The elimination of double taxation article in the tax treaties entered into by the UK enables the UK to relieve double taxation by providing a credit for foreign tax on income or capital gains which a UK resident has been subject to. The following basic principles apply to foreign tax relief claimed under an agreement or unilaterally:

Source rule – the income or gain should normally be in the country which has been charged the tax for which a credit is claimed;
Basis of allowance of credit – credit is allowed against UK tax on any income or gain referenced to the foreign tax on the same income and gain;
Residence of claimant – the claimant must be UK resident;
Limit of credit – the credit is limited to the lesser of the foreign tax, and the UK tax attributable to the income or gain subject to double taxation;
Minimum foreign tax rule – the credit allowed is the lower of the foreign tax charged under the laws of the foreign country and the provisions of the applicable tax treaty; and
Foreign taxes which qualify for credit – the foreign tax must be set out in the tax treaty or admitted by the Commissioners of Revenue & Customs for the purposes of unilateral relief.

Where relief is not available under a tax treaty, unilateral relief may be available to a UK resident for foreign tax paid in the other country. The foreign tax relief cannot exceed the amount of corporate tax paid in the UK.

A unilateral relief is available where:

There is no tax treaty in place with the other country; or
There is a tax treaty in place, however, the agreement does not cover the category of income or foreign tax. For example, the tax treaty with the US covers Federal Income Taxes and certain Federal excise taxes, but not state taxes. The UK therefore grants unilateral relief for many of these state taxes.

Where the UK resident is the recipient company and has the requisite degree of control over the paying company, the elimination of double taxation article enables the UK to give relief for foreign tax on profits out of which the dividend from the foreign company is paid.

In situations where it is advantageous for the taxpayer to not make a claim for tax credit relief, the foreign tax paid must be deducted from the foreign-source income in computing the amount of income for UK tax purposes. This could arise in situations where the trading profits are net off by capital allowance claims, and there is no corporate tax levied on these profits, or in situations where the business in the UK suffers a loss. This would then increase the loss which will be dealt with under the normal loss provisions.

A tax relief claim cannot be made partly by credit and partly by deduction, however, a credit may be claimed for the foreign tax paid on one item of income or gain against the UK tax charged on that item, and a deduction may be given for a different item of income or gain.

A foreign tax credit claim should be made on or within 4 years from the end of the tax year to which the claim relates or, if later, 31 January following the tax year in which the foreign tax is paid.

Tax Sparing

The domestic legislation of some developing countries grants special reliefs and exemptions, in order to encourage the economic development of these countries. Where UK residents receive income arising in these countries in this way, the legislation grants a credit, but not a deduction, for tax which would otherwise have been paid in the foreign country.

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