A US citizen living in the UK who holds American shares is taxed on the dividends by both countries, and the ordinary foreign tax credit does not help, because it only offsets US tax on foreign-source income. Article 24 of the US-UK treaty resolves this by treating the dividends as arising in the UK, to the extent needed, so that the UK tax above the 15% treaty rate can be credited.
This post is for US citizens resident in the UK with a US brokerage account, US shares from an employer or US funds. It takes the three-stage rule summarised in our guide to avoiding US-UK double taxation and works through it: why the problem exists, what each country does, how the claim is made on Form 1116, and where the rule stops helping.
Why are US dividends a double tax problem for Americans in the UK?
Because both countries tax them in full and the usual relief points the wrong way. The UK taxes its residents on worldwide dividends. The US taxes its citizens on the same dividends under the saving clause, and its foreign tax credit is limited to US tax on foreign-source income, which a dividend from a US company is not.
For a UK resident who is not a US citizen, the position is simple. The treaty caps US tax on portfolio dividends at 15%, collected by withholding once a Form W-8BEN is in place, and the UK gives credit for it. A US citizen cannot use that cap. The saving clause lets the United States tax its citizens as if the treaty did not exist, subject to listed exceptions, so the dividend is taxed on Form 1040 at the rates that apply to the citizen.
Without more, the UK would tax the dividend at its dividend rates, the US would tax it again, and the Form 1116 limitation would allow no credit for the UK tax, since the income is US-source. The relief article is one of the provisions the saving clause leaves in place for citizens, and paragraph 6 of Article 24 was written for this taxpayer. The treaty text is published by both governments, in the IRS treaty documents (opens the official IRS page in a new tab) and on GOV.UK (opens the official GOV.UK page in a new tab).
What does Article 24(6) actually say?
Paragraph 6 applies where the United States taxes a UK resident because that person is a US citizen. It limits the credit the UK gives, requires the US to credit the UK tax that remains, and treats the income as arising in the UK to the extent necessary to make that US credit work.
The paragraph has four sub-paragraphs. The first says the UK need not credit US tax on income that does not come from US sources. The second says that for US-source income, the UK takes into account only the US tax that could have been charged on a UK resident who was not a US citizen. The third requires the US to allow a credit for the UK income tax and capital gains tax paid after that UK credit, without reducing the US tax the UK has credited. The fourth deems the income to arise in the UK, for the exclusive purpose of that US credit.
Two limits are built into the wording. The deeming applies only for the US credit, so the dividend remains US-source for every other purpose. And it applies only to the extent necessary to avoid double taxation, so it cannot produce a credit larger than the double tax it is there to remove. The result is that the United States keeps the tax it could have charged a non-citizen, and gives way to the UK on the rest.
- Stage one: the UK taxes the dividend and credits US tax up to the 15% treaty rate
- Stage two: the US computes its tax on the dividend in the normal way
- Stage three: the US credits the net UK tax, treating the income as UK-source
- Floor: US tax on the dividend cannot fall below the amount the UK credited
How does the calculation work on a dividend?
The UK return goes first. It taxes the dividend at UK dividend rates and gives credit for US tax at the treaty rate. The US return then taxes the dividend and credits the UK tax actually borne after that relief, down to a floor equal to the treaty-rate tax.
Take a US citizen resident in Edinburgh who is a UK higher-rate taxpayer and holds shares in US companies through a US broker. On her UK return the dividends go on the SA106 foreign pages (opens the official HMRC page in a new tab), and she claims Foreign Tax Credit Relief (opens the official GOV.UK page in a new tab) for US tax at 15% of the gross dividend, although as a citizen she pays that tax through Form 1040 and not by withholding. On her US return the dividends are taxed at her US rate. She then claims a credit for the UK tax left after the relief, on a Form 1116 kept separate from her other income.
Where her UK rate on the dividend is higher than her US rate, the outcome is that the United States keeps tax equal to the treaty rate, the UK keeps the balance of its own charge, and no further US tax is due on that income. Where her US rate is the higher one, some US tax remains on top. In both cases the total comes to roughly the higher of the two countries' rates, not the sum of them. We put no figures on it here because both rates depend on her other income.
How is the claim made on Form 1116?
On a separate Form 1116 for the category called certain income re-sourced by treaty. The instructions require a separate limitation for each amount of re-sourced income from a treaty country, so these dividends are not mixed with the passive or general category income reported on the rest of the return.
The Form 1116 instructions (opens the official IRS page in a new tab) describe the category, and Publication 514 (opens the official IRS page in a new tab) contains a worksheet for the additional credit that US citizens resident in certain treaty countries may claim on US-source income. The worksheet follows the three stages. It estimates the US tax on the US-source income, works out what the United States could collect at source under the treaty, and limits the additional credit to the difference, or to the foreign tax available if that is less. The publication says the worksheet is filed with the return as an attachment to Form 1116.
Disclosure is the point on which practice varies. A treaty-based position is normally disclosed on Form 8833, but the reporting rule for a treaty that alters the source of income excepts individuals, and Publication 514 says Form 8833 is not required for the additional credit. The Form 1116 instructions say only that it may be required. Many preparers attach one anyway. We decide case by case and keep the working papers in every case, as part of our treaty relief service.
- Gross US dividends for the calendar year, payer by payer
- The UK tax charged on them, after relief for US tax
- The UK tax years the dividends fall into and the dates UK tax was paid
- The treaty-rate floor and the credit claimed above it
Does re-sourcing cover interest, capital gains and funds?
The paragraph is not limited to dividends. It applies to US-source income and gains that the United States taxes only because of citizenship, so US bank interest and gains on US shares can be re-sourced in the same way. What changes is the floor, because the treaty lets the US charge a non-citizen UK resident little or nothing on those.
For interest, and for most gains on shares, the treaty generally gives the taxing right to the country of residence. The UK therefore gives no credit for US tax at the first stage and charges its full tax, and the United States credits that UK tax at the third stage with no floor to preserve. Gains on US real property are different. The treaty leaves the United States a full right to tax them, and the ordinary rule that the UK credits the US tax applies.
US mutual funds and exchange-traded funds held by a UK resident pay dividends that can be re-sourced like any other, although their UK tax treatment needs checking fund by fund. The 3.8% net investment income tax (opens the official IRS page in a new tab) sits apart from all of this. It is generally not creditable under domestic law, and treaty-based claims to credit foreign tax against it are contested.
When does re-sourcing not help?
It gives nothing where there is no UK tax to credit, and it is limited where the UK tax is lower than the US tax. Re-sourcing does not create relief. It only makes UK tax that has actually been paid on US-source income usable against the US tax on that income.
The clearest case is the UK's regime for new arrivals. A person who claims relief under the rules for those new to the UK (opens the official GOV.UK page in a new tab) for their first four tax years pays no UK tax on the foreign dividends covered by the claim, so the United States taxes the dividend in full and there is nothing to re-source. The same applies to dividends covered by a UK allowance or held in a wrapper the UK exempts. An ISA holding US shares produces dividends with no UK tax and full US tax.
Timing can also strand a credit. UK tax on dividends is usually paid through Self Assessment after the tax year ends, which may fall in a later US year than the dividend, a mismatch explained in our post on which year to credit UK tax. Unused credits carry back one year and forward ten, but only against income of the same category. For the full set of relief mechanisms and how they fit together, return to the guide to avoiding US-UK double taxation.
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
