Property Developers, Property Investors

US and UK Tax Treaties

Simon Misiewicz

Simon Misiewicz

Expat & Property Tax Specialist

14th September 2021

Do you know about US and UK tax treaties?

The subject of US and UK tax treaties should be of interest to all American ex-pats living in the UK. The US has dozens of tax treaties with countries around the world. The US and UK tax treaty is one of them.

The US UK tax treaty protect US ex-pats in the UK from paying more tax than they need to.

US and UK tax treaties have been in place since 1945 as an important tool for preventing the double taxation of income on individuals. It covers US persons’ activities in the UK and British ex-pats in the US.

For US ex-pats in the UK, the US and UK tax treaties offer credits, deductions, exemptions and reductions in the income tax rate to prevent the double taxation of income in the US and the UK.

Resourcing income is also another significant benefit of the US UK tax treaties.

For most American ex-pats, utilization of the tax treaty for US tax purposes needs to be disclosed to the IRS on a Form 8833, which is included in the Federal income tax return.

Failure to disclose a treaty-based return position can result in a penalty for an individual of up to $1,000.

It is recommended that you review US and UK tax treaties to ensure you’re aware of your tax liabilities.

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What are the basics of US and UK tax treaties?

As tax accountants serving thousands of investors that purchase buy to let properties, we know that the basics of US and UK tax treaties can seem complex and confusing.

Tax rates on income in many countries increased significantly during World War I and stayed higher. UK multinationals with subsidiaries based abroad, such as in the US, suffered because the UK did not provide a foreign tax relief until 1945, when a tax treaty was signed with the US.

The double income tax discouraged British investment and reduced their competitiveness in the US during 1914-1945.

Under US and UK tax treaties, since 1945, residents of foreign countries have been taxed at a reduced rate or exempt from US taxes on certain items of income.

These reduced tax rates and exemptions vary among countries and specific items of income.

Under the same treaties, residents or citizens of the US are taxed at a reduced rate or are exempt from foreign taxes on certain items of income they receive from sources within countries such as the UK.

What are the main treaties?

Most income tax treaties contain what is known as a Saving Clause which prevents a citizen or resident of the US from using the provisions of a tax treaty to avoid taxation of US-sourced income.

The US and UK have entered into several different international tax treaties.

The two main treaties are the Double Tax Treaty and the Foreign Account Reporting Act.

The US and UK tax treaties that most impacts individuals are the US and UK Income Tax Treaty.

This US and UK tax treaty impact many different issues, including passive income, foreign pension, double taxation and more.

The treaty is good for assessing tax issues between the US and UK, but there can be hidden issues such as applying the Saving Clause.

If you’re unsure of your tax position, speak to one of our US and UK tax advisors today.

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Why do US and UK tax treaties exist?

The US and UK have an income tax that residents are obliged to pay.

This can create difficulties because American ex-pats pay US income tax and what they might pay in the UK.

The US is one of the few countries that taxes based on citizenship, not a place of residency.

Certain tools like the Foreign Earned Income Exclusion and the Foreign Tax Credit help to alleviate this.

US citizens living in the UK ran into trouble when it came to pension taxation. To resolve this, the US entered into individual tax treaties.

The main purpose of the US and UK tax treaties is to solve the double taxation issue.

The US-UK Income Tax Treaty – formally known as the ‘Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains’ also addresses tax evasion, income taxes and capital gains taxes between the two countries.

To find out more about the US and UK tax treaties, we recommend reviewing relevant documents.

What are the benefits of US and UK tax treaties?

Professional use of the US and UK tax treaties can reduce a taxpayer’s overall tax liability.

Because the US and UK tax systems are not the same and have different rules on what constitutes income and what income can be recognised and taxed, double taxation is still possible without the right advice from US and UK tax advisors.

Proper planning can reduce an individual’s exposure to taxation in the US and UK.

The US and UK have tax treaties in place designed to reduce any double taxation. The US also gives credit for UK taxes. It is still important to speak to tax experts to minimise your tax bill in the US and UK.

How do I avoid double taxation in the US and UK?

The US and UK allow for a credit against their domestic tax for foreign taxes paid on foreign-sourced income.

The domestic law foreign tax credit systems will sometimes reduce the impact of double taxation.

Countries such as the US and UK enter into tax treaties to clarify and formalise the use of foreign tax credits.

Within the US-UK tax treaty are specific provisions addressing individual tax issues.

