Foreign Tax Credit Relief: Determining US Tax Paid? Or revise US return?

Hello,

I'm way behind so am only just now doing my 2014/2015 UK Taxes. I'm US/UK dual citizen, residing in the UK, and I'm reporting US mutual fund gains/income, on the arising basis.

I ended up paying about $750 in 2014 US taxes, all due to mutual fund activity, and haven't filed 2015 taxes yet.

I've got about £7500 in income to report to the UK for 2014/2015, however I've already paid some tax on that in the US.

1) I understand the UK has first right of taxation, so should I just file my UK taxes and then revise my 2014 US return to include that foreign tax paid as a foreign tax credit?

or alternatively,

2) Can I get a credit on the UK return for the US tax I paid? And how should I go about figuring out how much tax was actually paid on each source of income, given the staggered tax years and lack of direct tax attribution by the IRS...

These are all non-reporting funds so I do understand everything is treated as regular income, not dividends or CG. Thanks!

As you say you calculate the gain under UK rules, including using historic spot exchange rates and share pooling (ie in the UK ones an average cost versus a FIFO method in the US). You then pay UK tax at, say, 40% on any gains. Losses cannot be offset against gains.

You claim a foreign tax credit in the US on either the paid or the accrued method.  Consequently to get a credit in the US on the paid basis, you should have paid the tax to HMRC by 31 December 2014.

I'm in a similar situation, though a little more up to date.

I'm doing my UK self assessment and I have US interest income on which no tax was deducted (but which was included in my US 2015 tax return, of course).

It sounds like I should not claim UK foreign tax credit relief for US income taxes paid on the 2015 US return, but should instead pay full tax to HMRC on my US interest income, and then use those UK taxes paid as a foreign tax credit on my US 2016 return.

Does this sound right, or should I be claiming foreign tax credit relief on my UK self assessment based on the 25% that the US took in the 2015 tax return ?

If you are subject to UK tax on the arising basis, the United Kingdom has the primary taxing rights over US source interest income.  Any credit is claimed in the US on Form 1116 using the treaty resourced basket. When you prepare your 2015 US return you would be creating a treaty-resourced basket to establish the maximum amount of potential foreign tax credit. Hopefully you paid the tax to HMRC by 31 December 2015. If you did not - and you have adequate credit to carryback on your 2016 return - you can amend the 2016 US return next year.

I would like to add some additional observations on the questions posed by MikeUK and sdt99.

I think that the relevant position under the UK US double tax treaty for them as UK resident US citizens is as follows-
•   The position is that under Article 1(4) the US generally reserves its rights to tax its citizens as if the treaty had not come into effect.
•   Article 1(5) says that the above general principle is subject to some exceptions. The exceptions include the application of Article 24, dealing with double tax relief.
•   Article 24(6) deals with the special double taxation rules for UK resident US citizens.
•   In particular, Article 26(6) says that, as regards US source income, the UK should give credit for the US tax that would be imposed by it on UK resident non US citizens.

It seems to me that the above principles would be applied to the three types of income or gains mentioned, as follows-
•   Interest income: Article 11 of the treaty would give exclusive taxing rights to the UK, and so the UK would not give any relief for US tax in computing the UK tax on US source interest income.
•   Dividends from mutual funds: Article 10(2)(b) means that the US would apply a 15% rate of tax on US dividends from mutual funds. The UK tax would be computed by giving credit for this (notional) US tax. The US would then allow credit for this (reduced) UK tax under the resourcing rules under Article 24(6) (d).
•   Gains on sales of mutual funds: Article 13(5) appears to give the UK exclusive taxing rights in respect of gains on US property (other than real property) and so the UK tax would be computed with no credit for US tax. The UK tax on any sales of mutual funds would be to income tax, under the offshore income gains rules – assuming that the funds are not reporting funds for UK tax purposes- rather than to capital gains tax. However, this does not affect the application of these rules. It seems to me that the US would give credit for the UK income tax against US on the gains on the mutual funds. Article 13(6) allows the US to tax gains on an individual who was resident in the US in the previous six years. I am unclear as to how this provision would operate in connection with Article 13(5).

