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  • Special circumstances

    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

    Superannuation funds

    Limits apply to the foreign income tax offset allowed for foreign income taxes paid by a superannuation fund or approved deposit fund where the fund changes:

    • from a complying superannuation fund to a non-complying superannuation fund, or
    • from a non-resident superannuation fund to a resident superannuation fund.

    Where a non-complying fund or a resident fund includes an amount in assessable income under items 2 and 3 in the table in section 295-320 of the ITAA 1997, and the fund paid foreign income tax on that amount (before the start of the income year), the fund is not entitled to a tax offset for the foreign income tax paid by the provider.

    Consolidated groups

    Only the head company of a consolidated group or multiple entry consolidated (MEC) group is entitled to a foreign income tax offset for foreign income tax paid on income or gains that are included in its assessable income under the single entity rule. Where a subsidiary member pays foreign income tax on income or gains included in the head company's assessable income, the head company is treated as having paid the tax.

    The head company's foreign income tax offset is determined in the same way as for taxpayers outside the consolidation regime.

    Special transitional rules allow a joining entity to transfer unused pre-commencement excess foreign income tax to the head company at joining time. The pre-commencement excess foreign income tax transferred from the joining entity is pooled with any other pre-commencement excess foreign income tax of the head company and subsidiary members. The head company can use pre-commencement excess foreign tax transferred from a joining entity in an income year starting at or after the joining time, subject to the general transitional rules.

    If an entity leaves a consolidated or MEC group, it will not have access to any pre-commencement excess foreign income tax that it transferred to the head company when it joined the group.

    More detailed information on the operation of the foreign income tax offset rules for consolidated groups or MEC groups, including the special transitional rules for pre-commencement excess foreign income tax, is contained in the Consolidation reference manual.

    Life insurance companies

    The core rules for the foreign income tax offset apply to life insurance companies. However, as the income of a life insurance company is taxed at two different rates (ordinary class, taxed at 30%, and complying superannuation/FHSA class, taxed at 15%), at step 2 of the foreign income tax offset limit calculation, it is necessary to determine the amount of assessable income in each class on which foreign income tax has been paid.

    Example 24: Life Insurance company derives income from different classes

    Life Insurance Co derives assessable income of $5m in the ordinary class and $5m in the complying superannuation/FHSA class. The ordinary class of income includes $1m on which foreign income tax of $200,000 is paid and the complying superannuation/FHSA class of income includes $2m on which foreign income tax of $400,000 has been paid. Assume there are no allowable deductions in relation to the classes of assessable income.

    The limit is worked out as follows:

    Step 1: Work out the tax payable on Life Insurance Co's taxable income

    Tax on ordinary class of assessable income: $5m × 30% = $1.5M

    Tax on complying superannuation/FHSA class: $5m × 15% = $750,000

    Total tax payable: $2.25M

    This is the result of step 1.

    Step 2: Work out the tax that would be payable if the income of the two classes on which foreign income tax has been paid is not included in Life Insurance Co's assessable income

    There are two income amounts on which foreign income tax has been paid that need to be excluded from assessable income for the purposes of this step:

    • $1m that belongs to the ordinary class of assessable income
    • $2m that belongs to the complying superannuation/FHSA class.

    In working out the tax that would have been payable had these amounts not been included in assessable income, it is necessary to identify the relevant class to which such amounts belong as follows:

    Tax on ordinary class (excluding $1m):

    ($5m − $1m) × 30% = $1,200,000

    Tax on complying superannuation/FHSA class

    ($5m − $2m) × 15% = $450,000

    Total tax that would be payable: $1,650,000

    This is the result of step 2.

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

    $2.25m − $1.65m = $600,000

    This is the offset limit. As the actual foreign income tax paid on the two income amounts is also $600,000, the foreign income tax offset of Life Insurance Co is $600,000.

    End of example

    Foreign income tax paid on non-assessable non-exempt income derived form segregated exempt assets does not count towards a tax offset.

    Offshore banking units

    Specific rules apply to calculating the tax offset for foreign income tax paid on the assessable offshore banking income of an offshore banking unit (OBU).

    The foreign income tax paid on the offshore banking income of an OBU is taken to be one-third (the current offshore banking eligible fraction) of the amount of tax actually paid. This approach mirrors the tax treatment of assessable offshore banking income, which results in only one-third of that amount actually being included in assessable income, with the other two-thirds being treated as non-assessable non-exempt income.

    Example 25: OBU derived foreign income

    Big Bank Ltd is an Australian resident bank that is declared an OBU. Big Bank Ltd derives offshore banking income and pays foreign income tax of $21,000 in respect of such income as follows:

    Source

    Income
    (A$)

    Expenses
    (A$)

    Foreign tax paid
    (A$)

    Borrowing and lending activity - commission

    $15,000

    $900

    $1,500

    Borrowing and lending activity - interest

    $20,000

    $600

    $3,000

    Advisory activity

    $50,000

    $6,000

    $16,500

    Total foreign income tax paid on assessable offshore banking income

    $85,000

    $7,500

    $21,000

    The amount of foreign income tax paid on the assessable portion of offshore banking income is the amount of foreign income tax paid multiplied by the eligible fraction:

    $21,000 × (10 ÷ 30) = $7,000

    This is the amount of foreign income tax that counts towards Big Bank Ltd's tax offset for the income year.

    End of example

    Foreign or non-residents

    While the offset mainly applies to residents, where the foreign income of a foreign /non-resident is taxed in Australia, they may be able to claim an offset.

    These circumstances apply where a foreign resident pays income tax in a foreign country on an amount that is included in their assessable income (under Australian tax law) and such tax is imposed because the income is sourced in that country. By contrast, where a foreign country imposes tax on the amount included in an entity's assessable income merely because it is a resident of that country (that is residence-based taxation), a foreign income tax offset entitlement does not arise if the tax is imposed on income from a source outside the foreign country.

    Example 26: Foreign resident derived foreign income in Australian PE

    XYZ PLC is a United Kingdom resident that carries on a business through a permanent establishment (PE) in Australia. In carrying on such activities, it derives US source income, which is subject to tax in that country. The US source income is derived in connection with the PE activity in Australia, and a combination of Articles 7 and 21 of the Australia-UK tax treaty permits Australia to tax the income and treat it as being derived from sources within Australia, and therefore subject to Australian tax. Given that the US source income is taxed in that country on a source basis, the US tax paid counts towards a tax offset in Australia.

    If XYZ pays UK tax on the US source income that is attributable to the Australian PE activity, the tax would be imposed on a residence basis on the non-UK sourced income and would not count towards the taxpayer's tax offset.

    End of example

    Australian source income

    While Australian residents are normally subject to foreign income tax only on their foreign source income, the foreign income tax offset applies to all income on which foreign income tax has been correctly applied. This situation will arise in very limited circumstances.

    For example, foreign income tax imposed by East Timor in accordance with Annexure G (the taxation code) of the Timor Sea treaty (refer to the Petroleum (Timor Sea Treaty) Act 2003) on assessable income derived by an Australian-resident taxpayer from certain activities carried out in the Joint Petroleum Development Area of the Timor Sea will count towards the taxpayer's tax offset.

    Last modified: 05 Aug 2020QC 22894