If you are working or living overseas, receiving income from an overseas investment, or are stationed overseas in the military, you may be subject to foreign taxes.
*Please be advised that while every effort is made to keep this information up to date, OFX nor AustralianTimes.co.uk do not provide tax (financial) advice. Consult a tax professional about your unique circumstances.
Do Expats Have to Pay Taxes?
The simple answer: yes. Expats may be required to pay income tax in any geography where they had residency and were earning during the tax year. If you are a U.S. citizen, you are usually required to file income taxes in the U.S. every year, and may be required to pay income tax if your income is above the Foreign Earned Income exclusion. Most other countries do not require citizens who reside abroad to pay income tax on money earned overseas, but you may need to pay taxes like capital gains tax or inheritance tax on the sale of assets in the jurisdiction where the assets are held.
What is a Foreign Tax Credit
Some countries, including the United States, the U.K. and Australia, have foreign tax treaties in place. These treaties usually offer foreign tax credits when you are able to prove that you’ve paid tax elsewhere. These credits help to prevent double taxation, and they may apply to income taxes (including pension payments), inheritance taxes, gift tax and/or and some interest payments. Speak to a qualified tax professional about your unique situation.
In order to be eligible for a foreign tax credit or offset:
- You must have a tax imposed on you.
- You must have paid that tax in a foreign country.
- The tax must be a legal and actual liability.
- The tax is on income, in lieu of income tax, or must otherwise be included in assessable income.
Limits to filing For Foreign Tax Credits in Australia
In Australia, as of 2017, you have four years to file regarding a foreign tax payment.1 If you paid a foreign tax on income that has already been filed in Australia, you can submit an amended assessment within the four year time period.
Limits to Filing For Foreign tax Credits in the United States
In the United States, you can choose a credit or a deduction for a qualifying foreign tax within the year of accrual. It is an annual choice for foreign taxes paid or accrued during the year, so the decision must be made with every annual filing. You may be able to amend a return up to three years after filing.2
Limits to Filing For Foreign Tax Credits in the U.K.
If you are a U.K. resident, you do not need to fill in a tax return on foreign income if your total dividends are under £300.3 The rules may be different when your domicile is abroad. If you have already paid a foreign tax and are trying to recoup that fee under a double-taxation agreement, it is important to know you may not recover the full amount of foreign taxes paid. There are two factors for this:
What is a Foreign Tax Treaty?
A foreign tax treaty is an agreement between two countries to prevent double taxation. Residents may have access to tax credits, deductions, exemptions or reductions based on taxes paid to a foreign government. Benefits of a foreign tax treaty are dependent on a taxpayer paying taxes in a foreign country then submitting documentation of those tax payment when filing elsewhere.
It is important to look at specific agreements when it comes to a foreign tax treaty. The United States Internal Revenue Service, for example, has tables for withholding rates, compensation, and benefits under foreign tax treaties.6 The U.K. provides detailed worksheets for filers claiming foreign tax payments and calculating returns.7 The Australian Taxation Office also provides a worksheet that can be downloaded and completed to determine tax offsets.8
What Types of Benefits are Part of Foreign Tax Treaties?
Benefits under foreign tax treaties vary by country, but you may have benefits waiting for you if you meet certain criteria. Here are a few categories that may have special tax treaty credits:
- If you are a professor or teacher doing research in a foreign treaty country
- If you are a student, trainee or apprentice and receive funds for study, research, business, professional or technical training
- If you receive some grants, allowances or awards associated with a non-profit organization
- If you have a non-government pension or annuities
- If you have investment income like interest or dividends
- If you have received capital gains other than sales of real property
Consult a tax professional to help you reduce your international tax burden.9,10
What Records Do I Need to Keep to Claim a Foreign Tax Benefit or Offset?
You will need written evidence that you have paid a foreign tax. This documentation should be retained for at least five years after all filings have taken place. In the United States and the U.K., this information is provided at the time of filing and specific forms must be completed when tax documents are remitted. In Australia, the Taxation Office advises that you keep evidence of foreign income tax offset, so it can be provided upon request. If they require information that is held overseas, they will provide time for it to be acquired and remitted.11
The written evidence should include the following information:
- Amount of foreign income or gains in the foreign currency
- The foreign tax year (may be different than home country tax year)
- The nature and amount of the foreign tax levied
- The date of payment of the foreign tax
- Any balance due on the tax
Which Foreign Taxes Do Not Qualify for a Credit?
In the United States there are some taxes that you pay to a foreign government that do not qualify for a foreign tax credit. These include, but are not limited to:
- Taxes which qualify for an itemised deduction
- Taxes on foreign mineral income
- A portion of taxes on combined oil and gas income
- Social security taxes paid or accrued to a foreign country where there is a social security agreement in place12
What Limits and Exemptions Exist for Foreign Tax Credits in the United States?
Your foreign tax credit cannot be more than your U.S. tax liability multiplied by a specifically determined fraction. That fraction is as follows: Your taxable income from sources outside the United States over your total taxable income from the U.S. and foreign sources combined.13
However, there are a few exemptions to this foreign tax credit limit.
- If your foreign source of income is passive income, you may not be subject to the limit.
- If your foreign taxes are not more than $300 single, $600 joint filing (as of 2017).
- If you otherwise report all of your gross foreign income and taxes on a payee statement.
- If you determine to exempt yourself from the foreign tax credit limit for the year.14
Which exchange rate should be used to pay foreign taxes?
Australian Exchange Rate for Tax Purposes
If you are in Australia and need to convert foreign income for tax purposes you have two options for this calculation:
First, you can use an exchange rate from a specific time period as determined by Australian tax law. A table of specific times is available on the Australian Taxation Office website for ordinary income, expenses, obligations, liabilities, receipts, payments, and other values that apply to revenue accounts, capital accounts or otherwise.
Second, you can use the average exchange rate. This means you can use average, daily or rates consistent with those used in an audited financial report. The goal of using average exchange rates is to find a rate that would be considered a “reasonable approximation” of an exchange rate if you had used spot rates.
An example of using average exchange rate is such: Say you are receiving a foreign pension. Instead of calculating the exchange rate at each and every payment, the average exchange rate can be applied to the entire yearly amount.
If you receive funds in the currency of your home country, then the amount total can be used without applying an average exchange rate.
US Dollar Exchange Rate for Tax Purposes
All items on a U.S. tax return must be reported in U.S. dollars. In general, the Internal Revenue Service advises that payer use a spot rate, or the prevailing rate when an item is received, paid or accrued. Some qualified business units (QBUs) can use a foreign currency. The IRS has no official exchange rate and generally accepts posted exchange rates that are consistent.
Note: When the IRS receives a tax payment in a foreign currency, the exchange rate of the date the currency is converted to U.S. dollars by the bank processing the payment will be used.16 To keep control of the exchange rate you get when paying taxes abroad, use OFX to lock in an exchange rate for up to 12 months.
U.K. Exchange Rate for Tax Purposes
The United Kingdom provides a list of monthly exchange rates as guidance for remitting payments or calculations. These exchange rates should be used to convert any foreign currency.17
How Do I Save Money When Paying Tax Abroad?
Transferring money internationally with banks is expensive. Most banks charge a margin on the exchange rate of up to 5% in additional to hefty international transaction fees. Use OFX to pay tax abroad, so you can keep more of your hard earned cash. Our margins are substantially less than the banks’ and we can help you lock in a rate today, for payment at a later date.
If your payment date is flexible, you can use a Limit Order to set your desired exchange rate, and your payment will be made when the rate is right. These services all give you more control over your money, which is how we think it should be.