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  • Part 3: What credit can you claim for foreign tax?

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    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

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    This part explains the general foreign tax credit rules for Australian residents and the rules that apply specifically to Australian companies.

    Summary of part 3

    Section 1

    Foreign tax credits available to all Australian residents

    Section 2

    Credits available only to Australian resident companies

    The general rule is that:

    • if you are an Australian resident for taxation purposes, you may be entitled to a credit for the foreign tax you have paid, and 
    • if you are an Australian company, you may also be entitled to a credit for foreign underlying tax paid by a CFC on your share of assessable, attributable income.

    Section 1: Foreign tax credits available to all Australian residents

    Partnerships

    Partners can claim a credit for their share of foreign tax paid on foreign income derived through a partnership. The amount of foreign income and the credit for foreign tax paid should be included in each partner's return.

    Trusts

    Where an amount of trust income is included in the return of a beneficiary, that beneficiary may claim a credit for the foreign tax paid by the trust.

    The trust's income must be divided into the appropriate classes of income. The beneficiary's share of the trust income must also be divided into the appropriate classes of income.

    The trustee has to show in the trust tax return the amount of foreign income and attributed foreign income.

    The trustee is also required to show in the trust tax return the sum of the foreign tax paid and deemed paid in respect of the part of the net income to which beneficiaries are presently entitled (and assessable) and the foreign tax credit allowable in respect of the part of the net income on which the trustee is assessable.

    On the distribution statement, the trustee has to show the portion of foreign tax that relates to the share of foreign income to which each beneficiary is presently entitled (and assessable).

    The trustee also has to show the amount of foreign income included in net income on which the trustee is assessable and the foreign tax credit allowable in respect of that income.

    A credit is not available for foreign tax paid in respect of income that is attributed to a transferor as a result of the transferor trust measures. For details on the transferor trust measures, see chapter 2.

    Unit trusts

    The foreign income of a unit trust is treated in the same manner as foreign income of any other trust.

    For which types of foreign tax is a credit allowable?

    Creditable foreign taxes include:

    • foreign tax equivalent in nature to Australian income tax - for example, a tax on net income or capital gains
    • foreign withholding tax similar to Australian withholding tax on interest and dividends
    • foreign taxes listed in Australia's double taxation agreements.

    Taxation Ruling IT 2507 - Income tax: foreign tax credit system - foreign taxes eligible for credit against Australian income tax provides a list of creditable taxes. The list in the ruling is not exhaustive. If you wish to seek credit for foreign taxes not identified in the list you should ask for a ruling from the Tax Office, using the format set out in Taxation Ruling IT 2507.

    You are not allowed a credit for penalties, fines, interest, and unitary or credit absorption taxes.

    Credit for notional tax forgone by developing countries

    Certain double taxation agreements with developing countries provide for 'tax sparing'. Tax sparing preserves taxation incentives which are provided by a treaty partner to promote economic development. If tax sparing applies to a tax incentive, you can claim a credit for tax forgone by a treaty partner under the incentive. The double taxation agreements list the taxes for which tax sparing is provided.

    Foreign tax credit allowable for a dividend paid from income which has previously been attributed

    Dividends derived by all Australian residents for tax purposes (including individuals) from profits that have been taxed on an accruals basis are non-assessable non-exempt income. A credit is available for foreign tax paid by the Australian resident on these dividends even though they are not assessable.

    Credit for foreign taxes paid after your assessment

    You are allowed a credit only for foreign tax which you have actually paid or which you are deemed to have paid. You will need to request that a determination of your foreign tax credit entitlement be made or amended if you wish to claim a credit for foreign tax paid after your original assessment. Your assessment may also need to be amended to gross up your foreign income for any additional foreign tax credit you claim.

    For further information please see Taxation Ruling IT 2529- Income tax: foreign tax credit system - foreign tax credit determinations. Note that the three-year period for claiming a credit referred to in the ruling has since been extended to four years.

    Refunds of foreign tax

    You cannot claim a credit for foreign tax refunded to you or to another person. Nor can you claim a credit where any other benefit is provided as a result of the payment of the foreign tax.

    Two types of benefits will not result in the denial of a tax credit:

    • a general benefit which arises as a result of the payment of foreign tax - a general benefit is a benefit not directly linked with the payment of foreign tax 
    • a benefit which is a reduction of a tax liability.

    A credit will therefore not be denied solely because a country provides an imputation credit, a rebate of tax or a foreign tax credit for the foreign tax.

