Double Taxation

Author: Michael Holland, Partner Blick Rothenberg

Double taxation is where income and gains are taxed twice. This can occur when an individual is within the scope of tax legislation in two jurisdictions at the same time.

With the right planning there is often a solution, but in some situations, individuals can find themselves in a double tax position.

It is important to distinguish between temporary double taxation and true, or permanent, double taxation.

Temporary double taxation can be a cashflow problem. In this situation, tax is paid or withheld in two jurisdictions – with the taxpayer usually having to wait before a tax return can be submitted to reclaim some or all of the double paid tax.

True, or permanent, double taxation is quite rare. This can occur when actions are needed within a particular period. If that opportunity is missed, the result can be permanent double taxation. Additionally, there are cases where the two jurisdictions are misaligned in terms of how a specific income or gain item is taxed – meaning that there is no ability to avoid double tax.

Who needs to be aware of potential double taxation?

American citizens and green card holders in the UK.

• The US taxes its citizens and green card holders on a worldwide basis. This is usually irrespective of where income or gains are created.
• Where a person is a UK tax resident, they will be within the scope of UK tax legislation too. This is where individuals can come up against potential double taxation.

The US-UK Double Tax Treaty

Most of the solutions rely on the double tax treaty between the US and the UK.

When it can help, the treaty is normally applied in one of two ways.

Firstly, and depending on a taxpayer’s specific circumstances, an income or gain item can sometimes be exempt from taxation in one of the countries altogether – if a treaty claim is correctly applied to override domestic legislation.

Secondly, in situations where two separate taxes are being applied, the treaty will often set out which of the countries has the primary right to tax. This typically leads to a solution in the form of a foreign tax credit – a credit applied to the tax liability for the other country’s tax.

To give a simple example, an American living and working in the UK will often have employment income that is taxed in both locations. Assume the UK tax rate on employment income is 45%, with the US rate at 37%. The individual will typically be able claim a foreign tax credit as part of the US tax calculation – that a 45% tax is being imposed overseas.

The result is no US tax liability on the income and therefore no double taxation.

So, the treaty solves all problems?

The treaty is a useful tool and often provides taxpayers with an opportunity to resolve potential double tax scenarios. However, seeking proactive, cross-border tax advice is key – careful management of timing is often needed.

It is important to engage advisors who have a strong understanding of the relevant domestic legislation, the treaty itself and how to apply any available solution.