• Calculating your offset limit

    Attention

    Warning:

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

    End of attention

    If you are claiming a foreign income tax offset of more than $1,000, you will first need to work out your foreign income tax offset limit.

    Step 1

    Work out the income tax payable by you for the relevant income year disregarding any tax offsets. This amount does not include Medicare levy, Medicare levy surcharge, penalties or interest.

    Step 2

    Work out the income tax that would be payable by you (excluding the Medicare levy and surcharge, penalties and interest), disregarding any tax offsets, if the following assumptions were made:

    • your assessable income did not include:
      • any amount included in your assessable income on which foreign income tax has been paid that counts towards your foreign income tax offset, and
      • any other income or gains from a non-Australian source, and
       
    • you were not entitled to the following (where such deductions are actually allowable):
      • debt deductions attributable to your overseas permanent establishment
      • any other deductions (other than debt deductions) that are reasonably related to any amount covered by the first dot point above, and
      • an amount of the foreign loss component of one or more tax losses deducted in the income year.
       

    For the purpose of this step, where deductions relate exclusively to the disregarded income amounts, you should assume that you were not entitled to these amounts. Whether a deduction reasonably relates to the disregarded assessable income amounts will be a question of fact depending on the circumstances of the taxpayer. Where deductions relate to both disregarded income amounts and other assessable income (as would typically be the case with head office and general administration expenses), you will need to apportion the deductions on a reasonable basis.

    Allowable deductions for items such as gifts, contributions, superannuation and tax agent's fees are not considered to be reasonably related to any amount on which foreign income tax has been paid or other non-Australian source income.

    Step 3

    Take away the result of step 2 from step 1. If the result is greater than $1,000, this is your offset limit.

    Example

    Anna, an Australian-resident taxpayer, has income and expenses and pays foreign income tax for the income year as follows:

     

    (A$)

    Employment income from Australia

    22,000

    Employment income from United States

    6,000

    Employment income from United Kingdom

    4,000

    Rental income from United Kingdom

    1,000

    Dividend income from United Kingdom

    600

    Interest income from United Kingdom

    400

    Total assessable income

    34,000

    Expenses incurred in deriving employment income from Australia

    2,000

    Expenses incurred in deriving employment income from United States

    450

    Expenses incurred in deriving rental income from United Kingdom

    250

    Interest (debt deduction) incurred in deriving dividend income from United Kingdom

    70

    Expenses (debt deduction) incurred in deriving interest income from United Kingdom

    30

    Gift to deductible gift recipient

    70

    Total allowable deductions

    2,870

    Taxable income

    31,130

    Foreign income tax paid:

     

    Employment income from United States

    1,800

    Dividend income from United Kingdom

    60

    Interest income from United Kingdom

    40

    Rental income from United Kingdom

    300

    Total foreign income tax paid

    2,200

    Anna calculates her foreign income tax offset limit as follows:

    Step 1:Work out the tax payable on her taxable income

    Tax on $31,130: $3,770 (excludes Medicare levy)

    Step 2:Work out the tax that would be payable if:

    (a) Her assessable income does not include any amount in respect of which foreign income tax has been paid, provided that the tax counts towards her foreign income tax offset or other non-Australian source amounts, calculated as follows:

     

    (A$)

    Employment income from United States

    6,000

    Employment income from United Kingdom

    4,000

    Rental income from United Kingdom

    1,000

    Dividend income from United Kingdom

    600

    Interest income from United Kingdom

    400

    Total

    12,000

    Although Anna has not paid foreign income tax on her employment income of $4,000 from the United Kingdom, it is subtracted from her assessable income at this step as it is from a non-Australian source.

    (b) Any expenses that relate to amounts included in her assessable income on which foreign income tax has been paid, provided that tax counts towards her foreign income tax offset, or other non-Australian amounts that are part of her assessable income (excluding debt deductions).

    Expenses

    (A$)

    Expenses incurred in deriving employment income from United States

    450

    Expenses incurred in deriving rental income from United Kingdom

    250

    Total expenses

    700

    Note: that the debt deductions of $100 that relate to the United Kingdom dividend and interest income are not disregarded as Anna does not have an overseas permanent establishment. Nor is the deduction of $70 for the gift to a deductible gift recipient disregarded, as it does not reasonably relate to the excluded assessable income amounts at step 2(a).