    Evidence of foreign tax paid

    The following documents will be acceptable as evidence of payment of foreign tax:

    • a notice of assessment and receipt for the tax paid 
    • a statement from a foreign tax authority setting out particulars normally recorded on a notice of assessment and receipt for payment 
    • a certificate for deduction of withholding tax issued by the person who pays the interest, dividends or any other income that is subject to a deduction of foreign tax.

    In all cases, retain the original documents because the Tax Office may need to see them at a later date.

    If the documentary evidence is in a foreign language, you will need a translation of the documents.

    For further information see Taxation Ruling IT 2527 - Income tax: foreign tax credit system -.procedures in relation to claims for foreign tax paid.

    Working out your foreign tax credits

    You must work out your foreign tax credit entitlement separately for each class of foreign income. This is called quarantining. Your foreign tax credit for each class cannot be more than the Australian tax applicable to that class of your taxable foreign income.

    Note: The government announced in the May 2005 Budget that the requirement to quarantine foreign tax credits will be removed, with effect for credits arising in income years first commencing on or after the relevant legislation receives Royal Assent.

    What are the classes of foreign income?

    Foreign income is divided into four classes for the purpose of allowing a foreign tax credit:

    • passive income
    • offshore banking income
    • certain lump sum payments from foreign non-complying superannuation funds
    • other income.
    What is passive income?

    Passive income includes dividends, interest, annuities, rental income, royalties, amounts received for the assignment of a patent, copyright, capital gains, passive commodity gains and amounts included in assessable income under the CFC, FIF or transferor trust measures.

    Capital gains

    An assessable gain or profit of a capital nature is deemed to be foreign income for working out a foreign tax credit if it is derived from a source in a foreign country. Capital gains are included in the 'passive' class of foreign income.

    For further details on credits for foreign tax paid on capital gains, please see Taxation Ruling IT 2562 - Income tax: foreign tax credit system - interaction of foreign tax credit provisions with capital gains and capital losses provisions of part IIIA.

    What is offshore banking income?

    Offshore banking income includes:

    • interest, fees, commissions or similar income derived from offshore banking transfers 
    • dividends paid by a company out of profits derived from offshore banking transfers.
    What are lump sum payments from foreign non-complying superannuation funds?

    These lump sum payments included in assessable income under section 27CAA are treated as a separate class of income.

    What is other income?

    Other income is income that does not belong to any of the other classes of income. For instance, it would include income from commercial activities, salary or wages and most pensions.

    Working out the amount of assessable foreign income for creditable foreign taxes

    Your assessable foreign income for each class is 'grossed up' by the amount of foreign tax credit you can claim for that class of income. A company must also include an amount equal to any credit allowable for foreign underlying tax.

    Example 8: Creditable foreign taxes

    A company resident in New Zealand pays a dividend of $100 to an Australian resident individual. As New Zealand deducts $15 withholding tax, the taxpayer actually received $85. The taxpayer's assessable foreign income for that dividend will be $100 - that is, the amount of the dividend before the payment of withholding tax.

    End of example
    What deductions are allowable?

    You may claim the following deductions for each class of assessable foreign income:

    • expenses directly related to that class of foreign income
    • other deductions relating to that class of foreign income
    • a share of the apportionable deductions - that is, deductions that cannot be related to a particular type of income - for example, gifts
    • unused quarantined foreign losses from prior years
    • prior year domestic losses, if you make an election to offset those losses against a class of foreign income
    • if your allowable deductions for the current year are more than your domestic source income, the amount by which those deductions are more than your domestic source income.

    See Appendix 2 of this guide and Taxation Ruling IT 2446 - Income tax: foreign tax credit system: allowable deductions referable to foreign income for more information on allowable deductions.

    Conversion of foreign amounts

    All foreign income, deductions and foreign tax paid must be expressed in Australian dollars, (unless a functional currency election is in effect). The following table shows how to convert certain amounts.

    Type of foreign income

    Convert foreign income to Australian dollars at:

    Foreign employment income, pensions and annuities

    the exchange rate that applied at the time you were paid or had the income applied or dealt with on your behalf or as you directed (such as into a bank account), even if no amount was remitted to Australia.

