Max – studying and working abroad for a year (foreign taxes paid)

The UK left the European Union (EU) on 31 January 2020 and entered a transitional period, currently due to end on 31 December 2020, during which EU law continues to apply in the UK. The UK’s relationship with the EU beyond the end of the transitional period has not yet been finalised. Please note that the guidance below reflects the law as it applied before the UK’s departure from the EU, and as it will continue to apply throughout the transitional period.

In the period 6 April to 1 July 2019, Max works part-time in a bar. He earns income of £2,500 and has tax deducted at source under PAYE of £500 (he was on an 0T tax code meaning tax was deducted at a flat rate of 20%). Once the summer term finishes, he moves to France to spend his third academic year working as a language assistant (he comes home for a few weeks at Christmas to see his family). In the period 15 July 2019 to 5 April 2020, he earns the equivalent of £13,000 in France and pays French taxes of £560.

Per the Statutory Residency Test, Max is considered UK tax resident throughout 2019/20 as he has his only home in the UK for part of the year (albeit his parent’s home), even though he has less than 183 days of physical presence in the UK. This means he is taxable in the UK on his worldwide income. We would expect Max to be resident in France (but treaty non-resident), meaning that he is only taxable in France on his French source employment income.

The UK will give a foreign tax credit to avoid double taxation on the language assistant earnings. 

His 2019/20 UK tax calculation would look like this:

Income £2,500 + £13,000 =	£15,500
Less personal allowance	(£12,500)
Taxable Income	£3,000
Tax thereon @ 20%	£600
Foreign tax credit	(£560)
Residual liability	£40
(less PAYE)	(£500)
Refund	£440

In the calculation above, the availability of the personal allowance means that Max does not have to pay tax on any of his UK earnings. The tax liability arises on the French income, part of which exceeds his personal allowance. The foreign tax credit serves to extinguish most of the UK tax liability on his French earnings – but not all. Max is therefore entitled to most of the UK PAYE he paid on his pre-departure earnings back – as the rest is offset against the £40 shortfall. 

Max will need to complete a tax return to report the foreign income so that HMRC can make the relevant adjustment to the refund amount. If, while Max is preparing his tax return, HMRC accidentally issue the full £500, this does not override the need to complete a tax return. Max must still file his tax return and pay £40 back to HMRC to keep everything correct.

It is worth noting that usually foreign taxes would need to be paid at a rate at least equivalent to the UK tax rate due on the foreign income (usually 20%) to fully extinguish any UK tax liability. However, in this example Max has some of his personal allowance available to use against his French income, meaning the effective UK tax rate on it is lower than 20% and the relatively small amount of French tax he paid nearly covers the UK tax liability on the French income.

For more information and examples involving foreign tax credits in slightly different circumstances, see Tom and Mark.