An Overview of the US/UK Tax Treaty Income Tax Rules

US UK Tax Treaty

Introduction to the US UK Tax Treaty 

US & UK Tax Treaty Documents

The United States and the United Kingdom (UK) first entered into an International Income Tax Treaty back in 1975 — almost 50 years ago. That tax treaty was then revamped in 2001 with a 2001 protocol. In addition, the US and UK have entered into a FATCA Agreement and Totalization Agreement as well. But, the reason why the US and UK income tax treaty is so important, is because it impacts various key issues for Taxpayers involving the tax rules between both countries, such as Pension, Passive Income (such as dividends, interest, real estate, and royalties), Social Security — and other related income generated from government/public institutions. While the United Kingdom and United States Tax Treaty is very detailed — our Board-Certified International Tax Law specialist team will introduce some of the most important concepts identified within this tax treaty — and how it may impact citizens and residents in both countries when dealing with the IRS.

Saving Clause in UK/US Income Tax Treaty

As we work through the treaty, one important thing to consider is the saving clause. The saving clause (essentially) provides that, despite any information provided in the treaty — both countries reserve the right to tax certain citizens and residents as they would otherwise tax them under the general tax principles of their respective countries. As with any tax treaty, the United Kingdom and US tax treaty contains a saving clause provision. 

• • • Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect. 5. The provisions of paragraph 4 of this Article shall not affect:

UK/US Tax Treaty Exceptions to Savings Clause (Article 1, Paragraph 5)

Paragraph five of Article 1 provides for certain carve-outs from the saving clause. 

• • • The tax treaty provides benefits to taxpayers who are parties to either country that would not otherwise be granted under general tax law principles. 

    • The saving clause limits the application of the treaty benefits to certain taxpayers; and

    • The saving clause exempts certain articles or provisions from the saving clause — so that if an article is exempted from the savings clause it will prevail over general tax principles of that country.

      • The provisions of paragraph 4 of this Article shall not affect:

        • a) the benefits conferred by a Contracting State under

          • paragraph 2 of Article 9 (Associated Enterprises)

          • sub-paragraph b) of paragraph 1

          • paragraphs 3 and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support),

          • paragraphs 1 and 5 of Article 18 (Pension Schemes) and

          • Articles 24 (Relief From Double Taxation), 25 (Non-discrimination), and 26 (Mutual Agreement Procedure) of this Convention;

        • b) the benefits conferred by a Contracting State under

          • paragraph 2 of Article 18 (Pension Schemes)

          • Articles 19 (Government Service)

          • 20 (Students)

          • 20A (Teachers), and

          • 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.”

    • The difference between subpart (a) and (b), is that subpart B is limited to individuals who are neither citizens nor permanent residents of that state where the benefit is being derived.

Permanent Establishment (Article 5)

• • • 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

    • 2. The term “permanent establishment” includes especially:

      • a) a place of management;

      • b) a branch;

      • c) an office;

      • d) a factory;

      • e) a workshop; and

      • f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

    • 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts for more than twelve months.

    • 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include:

      • a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

      • b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

      • c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

      • d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;

      • e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

      • f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in sub-paragraphs a) to e) of this paragraph, provided that the 9 overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

What does this Mean

It means that in general, unless there is a fixed place of business sufficient to meet the requirements of there being a Permanent Establishment (PE) in the other country — that the other country does not have the right to tax income generated by the business within its borders for income generated within its country’s borders. For example, if a UK citizen has a business in the United States then the United States has no right to tax income generated within the United States from that business — unless there is a permanent establishment.

Income from Real Property (Article 6)

• • • 1. Income derived by a resident of a Contracting State from real property, including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State.

    • 2. The provisions of paragraph 1 of this Article shall apply to income derived from the direct use, letting, or use in any other form of real property.

    • 3. The provisions of paragraphs 1 and 2 of this Article shall also apply to the income from real property of an enterprise.

What does this Mean

It means that if a person in one country generates income from real property located in the other country, then the other country has the opportunity to tax the income. What is important, is that it does not use the term shall — so it is not limited only to that other country.

