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HMRC internal manual

International Manual

Foreign tax paid on trade income: limitation on credit: 2005 legislation

Finance Act 2005 introduced a wholly new set of rules setting out the maximum tax credit that is available where foreign tax is paid on trade income. The sections can now be found in TIOPA10/Part 2/Chapter 2.

The legislation applies to companies for claims in respect of foreign tax paid on or after 16 March 2005, irrespective of the accounting date of the person making the claim and was extended to individuals by the 2008 Finance Act with effect for claims in respect of foreign tax paid after 6 April 2008 or income arising after that date.

The new sections amend the application of TIOPA10/S36 and TIOPA10/S42 in the case of trade income. They make it clear that the maximum tax credit must be calculated not by reference to the UK tax on the whole of the trade profits, but on the UK tax on so much of the trade profits as arise out of the transaction, arrangement or asset that gives rise to the foreign tax payment.

This means that a “mini” Trading Income computation must be undertaken, setting relevant expenses against the foreign income in order to compute the net foreign profit. The UK tax on this measure of profit establishes the maximum credit for the foreign tax.

Some expenses are incurred directly in the course of earning an item or items of income. For example, brokerage fees in respect of a transaction in shares can be directly attributed to a dividend from the same shareholding. Such expenses should be deducted from the income to which they relate.

Other expenses are in the nature of general overheads, and a proportion of these should be allocated against the item or items of income where they cannot be specifically allocated. A just and reasonable basis of allocation should be used. What is appropriate in any case is a matter of judgement, but the possibilities include allocation on the basis of any of the following:

  • Profit as calculated before deduction of the overheads
  • Headcount
  • Floorspace
  • In an equities or derivatives trade, the number of deal tickets
  • or any reasonable combination of such factors

Expenses to be allocated may be offset by incidental income, such as interest on short term deposits, to the extent that it is reasonable to identify it with the expenses.

These principles apply in all cases where foreign tax is paid on an item of income that is taken into account in calculating the profits of a trade, or to any other income taken into account in an equivalent profit calculation, and there is a claim for credit against UK tax in respect of the foreign tax payment. Examples are:

  • Tax withheld from royalties taken into account in calculating trade profits - for example, in the entertainment industry (see INTM168060)
  • Technical and management service fees (see INTM168062)
  • Artistes/athletes/sportsmen (see INTM168063)
  • Tax withheld from interest or foreign dividends received by financial traders (see INTM168020 to INTM168040)
  • Tax withheld from rents received in Property business