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HM Revenue and Customs Brief 76/09

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HM Revenue and Customs -Tax Authorities

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Issued 18 December 2009

Changes to the Income Tax credit for foreign dividends

Introduction

This brief publicises changes that have been made to the scope of the Income Tax credit for individuals in receipt of dividends from foreign companies. The changes take effect from 22 April 2009 for the current tax year and affect shareholders in:

  • foreign companies with a holding that is 10 per cent or more of the issued share capital of the company
  • foreign companies with a holding that is 10 per cent or more of a specific class of share in the company
  • offshore funds

Full details of the changes and how they affect individual taxpayers will be given in the Notes to the Foreign Pages of the Self Assessment Return.

Background

Dividends received by individuals are currently taxed at headline rates of:

  • 10 per cent in respect of basic rate taxpayers
  • 32.5 per cent in respect of higher rate taxpayers

However, individuals in receipt of dividends from UK resident companies are entitled under current law to a non-payable dividend tax credit. Since 6 April 2008, individuals with shareholdings of less than 10 per cent in foreign companies have also been entitled to a non-payable tax credit provided that the foreign company is not an offshore fund.

The dividend tax credit is equal to one ninth of the amount of the dividend. Because tax is charged on the gross dividend received, including the tax credit, the effective rate of tax on these dividends is reduced to 0 per cent and 25 per cent.

Changes to be made

Shareholders in offshore funds

There are two changes being made to the tax treatment of distributions from offshore funds that are companies where an offshore fund is:

  • Substantially invested (holds more than 60 per cent of its assets) in interest bearing assets, individuals receiving distributions will be treated for tax purposes as having received interest and not a dividend or other type of distribution. This means that no tax credit will be available and the tax rates applying will be those applying to interest.
  • Equity-based, individuals receiving distributions will be entitled to the dividend tax credit irrespective of the size of their holdings or the territory of origin of the fund.

Shareholders in foreign companies with a holding that is 10 per cent or more of the issued share capital of the company

The dividend tax credit is being extended to shareholders in foreign companies with a holding that is 10 per cent or more of the issued share capital of the company, subject to conditions:

  • the territory of the dividend-paying company must be a ‘qualifying territory’ (see below)
  • the tax credit is not available where the distribution is one of a series of distributions made as part of a tax avoidance scheme, and any dividend-paying company is not resident in a ‘qualifying territory
  • the company must not be an ‘excluded company’(see below)

‘Qualifying territory’

A ‘qualifying territory’ is defined as the UK and any territory with which the UK has a double taxation treaty with a non-discrimination article.

The Treasury has the power to make regulations adding to the list of territories that qualify even if the double taxation treaty in question does not contain an appropriate non-discrimination article, or to exclude territories even if the treaty in question does contain such an article.

The following are ‘qualifying territories’:

Argentina
Australia
Austria
Azerbaijan
Bangladesh
Barbados
Belarus
Belgium
Morocco
Bolivia
Bosnia-Herzegovina
Botswana
Bulgaria
Canada
Chile
China
Croatia
Cyprus
Czech Republic
Denmark
Egypt
Estonia Reunion
Falkland Islands
Fiji
Finland
France
Gambia
Georgia
Germany
Ghana
Greece
Guyana
Hungary
Iceland
India
Indonesia
Ireland
Israel
Italy
Ivory Coast
Jamaica
Japan
Jordan
Kazakhstan
Kenya
Korea
Kuwait
Latvia
Lesotho
Lithuania
Luxembourg
Macedonia
Malaysia
Malta
Mauritius
Mexico
Mongolia
Montenegro
Myanmar
Namibia
Netherlands
New Zealand
Nigeria
Norway
Oman
Pakistan
Papua New Guinea
Philippines
Poland
Portugal
Romania
Russian Federation
Serbia
Singapore
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sudan
Swaziland
Switzerland
Taiwan
Thailand
Trinidad & Tobago
Tunisia
Turkey
Turkmenistan
Uganda
Ukraine
USA
Uzbekistan
Venezuela
Vietnam
Zambia
Zimbabwe