    Calculation

    Taxable income (disregarding step 2(a) amount):

    $22,000

    Less allowable deduction (disregarding step 2(b) amount):

    2,170

    Taxable income under step 2 assumptions:

    19,830

    Tax on $19,830: $2,075

    Step 3: Take away the result of step 2 from step 1

    $3,770 - $2,075 = $1695

    This is Anna's foreign income tax offset limit. Although she has paid foreign income tax of $2,200, her foreign income tax offset is limited to $1,695.

    The difference between the foreign income tax that Anna has paid and the offset limit cannot be carried forward to a future income year.

    Example

    Foreign income tax offset limit and net capital gains

    Resident company X's taxable income for the income year is worked out as follows, including the realisation of the following capital gains and losses from a mix of domestic and foreign sources:

    Assessable income

    Domestic (A$)

    Foreign (A$)

    Total (A$)

    Sales revenue

    60,000

     

    60,000

    Net capital gain as calculated below

     

    125,000

    125,000

    Gross assessable income

       

    185,000

    Less

         

    Allowable deductions from sales revenue (under Australian law)

       

    20,000

    Taxable income

       

    165,000

    Foreign country capital gains and losses

    (A$)

    Foreign country A assessment

     

    Purchase price of foreign asset A

    70,000

    Proceeds from sale of foreign asset A

    200,000

    Net foreign gain on sale of foreign asset A

    130,000

    Foreign tax payable (30% of $130,000)

    39,000

    Foreign country B (nil assessment )

     

    Purchase price of foreign asset B

    50,000

    Proceeds from sale of foreign asset B

    65,000

    Net foreign gain on sale of foreign asset B

    15,000

    Foreign country B does not impose tax on capital gains made on the disposals of assets

    Foreign country C (capital loss)

     

    Purchase price of foreign asset C

    90,000

    Proceeds from sale of foreign asset C

    $50,000

    Loss on sale of foreign asset C

    (40,000)

    Australian capital gains and losses

     

    Cost base of asset 1

    90,000

    Capital proceeds from sale price of asset 1

    150,000

    Gain on sale of asset 1

    60,000

    Reduced cost base of asset 2

    65,000

    Capital proceeds of asset 2

    25,000

    Loss on sale of asset 2

    (40,000)

    To calculate the net capital gain, the taxpayer can choose the order in which capital gains are reduced by any capital losses to yield the greatest foreign tax offset as follows:

    Capital gain on sale of foreign asset A

     

    130,000

    Add Capital gain on sale of foreign asset B

    15,000

     

    Add Capital gain on sale of Australian asset 1

    60,000

     

    Deduct Capital loss on sale of foreign asset C

    (40,000)

     

    Deduct Loss on sale of Australian asset 2

    (40,000)

     
       

    (5,000)

    Net capital gain

     

    125,000

    The company calculates the net capital gain to ensure the maximum foreign income tax offset by:

    • firstly, adding together the domestic capital loss and the foreign capital loss
    • secondly, deducting this from the sum of the domestic capital gain and the foreign capital gain on which no foreign tax has been paid.
     

    Finally, as this yields a capital loss of $5,000, the taxpayer deducts this amount from the foreign capital gain on which foreign tax has been paid. Accordingly, the net capital gain of $125,000 relates entirely to the foreign source gain component on which foreign income tax has been paid.

    The foreign income tax offset limit calculation is as follows:

    Step 1:Work out the tax payable on taxable income.

    $165,000 x 0.30 = $49,500

    Step 2:Work out the tax that would be payable if the net capital gain on which foreign income tax has been paid is not included in the taxpayer's assessable income.

    As all of the net capital gain relates to the foreign source gain component on which foreign income tax has been paid, the amount of $125,000 is treated as if it is not included in assessable income.

    There are no deductions that need to be disregarded.

    Thus, the taxable income under this step would be $165,000 - $125,000 = $40,000.

    Tax payable on $40,000 would be 0.30 x $40,000, that is $12,000.

    This is the result of step 2.

    Step 3:Take away the result of step 2 from step 1.

    $49,500 - $12,000 = $37,500

    This is X's foreign income tax offset limit. Although X has paid foreign income tax of $39,000 on the net capital gain included in its assessable income, its foreign income tax offset is limited to $37,500.

    Last modified: 23 Jul 2009QC 22894