In certain circumstances UK companies can claim relief for foreign taxes which they suffer. This factsheet outlines the two forms of double tax relief (DTR) which can be claimed in the UK – credit relief and deduction relief – and how foreign taxes may, in many cases, be reduced under a double tax treaty (DTT).
Double tax relief
UK resident companies are taxed on their worldwide income, but they may also suffer tax in another country. For example, withholding tax on sales income, interest, fees or royalties, or tax charged on the profits of a foreign permanent establishment (branch). UK tax relief in respect of such amounts may be claimed either under the terms of a DTT or, where there is no treaty in place, by unilateral relief, but the outcome is generally very similar.
Foreign tax suffered on a company’s profits can reduce the UK corporation tax due on the same profits – this is credit relief. In cases where the foreign tax exceeds the UK corporation tax on those profits, the unutilised foreign tax can, in certain cases, be carried back one year or carried forward.
Foreign tax can become an absolute cost where there is insufficient UK corporation tax against which to credit the foreign tax, or where the rules require losses to be utilised in priority to DTR.
Credit relief can only be claimed against the UK corporation tax on the same income on which the foreign tax is suffered. It is therefore necessary to determine how this income is measured, and how the tax is calculated. The income must be reduced by the allowable deductions, charges and expenses that would be allowable in calculating the UK tax on that income. In some cases, expenses will need to be apportioned between different income sources on a ‘just and reasonable’ basis.
Other deductions – such as management expenses, non-trading loan relationship deficits or brought forward losses – can be allocated to UK income in priority to foreign source income. However, a restriction on DTR may still arise if there is insufficient UK income against which the deductions can be made.
Example of limit on Double Tax Relief
Company A Ltd has a contract in Peru under which it will receive £100,000 of fees, with associated costs of £80,000. It suffers 30% withholding tax under Peruvian domestic law, and there is no DTT between the UK and Peru to reduce the tax. Company A Ltd also has UK profits of £50,000. The corporation tax calculation is as follows:
Minimisation of foreign tax
DTR is only available if all reasonable steps have been taken to minimise the foreign tax. For this reason, HM Revenue & Customs will not accept a claim for DTR unless the company has taken reasonable steps to make any relevant claims or elections (under both local law and double tax treaties) for reliefs, deductions, reductions or allowances which would reduce the foreign tax.
Where credit relief does not give full relief for foreign tax, it may be preferable to claim relief by a deduction from the income as an alternative. It is not possible to claim relief for the same tax by both credit and deduction. A calculation is required to conform whether it is better to claim relief by way of credit (and lose any tax which cannot be credited), or by way of deduction in calculating taxable profits.
Reducing withholding tax under a DTT
As well as potentially increasing a company’s effective tax rate, suffering foreign withholding tax also has an adverse impact on cashflow, as the tax is suffered at source. In these situations, the best form of relief is to reduce or in some cases eliminate the foreign tax, for example by making a claim under one of the UK’s many DTTs. The process for making a claim can be complex and for this reason the relevant documentation should be obtained well in advance of receiving the income.
For more information about double tax relief, please contact your usual Saffery partner or speak to James Bramsdon.
This factsheet is based on law and HMRC practice at 1 February 2020.