The government has made regulations to exclude from this list companies which are excluded from the benefits of the double taxation agreement with the UK (‘excluded companies’). A dividend from an ‘excluded company’ will be treated as a dividend from a ‘non-qualifying’ territory and will not get the tax credit. The ‘excluded companies’ are:

Barbados – companies established under the International Business Companies Act(s)

Cyprus – companies entitled to any special tax benefits under various Cyprus enactments

Jamaica – companies established under enactments relating to International Business Companies and International Finance Companies

Luxembourg – holding companies established under the Luxembourg 1929 and 1937 Acts

Malaysia – companies carrying on offshore business activity under the Labuan Offshore Business Activity Act 1990

Malta – companies entitled to special tax benefits under various enactments.

Shareholders in foreign companies with a holding that is 10 per cent or more of a specific class of share in the company

Since 6 April 2008, an individual with a shareholding of less than 10 per cent of the issued share capital of a foreign company (a ‘minority shareholder’) has been entitled to the tax credit provided that the foreign company is not an offshore fund. Eligibility to the tax credit is not dependent on the source country of the dividend.

From 22 April 2009, there is an important change in the way the 10 per cent test is applied because the definition of ‘minority shareholder’ has been altered. A ‘minority shareholder’ is now defined as a shareholder with less than 10 per cent of a particular class of share in a company. This will have no impact on the vast majority of individuals with foreign shares, but it is possible that some shareholders with, for example, preference shares will no longer qualify as ‘minority shareholders’.

A shareholder who no longer qualifies as a ‘minority shareholder’ will still receive the tax credit if he can meet the ‘qualifying territory’ test explained above.

Foreign tax credit relief

There is no change to foreign tax credit relief in respect of foreign withholding tax. An individual who is eligible to receive both foreign tax credit relief and the dividend tax credit will get the benefit of both, subject to a ceiling equal to liability to UK income tax in respect of the dividend. ‘Excess credits’ are lost; they are not repayable and cannot be offset against liability to income tax elsewhere.

Please note that where foreign tax credit relief is restricted under the terms of the Double Taxation agreement with the UK, the amount allowable is calculated on the amount of the foreign dividend, not the amount of the dividend inclusive of the dividend tax credit.

Worked examples:

A basic rate taxpayer receives a net foreign dividend of 76.5 after 13.5 withholding tax is deducted at source.

The UK dividend tax credit of one ninth of the dividend is calculated on the gross dividend (1/9 x (76.5 + 13.5) = 10).

The amount subject to income tax is the gross dividend plus the dividend tax credit (90 + 10 = 100).

Basic rate taxpayers are subject to the dividend ordinary rate 10% on their grossed up dividend income (100 x 10% = 10).

This taxpayer is entitled to foreign tax credit relief and the UK dividend tax credit (13.5 + 10 = 23.5). The UK tax liability is eliminated but the excess credit cannot be used.

A higher rate taxpayer receives a foreign dividend on the same basis.

The UK dividend tax credit of one ninth of the dividend is calculated on the gross dividend (1/9 x (76.5 + 13.5) = 10).

The amount subject to income tax is the gross dividend plus the dividend tax credit (90 + 10 = 100).

Higher rate taxpayers are subject to the dividend upper rate 32.5% on their grossed up dividend income (100 x 32.5% = 32.5)

Again, the taxpayer is entitled to foreign tax credit relief and the UK dividend tax credit (13.5 + 10 = 23.5). The UK tax liability is reduced to 9 (32.5 – 23.5).


About the Author

© Crown Copyright 2009.

A licence is need to reproduce this article and has been republished for educational / informational purposes only. Article reproduced by permission of HM Revenue & Customs under the terms of a Click-Use Licence. Tax briefs are updated regularly and may be out of date at time of reading.



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Article Published/Sorted/Amended on Scopulus 2009-12-18 18:28:59 in Tax Articles

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