A Comprehensive Guide to the US-UK Tax Treaty
Updated: 3 days ago
Understanding the US-UK Tax Treaty is crucial for American living in the UK and to British people who have US source income. This comprehensive guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.
Relief of Double Taxation
The US-UK tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. Specifically, the treaty allows U.S. citizens and residents to claim a foreign tax credit for the income tax they pay to the UK against their U.S. tax obligations. Conversely, the UK offers a credit for U.S. taxes paid against the UK tax liabilities of its residents.
The Savings Clause
Every tax treaty of the United States, including the one with the UK, includes a provision known as a "Savings Clause." This clause ensures that the U.S. retains the ability to tax its citizens as per its domestic tax laws, irrespective of the stipulations outlined in the treaty. As a result of this clause, for U.S. citizen expats, the majority of the benefits and reductions offered by the treaty do not apply.
Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the Savings Clause exclusions in the US-UK Tax Treaty to accurately determine which tax benefits they can utilize.
Tax Residency and the Tie-Breaker Rules
The United States and the UK each have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual residency could cause, the U.S.-UK Tax Treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.
Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.
Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies, in other words, where they have a closer personal and economic interests.
Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.
Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.
Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and the UK will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.
Taxation of US-Sourced Passive Income
Passive income from U.S. sources, which is not tied to a U.S. trade or business, is taxed at a flat rate of 30% if earned by a non-resident alien. However, the US-UK tax treaty may lower this rate or totally exempt it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.
Treaty Article Citation
Dividends - Paid by U.S. Corporations
Dividends - Qualifying for Direct Dividend Rate
Pensions and Annuities
Social Security and Alimony
* Contingent interest that does not qualify as portfolio interest
**0% rate does not apply to a lump-sum distribution derived from a U.S. pension plan.
Personal Service Income Earned While Temporarily Present in the US
Generally, income received from work performed in the US would be considered US source income and would be subject to US taxation. However, the US UK tax treaty lists certain exemptions where taxes rates are reduced or even eliminated. It's important to note that these exceptions generally do not apply to US citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:
Maximum Presence in U.S
Required Employer or Payer
Maximum Amount of Compensation
Treaty Article Citation
Any foreign resident*
Treated as business profits under Article 7 (VII) of the treaty
Any U.S. or foreign resident
Teaching or research***
Any U.S. educational institution
Studying and training - remittances or allowances****
Any foreign resident
*The exemption does not apply if the employee's compensation is borne by a permanent establishment that the employer has in the United States. **Fees paid to a resident of the treaty country for services performed in the United States as a director of a U.S. corporation are subject to U.S. tax.
***Does not apply to compensation for research work primarily for private benefit.
****Applies only to full-time student or trainee.
The United States and the UK have a Totalization Agreement in place, which is designed to avoid double taxation of their income with respect to social security taxes. It establishes clear rules about which country's social security system covers the employee. As a result, employees and their employers can only be taxed by one country's social security system at a time.
State Taxes and Tax Treaties
Numerous states within the United States impose income taxes on their residents. The adherence to U.S. tax treaty provisions varies by state—some may recognize them, while others may not.
Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state.
Need Help Navigating the US UK Tax Treaty?
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Frequently Asked Questions
Does the U.K. have a tax treaty with the U.S.?
Yes, the U.K. and the U.S. have a tax treaty to prevent double taxation for U.S. expats in the U.K. However, the treaty includes a 'savings clause' allowing the U.S. to tax its citizens as if the treaty doesn't exist, except for certain income items excluded from this clause. This clause is vital for U.S. expats to understand as it can impact their tax obligations
Does the U.K. have a totalization agreement with the U.S.?
Yes, the United Kingdom and the United States have a Totalization Agreement in place. This agreement helps prevent dual social security taxation for individuals working in both countries. It ensures that workers and their employers contribute to only one country's social security system at a time, depending on the length and location of their employment. This agreement is particularly beneficial for expatriates and multinational companies with employees working across both countries.
Do U.K. citizens pay tax on US capital gains?
UK citizens are subject to tax on US capital gains only if they are residents in the US for tax purposes. Non-resident UK citizens typically do not owe US tax on capital gains from US investments. However, they must report and potentially pay tax on these gains in the UK, depending on their UK tax residency status and the specific tax rules applicable. It's important for UK citizens to understand both US and UK tax laws to ensure compliance and avoid double taxation.