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When a foreign income tax offset applies

Last updated 4 August 2020

To be entitled to a foreign income tax offset:

  • the foreign tax must be foreign income tax
  • you must have actually paid, or be deemed to have paid, the foreign income tax, and
  • the income or gain on which you paid foreign income tax must be included in your assessable income in Australia.

The offset is available in the income year in which the income or gain (on which the foreign income tax has been paid) forms part of your assessable income in Australia.

The foreign tax must be foreign income tax

To count towards a tax offset, foreign income tax must be imposed under a law other than an Australian law and be:

  • a tax on income
  • a tax on profits or gains, whether of an income or capital nature, or
  • any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953 (Agreements Act).

The foreign income tax includes taxes similar to Australian withholding tax that is imposed in place of a tax on the net amount of income.

(For examples, refer to Taxes imposed by Australia's major trading partners for which a foreign income tax offset is available.)

The foreign income tax must be correctly imposed under the relevant foreign law and in accordance with any tax treaty the country has with Australia. For example, if country A is limited under a tax treaty to taxing interest derived in that country by an Australian resident to 10% but imposes a domestic tax rate of 25% for interest derived by all foreign residents, only 10% of the tax counts towards the tax offset. The taxpayer would need to seek a refund of the balance (that is, 15%) from country A's tax authority.

The foreign income tax may be imposed at a supra-national, national, state/provincial or local/municipal level. An example of a supra-national tax is that imposed by the European Union on pensions paid to its former employees.

Foreign taxes not included

The following types of foreign tax do not count towards a foreign income tax offset:

  • inheritance taxes
  • annual wealth taxes
  • net worth taxes
  • taxes based on production
  • credit absorption taxes - that is, a tax that is payable only because the taxpayer or another entity is entitled to foreign income tax offset in Australia
  • unitary taxes - that is, a tax on income, profits or gains of a company derived from sources within the country where the tax is imposed that takes into account income, losses, outgoings or assets of the company (or of an associated company) derived, incurred or situated outside that country, except where the tax only takes those factors into account:
    • if such an associated company is a resident of the foreign country for the purposes of the law of the foreign country, or
    • for the purposes of granting any form of relief in relation to tax imposed on dividends received by one company from another company.
     

Penalties, fines and interest do not qualify as foreign income tax.

If you are unsure about whether a specific foreign tax is a foreign income tax, you can write to us and request a private binding ruling.

Taxes imposed by Australia's major trading partners for which a foreign income tax offset is available

A foreign income tax offset may be available for the foreign taxes listed below. This list is not exhaustive nor, except for India, does it include local or state taxes.

Argentina

Income tax (Impuesto a las ganancias)

Canada

Income taxes imposed by the Government of Canada under the Income Tax Act.

China

Income tax

France

Income tax and corporation tax, including any related withholding tax, prepayment (precompte) or advance payment.

Germany

Income tax (einkommensteuer)

Corporation tax (korperschaftsteuer)

India

Income tax, including any surcharge

Capital gains tax

Non-resident withholding tax

State government imposed taxes on various agriculture incomes

Italy

Individual income tax (l'imposta sul reddito delle persone fisiche)

Corporate income tax (l'imposta sul reddito delle societ , formerly l'imposta sul reddito delle persone giuridiche)

Japan

Income tax

Corporation tax

New Zealand

Income tax

Non-resident withholding tax

Tax on profits from property sales

Singapore

Income tax

South Africa

Normal tax

Secondary tax on companies (due to be replaced with a withholding tax on dividends)

Withholding tax on royalties.

South Korea

Income tax

Corporations tax

Inhabitant tax

United Kingdom

Income tax

Capital gains tax

Corporations tax

United States

Federal income taxes imposed by the Internal Revenue Code

You must have actually paid, or be deemed to have paid, the foreign income tax

To count towards a tax offset, the foreign income tax must have actually been paid by the taxpayer or be deemed to have been paid by them. It is not enough that the tax is payable.

If the taxpayer is entitled to a refund of the foreign income tax, or if another benefit worked out by reference to the amount of the foreign income tax (other than a reduction in the amount of the foreign tax) is received as a result of a tax payment, the tax is not considered to have been paid.

