Different countries have their own domestic tax laws, just because an individual pays tax in one country on a particular source of income, does not automatically mean that they will not pay tax on that same income in another – this concept is known as ‘double taxation.
Generally, the UK, in common with most other countries, will seek to tax an individual’s income where either:
As such, in normal circumstances, an individual who is resident in the UK for tax purposes would be charged to tax not only on their UK income but also on any income arising elsewhere in the world. It follows therefore that certain sources of income may fall to be taxed in more than one country.
A common example of this would be income arising on investments that a UK resident has made in another country, such as rental income from a property situated outside the UK, or interest from an overseas bank account.
In these circumstances, there are several mechanisms that may apply to eliminate this double tax either in whole or in part. They can be summarised as:
Which will be applicable to a UK resident individual, will depend on the source of income and where it arises.
The UK has entered into double tax agreements (DTAs) with numerous countries to avoid or reduce the level of double taxation. These agreements include a series of articles detailing the taxes covered and how relief is to be given for a particular source of income.
For UK tax purposes, TIOPA 2010, s. 6 provides that once an Order in Council has been made declaring that an arrangement with territory outside the UK should take effect, the terms of that double tax treaty override domestic law. As such, the terms of a DTA should be the first stop when considering relief for double taxation.
Generally, a DTA will provide for relief to be given either by:
Primary taxing rights are determined by the residence of the taxpayer. Should a person be considered a resident of both countries under their domestic law, provisions (known as a ‘tie-breaker’ clause) are included to determine residence for the purposes of the agreement.
A list of UK double tax agreements in force can be found on HMRC’s website. Whilst most agreements follow a similar model, they do differ and can be complex. It is important to check the agreement with the specific country in question to ensure double tax relief is claimed correctly.
If foreign tax has been suffered, the first step when considering double tax relief is to check whether an article within a DTA gives primary taxing rights for that particular source of income to one of the countries involved to the exclusion of the other.
If a UK resident has suffered tax in another country but an article of the DTA states that source of income should only be taxed in the country of residence, then a claim for double tax relief against a UK tax liability is not possible. The foreign tax is not due under the terms of the treaty. Instead, that individual should claim relief by exemption in the country where the income arises.
For example, article 17 of the DTA between the UK and Spain covers pension income and states the following:
“Subject to the provisions of paragraph 2, of Article 18, pensions and other similar remuneration paid to an individual who is a resident of a Contracting State, shall be taxable only in that state”
This article is giving primary taxing rights to the state of residence, meaning that if a UK resident received income from a Spanish pension that falls within this article, it would only be taxed in the UK. If the individual had suffered tax on the income under Spain’s domestic laws, relief would be given by claiming back any tax suffered in Spain.
In contrast, article 6 of the same agreement which covers income from immovable property, such as rental income, provides that:
“Income derived by a resident of a Contracting State from immovable property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other state.”
This article does not state that the income is only taxed in the state of residence, but instead states that it ‘may be taxed in that other state’. Therefore, a UK resident with a rental property in Spain, who would be liable to UK tax as part of their worldwide income, may, in addition also be liable to Spanish tax should their domestic laws allow.
If this were the case, although relief by the exemption is not possible, the individual may be able to claim relief for the tax paid in Spain as a credit against any UK liability to alleviate the double tax.
Where the articles of a DTA do not provide for relief by an exemption, and both countries have a right to tax the income, the country in which the recipient is a resident gives credit for the other country’s tax against its own tax.
In the UK, double tax relief by way of credit is available to an individual if they are resident in the UK and the foreign income has been correctly taxed under that country’s domestic law. This means that all reasonable steps must have been taken to minimize the foreign tax paid, including claiming any available allowances, reliefs, and exemptions in that country.
If allowable, relief is given by reducing the UK tax liability by the available credit. The available credit cannot exceed the UK tax on that same source of income, therefore the credit available is the lower of:
For this purpose, the UK tax on the foreign income is the difference between the individual’s UK tax liability for the tax year and the UK tax liability for the year without including the foreign income.
For example Rose has a taxable income of £40,000 for the year ended 05th April 2021, this is made up of employment income of £35,000 and foreign interest of £10,000. £2000 of foreign tax has been withheld on the foreign interest.
In some double tax agreements, the country with primary taxing rights may agree to tax the income at a rate lower than its normal domestic rates (this is usually seen with dividends, interest, and royalties). Where this is the case, when calculating the amount of credit allowed as a deduction against a UK tax liability, the foreign tax is restricted to the minimum tax payable per the agreement.
For example, article 11 of the DTA between the UK and Portugal which covers interest states that:
“(1) Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other state.
(2) However, such interest may be taxed in the Contracting State in which it arises, and according to the law of that State, but where the resident of the other Contracting State is subject to tax therein respect thereof, the tax so charged in the first-mentioned state shall not exceed 10 percent of the amount of the interest.”
Applying this to a UK resident receiving interest from a bank in Portugal, the first paragraph states that interest may be taxed in the UK (being the State of residence). In addition, the second paragraph goes on to state that interest may also be taxed in Portugal, being the Contract State where it arises, but the tax charged may not exceed 10 percent of the interest.
Therefore, as under UK domestic law, the interest would be subject to tax (as UK residents are taxed on their worldwide income), the maximum amount of foreign tax that can be claimed as credit relief is restricted to 10 percent. If domestic law in Portugal is charged at a higher rate, any additional amount would not be relievable against UK tax, a claim for relief in Portugal should be made instead.
A claim for credit relief in respect of income for a tax year should be made within four years of the end of that tax year, or if later, the 31 January following the tax year in which the foreign tax is paid.
Known as unilateral relief, where there is no double tax agreement between the UK and a particular country, or where there is an agreement, but it does not cover a particular source of income, relief for foreign tax paid may still be given against the UK tax on that same source.
Subject to certain restrictions, unilateral relief by credit is essentially calculated in the same way as treaty relief by credit.
If for any reason, tax credit relief is not claimed, foreign tax is deducted from foreign income, reducing the taxable amount for UK tax purposes.
This may be advantageous where there is no UK tax payable because of losses or allowances.
For example, an individual may occur a trading loss in a tax year which they claim to set against their total income, including foreign income that has had foreign tax withheld. If the losses are large enough to reduce an individual’s taxable income to nil, no credit relief would be available as there is no UK tax liability for the year. Instead, the foreign tax can be deducted from the income. This will reduce the amount of the loss claim and the excess can then be carried forward and relieved in a later year. Contact us for more information.
