Understanding Foreign Tax Credit Relief in the UK

At Towerstone Accountants we provide specialist small business accountancy services for owners, directors, and growing businesses across the UK. We created this webpage for small business owners and managers who want clear explanations of accounting terms, processes, and concepts they may encounter when running a business. Our aim is to make financial language easier to understand, and help you make better informed decisions with confidence.

Foreign tax credit relief is one of the most important yet misunderstood areas of UK tax, particularly for people with overseas income, international investments, or work that crosses borders. I regularly speak to individuals and business owners who are worried about being taxed twice on the same income, and in many cases that fear is justified, but only if the relief is not claimed correctly. Others do the opposite and assume they are protected automatically, only to discover later that HMRC still expects tax to be paid because the rules were misunderstood.

The reality is that foreign tax credit relief exists to prevent double taxation, but it is not automatic in every situation, and it is not always straightforward. It depends on the type of income, where it arises, whether a tax treaty exists, how much tax was paid overseas, and how UK tax applies to that same income.

In this article I want to explain foreign tax credit relief properly, in clear UK English, without jargon where possible, and with practical context. I will cover what foreign tax credit relief is, when it applies, how it works in practice, the role of double taxation agreements, and the common mistakes I see people make. This is written from real experience advising UK taxpayers with overseas income, and the aim is clarity rather than theory.

What Is Foreign Tax Credit Relief?

Foreign tax credit relief is a UK tax mechanism that allows you to reduce your UK tax bill when you have already paid tax on the same income in another country.

The key principle is simple. The UK does not want to tax the same income twice if tax has already been paid overseas, but it also does not want to give relief beyond what UK tax would have been.

In practice, this means that foreign tax credit relief usually allows you to offset overseas tax paid against your UK tax liability on the same income, up to a maximum of the UK tax due.

It does not usually result in a refund of overseas tax, and it does not always eliminate UK tax completely.

Why Foreign Tax Credit Relief Exists

Without foreign tax credit relief, international income would be heavily penalised.

Imagine earning income overseas, paying tax there as required, and then being taxed again in full when you declare that income in the UK. This would discourage international work and investment.

Foreign tax credit relief exists to balance the system. It ensures that income is taxed once, broadly at the higher of the two countries’ tax rates, rather than twice.

It also helps maintain fairness between UK based income and overseas income.

When Foreign Tax Credit Relief Applies

Foreign tax credit relief generally applies when all of the following are true:

• You are subject to UK tax on an item of income or gain

• You have paid tax on that same income or gain in another country

• The overseas tax is a tax on income or gains, not a penalty or fee

• The overseas tax was properly charged under that country’s rules

If these conditions are met, relief is usually available, either under UK domestic law or under a double taxation agreement.

The Role of Double Taxation Agreements

Double taxation agreements, often called tax treaties, play a major role in how foreign tax credit relief works.

The UK has tax treaties with many countries. These agreements set out which country has taxing rights over different types of income, and how double taxation should be relieved.

In many cases, the treaty will specify whether:

• The overseas country has the primary right to tax

• The UK must give credit for tax paid overseas

• Tax should only be charged in one country

Where a treaty exists, its rules usually take priority over domestic law.

Understanding the relevant treaty is often the key to getting foreign tax credit relief right.

Types of Income Where Foreign Tax Credit Relief Commonly Applies

Foreign tax credit relief can apply to many types of income, but some are more common than others.

These include:

• Employment income earned overseas

• Self employed or freelance income from overseas clients

• Overseas rental income

• Foreign interest and dividends

• Overseas pensions

• Capital gains on overseas assets

Each type of income has its own nuances, and the availability of relief can differ depending on the source and structure.

Employment Income and Foreign Tax Credit Relief

Employment income is one of the most common areas where foreign tax credit relief is needed.

This often arises where someone works overseas, either temporarily or permanently, and pays local income tax, but remains UK tax resident.

In these cases, the UK will usually tax the employment income as part of worldwide income. Foreign tax credit relief can then be claimed for the overseas tax paid.

The amount of relief is limited to the UK tax attributable to that income. If the overseas tax rate is higher than the UK rate, you do not usually get a refund of the excess.

If the overseas tax rate is lower, you may still have some UK tax to pay after relief.

Self Employed and Business Income

Foreign tax credit relief can also apply to self employed or business income earned overseas.

This is common for consultants, freelancers, and business owners who provide services internationally.

The key issues here are:

• Where the trade is carried on

• Whether there is a permanent establishment overseas

• How the overseas income is taxed locally

In some cases, the UK may have primary taxing rights. In others, the overseas country may tax the income first, with the UK giving credit.

These situations can become complex quickly, and careful analysis is often needed.

Overseas Rental Income

UK taxpayers who own property overseas are often surprised to discover that the UK still taxes that rental income if they are UK resident.

In most cases, the country where the property is located will tax the rental income first. The UK will then tax the same income, but foreign tax credit relief can usually be claimed for the overseas tax paid.

This prevents double taxation, but it does not mean the UK tax bill disappears entirely.

Differences in allowable expenses, tax rates, and exchange rates can all affect the final outcome.