There are more than a dozen provisions, although the ones that affect Americans in the UK the most are Article 17 (US taxation on UK pensions) and the Saving Clause.

Thanks to the tax treaty, contributions to a pension in the UK can be tax-deferred, just like the US 401K and other tax-deferred retirement vehicles.

Even though distributions are usually taxable, Article 17 will help prevent American ex-pats from paying taxes twice.

Another benefit of the US and UK tax treaties is that it allows your social security (UK state pension) to only be taxable in the country in which you are residing.

What is the Saving Clause?

The Saving Clause states that a country may tax its citizens as if the tax treaty never existed.

As a result, most treaty provisions are rendered ineffective for Americans living in the UK but provides coverage for UK citizens living in the US.

The Foreign Tax Credit (FTC) is available for American ex-pats to claim against British taxes paid.

The FTC is possible because of the exceptions of the Saving Clause.

If you’re an American ex-pat unsure of your tax position in the UK, speak to one of our UK tax accountants today.

How do I claim US-UK tax treaty benefits?

There are some situations where you may be double taxed on income despite all the exclusions and tax treaty benefits.

It is important to speak to a tax advisor before filling out Form 8833, as some of the US and UK tax benefits gained from tax treaties don’t have to be claimed with Form 8833.

If you were employed by a British company and live and work in England but your employer sends you to the US for a business trip where you receive income for services delivered in the US.  The IRS would consider this as US-based income, and you’d owe US income tax on this.

Article 24 of the US-UK tax treaty would alleviate this. To claim it, you would file Form 8833 and include your example in the summary.

Are there UK-specific tax issues to be aware of?

There are some complicated aspects of different types of accounts in the UK, including:

– Private pensions have different reporting requirements to public pensions
– Only certain companies can provide qualified life insurance policies
– Individual Savings Accounts (ISAs) can create foreign Trust issues as they are taxed annually in the US
– Treaty benefits and totalization benefits have specific reporting requirements
– The calendar year should be used to calculate US taxes, not the UK tax year
– It is common for American ex-pats to have non-UK financial accounts, so understanding other countries tax treaties is critical.

To fully understand UK tax law, speak to a UK tax advisor at your soonest opportunity.

When can I claim for Foreign Earned Income Exclusion?

American citizens and residents living and working in the UK may be entitled to a Foreign Earned Income Exclusion that reduces taxable income.

In addition, you may also exclude housing expenses. There are limits and special rules about who qualifies for the exclusion.

To claim the Foreign Earned Income Exclusion, the taxpayer must work full-time in a foreign country for an entire calendar year. This is called the Bona Fide Residence Test.

This means they must work outside of the US for at least 330 of any 365 day period, known as the Physical Presence Test.

How do I get Foreign Tax Credits if working in the UK?

Foreign Tax Credit is a non-refundable tax credit for income taxes paid to HMRC.

This is available to anyone who either worked in a foreign country or has investment income from a foreign source.

Before applying, you must prove that you’re eligible for tax relief.

Can I avoid being taxed under US and UK tax treaties?

US citizens and permanent residents are required to file ex-pat tax returns with the Federal Government every year regardless of where they reside.

Whether you need to pay income tax to HMRC depends on if you are classed as a resident in the UK.

If you’re not a UK resident, you will not have to pay UK tax on your foreign income.

You may be interested in services where we help Americans move to the UK with tax in mind. There are many legal matters and tax issues that you need to consider. We have also written a useful article about people moving from the US to the UK and getting a VISA.

A note for British pensions and the US UK tax treaty

British citizens benefit from tax deferral on their UK pensions. HMRC allows a tax reduction on your contributions going into the pension investment. There is no UK tax on the growth of the pension pot, be it income or capital gains. You will pay PAYE type of taxation when you withdraw your money from the pension fund upon retirement.

We have written a much more detailed article on pensions and how you will benefit from many tax breaks, go ahead and read that for more details.

Brits moving to the UK will be pleased to know that the US UK tax treaty allows the tax deferment to continue. The UK pension tax deferral is similar to the US pension tax deferral on a 401k pension.

Another benefit of the US UK tax treaty is that the UK government pension will only be taxable in the United Kingdom and will not be taxed by the IRS in the United States.

Make sure your expat tax advisor speaks to you about pensions. Please be mindful that the FCA regulates most UK financial advisors, but they may not be willing to talk about US pensions such as the 401K. This is also true of American financial advisors. They may not want to handle your UK pensions to avoid getting into trouble with their regulators.

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