(Adapted from an article in Tax Bulletin 76 – April 2005)
Dual contract arrangements are popular with foreign domiciled employees who work both in and outside the United Kingdom (UK). Although there is nothing to prevent an individual from entering into an employment contract with more than one employer, HMRC has concerns that employers, employees and their advisers provide written contracts that do not reflect the reality of the situation. This appendix first appeared as an article in Tax Bulletin 76 (April 2005). It explains how HMRC offices approach enquiries into dual contract arrangements. In summary, HMRC believes that the commercial reality in some cases may be that the employee has just one employment.
The question of the existence or otherwise of an employment
usually arises for tax purposes where there is doubt over whether
income derives from employment or self-employment. Once it has been
established that an individual performs services as an employee,
there is generally little difficulty in attributing earnings to a
particular employment relationship.
The Employment Income parts of the Income Tax (Earnings and
Pensions) Act 2003 (‘ITEPA’) charge to tax earnings
“from” employment. Although ITEPA does not attempt a
comprehensive definition of employment, section 4(1) provides that
“employment” includes “any employment under a
contract of service”.
Chapter 5 Part 2 ITEPA contains the rules for determining the
taxable earnings of employees (and office holders) who are
resident, ordinarily resident or domiciled outside the UK. Section
21 taxes the full amount of any general earnings for a tax year in
which the employee is resident and ordinarily resident, but not
domiciled, in the UK except to the extent that they are
“chargeable overseas earnings” for that year. Section
22 provides that the taxable amount of chargeable overseas earnings
is the full amount remitted to the UK in that year. Section 23
describes how to calculate chargeable overseas earnings. By section
23(2), “general earnings for a tax year are overseas earnings
for that year if:
“Foreign employer” is defined in section 721(1)
ITEPA as meaning “in the case of an employee resident in the
United Kingdom, an individual, partnership or body of persons
resident outside the United Kingdom and not resident in the United
Kingdom or the Republic of Ireland …”
Where the employment is in substance one whose duties fall to
be performed outside the UK, the requirement that the employee
performs the duties of the employment wholly outside the UK is
subject to section 39. This provides that duties performed inside
the UK, which are “merely incidental to” duties
performed outside the UK, are to be regarded as performed outside
the UK. In Robson v Dixon 48 TC 527, Pennycuick V.-C. observed
that:
“the words “merely incidental to” are upon that ordinary use apt to denote an activity (here the performance of duties) which does not serve any independent purpose but is carried out in order to further some other purpose.”
So duties performed in the UK that are of the same type as those
performed overseas are not merely incidental, even if performed for
only a very short time.
The calculation of chargeable overseas earnings is set out in
three steps in section 23(3). The first step is to identify the
full amount of overseas earnings. The second and third steps adjust
this figure by deducting allowable expenses and applying any limit
required by section 24. Section 24 imposes a limit on how much of
an employee’s general earnings are chargeable overseas
earnings where the duties of an associated employment are performed
in the UK. The limit is the proportion of the aggregate earnings
for that year from all the employments concerned that is reasonable
having regard to the nature of and time devoted to the duties
performed outside and in the UK respectively and to all other
relevant circumstances.
The legislative scheme outlined above is advantageous to employees or office holders who can show that they are:
As chargeable overseas earnings are taxed on remittance, there is a clear incentive to ensure that such earnings are paid overseas and to minimise the amount of earnings remitted to the UK. However, the requirement that the duties of the employment are performed wholly outside the UK presents problems to foreign domiciled employees whose jobs require them to work partly in the UK and partly abroad. Earnings from an employment with duties performed in and outside the UK would be taxable under section 21 wherever received. An employee may therefore be offered two employment contracts, for example:
Contract 1 covering the performance of duties in the UK and
Contract 2 with an associated employer resident overseas covering duties performed in the rest of the world excluding the UK.
The intention is that earnings from employment contract 2 will be chargeable overseas earnings and therefore taxable under section 22 only when remitted to the UK. For this reason, dual or multiple employment arrangements are popular with foreign domiciled employees whose duties are performed partly in the UK and partly outside the UK. The arrangement is generally that the individual enters into two separate written contracts, frequently referred to as the UK employment contract and the overseas employment contract.
