Where an individual is treated as UK and Italian resident under domestic rules, the UK–Italy Double Taxation Agreement determines a single treaty residence using the tie-breaker provisions. This note outlines the residence analysis and the resulting UK and Italian taxing rights for employment income and property income, including when treaty relief is available and when employment income may be exempt. A reversed fact pattern is included to highlight how the analysis changes. Examples are illustrative and based on the UK–Italy DTA and HMRC INTM guidance.
Background: dual residence under UK tax law
It is possible for an individual to be treated as tax resident in two countries at the same time under domestic law. For example:
Where this happens, the Double Taxation Agreement does not override domestic residence. Instead, it determines treaty residence, which is used solely to allocate taxing rights and relief.
Tie-breaker rules: deciding treaty residence
Where an individual is treated as resident in both states under domestic law, double tax treaties typically resolve the conflict using the OECD Model “tie-breaker” tests. The tests are applied in order, stopping as soon as one produces a clear outcome.
Example 1: Sara is dual resident but treaty resident in the UK
Sara is treated as tax resident in both the UK and Italy under their respective domestic rules. She maintains a permanent home in each country. However, her family life, principal bank accounts and long-term employment are based in the UK. On this basis, her centre of vital interests is in the UK and, applying the tie-breaker rules in the UK–Italy Double Taxation Agreement, she is regarded as UK resident for treaty purposes.
During the year, she earns employment income of £40,000 from duties performed in Italy. Italy taxes this income and charges tax of £8,000. As the UK is Sara’s treaty residence state, the UK also taxes the employment income under its domestic rules, resulting in a UK tax charge of £10,000 before relief. To prevent double taxation, the UK gives relief by allowing a credit for the Italian tax paid. After applying the £8,000 credit, Sara pays £2,000 of UK tax on her employment income.
In addition, Sara receives £15,000 of rental income from a property situated in Italy. Italy taxes the rental income and charges tax of £4,500. As the UK taxes Sara on her worldwide income, it also taxes the Italian rental income, with UK tax attributable to that income amounting to £5,000. Under the double taxation agreement, the UK allows a credit for the Italian tax paid on the rental income. After applying the £4,500 credit, Sara pays £500 of UK tax on the rental income.
Where an individual is treaty resident in the UK, the UK taxes worldwide income but must give double taxation relief for foreign tax paid on overseas employment and property income, limited to the amount of UK tax attributable to that income.
If, instead of being dual resident, Sara were resident only in the UK under domestic law, the overall UK tax outcome would be broadly similar, but the legal basis for relief would differ.
As a UK-resident individual, Sara would still be taxable in the UK on her worldwide income under ITA 2007. The UK would therefore tax both:
Italy would continue to tax both sources under its domestic law, as the income arises in Italy.
In this situation, Sara would still be entitled to double taxation relief in the UK, but the relief would arise as follows:
In practical terms, the UK would allow a credit for Italian tax paid, limited to the amount of UK tax attributable to the same income. This operates in the same way as in the dual-resident example.
Using the same figures:
- UK tax before relief: £10,000
- Italian tax paid: £8,000
- UK tax payable after credit: £2,000
- UK tax attributable: £5,000
- Italian tax paid: £4,500
- UK tax payable after credit: £500
The numerical outcome is the same, but the distinction is important conceptually:
Whether Sara is dual resident but treaty resident in the UK, or simply UK resident, the UK will tax her worldwide income and give credit relief for Italian tax, subject to the UK tax attributable to each item of income. The practical tax result may be the same, but the treaty residence analysis only becomes critical where dual residence exists or residence status is disputed.
Conditions for employment income exemption
For employment income to be taxed only in the residence country, all of the following must be met:
If any one condition fails, the exemption does not apply.
This is confirmed in INTM153070 and related HMRC guidance.
Example 2: Employment income exemption under the treaty
In certain circumstances, employment income may be taxable in only one country under the UK–Italy Double Taxation Agreement, but this outcome is not a matter of choice and applies only where specific treaty conditions are satisfied. In this example, Sara is treated as resident in both the UK and Italy under domestic law, but is regarded as UK resident for treaty purposes.
She works temporarily in Italy and is present there for fewer than 183 days in the relevant period. Her employer is not resident in Italy, the country in which the employment duties are performed, and her remuneration is not borne by an Italian permanent establishment. As all the treaty conditions are met, Italy is not permitted to tax her employment income.
During the year, Sara earns employment income of £30,000. Because the treaty exemption applies, Italy does not tax this income and the UK taxes the full £30,000 under its domestic rules, giving rise to a UK tax charge of £6,000. No foreign tax credit is required, as no Italian tax has been paid on the employment income.
Sara also receives rental income of £12,000 from a property situated in Italy. Italy retains taxing rights over this income because the property is located there and charges tax of £3,000. As Sara is treaty resident in the UK, the UK also taxes the Italian rental income as part of her worldwide income. To prevent double taxation, the UK allows a credit for the Italian tax paid on the rental income, limited to the amount of UK tax attributable to that income.
Overall, the treaty results in Sara’s employment income being taxed only in the UK, while her Italian property income is taxed in Italy with corresponding double taxation relief given in the UK.What if the position is reversed?
If Sara were treaty resident in Italy rather than the UK, the allocation of taxing rights under the UK–Italy Double Taxation Agreement would reverse accordingly.
As a general rule, UK employment income would remain taxable in the UK because the duties are performed there. Italy, as the treaty residence state, would then tax the same income under its domestic rules and give double taxation relief for the UK tax paid, usually by way of a foreign tax credit. Similarly, UK property income would continue to be taxable in the UK because the property is situated there. If Italy also taxed that income, Italy would be responsible for relieving the double taxation.
However, an exemption outcome may also arise in the reverse scenario, but only where the treaty conditions are met. If Sara is treaty resident in Italy and works temporarily in the UK for a short period, the UK may be prevented from taxing her employment income where all of the employment exemption conditions apply. In particular, the UK would not be permitted to tax if her presence in the UK does not exceed the treaty day limit, her employer is not UK resident, and her remuneration is not borne by a UK permanent establishment. In that case, the employment income would be taxed only in Italy, while any UK property income would remain taxable in the UK.
The underlying principle is consistent in both directions: the country where the income arises normally taxes first, unless the treaty specifically removes that right, and the treaty residence country gives relief where both countries are entitled to tax.
Summary: how the DTA works in practice
Treaty residence is determined using tie-breaker rules and does not cancel domestic residence. Employment income is usually taxed where the work is performed, with relief given by the treaty residence country. Exemption applies only in limited, fact-specific cases. Property income is almost always taxed where the property is located.
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