I would be interested to see comments on the above analysis.

The US tax on dividends may be lower than the 15% rate set out in the Treaty (because of both the zero percent tax bracket and other credits). The amount of DTR claimed in the UK is limited to the lower of the Treaty rate of 15% or the tax actually paid.

I would like to clarify the position, as I see it, on the taxation of US dividends.

The first stage is the computation of the UK tax on the US dividends. The treaty requires the UK to give a credit for the 15% tax that would have been levied on a UK resident non US citizen in computing the UK tax payable on the dividend. I do not think that the UK is allowed to reduce this even if the actual US tax on a citizen is less than this. This would be the tax payable by a non-citizen. The US would first seek to impose its general 30% withholding tax, and the UK resident would claim the benefit of the treaty to reduce this to 15%. Article 24(6)(b) says the relief if for US tax that the US may impose.

At the second stage, the US would give any DTR for the UK tax above.

I would be surprised if HMRC would give credit for foreign tax that is never paid to a tax authority.  Looking quickly, it seems that Article 10(2)(b) merely says that the tax charged by the United States shall "not exceed" 15%. HMRCs Tax Bulletin, Special Edition said similarly in commentary that Article 10 "limits the tax that the source country may impose" [on an NRA].

DTR is always the lower of tax in the UK at UK rates or tax in the foreign jurisdiction at foreign rates.

I would like to add some further comments about the calculation of the tax on US dividends.

The starting point is the rate of US withholding tax, linking to the US taxation of non-residents on US source income. The general rate is 30%; the treaty reduces this to 15%. In theory the US could reduce the general rate to say 10%; then the treaty would still give a rate of 10%. This theoretical possibility is reflected in the wording of Article 10(2)(b).

The position is rational and workable.  The UK is to assume a 15% US rate, since this applied to non US citizens. The US then applies its own tax, with credit for the UK tax actually paid. If the US imposes tax at a lower rate than the actual UK tax, then there might be no US tax paid. But this does not mean that the UK would recalculate its tax liablity.

Thanks both for the clarification.   I think my assumption is correct as regarding US interest income - pay full tax to HMRC then use it as a foreign tax credit on next year's US tax return.

You are correct. You failed to pay HMRC by 31 December 2015, so cannot claim credit on an original 2015 US return for foreign tax that had not been paid.

I would like to ask a question in relation to Guya’s answer. I have seen some references to claiming foreign tax relief on an accruals rather than a cash basis. Is this possible and what are the key requirements for its use?

US law permits a US taxpayer to elect irrevocably to claim credit for the foreign tax due for the foreign tax year that ends in the US tax year. Because the UK has a quaint / unconventional tax year, this means that the accrual claimed on a 2015 US return by a taxpayer using the accrued method for foreign tax credits would have to be for the UK tax due on all items of income/gains for the UK tax year 2014-15. 

This conceivably might be a solution for sdt99, but because the tax years do not match; it might produce a permanently worse answer.

Electing into the accrual method for foreign taxes remains a great strategy for many taxpayers moving to other countries such as France; but is typically not great planning for a UK resident.

Hi guya,

Can I ask why exactly it is not a good idea to use the accrual method for UK taxes?

Thanks,
J

Hi guya,

Can I ask why exactly it is not a good idea to use the accrual method for UK taxes?

Thanks,
J

Let's imagine a large hypothetical example. Say you make a gain of $1 million on shares in Marks & Spencer plc on 1 June 2016.  If you are on the paid basis you pay all of the UK CGT to HMRC by 31 December 2016 and you'd owe no US income tax on the gain because the tax you paid at the UKs 28% rate is higher than the US 20% rate on long-term gains.  (For completeness, it is worth saying you'd doubtless still owe NIIT).

If you were on the accrued method the accrual could not be claimed until the 2017 return as the gain arose in the 2016-17 UK tax year, leading to significant cashflow problems, as you'd have to pay both the IRS and HMRC long before possibly amending the 2017 US return during 2018 to carry back excess foreign tax credit from 2017.