It is not necessary for you to have paid the foreign income tax in the same income year in which the income or gain on which the tax has been paid is included in your assessable income. The tax could be paid before or after the income year in which you derive the assessable income. However, the offset can only arise when the foreign income tax is paid, and it is applied to the income year in which the relevant income or gain is included in your assessable income - refer to Special amendment rules for foreign income tax offsets.

Example 1: Foreign income tax paid in following income year

A resident taxpayer holds a qualifying security (Division 16E of Part III of the ITAA 1936) for the income years ending 30 June 2010 through to 30 June 2015. The taxpayer pays foreign income tax on the income from the security in the income year ending 30 June 2015.

Under Australian tax law, the taxpayer includes amounts in their assessable income for the 2010 to 2015 income years on an accruals basis. Only when the taxpayer pays the foreign income tax are they eligible for a tax offset. However, the offset arises in each of the income years in which the taxpayer's assessable income includes an amount on which foreign income tax is later paid.

The taxpayer is required to apportion the paid foreign income tax among the income years in which the amount is included in their assessable income. As a result, once they have paid the foreign income tax they will need to lodge amended assessments for the earlier income years in order to claim an offset for the foreign income tax paid.

End of example

The tax may have been effectively paid by someone else

A taxpayer is treated as having paid foreign income tax on all or part of their assessable income where the tax has been paid in respect of that income by someone else on their behalf under an arrangement with the taxpayer or under the law relating to that tax.

This tax-paid deeming rule ensures that the right taxpayer obtains the tax offset. It applies in situations where the foreign income tax has actually been paid by someone else in a representative capacity for the taxpayer, with the latter bearing the economic burden of the tax. Specifically, it applies where foreign income tax has been paid by:

  • deduction or withholding
  • a trust in which the taxpayer is a beneficiary
  • a partnership in which the taxpayer is a partner, or
  • the taxpayer's spouse.

Example 2: Foreign income tax withheld and paid by someone else

Tim, an Australian resident, derives interest income of $1,000 from a foreign country. As that country's laws require the payer of the interest to withhold tax at a rate of 10%, Tim receives $900 (that is, $1,000 less tax of $100). Although he has not directly paid the foreign income tax, Tim is taken to have paid that tax because it was paid under the law relating to the foreign income tax.

End of example

Example 3: Foreign income tax paid on partnership net income

A partnership of two Australian partners with equal interests in all income of the partnership derives net income of $1,000 on which it pays $100 of foreign income tax.

The partners each include $500 in their assessable income, being their share of the net income of the partnership. They will both be entitled to a tax offset to the extent that foreign income tax is paid on the amount that is part of their assessable income.

The foreign income tax paid is apportioned according to each partner's share of the net income of the partnership included in their assessable income. Therefore, each claims an offset for $50 of foreign income tax, as this is the proportionate amount of foreign income tax they are taken to have paid on the amount included in their assessable income, that is, (500 ÷ 1,000) × $100.

End of example

Example 4: Foreign income tax paid on joint income

Married couple Arthur and Lucy, both Australian residents, derive net rental income from a foreign country. Under that country's laws, joint filing of tax returns is allowed. Consequently, the net rental income is included in their jointly-filed return and income tax is paid jointly on that income. However, under Australian tax law, each person must show their share of the net rental income in their own tax return. Although the foreign income tax has been jointly paid under the laws of the foreign country, Arthur and Lucy are each deemed to have paid their relevant share of the foreign income tax that has been paid jointly

End of example

Example 5: Foreign income tax paid by trustee

S trust estate derives rental income from commercial property investments in a foreign country, on which the trustee pays foreign income tax. Samantha, an Australian resident, is the sole beneficiary of S trust estate and is presently entitled to all of its income. As such, she is assessed on the whole of the trust's net income. Although Samantha hasn't directly paid the foreign income tax, she is deemed to have paid it.

End of example

Special tax-paid deeming rules for beneficiaries of trust estates

A specific rule deems a taxpayer to have paid the relevant foreign income tax where they are presently entitled to a share of the trust income that can be directly or indirectly attributed to income received by the trust on which foreign income tax has already been paid. This tax-paid deeming rule applies where:

  • section 6B of the ITAA 1936 treats an amount of assessable income as being attributable to another amount of income having a particular character or source
  • foreign income tax has been paid in respect of the other amount of income, and
  • the assessable income attributed under section 6B is less than it would have been if the foreign income tax had not been paid.

