• Foreign income tax must have been paid on assessable income

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    To count towards a tax offset, the foreign income tax must have been paid on income or gains that are included in your assessable income.

    Where, for example, a person receives a dividend from a foreign company, the foreign income tax on the underlying company profits (the source of the dividend) is not paid in respect of the shareholder's dividend income. Similarly, a person receiving a pension from a foreign superannuation fund has not paid the foreign income tax levied on the income of the superannuation fund. In both of these cases the tax that has been paid relates to the income or gains of the other entity, which is being taxed in its own right.

    However, where an entity has been formed under a foreign country's laws that treat the entity as 'fiscally transparent' (that is, its profits are taxed in the hands of its members), income tax imposed by that country on a distribution to an Australian member may be counted towards their tax offset. This is the case even where the entity is treated as a company for Australian tax purposes and the distribution is characterised as a dividend.

    This situation could arise, for example, where an Australian taxpayer is a member of a US limited liability company (LLC) that is treated as fiscally transparent under US tax law, but under Australian tax law the Australian member of the US LLC does not elect to treat the LLC as a foreign hybrid.

    Example

    Aust Super Fund is a trustee of a complying superannuation entity and an Australian resident taxpayer with a 2% interest in a US limited partnership (a foreign investment fund interest).

    Under US tax law, the US limited partnership is treated as fiscally transparent; that is, it is not taxed on its profits but rather tax is borne by the partners on their share of the partnership distribution.

    Aust Super Fund's share of the US limited partnership's profits is $1m, on which tax of $350,000 is withheld by the partnership (under US tax law). The tax is imposed in accordance with the Australia-US tax treaty.

    Under Australian tax law, Aust Super Fund does not make an election under subsection 485AA(1) of the ITAA 1936 to treat the US limited partnership as a foreign hybrid limited partnership. Accordingly, the US limited partnership is taxed under Australian tax law as a company in accordance with Division 5A of Part III of the ITAA 1936.

    Although the absence of an election under section 485AA means that the interest held by the taxpayer in the US limited partnership is still a foreign investment fund interest, the taxpayer (being a trustee of a complying superannuation entity) is exempt from foreign investment fund tax by virtue of Division 11A of Part XI of the ITAA 1936.

    The net amount of $650,000 received by Aust Super Fund is characterised as a dividend for Australian tax law purposes and is included in its assessable income. Although Aust Super Fund has not paid the US tax of $350,000 personally (as the US limited partnership has been taxed on the distribution on a withholding basis), it will be treated as having paid it, as the US tax is imposed on the distribution rather than on the underlying profits of the US limited partnership out of which the distribution is made.

    Aust Super Fund is also required to gross-up its assessable income by the $350,000 of foreign income tax that it is deemed to have paid in relation to the dividend distribution.

    Last modified: 23 Jul 2009QC 22894