    Foreign business income, dividends, interest and other income

    the exchange rate that applied at the earlier of when you received or derived the income (or, for statutory income, the earlier of when you received the income or were first required to include it in your assessable income)

    Foreign capital gains

    the exchange rate that applied at the time of the transaction or event for each transaction or event involving an amount of foreign currency (or the market value of property expressed in a foreign currency). For example, if an amount included in the cost base of an asset is expressed in foreign currency, convert that amount into Australian currency on the date that the expenditure was incurred. Convert capital proceeds on the date of the CGT event.

    Foreign tax paid

    the exchange rate that applied at the time the foreign tax was paid.

    Foreign deductions (other than capital allowances)

    the exchange rate applicable at the earlier of when the amount was paid or when it became deductible.

    Depreciating assets

    the cost of a depreciating asset is to be converted at the exchange rate that applied at the earlier of when you begin to hold the asset or satisfied your obligations for it (that is, when you paid for it). This converted cost is then used to calculate the capital allowance deductible.

    At the time of publication, the tax law did not permit the use of average rates. However, there is a regulation-making power under which methods of conversion other than those set out above may be specified. For more information on converting foreign amounts to Australian dollars see Translation (conversion) rules.

    Working out your Australian tax payable

    The foreign tax credit you are allowed for each class of foreign income is limited to the Australian tax payable on that class of income. Therefore, you must first work out the Australian tax payable.

    To do this, multiply your average rate of Australian tax by your adjusted net foreign income. Deduct any rebates which apply to that income - apart from a rebate under an Act fixing the rates of income tax or under an Act imposing income tax. Expressed as a formula, the calculation is as follows:

    ATP = AR × ANFI

    ATP

    Australian tax payable

    AR

    average rate of Australian tax

    ANFI

    adjusted net foreign income

    How is the average rate of Australian tax worked out?

    The average rate of Australian tax (AR) is worked out by dividing the gross tax on your taxable income less certain rebates by your taxable income. Expressed as a formula, the calculation is as follows:

    AR = (gross tax + Medicare levy + Medicare levy surcharge − qualifying tax offsets) ÷ taxable income

    For this calculation, deduct concessional, zone or overseas service rebates.

    What is adjusted net foreign income?

    Adjusted net foreign income (ANFI) is your net foreign income adjusted for apportionable deductions. Apportionable deductions are deductions of a concessional nature that do not relate directly to income producing activities - for example, gifts.

    Net foreign income is your gross assessable foreign income less:

    • allowable deductions relating exclusively to your foreign income 
    • any domestic loss carried forward that you have elected to use against your foreign income 
    • deductions allowed as being appropriately related to your foreign income.
    How is adjusted net foreign income determined?

    Your adjusted net foreign income is determined as follows:

    • If your net foreign income exceeds the sum of your taxable income plus apportionable deductions, your adjusted net foreign income will equal your taxable income 
    • If your net foreign income consists of two or more classes of income - that is, quarantining applies - and your combined net foreign income from all classes is more than the sum of your taxable income plus apportionable deductions, your ANFI for each class will equal your taxable income. ANFI is divided proportionately, as shown in example 9, into:
      • passive income
      • offshore banking income
      • lump sum payments assessable under section 27CAA, and
      • other income 
    • In any other case, your adjusted net foreign income is your net foreign income multiplied by your taxable income divided by the total of your taxable income and apportionable deductions. Expressed as a formula, the calculation is as follows:

    ANFI = NFI × (TI ÷ [TI + AD])

    ANFI

    adjusted net foreign income

    NFI

    net foreign income of a class

    TI

    taxable income

    AD

    apportionable deductions

     

    Example 9: Working out adjusted net foreign income

    An individual has

    Domestic source income

    $7,000

    Allowable deductions from domestic source income

    $10,000

    net passive foreign income

    $2,000

    net other foreign income

    $5,000

    apportionable deductions

    $100

    Taxable income
    ($7,000 − $10,000 + $2,000 + $5,000 − $100)

    $3,900

    Taxable income plus apportionable deductions
    ($3,900 + $100)

    $4,000

    Net foreign income
    ($2,000 + $5,000)

    $7,000

    The net foreign income is greater than the taxable income plus apportionable deductions. Therefore, the adjusted net foreign income is taken to equal taxable income. As there are two classes of foreign income, it is necessary to apportion the adjusted net foreign income into the relevant classes - that is, passive income and other income.