When applied together, these rules ensure that a beneficiary of a trust can be deemed to have paid any tax on its share of trust income that is attributable to income that flows through the trust (or chain of trusts) on which foreign income tax is paid by another entity.

The amount of the foreign income tax that is taken to have been paid by the taxpayer is the amount by which the income included in their assessable income has been reduced because of the payment of the foreign income tax paid.

Example 6: Foreign withholding tax on income of trust

Holly is the sole beneficiary of the B trust estate and is presently entitled to all of its income. On its only activity (a portfolio investment in foreign company X), B derives foreign dividend income of $100,000 on which foreign dividend withholding tax of $10,000 is paid. B subsequently distributes all its income to Holly (that is, $90,000 net of withholding). As Holly's share of the trust income is attributable to the dividend income received by B (by virtue of section 6B of the ITAA 1936), she can treat the withholding tax paid on the dividend as having been paid by her.

End of example

Example 7: Foreign withholding tax deemed paid by ultimate beneficiary

Tim, an Australian resident, is the only unit holder in Managed Fund A, which in turn is the only unit holder in Managed Fund B, which has an interest in a US company. Both managed funds are unit trusts. The US company pays a dividend of $1,000 to Managed Fund B, on which withholding tax of $150 is payable, making the net distribution $850. This amount of $850 flows through both managed funds to Tim. The terms and conditions of the two managed funds are such that Tim is the beneficial owner of the shares on which the dividend was paid.

Tim correctly includes the $850 attributable to the US source dividend in his assessable income as he is presently entitled to all the income of Managed Fund A. As Tim's share of the trust income is attributable to the dividend income received by Managed Fund B, he can treat the withholding tax paid on the dividend as having been paid by him (even though the amount included in his assessable income is attributable to the dividend income that has flowed through a chain of trusts).

End of example

When foreign income tax is not treated as paid by the taxpayer

A taxpayer is not entitled to a tax offset for foreign income tax to the extent they, or any other entity, are entitled to:

  • a refund of the foreign tax, or
  • any other benefit worked out by reference to the amount of foreign income tax (other than a reduction in the amount of the foreign income tax).

The entitlement to a benefit may arise from the exploitation of arbitrage opportunities resulting from mismatches in debt and equity classifications and the different status granted to foreign hybrid entities (for example, where an enhanced yield is obtained by a taxpayer entering into a structured financing arrangement).

However, the taxpayer may still be entitled to a tax offset where the only benefit is a reduction in the tax liability of the taxpayer or another entity, such as provided by an imputation credit, a rebate of tax or a similar type of concession, provided that the concession does not result in a refund to the taxpayer or other entity.

Example 8: Foreign income tax refunded not treated as paid by the taxpayer

In a foreign country, Austco derives net rental income on which income tax of $50,000 is paid in that country.

Austco later finds out that it is entitled to a special concession in the foreign country, under which the $50,000 is fully refunded. Accordingly, Austco is taken to not have paid foreign income tax on that income.

End of example

Foreign income tax must have been paid on assessable income

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 9: Foreign partnership treated as company and foreign income tax deemed to have paid for the dividend distribution

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.

End of example

Foreign income tax paid on part of an amount included in assessable income

In some situations, the foreign income tax paid relates to only part of an amount included in the taxpayer's assessable income. This typically applies where a foreign source gain on which foreign income tax has been paid is part of a net amount included in a taxpayer's assessable income. In these situations, the foreign income tax counts towards the tax offset only to the extent that it is paid in respect of that part of the amount that is included in the taxpayer's assessable income.

This may be relevant where, for example, a taxpayer has both a capital gain and a capital loss and only the net amount is included in their assessable income. Under the capital gains tax rules, a taxpayer can choose the order in which capital losses are offset against gains. In particular, a taxpayer can choose to offset capital losses (whether current year or prior-year) firstly against domestic capital gains or foreign gains on which no foreign tax has been paid. Such an ordering of the losses maximises the foreign source capital gain component of a net capital gain on which foreign income tax has been paid.

