Foreign Income Tax Relief

Basic Overview

UK citizens living abroad or generating income in countries other than England, Northern Ireland, Wales, and Scotland need to pay tax on such incomes. But those who are domiciled and have permanent homes in foreign countries need not pay the tax. Such individuals should report their foreign income in self-assessment tax returns.

Unfortunately, such citizens may find themselves paying tax in two or more countries. This is where tax relief comes in. But they must prove their eligibility for tax relief. For purposes of this article, foreign income will be classified into three. Foreign trading income, foreign employment income, and foreign investment income. Foreign investment income consists of profits from overseas property, social security, pension, and any other overseas investment. The general rule on foreign income stipulates that it may only be subjected to tax to the extent that the income is remitted into the UK.

Individuals residing in the UK but who have a property in foreign countries may be required to pay tax in the UK. They should pay tax on the income they collect as rent or dividends they earn from abroad. The country in which the property is situated may also collect tax on the same property. This may result in double taxation. To avoid this, the UK has entered into various taxation agreements. The agreements are meant to reduce instances where residents pay tax more than two times on the same income. The agreements form the basis of the relief.

Notice that the following 3 options provide the basis on how the reliefs can minimise double taxation

Treaty Tax relief– the relief is intended to eliminate incidences of double taxation

Unilateral relief– if no treaty exists between the two countries, the affected individual may claim unilateral relief. This is done by deducting foreign tax paid from the UK tax. The taxpayers will then be required to pay the difference

Relief deduction- The individual may also deduct foreign tax from their income

The Mechanics Of How The Relief Works.

Before we delve into how the relief works, here are things to note.

Double taxation agreements (DTA)

They specify the country that has the right of collecting tax from the individual. In some cases, the two countries may have equal rights. So DTA specifies the one that takes the priority. The agreements come up with rules to govern the taxation of income between residents of the two countries. Also, they may exempt some gain or income from tax. In some cases, they may choose to set-off tax that was to be paid to their country against tax that is due in another country.

Tax credit relief

It provides relief in a case where there are no double taxation agreements. For instance, if a person pays 18% tax in a foreign country, and the UK tax is 25%, the taxpayer would only need to pay 7% to the UK government. In such a case, the taxpayer is said to have enjoyed 18% tax credit relief.

Employment income

Anyone working in the UK and whose employment income is taxed in the home country is entitled to relief. The employee has the right to ask the home country to stop taxing the income. They can deduct the amount that is taxed by the UK government from the tax they ought to pay in their home country. Where the home country does not accede to such request, the employee may contact HMRC for help.

Special categories

Anyone falling in the special categories is entitled to various reprieves. Such persons include students, government overseas officials, and teachers. These groups of people are entitled to special treatment. 

Residents whose foreign income has been taxed have recourse to some reliefs. They are entitled to foreign tax relief, unilateral relief, and treaty relief. They are the three approaches that the UK government uses to ensure that the taxpayer does not bear the burden of double taxation.

Minimising Foreign Tax

Individuals should only claim foreign tax credit after taking steps to ensure that foreign liability is minimized. They may do this by claiming for security deductions, allowances, liability reductions and so forth. It entails claiming deductions of allowances, reliefs, and any others that would be claimed if the taxpayers were not eligible for foreign tax relief. For instance, the taxpayers could deduct personal allowance overseas as personal as expenses.

Treaty relief

The individual must also consider the existing tax treaties. In most cases, the treaties are designed to help eliminate double taxation incidences. They directly provide for an exemption from taxation depending on the country in question. It may also entail the set-out procedure for the tax credit. Thus some of the tax relief available under a treaty may help to eliminate double taxation. Already, the UK government has published the treaties it has with foreign countries. Information about them is available on the government official website. Also, the government has a wide range of DTAs with many other countries. They are also meant to eliminate double taxation. The DTAs allow exemptions from taxation or define the procedures for foreign tax credits. The available relief helps to eliminate double taxation in one way or another.

 

To claim for relief under DTA, the claimant must be a resident in one of the countries that are a signatory to the treaty. It implies that if the individual is not a resident, they may not have access to the relief.

