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. As we will learn, 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 thought of as 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, but can occur in certain scenarios. Sometimes, actions are needed within a particular timeframe and, if that opportunity is missed, the result can be permanent double taxation. Additionally, there are some cases where the two jurisdictions in question 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?
Americans in the UK should be particularly aware of this issue, and for the avoidance of doubt, green card holders are typically impacted in the same way.
The US is one of the only countries in the world that looks to tax its citizens on a worldwide basis. This is usually irrespective of where income or gains are generated.
Of course, an American who is based in the UK will almost always be within the scope of UK tax legislation too, and that is where individuals can sometimes come up against potential double taxation.
The US-UK Double Tax Treaty
Most of the solutions we are alluding to here are thanks to a robust double tax treaty that is in place between the US and the UK – and so it is not always bad news.
When it can help, the treaty is normally applied in one of two different 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 jurisdictions altogether – if a treaty claim is applied correctly to override domestic legislation.
Secondly, in situations where two separate taxes are being applied and there is no scope for exemption, the treaty will often set out which of the jurisdictions holds the primary right to tax. This typically leads to a solution in the form of a foreign tax credit – a reduction of a tax liability in reference to the fact that tax is already being applied overseas.
To give a simple example, an American living and working in the UK will often be generating employment income that is subject to tax in both locations. Let us assume that the UK tax rate on that employment income reaches 45%, with the US rate sitting at 37%. The individual in question will typically be able claim a foreign tax credit as part of the US tax calculation – demonstrating that a 45% tax is being imposed overseas.
The result in that situation should be that the US liability on the employment income is reduced down to £0, with any concerns about double taxation being alleviated.
So, the treaty solves all problems?
The treaty is a very useful tool and often provides taxpayers with an opportunity to resolve a potential double tax scenario. However, seeking proactive, cross-border tax advice is absolutely key here – not least because careful management with respect to 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.
