Summary of Foreign Tax Credit
What is Foreign Tax Credit?
A foreign tax credit (FTC) is a credit offered to tax residents on their worldwide income. This credit can be used to mitigate double taxation on income tax liability. The credit may also be granted in systems taxing residents on income that have been taxed in another jurisdiction.
Are you eligible?
When it comes to FTC and how much a person can claim, there are different double tax treaties with every country. As many clients are not of British origin, residency and domicile issues often come into effect. Residency is defined as where the person lived during the accounting year. To work out the client’s residency status, especially if they resided in multiple locations throughout the accounting year, then the Statutory Residence Test can be used to work out their status. Use our interactive Statutory Residence Questionnaire to gain insight into whether you may be a resident of the United Kingdom.
Domicile is defined as where a person is born and/or intends to eventually settle. Domicile is inherited from our father at birth or, in the event our parents are not married, inherited from our mother. Up until the age of 16, a person’s domicile status is linked to their parents. After 16 their domicile can change independently. Domicile can change if a person relocates with the intention to settle in a new jurisdiction. It changes on the proviso that they will not be returning to their previous jurisdiction. If a person has been resident in the UK for at least 15 of the last 20 tax years, they are deemed domiciled in the UK for tax purposes.
When a person is non-resident in the UK, the only income which needs to be declared on the UK tax return is UK based income. When a person is resident in the UK, but non-domiciled, they generally need to claim all UK based and overseas income in the UK. However, if they have any overseas income which they have not brought into the UK, they can claim the remittance basis. This means that they need not declare any foreign income and gains which have not been brought to the UK.
If a person is living and working in the UK and receiving income from abroad, for instance, rental income from their US property, then they need to pay UK income tax on those earnings. This only applies to resident taxpayers. Non-resident taxpayers do not have to pay tax on foreign income.
Most countries including the US account for their taxes according to the calendar year. In contrast, the British accounting year runs from 6 April until 5 April of the following year. According to the US tax treaty, the UK is allowed to use US accounts per calendar year in their accounting period.
How to Claim Foreign Tax Credit
The US tax system requires every US citizen to report their worldwide income regardless of where they live. Therefore, if an American national lives and works in the UK, they still need to file their US tax return. A US tax return must be filed each year by 15 April, however there are further deadline extensions available. For instance, if a person lives outside the US, they are granted an automatic extension to 15 June. Moreover, the American taxpayers can request an additional extension until 15 October if they are living abroad, and they need more time to collect all information for US expat tax preparation.
For each American client there is a 1040 form, officially called the US Individual Income Tax Return, which is an IRS tax form used for personal federal income tax returns. Moreover, it is a form where all the income information can be found. For instance, information about wages and salaries, interest, dividends, pensions, capital gains, other income from Schedule 1 and information for FTC purposes. When filing the UK tax return, it is important to check clients’ information on their US tax return as well to ensure their UK tax return is filled out correctly.
An example can be found below of an American client living in the UK, having foreign income, partnership income and is a non-domiciled individual. The figures are initially taken from the 1040 form for the accounting year of 2021. This client must claim all UK based and overseas income in the UK as mentioned previously. The calculations have to be kept in both American dollars and British pounds. To convert the figures, we use yearly average exchange rate found on the Governmental website.
To calculate the FTC for US dividends, we need to take the dividends figure and divide it by the US taxable income figure and multiply it by the US tax figure. We follow the same pattern for the US interest and partnership income.
