I have just had an interesting phone conversation with an HMRC tax advisor about a wrinkle in the new dividend tax regime from April 6, 2016, as regards the application of foreign tax credits. This is somewhat an esoteric post - but I thought it might interest experts.
In the new regime, dividends have a £5,000 nil rate band and above that are taxed 32.5% for the higher rate tax payer. I could not find any advice on the HMRC web pages as regards "how does the new regime work with US dividends on which one has paid a 15% withholding tax?" It used to be easy, in that £90 US dividends were grossed up to £100, creating £32.50 tax, minus 10% tax credit (£10) and US foreign tax credit (£13.50), leaving £9 UK tax owing.
But under the new regime, suppose one had £6,000 UK and £1,000 US dividends. Apparently it will work like this: the key idea is that the nil rate band will be used first for UK dividends, preceding any foreign dividends. Doing this to the £(6,000-5,000), creates UK tax of 32.5% of £1,000 UK div (£325), and 32.5% of £1,000 US div (£325). From this we can subtract the 15% US tax (£150) to arrive a UK dividends tax bill of £500.
If one had £4,000 UK and £2,000 US, then only £1,000 US div would be UK taxable, for a bill of £325. But only half of the US tax paid could be used as a foreign tax credit, so 325-150 = 175 would be left owing to the UK.
In the above example, the US tax payer can owe 15% of £6,000 = £900 (on qualified dividends). The UK tax of £175 can be claimed as a tax credit on Form 1116, but will fall a long ways short of reducing the US tax liability to 0.
