Lessons In Global Mobility And Tax: Sir James Packs His Bags

Lately there has been a lot of chatter about wealthy folks who might not be paying much income tax. Here in Washington the attention concerns a New York Times

NYT
 exposé on President Trump. 

Across the pond there’s a controversy involving the United Kingdom’s richest man, Sir James Ratcliffe, who is changing his personal residence to Monaco to avoid paying U.K. income taxes. 

Ratcliffe is founder and CEO of Ineos, a petrochemical company. Ineos is privately held, with Ratcliffe owning a 60 percent stake. Most of the remaining Ineos shares are split between his two business partners, Andy Currie and John Reece, both of whom are also ditching London for Monaco. 

The Sunday Times estimated Ratcliffe’s net worth at £21 billion.

These pages periodically address the tax-inspired migration of the rich and famous because they highlight the tension between residence-based taxation (RBT) and citizenship-based taxation (CBT).

It raises the most basic of questions: Where should a person pay income tax?

Conventional thinking would have us pay tax in the jurisdiction in which we regularly use and derive benefits from public infrastructure and services. You pay tax in the place you call home, even if the location of your home changes from time to time.

Alternately, the answer might be dictated by the geographic accident of birthplace, irrespective of where a taxpayer chooses to live.

The United States and Eritrea are the only two nations that rely on CBT. The rest of the world adheres to RBT.

There are plenty of U.S. citizens who consider the U.S. preference archaic and unfairly restrictive. This is especially true for “accidental Americans,” who live abroad and have no obvious physical or economic connection to the United States other than having been born here. Why should they be stuck paying U.S. income tax for their entire lives, when the substance of their lives is elsewhere?

At the same time, there are plenty of U.K. citizens who are troubled by the outward flight of tax exiles like Ratcliffe, Currie, and Reece. Some expatriation by rich folks is inevitable under an RBT regime.

Allow people the freedom to relocate to a sunny tax haven with palm trees and nice beaches, and some among us will jump at the opportunity without regard to fiscal patriotism — if such a thing exists. Calls for the U.K. government to halt the tax advantages of these moves seem indistinguishable from calling for the adoption of CBT — and I believe that would be a step backward in terms of optimal tax policy.

What we have here is a classic example of people coveting the tax system they do not have. No matter how well you tend your lawn, the neighbor’s grass is always greener. Apparently the same holds true for cross-border taxation.

One Word, Benjamin . . . Plastics

Ratcliffe comes from humble beginnings. Born in 1952, he was raised in council housing in Failsworth, near Manchester. He attended college in Birmingham, receiving a degree in chemical engineering.

He briefly worked for British Petroleum (BP) and Esso before returning to school to study business administration. He later joined the private equity firm Advent International and in 1989 was involved in the acquisition of a BP chemical processing unit based in Antwerp.

In 1998 he founded Ineos to reacquire the assets of the Antwerp operation in a separate entity, causing him to take out huge loans for which he was personally on the hook. The gamble paid off handsomely.

What does Ineos do that caused Ratcliffe to become the richest man in the United Kingdom? To oversimplify the matter, the company combines petroleum with chemicals and turns them into plastics or other substances that can be used in a variety of industrial applications and consumer products.

Where there are plastics, there is profit. In Ineos’s case, lots of it.

Ineos’s output is ubiquitous, but often goes unnoticed by end-users or the public at large. The plastic cap on your toothpaste tube was likely made by Ineos. So is the lubricant that allows the blades of wind turbines to rotate smoothly.

You wouldn’t think there’s a lot of money to be made in such mundane things, until you consider that every aspect of our lives is awash in plastics or other petrochemical byproducts.

Ineos has excelled at strategic expansion. Over its first 10 years, from 1998 to 2008, it acquired 22 companies — often snapping up the underappreciated business units of larger competitors, such as Germany’s BASF.

The expansion boom included the 2005 purchase of Innovene, a refining subsidiary of BP. The addition quadrupled Ineos’s annual turnover.

To paraphrase Ratcliffe’s acquisition strategy, he seeks out the pieces of other firms that are considered “unfashionable or unsexy” or in which management has grown lax in controlling fixed costs. Ineos swoops in, buys the target, and runs the shop a bit more efficiently.

Recently the company started dabbling in automobiles. It hopes to produce a new series of 4×4 sport utility vehicles under the Grenadier brand.

Rather than design SUVs from scratch, Ineos acquired the rights to take up production of a previously discontinued Land Rover model. That reflects the same tendency to find hidden value in other people’s rejects.

Today, Ineos operates 170 facilities across 23 countries, employing 19,000 workers.

