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HMRC internal manual

International Manual

Foreign tax paid on trade income: limitations on credit: 2009 legislation

FA09/S60 inserted three new subsections into ICTA88/S798A and 798B, now TIOPA10/S44, S45 and S49. Those sections are concerned with limitation of the credit for foreign tax against corporation tax in respect of trade receipts. (See INTM168010.)

The new rules apply to payments of foreign tax on or after 22 April 2009 or income received on or after that date in respect of which foreign tax has been deducted at source.

TIOPA10/Section 49

Where the taxpayer is not a bank or a company associated with a bank, there is no change to the existing legislation.

The new legislation puts it beyond doubt that, where the taxpayer is a bank or a company associated with a bank, the reasonable proportion of deductions and expenses which have to be included in the calculation of the amount of profit attributable to the foreign income according to UK principles must include funding costs. This may reduce or even extinguish the amount of foreign tax that may be credited against their corporation tax.

One way in which banks have attempted to frustrate the intention of the existing legislation is to claim to have funded avoidance schemes from sources which have no or low associated costs, for example, customer deposits in nil or low interest bearing current accounts or surplus capital. This is in spite of the fact that banks calculate their average funding costs on a daily basis and use this information to inform their investment decisions including decisions on avoidance schemes.

The new rules put it beyond doubt that, from 22 April 2009, in calculating the amount of double taxation relief (DTR) available, a bank or a company associated with a bank must deduct a reasonable proportion of the funding costs the bank would incur in respect of the capital needed to wholly fund the transaction (the notional funding costs), and that this cannot be avoided by allocating a specific source of funds to specific transactions. The rules require a comparison between the funding costs allocated to the transaction and the bank’s notional funding costs. If the notional funding costs are significantly higher, the difference must be added to the allocated funding costs and the sum must be included in those costs in the UK measure of the foreign profit against which DTR is allowable.

How will HMRC interpret “significant”?

This is not defined in the legislation and each case should be considered on its merits taking into account all the facts. However, in general HMRC will not interpret the difference as significant where the actual funding costs are at least 75% of the notional costs or where the difference arises purely out of a difference in the credit ratings of the bank and the associated company, although this limit may not apply if there is evidence of fragmentation for the purpose of avoiding this limit.

Example 1

DTR calculation for a transaction carried out by company associated with a bank funded entirely by the bank.

A securities trader invests 1000 in overseas securities with a return of 4.0% and pays foreign tax at 15%. For tax purposes only, the company claims that the transaction is entirely funded from customer deposits in current accounts paying interest of 0.3% interest. The bank’s average cost of funding over all its transactions is 3.0%.

Including Funding     Bank’s Notional Funding  
Income 40   Income 40
Overheads 6   Overheads 6
Funding allocated 3   Bank’s notional funding 30
Profit on foreign income 31   Profit on foreign income 4
Tax at 28% 8.68   Tax @ 28% 1.12
Foreign tax 6.00   Foreign tax 6.00
DTR claimed 6.00   DTR allowable 1.12



In this case the allocated costs of 3 are less than 75% of the bank’s notional funding costs of 30. The bank’s costs are significantly higher than the allocated funding costs and the difference should be deducted in the calculation of DTR. The same adjustment would be required if the company claimed that the funding costs allocated for tax purposes were zero.


Example 2

DTR calculation for same transaction but instead of being funded entirely by the bank 600 is funded directly by a loan carrying a rate of interest of 2.5% and the remaining 400 is funded out of the bank’s general treasury reserves/borrowings with a cost of 3%.

Included Funding     Bank’s Notional Funding  
Income 40   Income 40
Overheads 6   Overheads 6
Actual funding costs     Bank’s notional funding 30
Loan interest 15      
Bank funding 12      
Profit 7   Profit 4
Tax at 28% 1.96      
Foreign tax 6.00      
DTR claimed 1.96      



In this case the costs of 27 incurred to fund the transaction are more than 75% of the bank’s notional funding costs of 30 so the notional funding costs need not be deducted in the calculation of DTR.


As customary, this guidance should not be relied on in the context of an avoidance scheme.

Please refer any cases of doubt or difficulty to CSTD Business, Assets & International, Base Protection Policy team, 3C/21 100 Parliament Street, London SW1A 2BQ.