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HMRC internal manual

International Manual

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HM Revenue & Customs
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UK residents with foreign income or gains: double taxation relief: Deduction for taxes (amount brought into account)

The Finance Act 2010 introduced some clarifications to TIOPA10/S112. The amendments confirmed that a person may only deduct foreign tax from any foreign income where that person has not already reduced his income by reference to the foreign tax, so ensuring the foreign tax is only deducted once.

The new sections 112(2A) and (2B) determine whether the foreign tax has already been taken into account by comparing what income the person brings into account for income, capital gains or corporation tax purposes less any deduction that the person would be allowed to make for the non-UK tax (amount X) to the gross amount of income arising outside the UK (amount Y). If X is the same as Y then the person has not already reduced his income by reference to the foreign tax and so the person can use section 112 to reduce his taxable income by the amount of foreign tax. If X is less than Y by the amount of the foreign tax then the person has already deducted the foreign tax and should not have a further deduction under section 112.

For example:

Branch profits

If a company’s foreign branch receives 100 of foreign income and incurs 15 of tax on its profits in the branch, amount X will be 100 because the company will bring 100 into account for corporation tax purposes and cannot deduct the branch profits tax as an expense (CIR v Dowdall O’Mahoney & Co. Ltd [1952] 33TC259). Amount Y will be 100 being the income arising outside the UK. As there is no difference between X and Y, the company can deduct the foreign branch tax of 15 under section 112(1)(a).

Company with share on its balance sheet

Scenario 1: Non-financial trader not otherwise entitled to a deduction for foreign tax.

Where a company holds a share on its balance sheet and receives a foreign dividend of 85 which has suffered 15 of withholding tax, amount X should be 100 because the company should bring the gross dividend into account and cannot deduct the foreign tax absent section 112. Amount Y will be 100, being the income arising outside the UK. As there is no difference between X and Y, the company can deduct the foreign branch tax of 15 under section 112(1)(a).

Scenario 2: Financial trader entitled to a deduction for foreign tax.

On the above facts, amount X will be 85 because the trader will initially recognise 100 as income but will also recognise an expense of 15 in respect of the foreign tax. Amount Y will be 100, being the income arising outside the UK. As X is less than Y by the amount of the foreign tax, then the trader has already reduced his income by reference to the foreign tax so no further relief is due under section 112(1)(a).

Company with share off balance sheet

Where a company does not hold the share on balance sheet, then it will not recognise the gross dividend (i.e. 100) in its income statement. However, it will recognise the net dividend (i.e. 85) as a component of the underlying calculation of the financing return on the transaction. As a result, amount X will be 85. Amount Y will be 100, being the income arising outside the UK. As X is less than Y by the amount of foreign tax, the company has already effectively had a deduction for the foreign tax and so cannot then use section 112 to reduce its income further.