Double tax relief in a nutshell
If a person has income or gains from a source in one country and is resident in another, that same income or gain can suffer tax twice. Double Tax Relief (DTR) is designed to alleviate this double charge on the same source of income or gain.
What types of double tax relief are available in the UK?
The UK provides three options for providing relief from double taxation – two via a form of tax credit and one by way of deduction from the profits of the business.
Of the two forms that provide relief via a tax credit, one is called unilateral relief which is provided under UK domestic legislation and the other is provided through double tax treaties with other countries. The precise mechanism for relief under a double tax agreement will vary from treaty to treaty.
Do all types of foreign taxes qualify for credit relief?
DTR will generally be available if the UK resident is receiving royalties or interest from abroad and withholding tax has been suffered.
The position for dividends is different for UK companies compared to other UK residents. The majority of dividends received by a UK company from an overseas subsidiary are exempt from UK corporation tax. As a result, double tax relief is not relevant. However, where the exemption is not available, and dividends are therefore taxable, double tax relief is available in respect of any withholding taxes incurred. Relief is also available for underlying tax suffered on the profits out of which the subsidiary pays a dividend, provided the UK company holds at least 10% of the voting power in the subsidiary.
Credit relief is available on foreign tax incurred on business profits or gains provided that the foreign tax suffered corresponds with UK income tax, capital gains tax or corporation tax in relation to profits or gains.
Foreign turnover taxes (i.e. taxes that are calculated as a proportion of gross income) and taxes that have characteristics similar to turnover taxes are generally excluded.
How does tax treaty relief work?
The UK has a wide network of comprehensive double tax treaties with other countries.
Double tax relief under a double tax treaty is normally given via one of the following ways:
- the country where the income arises (also known as the source state) gives up all its taxing rights in favour of the country of which the recipient is a resident
- the source state applies a reduced rate of tax compared to the normal domestic rate that would apply to non-residents
- credit relief – where the income remains taxable in both countries, but credit is given for the foreign tax by the country in which the recipient is a resident
To obtain relief, it is necessary to be resident in one of the countries that is party to the treaty. Where the claimant is dual resident (i.e. resident in both countries under their respective domestic laws), the treaty itself will determine the individual's country of residence purely for the purposes of that treaty.
How does unilateral relief apply?
Unilateral relief is a form of credit relief and may be available if relief is not available under a double tax treaty (for example where there is no double tax treaty between the UK and the other country or where the particular category of income or gain is not covered in the treaty).
Under unilateral relief, the amount of DTR is calculated on a source by source basis. The basic rule is that the relief available is the lower of the UK tax due on that source of income and the foreign tax suffered. The foreign income must be recalculated using UK tax principles to determine the UK tax arising which is to be relieved by way of credit.
How should deductions such as losses be allocated to maximise double tax relief?
In determining credit relief, it is possible to choose how to allocate certain types of allowable deductions, such as losses and (for UK companies) management expenses and qualifying charitable donations.
It is normally beneficial to allocate such deductions to the UK source income in preference to the overseas income. This helps maximise the amount of credit relief given in the UK on the foreign income or gains.
What is expense relief (also known as deduction relief)?
Where credit relief is not claimed, it is possible to take a deduction from income for the foreign tax instead. No separate claim for deduction is required – it applies automatically where a claim for credit is not made.
When would expense relief be given instead?
Expensing the foreign tax is usually done in circumstances where a company cannot benefit from credit relief. This could arise, for example, where the company has excess losses or where there is another form of relief that reduces the taxable income or gain to nil.