Foreign Income

HS260  HS261  HS321

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Income earned or arising in a foreign country is taxable in the UK. If the person is not domiciled in the UK, the income will be taxable only if it remitted to the UK. The same basic rule applies here as to other sections in IRIS: if it isn't taxable, don't enter the data.

Most foreign income will be entered in the foreign income section but it is also possible to enter foreign income on the following sources:

Employments

Sole Trades and Partnerships

Estates

Foreign income is treated in the same way as the equivalent UK income. Therefore income from foreign savings is treated in the same way as income from UK savings, income from foreign dividends as UK dividend, income from foreign property as UK property etc.

Where foreign tax has been deducted, relief is available for the foreign tax suffered. There are two ways of claiming relief for foreign tax paid:

• As a deduction from the foreign income; or

• As a tax credit.

The second method (tax credit relief) is normally more beneficial.

1.Foreign Tax Deduction

2.Foreign Tax Credit Relief

3.Double Taxation Relief Calculation

4.Affect of Age Allowance and Top-Slicing Relief

1.Foreign Tax Deduction

To claim foreign tax as a deduction, enter N in the 'claim tax credit relief' question on the data entry screen. The foreign tax paid will be deducted from the income taxable. For example, if £150 of foreign tax has been paid on £1,000 of foreign income, £850 will be taxable.

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2.Foreign Tax Credit Relief

To compute foreign tax credit relief, enter Y in the 'claim tax credit relief' question on the data entry screen. The relief given is the lower of:

• The UK tax due on the foreign income; and

• The foreign tax paid

The double taxation relief calculation required to work out the UK tax due on the income is complex. The following examples illustrate the basic rules:

To take the same example as the foreign tax deduction, above, £150 foreign tax paid on £1,000 of foreign income and assume that the taxpayer is liable to tax at the basic rate. £1,000 @ 22% = 220 - 150 foreign tax already paid = £70 still to pay. (Note that claiming the £150 as a deduction gives this result: £850 @ 22% = £187 UK tax to pay.)

If the foreign tax paid had been £300 for a basic rate taxpayer, the foreign tax credit would be restricted to £220 (the UK tax due on £1,000).

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3.Double Taxation Relief Calculation

To compute the amount of foreign tax credit available, it is necessary to do a comparative computation between the tax due on all income and the tax due on the income excluding the source of foreign income. The difference between the results from each computation is the UK tax due on the foreign income.

If there are two or more sources of foreign income, the comparatives continue by progressively removing each source of foreign income and recomputing the tax due. A strict sequence is applied when performing these comparative computations. The foreign income must be sorted into order by rate of foreign tax. The source bearing the highest rate of foreign tax is taken first, continuing to the item with the lowest rate. Note that it is the rate of tax that matters. For example, if there are two sources of foreign income, one of £3,000 with £1,000 of foreign tax paid and another of £500 with £200 foreign tax paid, the £500 income would be taken first because foreign tax has been suffered at 40% compared to 33.3% on the £3,000 income. If the taxpayer has taxable income of £28,500 in 1999-2000 the double taxation computation would be as follows:

  Initial  First foreign  Second

 computation  source foreign source

The foreign tax credit allowed on the first source of income is the full amount of foreign tax paid because the UK tax paid on that income is also at 40% (£6,445 - £6,245 = £200). However, the credit allowed on the second source has been restricted to 23% because the UK tax paid on that source is only 23% (£6,245 - £5,555 = £690).

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4.Affect of Age Allowance and Top-Slicing Relief

When recomputing tax due on progressively lower levels of income, changes can occur in the level of age allowance and top-slicing relief.

Personal allowance is given at a higher level for taxpayers aged over 65. The higher level is gradually reduced to the normal level where the person's income is above the income limit. Therefore, if the age allowance had been reduced because it breached the income limit, it follows that it will be increased as the income drops down during the double-taxation relief calculations. This has the effect of increasing the effective UK rate of tax.

For example assume that a 70 year old taxpayer has net statutory income in 1999-2000 of £17,800 and that there is a source of foreign income of £1,000.

  Initial After removing

 computation foreign source

The UK tax due on £1,000 foreign income, in this case, is £345 (2,698.40 - 2,353.40).

Personal age allowance is recomputed as the income drops but married couple's age allowance remains unchanged at the level set by the income in the initial computation.

Top-slicing relief is given where a taxpayer has income from a life assurance gain that has accrued over a number of years and it has pushed the taxpayer into the higher rate tax band. The level of relief will change as each double tax relief calculation takes place. The relief may go up or down.

For example a taxpayer has taxable income of £31,000 in 1999-2000 that includes a £3,000 life assurance gain (3 year term). There are two sources of foreign income both of £1,000.

  Initial  First foreign  Second

 computation  source foreign source

The UK tax due on the first foreign source of income, in this case, is £740 and just £230 on the second source!

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