Five common US-UK income tax misconceptions

We outline common incorrect statements regarding the application of the US-UK income tax treaty and the impact on US and UK tax planning.

In brief

• For anyone who falls within the US and UK income tax systems, it is essential to understand how the tax treaty between the two countries works.
• Double taxation is a distinct possibility without careful planning.
• The US-UK income tax treaty provides solutions, but its application is not always intuitive.

We continue to meet with potential clients that do not have a clear understanding of their tax exposure in the US and UK. Much of this uncertainty comes from an incorrect understanding of how the US-UK tax treaty (the “treaty”) works. The income tax treaty between the US and UK provides the rules necessary for the intended avoidance of situations leading to double taxation where a taxpayer is exposed to taxation in the US and UK.

Although this agreement between the US and UK governments is intended to mitigate situations of double taxation, careful planning is required to ensure it is utilised correctly.

The treaty is relatively straightforward when dealing with the situation of a resident of one country deriving income or gain from the other country, but not actually residing there. However, for the US person living in the UK (i.e., resident of both countries), the application of the treaty becomes more complex.

Below are some of the incorrect statements that we regularly hear:

“There is an income tax treaty between the US and UK and, therefore, a US person living in the UK cannot be taxed twice on the same income or gain.” 

“The US-UK income tax treaty article wording says which country has the right to tax. The other country can therefore not claim any tax.” 

Again, this is incorrect. 

The ‘savings’ clause within all US treaties provides, in very general terms, that the US will continue to tax its citizens and green card holders on most of their worldwide income and gains, irrespective of any treaty in place. 

As discussed in point one above, the treaty in most cases determines ‘first’ taxing rights rather than ‘sole’ taxing rights. 

“I have income and gains realised outside the UK that I have shielded from UK tax using the remittance basis. As I’ve paid US tax on this income and gains the treaty enables me to bring them to the UK with a full tax credit for US tax suffered.”

This is incorrect.

Simply having previously paid US tax on an item of income and gain does not mean that the UK is obliged to provide a credit for that tax upon future remittance. If it is an item of income and gain upon which the UK has first taxing rights, the fact US tax has previously been paid is irrelevant to the UK liability. 

Again, tax credit planning is essential. The deferral mechanism of the remittance basis in many cases is not beneficial for US citizens living in the UK, where the funds will be needed in the UK at some point in the future. 

Using the example of capital gains again: 

• A US citizen who is non-domiciled in the UK is taxable in the US on worldwide income and the UK on the remittance basis. 
• They realise a $100,000 gain on the sale of shares in Amazon in 2017.
• They paid US federal income tax on this gain of $20,000 (20% long term capital gain rate). 
• They emitted the remaining $80,000 to the UK in March 2022. 
• The UK will tax the remitted gain of $80,000 also at 20% ($16,000) but will not give a credit for the US tax previously suffered. 
• Again, the treaty provides that the UK has first taxing rights, and the US must allow a credit for the UK tax suffered against any UK tax liability. However, it may be the case that given the timing of the UK tax payment, the tax credit in the US will not work efficiently. 
• This could be a situation of double taxation. 
   

“I’m a US citizen living in the UK. I have only a UK-based source of income and therefore the treaty removes any requirement for me to file anything with the IRS.” 

This statement is incorrect.

The treaty has no impact on the requirement of a US individual to file a US federal income tax return, and related information reporting annually. This is irrespective of any tax liability arising in the US.

“I’m a UK resident (non-US person) in receipt of US source income. The US-UK tax treaty means I am not exposed to US tax.” 

Sadly, this is incorrect. 

The US-UK tax treaty can certainly reduce the level of tax withholding on certain items of income but does not necessarily remove the exposure completely. 

If a UK resident is in receipt of a US source of income, it is essential that the payor is furnished with a W8-BEN or equivalent to confirm non-US status and the availability of treaty relief. Also, the individual will still need to determine whether a US tax return filing obligation still exists because of that type of income or gain, as it may be necessary to formally claim any treaty benefits available. 

This is a complex area and in a lot of cases certainly not intuitive.

When these points are discussed, it is not uncommon to be asked, “How will the IRS and HMRC ever find out about this?”, which is not a recent development. 

The obligation remains firmly placed on the taxpayer to comply with any self-assessment obligations they have in either or both countries. 

However, the significant amount of information flow between governments, under enforcement strategies such as Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS), means the likelihood of enquiry is increasing.