    The taxpayer's passive income is 2/7 and other income 5/7 of the combined net foreign income. The adjusted net foreign income for each class is as follows:

    ANFI - passive income
    (2/7 of the taxable income of $3,900) 

    $1,114

    ANFI - other income
    (5/7 of the taxable income of $3,900)

    $2,786

     

    End of example

     

    Example 10: Working out adjusted net foreign income

    An individual has:

    Domestic income

    $7,000

    passive foreign income

    $2,000

    other foreign income

    $5,000

    apportionable deductions

    $100

    First work out ANFI for passive income:

    The taxpayer's taxable income
    ($7,000 + $2,000 + $5,000 - $100) 

    $13,900

    ANFI - passive income
    $2,000 × $13,900 ÷ (13,900 + 100)

    $1,986

    then work out ANFI for other income:

    ANFI - other income:

    $5,000 × ($13,900 ÷ [13,900 + 100]) = $4,964

    End of example
    Working out the credit

    Your foreign tax credit entitlement for a class of foreign income is the lesser of:

    • the creditable foreign tax which you have paid on that class of income, and 
    • the Australian tax payable on that class of income, worked out using the above procedure.

    The following example shows the steps to use to work out your foreign tax credit.

    Example 11: Working out the foreign tax credit

    An individual has:

    Domestic income

    $7,000

    passive income - net of foreign tax

    $2,000

    foreign tax paid - passive income

    $200

    other income - net of foreign tax

    $5,000

    foreign tax paid - other income

    $1,000

    apportionable deductions

    $100

    Step 1

    Work out taxable income.

    Gross up foreign income by the amount of creditable foreign tax paid:

    Assessable passive income (2,000 + 200)

    $2,200

    Assessable other income (5,000 + 1,000)

    $6,000

    Taxable income (7,000 + 2200 + 6,000 − 100)

    $15,100

    Step 2

    Work out the average rate (AR) of Australian tax

    AR = (gross tax + Medicare levy + Medicare levy surcharge − qualifying tax offsets) ÷ taxable income

     

    Gross tax on $15,100

    $1,365.00

    Medicare levy

    $0

    Medicare levy surcharge

    $0

    Qualifying tax offsets

    $0

    AR = ($1,365 + 0 + 0 − 0) ÷ $15,100

    0.09%

    Step 3

    Work out adjusted net foreign income.

    For the passive class of income:

    ANFI (passive income) = (NFI × TI) ÷ (TI + AD)

     

    NFI - net foreign passive income

    $2,200

    TI - taxable income

    $15,100

    AD - apportionable deductions

    $100

    ANFI (passive income) =
    ($2,200 × $15,100) ÷ ($15,100 + $100)

    $2,185.53

    For the other class of income:

    NFI - net foreign passive income

    $6,000

    TI - taxable income

    $15,100

    AD - apportionable deductions

    $100

    ANFI (other income) =
    ($6,000 × $15,100) ÷ ($15,100 + $100)

    $5,960.53

    Step 4

    Work out the Australian tax payable (ATP) on each class of income.

    For foreign passive income:

    ATP = AR × ANFI (passive income)

    ATP = 0.09 × $2,185.53 = $197.57

    For foreign other income:

    ATP = AR x ANFI (other income)

    ATP = 0.09 × $5,960.53 = $536.45

    Step 5

    Determine allowable foreign tax credit for each class of foreign income.

    Foreign tax paid on passive income

    $200

    Australian tax payable

    $197.57

    As the Australian tax payable is less than the foreign tax, the foreign tax credit is

    $197.57

    Foreign tax paid on other income

    $1,000

    Australian tax payable

    $536.45

    As the foreign tax paid is more than the Australian tax payable, the foreign tax credit is limited to the extent of the Australian tax payable on the foreign income - that is, $536.45.

    The excess foreign tax credit can be carried forward for offset in later years against Australian tax payable on the same class of foreign income.

    End of example
    Carry forward of excess foreign tax credits

    You will have an excess foreign tax credit for an income year if the amount of foreign tax you have paid is more than the Australian tax payable on that class of foreign income.

    You may carry forward an excess foreign tax credit that arises in an income year for a class of foreign income for five years immediately following that income year. Your excess credit for a class of income may only be used where there is a credit shortfall for the same class of income in a later year. A credit shortfall will arise where the credit allowed for a class of foreign income for an income year is less than the Australian tax payable on that class of foreign income.

    If you have incurred a loss for a class of foreign income, you cannot claim a tax credit in that year because the Australian tax payable on that class of income is nil. You may, however, carry forward the foreign tax credit relating to that class of income to subsequent years.

    Last modified: 18 May 2020QC 19443