HMRC offices may make enquiries in order to check whether the
earnings under the overseas contract are chargeable overseas
earnings. They may also consider whether there is in fact a single
employment contract notwithstanding the production of two written
contracts. This approach has generally been deployed where there is
concern that there has been an attempt to split a single employment
to exploit the legislation that provides for chargeable overseas
earnings to be taxed on remittance.
Employers, employees and their advisers maintain that there
are separate and distinct employments. They invariably argue that
the employee performs a different role with different
responsibilities under each contract of employment and that the
duties under each do not overlap and are not dependent on each
other. In many cases written contracts have been drafted that
fairly represent the true employment relationships and include a
proper job description along with details of the remuneration
package and other entitlements (annual leave etc) relating to each
employment. Care has been taken to ensure that the roles described
in each contract are capable of independent existence with proper
regard given to what would happen on termination of one of the
employments. Best practice has recognised the importance of
maintaining separate payroll and expenses regimes and different
line management and reporting arrangements.
Where there are two employment contracts and the written
contracts reflect this, dual contract arrangements provide a
legitimate way to structure an individual’s employment
relationships. Where the arrangements reflect the true employment
relationships, enquiries focus on:
Given the way in which modern business operates and the ease and speed of communication, some employees may find it increasingly difficult to avoid performing substantive UK duties under their overseas contracts. For example, an employee who is responsible under their overseas contract for servicing the business of overseas clients may have to respond to a telephone call or e-mail from a worried overseas client with an urgent problem when the employee is in the UK. Formulating and communicating a response to such a problem would be regarded as a fundamental duty under the overseas contract. It follows that the performance of such duties in the UK will not be merely incidental to the performance of duties outside the UK as they will be of equal importance to the overseas duties. It is the quality of the UK duties and not the time devoted to their performance that determines whether they are merely incidental.
In a number of cases, the duties required under each purported
employment contract are defined according to where those duties are
performed. For example, the UK contract states that the duties of
the employment are all those duties performed in the UK whereas the
overseas contract states that the duties of the employment are all
those duties performed wholly overseas. Employees and their
advisers may contend that all overseas duties are duties of the
overseas employment and all UK duties are duties of the UK
employment. On that analysis, duties performed in the UK in
connection with the business of the overseas employer are performed
under the terms of the UK contract and are not duties of the
overseas employment.
HMRC does not consider that the existence of separate and
distinct employments is determined by the terms of written
contracts where the main distinction between the duties required
under each contract is geographical. There are concerns that
arrangements of this nature artificially divide a single job so
earnings attributable to overseas duties can be treated as
chargeable overseas earnings. HMRC has received legal advice that
supports a robust challenge to such arrangements.
As a result of the legal advice referred to above, HMRC
considers that a dual contract arrangement based solely or mainly
on a geographical split of employment duties without commercial
underpinning is vulnerable to challenge on the grounds that there
is in reality a single employment with duties in and outside the
UK. In such cases, HMRC offices should fully investigate the facts
and circumstances including the commercial rationale and context
and assess an employee to tax where the evidence shows that there
is in fact a single employment.
HMRC takes the view that a dual contract arrangement is
unlikely to work unless there are two distinguishable jobs. For
example, a French resident employer ‘A’ sends employee
‘B’ who is domiciled outside the UK to establish an
office in London for its UK subsidiary ‘C’. A requires
B to work in its Paris office servicing their existing portfolio of
French clients two days per week. On the other three days, C
requires B to work in London. This is likely to constitute a proper
basis for B holding separate employment contracts with A and C.
In order to decide whether the arrangements create two
employments, rather than artificially divide a single employment
for tax purposes, it is appropriate to look at the economic
advantage that an employer gains from the employee’s
activity. If the contractual arrangements are to have any meaning,
they must be seen in the context of the underlying commerciality of
the arrangements. Regardless of there being two written contracts,
HMRC would not accept that there were two employments if the risks
and rewards relating to work done in the UK and overseas were in
fact substantially borne and received by a single employer.
Moreover, an arrangement requiring a written contract between an
employee and a UK employer which provides only for the performance
of duties in the UK would appear artificial if the employer’s
business extends outside the UK.