Taxpayers may also claim a foreign tax credit-earning or a tax exemption on earnings. This is only possible if they are residents of a country that is a signatory to DTA. But in a case where a person is a resident just for the tax purpose, the domestic law of the country that is part of the DTA will determine the person’s residency.

 

Using DTA to avoid tax

A few people may use DTA to avoid paying tax. Here, HMRC is empowered to ensure that people who should not enjoy treaty reliefs don’t use the double tax agreement to avoid paying tax. They have a mechanism that can help them do this. Also, territories are allowed to exchange information with countries concerned. It helps to eliminate cheating. In some cases, an exchange information article may be included in the DTAs.

Overriding

There are cases when countries override the treaties. It has happened in the US but the UK has not tried to override the treaties it has entered into with other countries. Generally, countries can deliberately override treaties. This is especially the case where individuals want to use them to avoid paying tax.

Unilateral relief

The relief is granted in respect to foreign taxes in a country in which the United Kingdom does not have a DTA. In such a case, HMRC considers the relief that would have been due if a Double Tax Agreement existed.

Trusts

Double taxation is a common issue on trusts. In the UK, it all depends on whether you are dealing with discretionary or possession trust.

Gifts and inheritance

Gift transfers after the death of the owner attract some tax. The UK law allows the government to enter into tax convection with other government authorities over the issues. If the transfer of such property is subject to inheritance tax or similar to any other tax charged by a country which the United Kingdom does not have a domestic tax agreement with, the affected parties may have unilateral relief provision.

Anyone who has paid foreign tax on capital gains and income received may claim for relief. But if such persons are not residents of either the Channel Islands, Isle of Man and the wider UK, they may not be entitled to UK tax relief. Such persons should not fill the foreign pages.

 

Forms of relief

Double taxation relief comes in 3 forms:

  • If DTA gives the UK the exclusive rights, there will be no need for relief since no foreign tax is paid.
  • If the DTA gives the exclusive rights to some other country, no tax will be payable to the UK. So there will be no need for relief. But, if the DTA does not apply to the circumstances, one will be required to provide details.
  • In some cases, DTA restricts the amount of money payable as tax. It affects the amount that one can claim as a relief

Benefits of Foreign Income Tax Relief

The UK income tax relief is meant to reduce instances where people pay tax twice. The reliefs are products of double taxation agreements with the state that has a right to collect the tax. Typically, the DTA agreements override domestic laws. In the case of the UK and France, the agreement states that interests will only be taxed in France. It means that the UK must forgo the right to the tax income. So UK residents will need to claim to HMRC. UK citizens who reside in countries that do not have a double tax treaty with the UK should claim for unilateral tax relief.

Example

Peter earns£ 100 from Ukraine property income dividend and pays a foreign tax of £20. The allowable Ukrainian income dividends are 15%. Peter can claim £5 from the Ukrainian authority.

The Implications Of Tax Reliefs And Who It Affects.

Foreign tax reliefs are meant to make the burden lighter to the taxpayers. They are meant to provide a reprieve to those who are double taxed. Thus it affects four categories of people:

1. A person who resides in the UK and owns rental property in a foreign country should pay a rental income. The income is paid to the country where the property is situated and the UK. It is common with migrants who go to the UK to work and who receive income from abroad. If reliefs are not applied, it can lead to double taxation.

2. Where an individual who does not reside in the United Kingdom but has income that is UK –sourced. If such persons pay taxes to their home country, it may result in double taxation.

3. Persons who reside in two countries at the same time may find themselves paying taxes in both countries. So several mechanisms will give relief to reduce the impact. Double tax agreements limit the right of either the country from taxing such income.

4. Double taxation may arise where more than two countries are involved. For instance, a national of country A works in the UK but who receives foreign income from a third country may find themselves at a crossroad. If the income is taxed in the three countries, it is a case of double taxation.

Note that the method of relief that will be adopted depends on the exact circumstances. It is also dependent on the nature of the income and the wording used in DTA agreement.

Things to note

A person classed as a UK tax resident can earn some amount of money without paying tax to the UK government. For instance, European Economic Area or UK nationals may not need to pay tax to the UK government. But if the employer taxes the income and forwards the proceeds to HMRC, the taxpayer can reclaim all or part of the money from HMRC. Such nationals cannot claim foreign tax credit since the amount is refundable.

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