Prior to 6th April 2008, the UK tax position favoured UK equity (i.e. share) investments over foreign (i.e. non-UK) equity investments. Whilst dividend income from both was subject to either 10% (for a basic taxpayer) or 32.5% (for a higher rate taxpayer), dividends from UK equity investments carried with them a tax credit of one ninth but no such credit applied to dividends on foreign equity investments making the latter less attractive.
In December 2007, Tom Smith invested £1,000 in ABC Ltd, a UK company, and £1,000 in XYZ Ltd, a foreign company. Each company paid a dividend of £99 to Tom in February 2008.
As a higher rate taxpayer, Tom’s income tax liability was a net £24.75 on the UK dividend [i.e. 32.5% of [99 + 1/9 of 99] less tax credit of 11 is 24.75], leaving Tom with £74.25 cash in hand. On the foreign dividend the liability was £32.175 [i.e. 32.5% of 99 is 32.175] leaving Tom with £66.825 cash in hand.
Post 5th April 2008 - Less Than 10% Shareholding
However, effective 6th April 2008, dividends on foreign equity investments now also carry a one ninth tax credit so, in principle, making them more attractive than before and as attractive as a UK equity investment (at least in tax terms).
The extension of the tax credit in this manner initially only applied if the foreign equity investment amounted to less than 10% of the issued share capital of the relevant company.
Thus, in Example 1 above, if the dividends had been paid on or after 6th April 2008, Tom’s cash in hand on the dividend from XYZ Ltd would have been £74.25, the same as re ABC Ltd.
10% or More Shareholding
From 22nd April 2009, the tax credit also applies even where the percentage of the issued share capital owned is 10% or greater if the company is resident in a qualifying country (broadly, a country with which the UK has a double tax agreement which contains a so-called Non-Discrimination clause e.g. Belgium, France, Germany, Canada and the USA; investments in, for example, Guernsey, Isle of Man and Jersey do not qualify). Also be aware that investments in, inter alia, certain Luxembourg companies may also be problematic.
Although, pre 22nd April 2009, no tax credits were available on dividends from offshore funds, from this date tax credits are available on many, but not all, offshore funds.
Foreign Withholding Tax
It is not uncommon for foreign dividends to have suffered some form of local withholding tax prior to remittance to the investor. In such cases the UK tax position is as follows:
Tom Smith receives a cash foreign dividend of 84 after 15 of local withholding tax (i.e. gross dividend of 99 from which 15 has been withheld by the local tax authorities).
As a higher rate taxpayer Tom’s UK tax liability is:
32.5% x [[84 + 15] + 1/9 of [84 + 15]]
i.e. 35.75 less tax credit of [11 (UK) + 15 (foreign)] is 9.75.
Tom thus receives cash in hand [84 – 9.75] 74.25.
Non-UK Domiciled (Broadly, Non-British) Individuals
For an individual who is subject to UK tax on the remittance basis (i.e. taxed only when monies remitted to the UK) an entitlement to the tax credit is still applicable but the UK income tax charge on the dividends is at 20% or 40% (and not the above 10% and 32.5% rates).
Non-Repayable Tax Credit
As with tax credits on UK dividends, the tax credits on foreign dividends are not repayable should an individual’s income tax liability fall below the amount of the tax credit.
The discrimination in UK tax terms against foreign equity investments for UK residents has now been largely addressed. There are, however, other issues which must be watched including local capital gains taxes on sales; local death and gift taxes and foreign currency fluctuation issues.