Also, Article 6 is not exempted from the saving clause.

Dividends (Article 10)

1. 1. 1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

      2. 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the dividends are beneficially owned by a resident of the other Contracting State, the tax so charged shall not exceed, except as otherwise provided,

         1. a) 5 per cent. of the gross amount of the dividends if the beneficial owner is a company that owns shares representing directly or indirectly at least 10 per cent. of the voting power of the company paying the dividends;

         2. b) 15 per cent. of the gross amount of the dividends in all other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

What does this Mean

As with most tax treaties, the rules involving dividends are very complicated — but from a baseline perspective, dividends which are paid by a company of one country, to a resident of the other country may be taxed by that other country. And, while the first country (country of source) still gets the opportunity to tax the income — it can only be taxed at limited tax rates as provided in the treaty.

*The United States and United Kingdom tax treaty is very detailed involving dividends, and so a thorough review must be had by all involved prior to making any determination on how dividends will be taxed.

Interest (Article 11)

1. 1. 1. Interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.

      2. The term “interest” as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits, and, in particular, income from government securities and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds or debentures, and all other income that is subjected to the same taxation treatment as income 15 from money lent by the taxation law of the Contracting State in which the income arises. Income dealt with in Article 10 (Dividends) of this Convention and penalty charges for late payment shall not be regarded as interest for the purposes of this Article.

What does this Mean

When it comes to interest income, when interest is being derived in one country but paid to a resident of another country — it shall only be taxable in that other country. As with dividends, there are various exceptions and exclusions — especially when it involves issues involving the Permanent Establishment or other relationships between parties.

Gains (Article 13)

1. 1. 1. Gains derived by a resident of a Contracting State that are attributable to the alienation of real property situated in the other Contracting State may be taxed in that other State.

      2. For the purposes of this Article the term “real property situated in the other Contracting State” shall include:

         • a) rights to assets to be produced by the exploration or exploitation of the sea bed and sub-soil of that other State and their natural resources, including rights to interests in or the benefit of such assets;

         • b) where that other State is the United States, a United States real property interest; and

         • c) where that other State is the United Kingdom:

           • (i) shares, including rights to acquire shares, other than shares in which there is regular trading on a stock exchange, deriving their value or the greater part of their value directly or indirectly from real property situated in the United Kingdom; and

           • (ii) an interest in a partnership or trust to the extent that the assets of the partnership or trust consist of real property situated in the United Kingdom, or of shares referred to in clause (i) of this sub-paragraph.

      3. Gains from the alienation of property (other than real property) forming part of the business property of a permanent establishment that an enterprise of a Contracting State has or had in the other Contracting State, including gains from the alienation of such a permanent establishment (alone or with the whole enterprise), may be taxed in that other State, whether or not that permanent establishment exists at the time of the alienation.

What does this Mean

When it comes to gains, if it is received by a resident of one country as a result of real property located in the other country — then it may be taxed in that other country. There is a very complex and detailed definition of what qualifies as real property situated in the other contracting state. As with dividend income, there are many exceptions and exclusions to take into consideration when determining whether or not gains will be taxed by one country or the other — or both.

Entertainers and Sportsmen (Article 16)

1. 1. 1. Income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as a sportsman, from his personal activities as such exercised in the other Contracting State, which income would be exempt from tax in that other State under the provisions of Article 7 (Business Profits) or 14 (Income from Employment) of this Convention, may be taxed in that other State, except where the amount of the gross receipts derived by that resident, including expenses reimbursed to him or borne on his behalf, from such activities does not exceed twenty thousand United States dollars ($20,000) or its equivalent in pounds sterling for the taxable year or year of assessment concerned.

What does this Mean

When a person is an entertainer and they receive income as a result of performing entertainment activities in the other country, it may be taxable in that other country unless it is exempt — which for these purposes means it did not exceed $20,000 total.

Pension Income

Pension income involving the UK is incredibly detailed and complex — so much so that we have an entire detailed separate article on the limited issue of UK Pension Income and US Tax.