Foreign Dividends and Interest

Foreign dividends and interest are another common area where foreign tax credit relief applies.

Many overseas investments deduct withholding tax at source before income is paid. This tax is often charged automatically and can vary widely between countries.

When you declare the income in the UK, you may be entitled to claim foreign tax credit relief for the withholding tax deducted.

However, relief may be limited by the terms of the relevant tax treaty, which often caps the amount of withholding tax that can be credited.

Capital Gains and Foreign Tax Credit Relief

Capital gains tax can also give rise to foreign tax credit relief, although this area is particularly nuanced.

Some countries tax capital gains differently to the UK, and some do not tax them at all.

If a gain is taxed overseas and also subject to UK capital gains tax, foreign tax credit relief may be available.

However, relief is limited to the UK capital gains tax attributable to that gain, and differences in calculation methods can complicate matters.

How the Credit Is Calculated in Practice

Foreign tax credit relief is not a pound for pound offset in every case.

The basic calculation involves comparing:

• The overseas tax paid on the income

• The UK tax due on that same income

The credit allowed is the lower of these two amounts.

For example, if you pay £1,000 in overseas tax and the UK tax on that income is £800, the relief is capped at £800.

If the UK tax is £1,200, the relief is limited to the £1,000 paid overseas, and you pay the remaining £200 to HMRC.

The Importance of Matching Income Correctly

One of the most common mistakes I see is mismatching income and tax.

Foreign tax credit relief must relate to the same income. You cannot offset overseas tax paid on one source of income against UK tax on another.

This means accurate records are essential, particularly where income is earned across multiple countries or tax years.

Timing differences between overseas tax systems and the UK tax year can also cause confusion.

Claiming Foreign Tax Credit Relief on a UK Tax Return

Foreign tax credit relief is usually claimed through your UK Self Assessment tax return.

You must:

• Declare the overseas income in full

• Declare the overseas tax paid

• Claim the appropriate credit

In many cases, HMRC requires evidence that the overseas tax was paid, such as tax assessments, payslips, or withholding tax certificates.

Failing to claim relief correctly can result in either overpaying tax or facing queries later.

When Foreign Tax Credit Relief Is Not Available

Foreign tax credit relief is not available in every situation.

Common situations where relief may be denied include:

• The overseas charge is not a tax on income

• The overseas tax was not properly due

• The income is not taxable in the UK

• Relief is limited or excluded by a tax treaty

Understanding when relief does not apply is just as important as knowing when it does.

Foreign Tax Credit Relief Versus Exemption

In some cases, income may be exempt from UK tax altogether under a tax treaty.

This is different from foreign tax credit relief.

Under an exemption, the income is not taxed in the UK at all, so no credit is needed.

Under a credit system, the income is taxed in the UK, but overseas tax is credited.

Knowing which applies is critical, as treating exempt income as creditable income can lead to errors.

Common Mistakes With Foreign Tax Credit Relief

Over the years, I see the same issues repeatedly.

These include:

• Assuming relief is automatic

• Claiming credit for taxes that are not eligible

• Failing to keep evidence of overseas tax paid

• Misunderstanding treaty limits

• Incorrect currency conversions

• Claiming relief in the wrong tax year

Most of these mistakes are avoidable with proper advice and careful record keeping.

Currency and Exchange Rate Issues

Foreign tax credit relief calculations must be done in sterling.

This means overseas income and tax paid must be converted using appropriate exchange rates.

Using the wrong rate, or inconsistent rates, can distort the relief claimed and attract HMRC attention.

This is a small detail that often causes disproportionate problems if handled incorrectly.

How an Accountant Helps With Foreign Tax Credit Relief

Foreign tax credit relief is not something to guess.

An accountant can help by:

• Identifying which income qualifies for relief

• Interpreting relevant tax treaties

• Calculating relief correctly

• Ensuring claims are supported by evidence

• Avoiding overclaims and underclaims

In many cases, the tax saved or penalties avoided far exceed the cost of advice.

Planning Ahead to Use Foreign Tax Credit Relief Properly

The biggest benefits often come from planning before income is earned, not after.

This can include:

• Structuring contracts and income sources

• Understanding withholding tax rates in advance

• Timing income and payments

• Keeping proper documentation from the outset

Once income has been received and tax paid, options are more limited.

Foreign Tax Credit Relief and HMRC Enquiries

Claims for foreign tax credit relief can attract HMRC scrutiny, particularly where amounts are large or complex.

This does not mean claims are wrong, but it does mean they should be robust.

Good records and clear explanations make these enquiries far easier to deal with.

Final Thoughts

Foreign tax credit relief exists to protect you from being taxed twice, but it only works if it is understood and applied correctly.

It is not automatic, not universal, and not always straightforward. It depends on income type, tax treaties, and accurate reporting.

For anyone with overseas income, understanding foreign tax credit relief is essential. Getting it wrong can mean paying too much tax or facing avoidable disputes with HMRC.

With the right approach, foreign tax credit relief does exactly what it is designed to do. It creates fairness, clarity, and confidence in an increasingly international financial world.

You may also find our guidance on expat tax and what is income tax useful when exploring related accounting topics. For a wider collection of plain English explanations, you can visit our knowledge hub.