Paying tax in two countries on the same income is not inevitable. Foreign tax credits exist to prevent exactly that. But they do not work in the way most people assume.

You have income from overseas. You have paid tax on it in the country where it arose. Now HMRC wants to tax the same income in the UK.

Surely the double tax treaty prevents this?

Not quite. Double tax treaties do not let you choose where to pay your tax. They provide a mechanism to make sure you do not pay full tax in both countries at the same time. That mechanism is the foreign tax credit, and understanding how it works is essential for anyone with cross-border income.

What Is a Foreign Tax Credit?

A foreign tax credit is a reduction in your UK tax liability that reflects tax you have already paid overseas on the same income.

The UK has double tax treaties with a large number of countries. Those treaties determine which country has the right to tax specific types of income, and to what extent. Where both countries have some taxing right, the foreign tax credit system steps in to prevent genuine double taxation.

You claim foreign tax credits through your UK self assessment tax return. The claim does not happen automatically. If you do not make it, HMRC will simply tax the income in full.

How the Mechanism Works in Practice

A practical example makes this much clearer.

You live and work in the UK. You also rent out a property in France. The rental profits are £10,000. France taxes those profits and charges you £1,500. When you complete your UK tax return, HMRC would normally charge you £2,000 on the same profits at the basic rate.

Without a foreign tax credit, you pay £3,500 in total. With the credit, you offset the £1,500 paid in France against your UK bill. You pay £500 in the UK and £1,500 in France, a total of £2,000. You end up paying the higher of the two rates, not both rates in full.

What Happens When the Overseas Tax Is Higher?

The credit works in one direction only. It reduces your UK liability. It never generates a refund.

Take the same example but reverse the numbers. France charges £2,500 on the same income and the UK would charge £2,000. The UK gives you a credit that reduces your liability to nil. You pay nothing in the UK. But the UK does not refund the £500 difference. Your total bill is £2,500, paid entirely in France.

This is one of the most common misunderstandings we encounter. The credit eliminates UK tax in this scenario, but it does not compensate you for the higher overseas rate.

When Foreign Tax Credits Do Not Apply

Foreign tax credits are not available in every situation. The treaty between the UK and the relevant country governs whether a credit is available, and for some income types the rules are more restrictive than people expect.

Pensions

Pensions are a common area where credits cause confusion. Many double tax treaties give one country exclusive taxing rights over pension income. Where the UK has exclusive taxing rights, no credit is available for tax paid overseas because the overseas country should not have taxed the income in the first place.

In that situation, the correct approach is to go back to the overseas country and claim a refund of the tax they withheld. This is often more complicated in practice than it sounds, but it is the right route.

Dividends

Dividends create a different problem. Most double tax treaties allow the country where the dividend originates to tax it, but only up to a specified limit. Germany, for example, often withholds tax at 30% or more on dividends paid to UK residents. Under most treaties, the permitted withholding rate is only 15%.

In this situation, the UK gives you a credit only up to the treaty limit of 15%. The excess withholding, the amount above what the treaty permits, needs to be reclaimed directly from the German tax authorities. That process is separate from your UK tax return and requires a direct application to the overseas revenue authority.

Why Getting This Right Matters

Foreign tax credits sit at the intersection of UK domestic tax law and international treaty obligations. Get the claim right and you avoid genuine double taxation. Get it wrong and you either overpay tax in the UK, miss a reclaim you are entitled to overseas, or both.

The key points to remember are these. Always check what the relevant treaty says about the specific type of income before assuming a credit is available. Never assume that paying tax overseas removes your UK reporting obligation. And always make the claim through your tax return rather than assuming HMRC will apply it automatically.

Getting the Right Advice

If you have overseas income and you are not certain whether you are claiming the right credits in the right way, the consequences of getting it wrong compound over time. Overpaid tax that falls outside the four year window for amendments cannot be recovered.

At LSR Partners, we deal with foreign tax credit claims regularly across a wide range of income types and treaty relationships. We make sure you claim what you are entitled to and pay no more than the rules require.

LSR Partners help you pay the right tax in the right place at the right time. Book a call with us at lsrpartners.com to discuss your situation.

This article is for general information purposes only and does not constitute tax advice. Your individual circumstances will affect how foreign tax credits apply to you. Please contact us to discuss your specific position.