Reporting Forms for UK Accounts/Assets

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investment funds and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.” There are four main thresholds for individuals is as follows:

• • • Single or Filing Separate (in the U.S.): $50,000/$75,000

    • Married with a Joint Returns (In the U.S): $100,000/$150,000

    • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

    • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance, or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• • • Gift from a Foreign Person: More than $100,000.

    • Gift from a Foreign Business: More than $16,815.

    • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• • • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

    • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

    • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

    • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

    • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).  The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Received a Gift or Inheritance From the United Kingdom?

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business, or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in the United Kingdom Report U.S. Account Holders?

There are thousands of Foreign Financial Institutions within the United Kingdom that report US account holder information to the IRS. The list can be found here: FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• • • Bank Accounts

    • Investment Accounts

    • Retirement Accounts

    • Direct Stock Ownership

    • ETF and Mutual Fund Accounts

    • Pension Accounts

    • Life Insurance or Life Assurance Policies

Totalization Agreement & the United States/United Kingdom

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

• • • An agreement between the United States and the United Kingdom (U.K.) improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries.

      It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

The United States has entered into 26 Totalization Agreements, including the UK.

International Information Reporting Requirements

Each year, US taxpayers who have foreign investments, accounts, pension plans, and life insurance policies may be required to report the values of their overseas assets — along with any income generated from them — to the Internal Revenue Service. When a taxpayer misses an international information reporting return deadline, it may lead the IRS to issue fines and penalties. Oftentimes these international penalties can be avoided or abated through one of the offshore voluntary disclosure programs — or other IRS amnesty procedures. It is important to note that not all foreign account filing forms have the same deadlines and due dates — and the process for seeking an extension will vary depending on the type of form. Let’s look at six important facts about foreign account filing deadlines.

FBAR Due Date and Extension

The FBAR is used to report foreign bank and financial accounts to the US Government. The Form is due on April 15, but is currently on automatic extension. Therefore, if you did not file the FBAR (FinCEN Form 114) by April 15, you still have until October to file it. And, you do not have to file an extension form such as Form 4868 or 7004 to obtain the FBAR extension — because the extension is automatically granted.

Form 8938 Due Date and Extension

Form 8938 is used to report foreign assets to the IRS in accordance with FATCA (Foreign Account Tax Compliance Act). It is similar (but not identical) to the FBAR. Form 8938 is filed with your tax return and is due when your tax return is due. If you are an individual filing a Form 1040, then the form 8938 would be due in April along with your 1040 tax return — but if you extend the time to file your tax return, then your Form 8938 will go on extension as well.

Form 3520 Due Date and Extension

Form 3520 is used to report foreign gifts and foreign trust information. The due date for Form 3520 is generally April 15, but taxpayers can obtain an extension to file Form 3520 by filing an extension to file their tax return for that year. Similar to Form 8938, there is no specific Form 3520 extension form required beyond requesting an extension of the underlying tax return.

Form 3520-A Due Date and Extension

Form 3520-A is used to report US ownership of a Foreign Trust. Unlike Form 3520, Form 3520–A is usually due in March and not April. In addition, the rules for filing an extension for Form 3520-A are different as well (subject to the substitute filing rules). In order to extend the due date to file Form 3520-A, the taxpayer must file a separate Form 7004 extension form.

Form 5471 Due Date and Extension

Form 5471 is used to report the ownership of certain foreign corporations. The filing date is the same as when a person’s tax return is due — and if the taxpayer files an extension for the underlying tax return, Form 5471 will go on extension as well. In recent years, Form 5471 has become infinitely more complex — so taxpayers should be cognizant of the different filing requirements and plan accordingly.

Missed Prior Year’s Foreign Account Reporting Deadlines?

If a taxpayer has not properly reported their foreign accounts, assets, or investments in prior years, they may want to wait before filing these documents for the current year. That is because Taxpayers should try to avoid making a quiet disclosure (which may result in significant fines and penalties). To do that, Taxpayers should submit to one of the offshore disclosure programs. Taxpayers may also want to consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in international tax matters before submitting to the IRS to get an understanding of the different requirements.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.