Introduction
A UK resident must declare on their UK tax return any worldwide income they received in that tax year and pay UK tax on this income. However, if they have already paid foreign taxes on this income, they may have the possibility to claim a foreign tax credit (FTCR) to reduce any UK tax owed on their foreign income under the terms of a Double Taxation Agreement (DTA).
How much can I claim?
The first step is to check the allowable rates as per double taxation treaty – see HMRC guidance on this link – Digest of Double Taxation Treaties April 2018 (publishing.service.gov.uk).
Here are some examples to help understand the topic:
Example 1 – Restricted Claim based on double taxation treaty
Chris receives £100 of Spanish dividends with £20 foreign tax paid, in addition to other UK dividends he earnt in the tax period that is greater than the dividend allowance. The allowable rate for Spanish dividends is 15% (see page 32 of the Digest of Double Taxation Treaties), so the amount of foreign tax Chris can claim for is £15. The excess of £5 paid in Spain is not available for credit against the UK tax liability.
Example 2 – Restricted Claim based on higher foreign taxes than the UK
Sam has total income of £60,000, comprising of self-employment income and foreign interest, Sam paid £900 of foreign interest. Sam’s total UK tax bill including both sources of income is £7,500 and £7,000 when calculating just the self-employment income, so total UK tax on foreign income is £500. Sam cannot claim £900 as this exceeds the UK tax due on this income, rather claims £500.
If Sam would have foreign interest from multiple countries, paying different foreign tax amounts in each country, one would need to calculate each foreign income separately to ensure not claiming more than the UK tax on that specific amount.
Example 3 – Foreign Capital Gain
Harry, a higher-rate taxpayer, sold two buy-to-let properties in 2022 to 2023: one in the UK for a gain of £26,000 and one overseas for a gain of £7,000. Foreign tax of £2,100 was paid on the latter disposal.
His Annual Exempt Amount (£12,300) should be set against the UK gain to maximise the FTCR claimed. This gives: £13,700 (£26,000 – £12,300) at 28% (as the asset is residential property) = £3,836 of taxes.
£7,000 at 28% = £1,960 is the UK CGT due on the overseas property
As this is less than the foreign tax paid, Harry’s FTCR claim is £1,960, giving a final UK CGT liability of £3,836.
Example 4 – Two foreign incomes that straddles different rates
John receives £55,000 taxable earnings. The higher rate limit for this taxpayer is (for example) £50,000. So, £50,000 taxed at 20% (£10,000) and £5,000 at 40% (£2,000), total tax of £12,000.
Included in this are two items of foreign income
(1) £10,000, foreign tax £3,000 (DTR 30%),
(2) £5,000, foreign tax £1,750 (DTR 35%).
There are two orders to consider:
- Removing item (1) £10,000 first – income that straddles the basic and higher rates of tax:
The revised UK liability is: 45,000 x 20% = 9,000. So, total UK tax on item (1) is £3,000, so John can claim full foreign tax on item (1) of £3,000.
When item (2) £5,000 is also removed, the calculated revised UK liability is:
40,000 x 20% = 8,000
The allowable FTCR on item 2 is £1,000, the lower of the UK liability on item 1 £1,000 (£9,000 – £8,000) and the foreign tax paid £1,750.
So, choosing option 1, the total FTCR is (£3,000 + £1,000) £4,000.
Removing item (2) £5,000 first – income that is all in the higher rate of tax:
The revised UK liability is: 50,000 x 20% = 10,000
The allowable FTCR on item 2 is £1,750, the lower of the UK liability on item 2 £2,000 (£12,000 – £10,000) and the foreign tax paid £1,750.
When item (1) £10,000 is also removed, the calculated revised UK liability is:
40,000 x 20% = 8,000
The allowable FTCR on item 1 is £2,000, the lower of the UK liability on item 1 £2,000 (£10,000 – £8,000) and the foreign tax paid £3,000.
So, choosing option 2, the total FTCR is (£1,750 + £2,000) £3,750.
So, choosing option 1 will be maximise the FTCR that you can claim.
Deduction relief
There are certain circumstances that you are unable to claim foreign tax credit relief, but you may be able to claim deduction relief.
Example
Gemma makes a trading loss of £19,000 in 2022 to 2023. Her other income is UK rental income of £8,000 and foreign interest of £9,000, on which tax of £900 was paid overseas. Gemma has no UK tax liability as her trading losses cover the other sources of income. This means that no FTCR is available, as there is no UK tax due to apply any credit.
However, claiming deduction relief reduces the foreign interest of £9,000 to £8,100, acknowledging the foreign tax paid. This reduces the amount of the loss that Gemma needs to set against her total income in 2022 to 2023, allowing her to use more of the loss to reduce her tax liability in another year.