Its headquarters are in the Knightsbridge district of London, after having relocated to Switzerland between 2010 and 2016. The Swiss move was estimated to save the company £100 million per year in taxes and came after a protracted tax dispute with HM Revenue & Customs. Relocation of the head office reveals that Ratcliffe is a cool-minded pragmatist when it comes to finding ways to reduce the company’s bottom line. There is no sentimental baggage about the supposed loss of Britishness.

According to The Sunday Times list of top U.K. taxpayers, Ratcliffe was paying the exchequer £110 million on his salary, dividends, and other sources of income. That’s about to change.

How do we know the move to Monaco happened? It was revealed on a government regulatory disclosure required of limited liability partnerships.

U.K. LLPs must disclose details regarding the identity of persons with significant control over their operation. Ratcliffe has significant control over Hampshire Aviation LLP, his private jet company. According to the disclosure, the relocation to Monaco was effective as of March. 

The Guardian

UG
 reports that PwC is advising Ratcliffe on the details of the move.

It’s Always Sunny in Monaco

What does it mean to switch your personal tax residence from the United Kingdom to Monaco? We’ll take a quick look at each jurisdiction’s residency rules.

From Monaco’s perspective, a person must reside in the self-governing principality for at least 183 days of the tax year. Obviously, 183 days is just over half of the year, which presumably (but not necessarily) precludes the establishment of tax residence elsewhere within the same 365-day period.

One burden of being a tax exile is that you need to track and record your precise whereabouts daily. Satisfy Monaco’s 183-day standard and you will not pay income or property tax to their government.

For folks like Ratcliffe, that compares nicely with a 45 percent top marginal tax rate in the United Kingdom that kicks in on taxable incomes above £150,000.

While we’re discussing this, I should note that I have my doubts about whether the purported residents of Monaco actually live there.

Despite its reputation for glitz and glamour, many of the local dwellings are unimpressive. Beyond the casino and posh boutiques, a lot of the homes and apartments could benefit from a sprucing up.

How is it that rich folks with their acquired tastes manage to live in those bland accommodations? Furthermore, the place is cramped to the point of discomfort.

Statistically, Monaco is the most densely packed country in the world. Its 38,000 inhabitants are squeezed into just 0.78 square miles. The entire country could fit inside of New York’s Central Park. Tax advantages aside, something doesn’t add up in terms of Monégasque creature comforts.

By contrast, the lavish estate homes on the French side of the border look like something out of a Bond film. I suspect what goes on is that tax exiles buy mansions in the neighboring towns of Villefranche-sur-Mer, Èze, or Cap Ferrat, while acquiring no-frills pieds-à-terre in Monaco to serve as their nominal abodes.

The pied-à-terre might sit empty or be rented out to tourists, which explains the lack of curb appeal. Meanwhile, over the border in France, the tax exiles are living in luxury with private swimming pools and yacht clubs.

That’s to say a lot of people are playing fast and loose with the distinction between residing in Monaco and residing in the vicinity of Monaco. In principle, those are two different things and should carry quite different legal consequences.

In practice, it feels a bit like a distinction without a difference. It’s not like anyone is policing the border. Monaco is treated as a de facto member of the Schengen Area. People pass freely between the two nations.

You might think French tax authorities would have their own incentive to patrol the border. Not really. French citizens cannot avail themselves of the tax benefits of living in Monaco. They’re free to move there but remain obliged to pay French taxes by virtue of French citizenship.

You might recall that when French actor Gérard Depardieu wanted to obtain tax residence in Monaco, the first thing he had to do was try to become a citizen of a third country as an intermediate step. To that end, Depardieu unsuccessfully applied for Belgian citizenship. He was eventually granted Russian citizenship, which could (in theory) open the door for him to eventually claim tax residence in Monaco.

But nobody should follow Depardieu’s lead and seek out Russian citizenship as a gateway to tax-free living in Monaco; you’ll probably end up in a Siberian prison.

On the U.K. side, the basic residence rules are fairly standard. Residents are taxed on their worldwide income including capital gains and dividends, while nonresidents are taxed only on U.K.-source income.

There’s an exception to the basic rule that could affect tax exiles like Ratcliffe. As of 2013, Parliament introduced a clawback rule for temporary nonresidents who leave the country, establish residence elsewhere, and return within five years.

In these cases, the U.K. tax charge on dividends received during the period of nonresidence (being less than five years) is revived in the year the individual returns to the United Kingdom. If Ratcliffe is aiming to avoid U.K. taxes on any dividends that he plans to receive from Ineos or other companies, he must remain a nonresident for at least five years.

