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HMRC internal manual

International Manual

HM Revenue & Customs
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Foreign tax paid on trade income: limitation on credit: Methods of approximation

In practice it will not usually be possible to subdivide trade profits between each class of share, bond or other income bearing asset. Where derivatives are involved, it may be similarly unrealistic to expect an apportionment of each derivative by reference to the underlying subject matter, or the extent to which the derivative is hedged by each class of equity holding.

Therefore, in practice, it will be necessary to allow results to be aggregated, so that for example more than one class of shareholding are considered together. This sort of approximation is acceptable only if it uses all information that is available, or that can reasonably be made available, to the extent that such information is likely to produce a more accurate result.

It may often be the case that the use of approximate methods will not lead to any material difference in the calculation of credit relief. Where this is the case, even if information enabling a more precise calculation is available approximate methods may be used.

In designing an approximate method, it will often be necessary to exclude altogether certain trade results from the calculation of the profit for which credit relief is available. For example:

  • If an equity trader includes both UK and foreign dividends in a portfolio, the results of the portfolio should be apportioned on a reasonable basis between profit attributable to UK equities and that attributable to foreign equities.
  • If a derivatives trader hedges risks that result from the issue of derivatives by acquiring equities, only that part of the derivatives’ profit for which the risk is hedged by foreign equities should be included in the calculation of tax credit for tax withheld from dividends received in respect of the foreign equities. Where, or to the extent that, the derivatives are unhedged, or hedged by other means, their profit or loss should be excluded from the calculation of the limit on foreign tax credit . A reasonable basis should be used to apportion a derivative, or a portfolio of derivatives, between the part that is in a hedging relationship with foreign equities and the part that is not.

This may require an apportionment to be made of portfolio results, and this can be done on any reasonable basis, such as asset value, headcount, floorspace or deal tickets, or any reasonable combination of such factors. Where appropriate, these values may be taken from balance sheet date information. The basis should be used consistently but may include some flexibility to take account of changing circumstances. Having identified the gross profit, it is necessary to deduct funding cost and overheads. Here also, a suitable approximate basis may be used - for example, apportionment of expenses on the basis of profit calculated before deduction of funding expense and overheads may be appropriate.

Example 1

The results of an equities trader whose UK and foreign trades are highly integrated has results as summarised below:

  Gross Profit Expenses        
  Equities Derivatives Funding Overheads Net Profit  
  UK Foreign        
  100 500 200 400 200 200

The derivatives are used to hedge risk from equities, and the hedging policy is the same for UK or foreign equities. As gross profit on foreign equities is 83% of the total, for the purpose of this example, we attribute the same proportion of the profit on derivatives, and of expenses. If follows that 83% of the net profit, which comes to 167, is attributable to the foreign part of the business. The maximum credit relief that can be given for tax withheld from the foreign equities is therefore 30% of 167 = 50. This method of allocation is only illustrative, and in other cases, a different basis of allocation may be preferable.

Example 2

A derivatives trader’s results are summarised below

  Derivatives hedged by equities Equities profit Expenses Profit      
  Profit % Hedged UK Foreign Funding Overheads  
  1000 60% 100 300 700 500 200

On average 60% of the risk attaching to derivatives is hedged by holdings of equities, and profits from these holding are 75% foreign, 25% UK. Hedging policy is the same for UK or foreign risks, so it is reasonable to attribute 75% of 60% of the derivatives profit to the foreign equities, giving a figure of 450.

The gross profit attaching to the foreign equities is 300 + 450 = 750 out of a total of 1000 + 100 + 300 = 1400. Again assuming allocation on the basis of gross profit, the amount of expense to be attributed to this figure is 750/1400 X 1200 = 643. Therefore net profit attaching to the foreign equities is 750 - 643 = 107 and the limit on credit relief is 30% of 107 = 32.1.