Double Tax Relief – Common Pitfalls
Where a person pays tax in both the UK and abroad, the general rule is that double tax relief may be available up to the lower of (i) the UK tax on the doubly taxed income, or (ii) the foreign tax on the doubly taxed income.
However, there are a number of issues that should be considered before making a claim for double tax relief:
1. Is there a double tax treaty with the country concerned?
Double tax relief may be available through either a double tax treaty or through statute where there is no double tax treaty with the country concerned.
Where there is a double tax treaty in place, this may affect the amount and mechanism of the relief.
2. Does the double tax treaty cover the relevant tax?
For example, the UK currently only has double tax treaties for inheritance tax purposes with the Republic of Ireland, USA, South Africa, France, Netherlands, Sweden, Switzerland, Italy, India and Pakistan.
3. Was the liability to foreign tax minimised?
HMRC guidance notes that taxpayers have a duty to minimise their liability to foreign tax and HMRC will seek to apply this principle rigidly.
For example, Swiss withholding tax is typically applied at 35%, however under the terms of the UK-Swiss tax treaty the rate of withholding tax applicable to UK residents is reduced to 15% for dividends and 0% for interest. Any over deductions of tax may be refunded from the Swiss tax authorities – but only within certain time-limits.
Therefore, the amount of double tax relief available in the UK will be limited to the maximum tax rates set in the double tax treaty and not the actual tax suffered.
We recently had a case where a person worked in Australia but remained UK resident and was therefore subject to both UK income tax and Australian withholding tax at the rate of 45%. The taxpayer was not required to submit an Australian tax return and this being the case had no reason to apply for an Australian tax reference which would have permitted his employer to deduct tax at a much lower rate. HMRC argued that double tax relief was only available at the Australian rate of tax that would have applied had he submitted an Australian return.
4. Was the income ‘subject to’ or ‘liable to’ tax in the foreign country
The first tier tribunal recently considered the meaning of the phrase “subject to tax” in the double tax treaty between the UK and Israel (Paul Weiser v HMRC, 2012, TC02178).
Under the double tax treaty between the UK and Israel, UK source pensions are not taxable in the UK where they are received by a person resident for tax purposes in Israel and subject to tax in Israel.
In this case the taxpayer was not liable to tax in Israel because of an Israeli tax rule which exempts income from foreign pensions in the first 10 years of residence.
The taxpayer sought to argue that the income was within the scope of the double tax treaty between the UK and Israel, albeit that Israel chose not to exert its rights to tax the income.
HM Revenue & Customs on the other hand argued that the phrase “subject to tax” requires that foreign tax must be levied and can be contrasted to the phrase “liable to tax” which has a broader meaning and simply requires that the income be within the scope of foreign tax.
The first tier tribunal felt that the purpose of double tax treaties is to eliminate double tax rather than assist taxpayers to avoid tax in both countries and therefore found in favour of HMRC.