• How to work out your foreign tax credit

    The following steps will help you to work out your foreign tax credit. An example is shown in this guide.

    Do you have assessable foreign income and have you shown exempt foreign employment income at N item 20 on your tax return (supplementary section)?

    NO Go to step 1.

    YES You will not be able to work out your foreign tax credit using this guide. We will work out your foreign tax credit for you from the information you provide below.

    If this is the case, print SCHEDULE OF ADDITIONAL INFORMATION - ITEM 20 on the top of a separate piece of paper and explain your situation. Include:

    • your name, address and TFN
    • each type and amount of foreign income you 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.

    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 $ TAXABLE INCOME OR LOSS 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 2008.

    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 taxpayers.

    A description of these offsets is in TaxPack 2008 and TaxPack 2008 supplement. 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 three classes for the purpose of claiming a foreign tax credit. The amount of your assessable foreign income is the amount before any foreign tax is deducted.

    These classes are:

    • passive foreign income
    • lump sum payments from foreign superannuation funds that are taxed under section 305-70 of the Income Tax Assessment Act 1997 (ITAA 1997)
    • other foreign income.

    Most taxpayers will have only 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
    • income attributed from a controlled foreign company, foreign investment fund or 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 18 on your tax return (supplementary section). The amount of a 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 from the current year, and net capital losses from earlier years, and
    • whether any CGT concessions apply to the capital gain (for example, the CGT discount or small business concessions).

    For further information, refer to the Guide to capital gains tax 2008 (NAT 4151).

    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 apply capital losses first against domestic capital gains or foreign capital 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 foreign 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 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. As an individual who owned the foreign property for at least 12 months, you then apply the 50% 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 foreign superannuation funds?

    Certain lump sum payments made from foreign superannuation funds are subject to special tax rules under section 305-70 of the ITAA 1997. 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 tax loss carried forward from a previous income year that you have elected to deduct from your foreign income, and
    • 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 or maintaining debt finance. The term is defined in section 820-40 of the ITAA 1997. Examples of debt deductions are interest, amounts in the nature of interest and fees or charges in respect of debt finance.

    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 your adjusted net foreign income (ANFI) for each class of foreign income.

    This involves allocating to each class of foreign income any apportionable deductions that you are able to claim. 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 do not 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 the ANFI. If your net foreign income (of all classes) is less than or equal to the sum of your taxable income and apportionable deductions, as is most often the case, the ANFI for each class of foreign income equals:

    net foreign income

    X

                  taxable income              
    taxable income + apportionable deductions

    The other methods of working out the 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 foreign income.

    Step 7 Work out your foreign tax credit limit for each class of foreign income.

    The foreign tax credit to which you are entitled 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 from which you derived 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 entitled to claim for each class - from step 7 - and insert the total at O item 20 on your tax return (supplementary section).

    Last modified: 28 Oct 2008QC 27910