• How to work out your foreign tax credit

    Note

    You will not be able to work out your foreign tax credit using this guide if you have shown exempt foreign employment income at N item 19 on your tax return (supplementary section) and you have assessable foreign income. The Tax Office will work it out for you.

    If this is the case, print schedule of additional information - item 19 on the top of a separate piece of paper and explain your situation. Include:

    • your name, address and tax file number
    • each type and amount of foreign income received, and
    • any foreign tax paid on each type of foreign income.
     

    Print X in the YES box at question 2a in Taxpayer's declaration on page 8 of your tax return.

    Sign and attach your schedule to page 3 of your tax return.

    If you do not have exempt foreign employment income, work through the following steps to find out your foreign tax credit. A practical example is available.

    Step 1: Work out your taxable income

    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

    You need to fill in the rest of your tax return before you can do this. Your taxable income is the amount at $ on page 3 of your tax return.

    Step 2: Work out the amount of gross tax, Medicare levy and, if applicable, Medicare levy surcharge (MLS) payable on your taxable income

    See the calculation pages in TaxPack 2006 (NAT 0976-6.2006).

    Step 3: Work out the average rate of Australian tax payable on your taxable income

    Use the following formula:

    Average rate of tax

    =

    gross tax + Medicare levy + MLS - qualifying tax offsets
    taxable income

    The qualifying tax offsets you can use to work out your average rate of Australian tax are:

    • spouse, child-housekeeper or housekeeper
    • overseas forces or zone
    • medical expenses
    • invalid relative
    • parent or spouse's parent
    • certain low income taxpayer.

    A description of these offsets is in TaxPack 2006 (NAT 0976-6.2006) and TaxPack 2006 supplement (NAT 2677-6.2006).

    Step 3 of the example shows you how to work out your average rate of Australian tax.

    Step 4: Work out whether you have assessable foreign income from more than one class

    Assessable foreign income is divided into different classes for the purpose of allowing a foreign tax credit. These classes are:

    • passive foreign income
    • lump sum payments from non-resident superannuation funds that are taxed under section 27CAA of the Income Tax Assessment Act 1936 (ITAA 1936), and
    • other foreign income.

    Most taxpayers will only have passive foreign income and other foreign income.

    What is passive foreign income?

    Passive foreign income includes:

    • foreign dividends, interest, rental income and royalties
    • assessable foreign annuities
    • amounts for the assignment of a patent or copyright
    • foreign capital gains and passive commodity gains, and
    • income attributed from a controlled foreign company, foreign investment fund or a transferor trust.

    What are foreign capital gains?

    If you paid foreign tax in respect of a foreign capital gain, you need to work out how much of that foreign capital gain is reflected in your net capital gain. For an individual, your net capital gain is the amount shown at A item 17 on your tax return (supplementary section). The amount of foreign capital gain reflected in your net capital gain will depend on:

    • the amount of the capital gain calculated for Australian tax purposes
    • how you have applied any capital losses and net capital losses from earlier years, and
    • whether any capital gains tax (CGT) concessions apply to the capital gain (for example, the CGT discount or small business concessions).

    Capital losses and net capital losses can be applied against capital gains in the order that you choose. To maximise your foreign tax credit entitlement, you can offset losses first against domestic capital gains or foreign gains in respect of which you have not paid tax.

    If you are claiming a foreign tax credit in respect of a foreign capital gain, include a note on your tax return that specifies the amount of the foreign capital gain included in your net capital gain.

    Example

    You sold a property that you acquired in January 2000 in a foreign country. Under that country's tax laws, you made a capital gain of $12,000 and you paid tax in respect of that gain. For Australian tax purposes, your capital gain calculated in accordance with Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997) is $10,000.

    You also sold a property in Australia and made a capital loss of $3,000 on that sale. You must apply this loss against your foreign capital gain of $10,000. You then apply the CGT discount to the remaining capital gain of $7,000, which gives you a net capital gain of $3,500. Because your net capital gain relates entirely to a foreign capital gain in respect of which you have paid foreign tax, this is the amount ($3,500) that is included in working out your passive foreign income.

    What are lump sum payments from non-resident superannuation funds?

    Certain lump sum payments made from non-resident superannuation funds are subject to special tax rules under section 27CAA of ITAA 1936. These payments form their own class of foreign income.

    What is other foreign income?

    Other foreign income is foreign income that does not fit into either of the other classes of income. It includes income from commercial activities and salary or wages that are not exempt.

    Step 5: Work out your net income for each class of foreign income

    Net foreign income is the amount of your assessable foreign income of each class, less the following deductions:

    • expenses directly related to that class of foreign income other than relevant debt deductions (see What is a relevant debt deduction?)
    • any domestic loss carried forward from a previous year that you have elected to use against your foreign income
    • other deductions appropriately related to that class of foreign income other than relevant debt deductions.

    What is a debt deduction?

    Debt deductions are, broadly, deductible costs incurred in obtaining and maintaining debt finance. The term is defined in section 820-40 of ITAA 1997. Examples of debt deductions are interest, amounts in the nature of interest and fees in respect of debt.

    What is a relevant debt deduction?

    A relevant debt deduction is a debt deduction to the extent that it is not attributable to any of the taxpayer's overseas permanent establishments.

    The example shows you how to work out your net income for each class of foreign income.

    Step 6: Work out the adjusted net foreign income (ANFI) for each class of foreign income

    This involves allocating any apportionable deductions that you are able to claim between each class of foreign income. Apportionable deductions are those deductions of a concessional nature which do not relate directly to income-producing activities - for example, gifts to deductible gift recipients (DGR).

    If you don't have any apportionable deductions, your ANFI for each class will equal your net foreign income of that class.

    If you do have apportionable deductions, there are three methods for working out ANFI. If your net foreign income (of all classes) is less than or equal to the sum of taxable income and apportionable deductions, as is most often the case, ANFI for each class of income equals:

    Net foreign income

    x

                        taxable income                       
    taxable income + apportionable deductions

    The other methods of working out ANFI are:

    • If your net foreign income consists of one class of income and the amount exceeds the sum of your taxable income plus apportionable deductions, your ANFI will equal your taxable income.
    • If your net foreign income consists of two or more classes of income and your combined net foreign income from all classes exceeds the sum of your taxable income plus apportionable deductions, your ANFI for each class will equal your taxable income divided proportionately into each class of income.

    Step 7: Work out the foreign tax credit limit for each class of foreign income

    The foreign tax credit that you are entitled to receive is limited to the lesser of:

    • the foreign tax you have paid on that class of foreign income, and
    • the Australian tax payable on that class of foreign income.

    The Australian tax payable in relation to a class of foreign income equals:

    ANFI

    x

    average rate of Australian tax

    The amount of credit you are able to claim in Australia may be further limited by tax treaties Australia has with the country in which you earned the income. If you received income from a country that has a tax treaty with Australia and that treaty limits the amount of tax that the foreign country can levy on your income, the amount of foreign tax credit you are allowed is limited to the amount payable under the treaty. If the foreign country has deducted more tax than is permitted under the treaty, you will need to seek a refund of the excess tax from the tax authority of that country. The tax treaties can be found as Schedules to the International Tax Agreements Act 1953. This Act is available on our legal database on our website.

    Step 7 of the example shows you how to work out your foreign tax credit limit.

    For more information, phone us on 13 28 61.

    Step 8: Enter your foreign tax credit amount on your tax return

    Add up the amount of foreign tax credit you are able to claim for each class - from step 7 - and insert the total at O item 19 on your tax return (supplementary section).

    Last modified: 30 Jul 2006QC 27786