INTM168210 - Foreign tax paid on trade income: limitation on credit: 1998 legislation: Examples
In each of the following examples, it is assumed that the `foreign loan interest’ is £100,000, being interest at 10 per cent on a loan of £1m and that the financial expenditure incurred in making the loan is £85,000. The other main conditions for each example are summarised in the table below:
| Example | Lender | Borrower - country of tax residence | Type of rate | Foreign tax rate |
|---|---|---|---|---|
| 1 | UK Bank | Brazil | Tax withheld | 25 per cent |
| 2 | UK Bank | Malaysia | Tax `spared’ | 15 per cent |
| 3 | UK Bank | Pakistan | Tax ‘spared’ | 55 per cent |
| 4 (see Note a) below) | UK Bank | Spain | Tax withheld | 25 per cent |
| 4 (see Note a) below) | UK Bank | Spain | Tax `spared’ | 10.75 per cent |
| 5 (see Note (b) below) | UK branch of Cyprus Bank | Country X | Tax withheld | 15 per cent |
| 6 (see Note (c) below) | UK branch of Cyprus Bank | Spain | Tax withheld | 25 per cent |
Notes: -
- Spanish incentive legislation (matched in the double taxation agreement between Spain and the UK) provides for 95 per cent of the income to be exempt from Spanish tax. The remaining 5 per cent is liable to Spanish tax at the full domestic rate of 25 per cent. However, Article 11(2) of the agreement limits Spanish tax paid or
spared' to 12 per cent of the gross amount of the interest. Since tax at a rate of 1.25 per cent (that is, 5 per cent of 25 per cent) is actually paid, thespared’ tax is limited to 10.75 per cent of the gross interest. - For Country X it is assumed that the domestic rate tax is 15 per cent. but under a double taxation agreement with the UK, tax is limited to 5 per cent. of the gross interest. There is no agreement with Cyprus.
- Cyprus does not at present have a double taxation agreement with Spain. A Cyprus bank will suffer tax at the full Spanish domestic rate, currently 25 per cent.
Example 1
| - | £ | £ |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| Amount eligible for credit limited to 15% of the foreign loan interest | 15,000 | - |
| - | £ | - |
| Foreign tax withheld | 25,000 | - |
| less amount eligible for credit | (15,000) | - |
| less excess foreign tax withheld | (10,000) | (10,000) |
| Adjusted interest | - | 90,000 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 5,000 |
| Corporation tax @ 35% | - | 1,750 |
| Tax credit relief limited to | - | 1,750 |
Example 2
| - | £ | £ |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| Amount eligible for credit limited to 15% of the foreign loan interest | 15,000 | - |
| plus amount eligible for credit as ‘spared’ tax | - | 15,000 |
| Adjusted interest | - | 115,000 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 30,000 |
| Corporation tax @ 35% | - | 10,500 |
| Tax credit relief limited to | - | 10,500 |
Example 3
| - | £ | £ |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| Amount eligible for credit limited to 15% of the foreign loan interest | 15,000 | - |
| plus amount eligible for credit as ‘spared’ tax | - | 15,000 |
| Adjusted interest | - | 115,000 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 30,000 |
| Corporation tax @ 35% | - | 10,500 |
| Tax credit relief limited to | - | 10,500 |
It should be noted that no relief is available for excess foreign tax since the whole of the balance of 40,000 (tax spared' 55,000 less 15,000 eligible for credit) is spared’ tax (see INTM168110).
Example 4
| - | £ | |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| - | £ | - |
| Amount eligible for credit limited to: | - | - |
| Tax withheld | 1,250 | - |
| Tax ‘spared’ | 10,750 | - |
| Amount eligible for credit | 12,000 | - |
| plus amount eligible for credit as ‘spared’ tax | - | 10,750 |
| Adjusted interest | - | 110,750 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 25,750 |
| Corporation tax @ 35% | - | 9,012.50 |
| Tax credit relief limited to | - | 9,012.50 |
It should be noted that although 5 per cent of the foreign loan interest suffers Spanish tax at 25 per cent, tax on the remaining 95 per cent being `spared’, the amount eligible for credit is limited to 12 per cent of the interest (see (a) of the Notes above). As no restriction is required to the amount eligible for credit there is no excess tax to be relieved by way of deduction in adjusting the amount of the interest for tax purposes.
Example 5
| - | £ | £ |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| Amount eligible for credit limited to the amount which would have been eligible if the branch had been resident in the UK. Under the double taxation agreement, the amount eligible is limited to 5 per cent of the foreign loan interest | 5,000 | - |
| - | £ | - |
| Foreign tax withheld | 15,000 | - |
| less amount eligible for credit | (5,000) | - |
| less excess foreign tax withheld | (10,000) | (10,000) |
| Adjusted interest | - | 90,000 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 5,000 |
| Corporation tax @ 35% | - | 1,750 |
| Tax credit relief limited to | - | 1,750 |
Example 6
| - | £ | £ |
|---|---|---|
| Foreign loan interest | - | 100,000 |
| Amount eligible for credit limited to the amount which would have been eligible if the branch had been resident in the UK. Under the double taxation agreement, the amount eligible is limited to 12 per cent of the foreign loan interest | 12,000 | - |
| - | £ | - |
| Foreign tax withheld | 25,000 | - |
| less amount eligible for credit | (12,000) | - |
| less excess foreign tax withheld | (13,000) | (13,000) |
| Adjusted interest | - | 87,000 |
| less financial expenditure | - | (85,000) |
| Interest for tax credit relief purposes | - | 2,000 |
| Corporation tax @ 35% | - | 700 |
| Tax credit relief limited to | - | 700 |
It should be noted that since the branch is not a resident of the UK for the purposes of the double taxation agreement between the UK and Spain, it is not entitled to claim tax credit relief in respect of any Spanish tax `spared’.