Until 2013 the United Kingdom lacked a statutory residency test, which seems odd for a country so economically developed. Previously, outcomes were determined by applicable case law. Now, three separate tests will determine residence for tax purposes.

The first test is a primary residence standard based on three criteria, any of which is sufficient to establish U.K. residence:

• being present in the United Kingdom for at least 183 days in the current tax year;
• maintaining a home in the United Kingdom; or
• performing full-time work in the United Kingdom for at least 365 days.

A second test is aimed at determining whether an individual is a per se nonresident, based on the following three criteria:

• Did the individual reside in the United Kingdom for one or more of the previous three tax years, and was the individual present in the United Kingdom for less than 16 days in the current tax year?
• Was the individual not resident in the United Kingdom for each of the previous three years and present in the United Kingdom for less than 46 days in the current year?
• Did the individual work abroad for an average of at least 35 hours per week for the duration of the current year, and is present in the United Kingdom for less than 91 days in the current year, of which less than 31 days were spent actively working in the United Kingdom?

The taxpayer need satisfy only one of these overseas criteria to be automatically considered a nonresident. In the event an individual satisfies one or more of the residence criteria and one or more of the overseas criteria, the latter has priority and the individual is not considered a resident.

If you mash these rules together, you realize there might be no clear determination of residence status for individuals who are present in the country for more than 46 days, but less than 183 days. In those cases, residence is determined by application of a third test, based on recognition of “sufficient ties.” It considers five prescribed factors:

• Family ties: whether the individual’s spouse or domestic partner is a U.K. resident, or whether the individual has a minor child, with whom he or she lives at least 61 days in the tax year.
• Accommodation ties: whether the individual has a place to live in the United Kingdom that’s available for a period of at least 91 consecutive days; or whether the individual spends at least one night in such an accommodation — or at least 16 nights in cases in which the accommodation is shared with a close family relative.
• Work ties: whether the individual works 40 days or more in the United Kingdom during a tax year, defining a workday as a day in which at least three hours of work is done.
• Prior-year ties: whether the individual spent at least 90 days in the United Kingdom for either of the two prior tax years.
• Country of preference ties: whether the individual spent more time in the United Kingdom than any other jurisdiction for the tax year in question.

The number of factors necessary to satisfy the sufficient ties test depends on the number of days the person was present in the country, and whether the individual is entering or exiting. The sufficient ties test is summarized in tables 1 and 2.

Should He Stay or Should He Go?

The reaction to Ratcliffe’s departure has been predictable. Vince Cable, leader of the Liberal Democrats, called it “deeply cynical” and reflected a lack of commitment to the country. Cable added that it was “rather shameful” in light of Ratcliffe’s knighthood. 

John McDonnell, the shadow chancellor, claimed to be disappointed by the move. He linked the reduction in number of U.K. taxpayers with fewer funds for the National Health Service, education, and public safety. The nongovernmental organization community didn’t like Ratcliffe’s move, either. It sees it as another instance of rich people working the tax system to keep more money in their pockets.

That might be perfectly true, but I still find it difficult to blame Ratcliffe — provided he complies with the applicable rules. Do we really think he cares about whether politicians or the media label him as self-interested? The man is a profiteer and a good one at that. No apologies are necessary; he’s not running for sainthood.

Let’s ask what is fundamentally wrong with a person moving to Monaco for the specific purpose of lowering his or her tax bill.

We’ve previously noted how the French can’t do that. I can’t do it either, short of renouncing my U.S. citizenship — which is something I’d never consider. That’s because the U.S. taxation of individuals is based on CBT. Being a nonresident might get me some things, such as the earned income exclusion under section 911, but it won’t land me a blanket exemption from U.S. income taxes.

If we reach the conclusion that RBT is a superior policy to CBT (per the benefit principle) it seems to follow that we must accept that a tax-driven expatriation will sporadically occur and likely draw public disaffection.

Simply put, it comes with the turf. There’s an understandable urge to make departures difficult for tax exiles, perhaps to the point of deterring them altogether.

But that would be short-sighted. People have other reasons to move overseas that are perfectly legitimate. You might want to spend the rest of your life surfing in Costa Rica, for example, without regard to potential tax savings.

In those cases, should a government make the tax costs of expatriation so burdensome that economic considerations become a hindrance, when they otherwise wouldn’t if taxes were left out of the picture?

What’s a country to do, short of moving to CBT? The U.K. rules are getting it just about right, especially with the adoption of the five-year clawback rule for dividends.

There are a handful of other ways the government could make the statutory residency tests a bit stricter. Perhaps the clawback term could be extended to 10 years. Any of those measures would be preferable to adopting CBT.

I’m curious as to where our readers think the ideal balance lies.