February 21, 2010 7:38 pm

Tax and citizenship

The US system of taxing worldwide is worth copying

It is a worrying time to be a so-called Monaco millionaire. The complex rules that govern whether a British citizen is tax resident have just been “clarified” by a court ruling. A Seychelles-based British businessman has been denied tax exile status despite spending trivial amounts of time in the UK because he was deemed not to have “severed his social and family ties” with the country. This new principle threatens to sweep other millionaires who had thought that they were within the rules into the taxman’s net.

Countries understandably want to tighten their rules on tax residency given the large deficits that many face. Britain is not alone in cracking down on possible abuses. But the current system requires the taxman to play a game of cat-and-mouse with wealthy citizens. True, few will weep if the odd juke box magnate is hit with hefty back-taxes. But it seems cumbersome. Isn’t there a simpler way?

The US is unique in using citizenship in determining whether a person’s worldwide income is subject to taxation. Most countries do not impose tax on their citizens who are not resident within their borders – apart from any income that is sourced in that country. But the US system has much to commend it. After all, any citizen of a country enjoys the implicit legal and physical protection it affords. Can it be unreasonable to impose on those citizens the reciprocal obligation to account to it for tax? The US system is not obviously unfair; provision is made to avoid double taxation. Moreover, there is an exit for individuals who do not accept it as they can renounce their citizenship and move elsewhere. But perhaps the best thing about it is that a worldwide system linked to citizenship is simple and easy to understand. Most American citizens do accept it, although more have handed back their passports recently.

It would be hard for, say, the UK or Germany to introduce such a system unilaterally. There would be the risk of citizens jurisdiction-hopping by swapping one passport for another within a common economic area. But all European Union states could introduce the same rule. That would not be impossible. After all, EU countries already co-ordinate their policies on savings taxes and their tax authorities exchange information.

Would it raise more tax than the existing cat-and-mouse system? Perhaps not; but it would at least create one that even a Monaco millionaire could follow. That might upset tax lawyers, but no one else would lose much sleep.

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