If you’re a UK resident, you’ll normally be liable to pay UK income tax on your dividends from foreign shares, unless you hold the shares in a tax-free account such as an ISA or a SIPP.
These dividends will usually be subject to the same tax rates and allowances as dividends from companies in the UK. You enter them in a different section of your self-assessment tax return – known as SA106 or the Foreign pages – but they count as part of your overall dividend income.
This sounds simple and in some cases it really will be that easy. Where the situation gets complicated is that a foreign dividend will often have had some withholding tax (WHT) deducted before you receive it. This tax goes to the tax authority in the country where the company is based.
You are then liable to pay a further round of tax on the same gross income to the UK tax authorities. So under some circumstances, you could end up being taxed twice on the same income (known as double taxation).
This is obviously something to avoid. So it’s important to understand how these taxes interact, which stocks may have the simplest tax treatment and which may end up costing you more.
Getting credit for foreign tax
In theory, double taxation shouldn’t happen. The UK has double taxation agreements with most other countries and these include a limit on how much WHT the foreign authorities should deduct from dividends being paid to a UK resident.
Any WHT that is deducted under these agreements can usually be offset against any UK tax that would be due on that income. HM Revenue & Customs calls this Foreign Tax Credit Relief (FTCR).
Let’s take an example where this process works smoothly. The typical WHT rate under most of the UK’s treaties is 15%, although in some cases the rate will be lower or there will be no WHT deducted at all (a detailed list is on the HMRC website).
So a UK investor receives his dividend net of 15% tax. He must then declare the dividend to HMRC in his tax return and pay UK tax on it at a rate that depends on his marginal income tax rate and whether he has any tax-free personal allowance or dividend allowance left unused.
So for the 2020/2021 tax year, his UK tax rate could be 0% (if the dividend is covered by one of his allowances), 7.5% (basic rate), 32.5% (higher rate) or 38.1% (top rate). However, the Foreign Tax Credit Relief allows him to reduce his UK tax liability by the smaller of the UK tax due or the foreign WHT already paid.
The table below shows how this would work for an investor in each tax bracket who receives the equivalent of £100 in dividends from a country with 15% WHT.
|Foreign WHT rate||15%||15%||15%||15%|
|Dividend after WHT||£85||£85||£85||£85|
|UK tax rate||0%||7.5%||32.5%||38.1%|
|Foreign Tax Credit Relief||0%||7.5%||15%||15%|
|UK tax due||0||0||17.5||23.1|
|Dividend after tax||£85||£85||£67.5||£61.9|
|Total tax paid||15%||15%||32.5%||38.1%|
You’ll notice one important point. For higher-rate and top-rate taxpayers in this example, the total tax they pay exactly equals their UK tax rate. But the non-taxpayer and basic-rate taxpayer lose a total of 15%, higher than their UK tax rates.
That’s because the Foreign Tax Credit Relief isn’t intended to give you a refund on all the tax you paid to the foreign tax authority or offset it against your wider UK tax bill. It’s simply intended to stop you paying tax twice on that dividend.
How you can be taxed twice
So far, so good. But there’s a complication. While the tax treaty says that the maximum WHT that the foreign country can charge a UK investor is 15%, the foreign country is allowed to deduct more initially and then refund it to anybody who’s eligible.
That’s often what happens. The foreign tax authority might deduct a lot more – say 35% – and expect you to submit a claim to get the extra WHT back.
Meanwhile, the maximum Foreign Tax Credit Relief that HMRC will allow you to claim is the amount in the treaty, not the amount actually deducted. It expects you to reclaim the rest.
Let’s take an example of what happens an investor gets a dividend with 35% WHT deducted, but the treaty only allows for 15% and she doesn’t reclaim the rest.
|Foreign WHT rate||35%||35%||35%||35%|
|Dividend after WHT||£65||£65||£65||£65|
|UK tax rate||0%||7.50%||32.5%||38.1%|
|Foreign Tax Credit Relief||0%||7.5%||15%||15%|
|UK tax due||£0||£0||£17.5||£23.1|
|Dividend after tax||£65||£65||£47.5||£41.9|
|Total tax paid||35%||35%||52.5%||58.1%|
You can see that the amount of tax that she loses on this dividend is much higher than her UK tax rate and higher than the original WHT rate on the dividend. She’s been taxed twice on the same income and in this case it’s very costly.
Reclaim tax or shelter your dividends
So what can you do in this situation? The theoretical answer is to file a claim with the foreign tax authorities and reclaim the rest of the WHT. In practice, many tax authorities make this very bureaucratic or costly and often not realistic for most investors or for small dividends.
The more practical option is to minimise the amount of UK tax you have to pay, so at least you are not being taxed twice. That probably means holding the shares in an tax-free account such as an ISA or a SIPP.
The third point is to make sure that you look at foreign dividends in the context of what they will be worth to you after all tax, not just the headline gross yield.
That may mean you end up favouring dividends from countries with low WHT or where brokers can get dividends paid net of WHT.
For example, the US headline WHT rate is 30%, but UK residents are entitled to a reduced rate of 15% if you complete form W-8BEN [PDF] (most brokers will get you to do this when you open an account). US stocks held in a SIPP can have dividends paid with no WHT at all, if your broker is set up to do this.