Question on Income Resourced by Treaty form(s)

Hello,

I am confused about how to avoid double taxation on US-based dividends.

If I paid HMRC tax on $2,000 of US dividends, can I include a $300 (i.e 15%) credit in the calculations for form 1116,  "Income Resourced by Treaty"? 

Must I also complete 8833 to indicate the relevant treaty? If so, where do I find this information?

Thank you in advance for your help.

Hello,

I am confused about how to avoid double taxation on US-based dividends.

If I paid HMRC tax on $2,000 of US dividends, can I include a $300 (i.e 15%) credit in the calculations for form 1116,  "Income Resourced by Treaty"? 

Must I also complete 8833 to indicate the relevant treaty? If so, where do I find this information?

Thank you in advance for your help.

I expect the tax experts to come along soon but I believe you can only claim back the actual tax you paid. In our situation our US income is such that $2,000 of qualified dividends would indeed attract tax of $300. (Filing MFJ). However in the UK we are taxed as individuals and all of our qualified dividends are owned by wife so her UK tax on that $2,000 would be zero so we would not have any UK tax to set off against that $300.

Thanks for your response.
I should have specified that this dividend income fell in the higher (32.5%) band, but I understand the US will only give 15% credit. 

Thanks for your response.
I should have specified that this dividend income fell in the higher (32.5%) band, but I understand the US will only give 15% credit.

In that case I believe you are correct in that you can claim $300 as a tax credit against your US taxes, and you may even be able to carry the excess forward as a tax credit to use in future years when or if the opposite situation occurs.

The attached summary might help clarify the taxation of US dividends received by UK resident US citizens.
http://www.trustedtaxadviser.co.uk/upfiles/USdividendincomeofUKresidentUScitizenf1.pdf

It looks to me that some of the above pdf is out of date. For example, it is no longer the case that UK "dividends are deemed to carry a 10% notional tax credit."

In fact, I think you are misunderstanding your US tax liability. My understanding is that, according to the UK-US treaty on double taxation, the US has primary taxing authority for 15% of any US source dividends. If you are not a US citizen then this will have been deducted at source (provided you have completed a W8-BEN). If you are a US citizen then nothing will have been deducted at source, but you are expected to pay US tax via your 1040 return, if indeed your 1040 calculation shows that this tax is due on this passive income.

The US tax can then be deducted against the UK tax (of 32.5% for the higher rate taxpayer). To illustrate: suppose you had £10,000 US dividends (and no other dividends). The US would take tax of £1,500. As a UK higher rate taxpayer you would owe 32.5% x (10,000 - 5,000) = £1,625 (after deduction of the 5,000 dividend allowance.) So the UK tax bill would be 1,625 - 1,500 = £125 after taking a credit for the US tax paid.

In the 2018-19 UK tax year the dividend allowance reduces to £2,000 and so the US tax bill would be the same, but the UK bill would rise to .325*(10,000-2,000)-1,500=£1,100.

If you also had UK dividends you can arrange the order in which tax is charged so as to minimize the total bill. Suppose in the 2016-17 year you had £4,000 of UK dividends and £5,000 of US dividends. The dividend allowance of £5,000 could be be applied to the £4,000 UK dividends and £1,000 of the US dividends, leaving a UK tax bill of .325*4,000 = 1,300 on US dividends. From this you can deduct the .15*5000=750 paid to the US. (Note that you can deduct the entire 750, not just the .15*4,000= 600 pertaining to the US dividends which lie outside the allowance.)

Finally, if you are not a US citizen and have not signed a W8-BEN then 30% US tax may have been deducted at source. However, you are only allowed by HMRC to take a 15% credit against UK tax.

A UK person who invests in something like a VUSA ETF will be unavoidably double taxed, in the sense that Vanguard will have paid 15% on the US dividends, and then will have distributed the remainder to the ETF holders, who will be liable for a full 32.5% UK tax, with no chance to take a tax credit for the tax which Vanguard has already paid.

You are correct that the summary has not been updated for the removal of the notional tax credits.

However, the logic of the rest of the summary is correct. For a US citizen-
•   No withholding tax is deducted.
•   UK tax is computed as if there had been a 15% US withholding.
•   The US should give relief for the above UK tax under the resourcing rules.

•   The US should give relief for the above UK tax under the resourcing rules.

I think there may be some confusion about what this means.

The OP (TinaS) wrote of paying UK tax of 32.5% on $2,000 of qualified US dividends. I think that is wrong. I would expect that the OP owes US tax at the rate of 15% ($300), and UK tax at the rate of (32.5 - 15)% ($350) (assuming the $2,000 lies outside the dividend allowance and so incurs UK tax).

Can the $350 of UK tax paid be stockpiled as foreign tax credit against other US tax? I think not. Article 24 6(d) is exclusively about avoiding double taxation. There is no double taxation taking place. The dividends have merely incurred the full 32.5% UK rate, being split US:15%, UK:17.5%. It is not intended by HMGov that a US citizen resident in the UK should enjoy a lower effective dividend tax rate than does a non-US citizen living in the UK, simply by dint of being a USC.

The bullet point above (from Article 24 6(d)) has no effect under present UK/US qualified dividend tax rates. When does it have effect? The US has a tax rate on non-qualified dividends of 35% for some USC taxpayers, but is only allowed to charge 15% to non USCs in the UK, as restricted by Article 10 2 (b). The effect of Article 26 6 is that if the UK rate is 32.5%, then the UK would allow a 15% tax credit against UK tax, taking for itself 17.5%, and then the US would allow this is as credit of 17.5% against US tax (by the resourcing calculation), making tax to the US = 15% + 2.5% and UK = 17.5%, for a total of 35%, so avoiding double taxation (but not avoiding "worst of two worlds taxation").

Thank you Dunedin and John for taking the time to answer my question so fully.
 
As a dual US/UK citizen, resident in the UK, I had assumed that HMRC has precedence over the IRS and that there was double taxation. John's explanation clearly shows me why this is incorrect. I receive both UK and US dividends, so appreciate the suggestion for minimising the tax bill.

But I'm thinking the third paragraph of my above comment is not correct. The $350 of UK tax paid on the qualified dividends in this example can be used as a foreign tax credit against other US passive income tax.


.

John,

By "US passive income tax, do you mean UK tax paid on capital gains and interest from US -based investments? And we can therefore include dividends with gains and interest on an F1116 "Income resourced by treaty?"

Am i correct in thinking that the only way of getting any relief from taxation on US-based gains and interest is to claim this from the US because these are outside the treaty?

Thanks.

By "US passive income tax" I was thinking of US tax charged on UK passive income. I have no experience of this, but I think it is possible for one to accumulate tax credits with Form 1116 "passive" and use these to reduce US tax on the UK dividends you might still receive after moving back to the US and when you are no longer paying UK tax.

US based interest will be taxed in the UK at 40% (assuming that is your UK marginal rate) and will create a foreign tax credit in Form 1116 "general", probably meaning you have no US tax on the interest. [It is Form 1116 "general" rather that "passive" because of the high tax kick out rule.]

US based capital gains can incur US tax because the first £11,100 of gains are not taxed in the UK. If your gains are more than £11,100 then the gains above this limit will incur UK tax, which will give you some foreign tax credit to use against the US tax liability on these gains, by completing Form 1116 "resourced by treaty".

John,

Thanks again for replying, especially for pointing out that the interest falls in the "general" category.

I understand that the 1116 categories cannot be mixed together, so excess US-based "resourced by treaty" credits could not be applied to future UK-based "passive" investment income.

 

Yes that's correct.