Example 10: Foreign income tax paid on part of an amount included in assessable income

Company C derives the following capital gains and losses on disposals of assets during the year:

Domestic capital gain on land:

$100,000

Foreign capital gain on asset B:

$50,000 (no foreign tax paid)

Foreign capital gain on asset C:

$20,000 (on which foreign income tax of $2000 is paid)

Domestic capital loss on asset A:

($150,000)

Net capital gain:

$20,000

As the foreign income tax offset can only apply where foreign income tax has been paid on an amount included in the taxpayer assessable income, company C chooses to offset its domestic capital loss on asset A of $150,000 first against the domestic gain on land of $100,000, and the balance of $50,000 against the foreign capital gain on asset B on which no foreign income tax has been paid. Therefore, the net capital gain of $20,000 relates to the foreign capital gain on asset C. As this is the amount included in assessable income on which foreign income tax has been paid, the tax paid of $2,000 counts towards company C's foreign income tax offset.

Where foreign income tax is paid on a foreign source gain but the taxpayer is in an overall capital loss situation for the income year because of other capital losses, none of the foreign income tax paid counts towards a tax offset because the gain is not included in the taxpayer's assessable income.

End of example

Example 11: No foreign income tax offset - foreign income not included in assessable income

On the sale of an asset, an Australian-resident taxpayer makes a foreign source capital gain of $10,000, on which foreign income tax of $2,000 has been paid.

The taxpayer also realises a capital loss of $10,000 on the disposal of an Australian asset.

The loss of $10,000 is offset against the foreign gain of $10,000, which results in no net capital gain being included in the taxpayer's assessable income. As their assessable income does not include an amount on which foreign income tax has been paid, the taxpayer is not eligible for a foreign income tax offset for the foreign income tax paid on the foreign source capital gain.

End of example

The same principle applies where foreign income tax has been paid on an amount that forms part of a partnership or trust's assessable income, but because there is an overall partnership or trust loss for the year (rather than there being net income), the relevant foreign income is not included in the partner or beneficiary's assessable income.

Foreign income tax on exempt or non-assessable non-exempt income

Foreign income tax paid on amounts that are exempt or non-assessable non-exempt (NANE) income in Australia does not count towards a tax offset (except where the taxpayer derives NANE income under section 23AI or 23AK of the ITAA 1936).

Example 12: No foreign income tax offset - NANE income

Austco, an Australian-resident company, wholly owns Foreign co, which pays a dividend of $10m to Austco out of which foreign income tax of $2m is paid. The dividend is not paid out of previously attributed income. As the dividend is NANE income of Austco under section 23AJ of the ITAA 1936, the foreign income tax paid of $2m does not count towards Austco's tax offset.

End of example

Foreign income must be grossed up

Where you have paid foreign income tax on an amount that forms part of your assessable income, you must include the gross amount (including any tax paid by you) in your assessable income on your tax return.

Example 13: Grossing up foreign income

An Australian-resident taxpayer invests directly in a foreign company, which pays a dividend of $100 from which it deducts $15 withholding tax.

The taxpayer must gross-up the net distribution of $85, adding the foreign income tax withheld of $15, to show $100 in their tax return. This is the amount on which the taxpayer is assessed for income tax purposes.

End of example

Attributed income

A special grossing-up rule applies to attributable taxpayers that are deemed to have paid foreign income tax that is actually paid by their controlled foreign company (CFC) or foreign investment fund (FIF). In respect of the attributed income of a CFC or FIF (where the calculation method is used), a notional deduction is allowed for any foreign income tax, income tax or withholding tax it pays. The attributable taxpayer includes in their assessable income this net amount multiplied by their attribution percentage. Thus, the attributable taxpayer is effectively entitled to a deduction for foreign income tax, income tax or withholding tax paid on an amount included in the CFC's or FIF's attributed income.

Where the attributable taxpayer is deemed to have paid the foreign income tax that is actually paid by the CFC or FIF and counts that towards their tax offset, they have to gross-up their attributed income by the amount of foreign income tax (including withholding tax) they are deemed to have paid.

Note that there are special rules for claiming an offset for foreign income tax paid on attributed income.

Example 14: Grossing up foreign income - attributed income

A co is an Australian-resident company with a 100% interest in Y co, a CFC. Y co works out its notional assessable income as $1.2m and claims a notional allowable deduction of $200,000 for foreign tax paid by it, thereby resulting in attributed income of $1m. A co includes the amount of $1m in its assessable income under section 456, as its attribution percentage is 100%. A co is also required to treat the foreign income tax paid by Y co as having been paid by it under the special tax-paid deeming rules that apply to attributable taxpayers. Accordingly, A co is required to gross-up its attributed income of $1m by the $200,000 of foreign income tax that it is deemed to have paid.

End of example

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