who was a leading advocate of the expansion of university education in the UK.
The main objection of the Lords to the arguments of the courts below was that an Immigration Act had been applied to an Education Act and had been used to show what Parliament had or had not intended.
Objections to this approach would only be relevant, as Lord Scarman pointed out, if the students could be regarded as ordinarily resident. In deciding whether they possibly could be he turned to the tax cases of Levene and Lysaght.
He expanded on what his predecessors had said was a voluntary or settled purpose.
He contrasted ‘voluntary’ with incarceration, kidnap or a Robinson Crusoe scenario. With regard to ‘settled purpose’ he stated that the settled purpose may be for a limited period to do with ‘education, business or profession, employment, health, family or merely love of the place’.
He also stated that settled purpose was to be determined by what had occurred and not what someone’s intention was. There was no reason to delve into the individual’s mind.
The House of Lords did not actually find that the students were ordinarily resident because they had been in the UK for three years; instead, the cases were handed back to the various councils to reconsider their residence rulings in the light of the House of Lords’ guidance.
At this point the fate of Mr Shah and his fellow students is lost in the mist of time and data protection.
The Genovese case
HMRC had taken particular objection to the fact that at the end of the year in question, Mr Genovese had taken steps to buy a property in London.
He had also put his sons’ names down for private nursery/prep school in inner London. His pleas that he had not actually bought a house, that his sons had to be educated somewhere, and that he was fully expecting his job to be moved to Milan within weeks fell on deaf ears.
The inspectors tried to use HMRC success in cases concerning British or Commonwealth citizens trying and failing to break UK tax residence.
The latest of these cases was that of Mr Grace (see Bowled by a googly), where an airline pilot based at Gatwick whose claim to have been in the UK for a temporary purpose each time he touched down was rejected in the High Court.
In that case HMRC barristers had taken their adhesion to the Shah case to a new level, contending that anyone present voluntarily in the UK for the purpose of employment was ordinarily resident here.
This view was not endorsed by the court which had already decided against Mr Grace.
However, the same argument was put forward against Mr Genovese as if it had case law validity.
Mr Nawbatt, HMRC’s barrister, also argued that Reed v Clark [1985] STC 323 indicated that someone could be regarded as ordinarily resident in a country if they remained there for little more than a year.
Finally, Mr Nawbatt contended that in order to be not ordinarily resident in the UK someone had to prove that they were resident elsewhere.
When asked by Mr Clark whether HMRC had abandoned their guidance in IR20, Mr Nawbatt – after consulting HMRC’s residence specialist – stated that IR20 was in full accordance with the department’s view to the extent that it followed common law.
The commissioner’s judgment
In his judgment, Mr Clark rejected all the department’s contentions save one. He dismissed the arguments about contemplating house purchase and making provision for the children’s education.
He rejected the convoluted logic applied to Reed v Clark and the notion that you have to be resident somewhere else to be not ordinarily resident in the UK.
He also clearly stated that he accepted Mr and Mrs Genovese’s evidence that they did not regard themselves as settled in the UK for any period of time until a turn of events in the following tax year.
Mr Clark pointed out that Mr Genovese had followed HMRC guidance in completing his tax return.
However, the Commissioner concluded that he could not follow the department’s guidance where it was at odds with common law.
In the Shah decision he concluded that the students had been held to be ordinarily resident because they had lived in the UK for three years and there had to be a point where someone became habitually resident.
Apparently following the Shah case, Mr Clark held that Mr Genovese became ordinarily resident on the third anniversary of his arrival in the UK and so was subject to UK tax on his employment income on the arising basis for the whole year.
Mr and Mrs Genovese’s stated intentions, which he fully accepted, were irrelevant. Mr Clark stated that in the Shah case ‘the individuals were found to have fulfilled the condition of three years’ ordinary residence’. In fact, all the law lords did was to decide that they may have done.
The split year issue
The other finding which needs to be considered is the ‘split year’ issue.
Case I of Schedule E taxed employment income on the arising basis where the employee was ordinarily resident in the year.
Mr Clark concluded that since Mr Genovese had been ordinarily resident at some point in the year he was subject to tax under Case I on all employment income.
However, Case II of Schedule E taxed UK earnings of anyone resident but not ordinarily resident in the year.
Given that (unlike the position for residence and non-residence) HMRC did not allow a tax year to be split between periods of ordinary residence and not ordinary residence, the practice was to treat the individual as not ordinarily resident for the whole year.
This implies that HMRC should treat someone as not ordinarily resident for the whole year even if they were ordinarily resident for some part of it. Mr Clark’s decision makes this more difficult.
This decision, if upheld, takes us back to the point in the mid-1990s when the Inland Revenue (as it then was) issued a revised edition of IR20 that stated that someone would be ordinarily resident in the UK from the beginning of the tax year in which the third anniversary of their arrival in the UK fell.
After some considerable furore the new version was withdrawn. Some in the department have been trying to get back to that position for years. It may be that this case has achieved that goal.
The Genovese case is likely to be quoted by both sides until some statutory residence rules are applied.
HMRC are bound to argue that anyone still here after the third anniversary of their arrival is ordinarily resident for that year.
Quite what view they will take of someone who is still here on the third anniversary, but leaves in the same tax year remains to be seen.
However, anyone who leaves within three years should now be regarded as not ordinarily resident throughout, regardless of their stated intention at the outset.
It can also be argued that any foreign national who arrives in the UK is not ordinarily resident for at least two years, particularly if they stay in employer-provided accommodation.
HMRC should immediately close the large number of enquiries based on family, school places, contemplation of house purchase and even the purchase of new cars.
IR20 and the statements of practice served us well for decades until the Revenue’s old CI Claims stalwarts retired early this decade.
The new team embarked on a strategy of litigation which was supposed to clarify the rules.
The problem with litigation is that lawyers set out to win regardless of the practical problems that may arise. The holistic view goes out of the window.
The honourable thing
Fabio Genovese was assured by HMRC in person and in writing that if he followed the guidance in IR20 his claim to be resident but not ordinarily resident would be accepted.
The Special Commissioner made it very clear that he accepted that Mr Genovese had followed the guidance.
The honourable thing for HMRC to do would be to accept his claim in the same way that they have accepted the claims of thousands of others still here beyond the third anniversary of their arrival.
In any case he should be congratulated for taking a stand and reining back HMRC’s attempts to make R/NOR (resident but not ordinarily resident) assignees an endangered species.
Any bland statement that everything will be made fair once a statutory framework is in place would ignore the moral obligation that HMRC appear to wear so lightly these days.
Rob Gell is a senior tax manager and Phil Davis is a partner at Ernst & Young and are part of the global mobility tax technical team. Rob can be contacted by email.