An employer’s interest does not lie in having the
employee work in a defined geographical area but in an economic
activity that benefits the employer. An employee may perform duties
overseas that directly benefit the business of the UK employer.
When performing those duties, the employee is not working for the
overseas employer but for the UK employer overseas. If the
arrangement were genuine, the employee would not be paid by the
overseas employer to work for the UK employer overseas. If that is
what the contract requires, it would indicate a lack of
commerciality. Conversely, an employee who performs duties in the
UK that directly benefit the business of the overseas employer is
working for the overseas employer in the UK. It is difficult to
imagine circumstances in which contracts that can require an
employee to work for the benefit of a UK employer whilst being paid
by an overseas employer or vice versa would be offered by employers
that were not associated.
Various mechanisms exist for allocating costs to another
entity that benefits from an employee’s services. These
include transfer pricing adjustments. It has been suggested that
such adjustments restore the commercial equilibrium and thus
support the existence of separate employments. However, the fact
that such adjustments are necessary indicates that the employer has
misjudged the commercial reality of the arrangements. Separate
employers do not for sensible commercial reasons pay employees to
work for someone else, with or without transfer pricing.
Dual contract arrangements are sometimes used when a UK
resident employee holding one employment with worldwide duties
first becomes ordinarily resident. Some individuals who are self
employed before they arrive in the UK become employees with dual
contract arrangements on attaining UK resident and ordinarily
resident status without any significant change in the way in which
they carry out their professional activities. In other cases,
recruitment material suggests that the employer has a single
vacancy to fill and a dual contract arrangement is only implemented
following the appointment of a non-domiciled individual. In such
scenarios, HMRC offices will test whether the facts reflect
commercial reality.
Where the commercial reality shows the existence of separate
employment contracts, it is sometimes argued that contractual terms
that prohibit the performance in the UK of duties connected with
the business of the overseas employer, preclude HMRC offices from
arguing that the employee has performed duties of the overseas
employment in the UK. These arguments are based on the UK duties
being “ultra vires”.
HMRC does not consider that the presence of such clauses
allows the performance of duties in the UK that clearly benefit the
overseas employer to be ignored. To that end, both employers ought
to be closely monitoring the employee’s UK activities. For
example, where the employee has performed substantive duties in the
UK that directly benefit the overseas employer, HMRC would expect
the UK employer to mark the fact that the employee is effectively
abusing its time and take appropriate disciplinary action. And if
the UK work in question was valuable, the overseas employer should
take it into account when calculating bonus entitlement. It is
possible that clauses like this are frequently waived or ignored
and may be inserted to create a misleading impression.
Where the facts indicate that there is, in commercial reality,
only one employment contract whereby the employee performs duties
for the benefit of one employer both in and outside the UK, all of
the employee’s general earnings will be taxable under section
21 ITEPA. As earnings attributable to overseas duties will not be
chargeable overseas earnings, tax will be charged on receipt rather
than on remittance to the UK. The identity of the
“employer” will depend on all the facts and
circumstances of the individual case. However, the UK entity that
receives the benefit of an individual’s services will be
obliged to apply PAYE to all payments of PAYE income made to the
employee during the period that the employee works for that entity.
This is because the UK entity will either be the employer or (for
the purposes of section 689 ITEPA) the relevant person.
If there are genuine separate employments but the employee
has performed substantive duties in the UK for the overseas
employer, then all earnings from the overseas contract will be
taxable under section 21 in the relevant year. They will not
qualify as chargeable overseas earnings under section 22 because
the duties of employment with a foreign employer will not have been
performed wholly outside the UK in the year in question. There is
unlikely to be an obligation to operate PAYE on earnings from the
foreign employer, as that employer will not have the necessary
presence in the UK for PAYE purposes, and the UK employer will not
be the relevant person in relation to duties performed by the
employee under the separate overseas employment.
Where for tax purposes the facts indicate that despite the existence of two written employment contracts, there is a single employment covering UK and overseas duties, there could also be National Insurance consequences. If it is found that the earnings relating to overseas duties are attributable to employment with the UK employer, there will be liability to pay further National Insurance.
