Soak-up tax

A soak-up tax is a charge imposed by a foreign country with the intention of using up the foreign tax credit that a taxpayer would otherwise claim in their home jurisdiction. The idea is that the foreign country increases its tax to match the maximum credit the home country will allow, so the taxpayer’s overall tax bill does not rise, but more of the tax revenue is collected abroad.

Example: Assume Countries A and B have a tax treaty that permits residents of A to credit taxes paid in B against their domestic tax, up to a limit of 20%. Country B normally levies a 10% tax on foreign enterprises. Realizing that taxpayers from A can claim a credit up to 20%, B adds a special 10% soak-up tax for those eligible for the credit. As a result, the taxpayer pays a combined 20% in B. Country A then grants an equivalent foreign tax credit, leaving no tax due in A. While the taxpayer’s overall liability remains unchanged, Country B captures the extra 10% through the soak-up tax.