• 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. This amount is based on a comparison between your tax liability and the tax liability you would have if certain foreign-taxed and foreign-sourced income and related deductions were disregarded.

    Step 1

    Work out the income tax payable by you (including Medicare levy and Medicare levy surcharge) for the relevant income year, excluding penalties and interest and disregarding any tax offsets.

    Step 2

    Work out the income tax that would be payable by you (including Medicare levy and Medicare levy surcharge) excluding penalties and interest and 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
      • any other income or gains from a non-Australian source
       
    • 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
      • 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 the deductions.

    Whether a deduction is reasonably related to the disregarded assessable income amounts will be a question of fact depending on the circumstances of the taxpayer. The meaning of 'reasonably related to' is broad - it includes a relationship that may either be direct or indirect, provided that the relationship consists of a real connection. However, a merely remote relationship is insufficient.

    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.

    Where foreign income is subject to averaging (for example, where the special professional income rules or primary production income rules apply) only the foreign income for the current year is excluded at this step. It is not necessary to separate the Australian and foreign amounts for prior years.

    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 for the year ended 30 June 2012, 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: $4,236.45 (includes Medicare levy but excludes any Flood levy applicable)

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

    (a) Her assessable income does not include any amount of foreign income in respect of which foreign income tax has been paid, provided that the tax counts towards her foreign income tax offset. Other non-Australian source amounts are also disregarded 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) Certain expenses are disregarded. These are 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 expenses relating to 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: $2,208.70 (includes Medicare levy but excludes any Flood levy applicable)

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

    $4,236.45 - $2,208.70 = $2027.75

    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 $2,027.75.

    Subject to the following section, the difference between the foreign income tax that Anna has paid and the offset limit cannot be refunded or carried forward to a future income year.

    Flood levy and tax paid in tax treaty countries

    A further credit in the form of a foreign income tax offset, may also be allowed against your liability to pay the Temporary flood and cyclone reconstruction levy (flood levy) imposed on foreign income sourced in a country with which Australia has entered into a tax treaty (a list of tax treaty countries is provided at attachment A) where:

    • the foreign tax was paid in a country with which Australia has a tax treaty, and
    • either:
      • foreign tax paid exceeds the foreign income tax offset limit, or
      • foreign tax paid is in excess of the foreign income tax offset applied against your Australian tax payable, Medicare levy and Medicare levy surcharge.
       

    If you are eligible for this further credit, we will calculate it for you. You will need to attach a schedule to your tax return clearly headed 'Flood levy reduction' and advising:

    • the foreign income derived for the year that is sourced in a country with which Australia has entered into a tax treaty, less any allowable deductions related to this income, and
    • amount of foreign income tax paid in a country with which Australia has entered into a tax treaty
    • amount of foreign income tax paid in a country with which Australia has not entered into a tax treaty.

    Deferred non-commercial business losses

    If a current year foreign business loss is required to be deferred because of the non-commercial business loss rules, then step 2 in the foreign income tax offset limit calculation needs to be adjusted for the amount of any foreign business loss that is deferred. This is done before working out the amount of foreign income and expenses to be disregarded.

    Note that to be eligible for the foreign income tax offset where you have a net foreign business loss there must be other foreign income included in assessable income on which foreign income tax has been paid.

    To work out the amount of foreign income and expenses to disregard at step 2, add back the foreign component of the current year deferred non-commercial business loss to the net foreign income amount, and then subtract the net foreign income from taxable income.

    If the net foreign amount is zero or negative after adding back the deferred foreign loss component, then the foreign income tax offset amount will be the lower of the foreign income tax paid or the default foreign income tax offset limit amount of $1,000.

    Example

    Assume for the year ended 30 June 2012 that Karen has an Australian salary of $60,000 and a $7,000 business loss made up of $4,000 Australian loss and $3,000 foreign loss, and the current year loss is required to be deferred as it does not meet one of the four non-commercial loss tests. There is also $20,000 of other foreign income on which foreign income tax of $2,000 has been paid. The net foreign income is ($20,000 - $3000) = $17,000.

    Add the foreign component of deferred loss back to the net foreign income and then subtract the adjusted net foreign income amount from taxable income:

       

    (A$)

    Salary

     

    60,000

    Australian component of net business loss

     

    (4,000)

    Foreign component of net business loss

    (3,000)

     

    Other foreign income (tax paid $2,000)

    20,000

     

    Net foreign income

     

    17,000

    Deferred loss added back

     

    7,000

    Taxable income

     

    80,000

    Net foreign income after adding back foreign component of deferred loss

    (17,000 + 3000)

    20,000

    Taxable income disregarding any foreign income and expenses

    (80,000 - 20,000)

    60,000

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

    Tax on $80,000: $18,750 (includes Medicare levy but excludes any Flood levy applicable)

    Step 2: Work out the tax that would be payable based on the stated assumptions

    Taxable income under step 2 assumptions: $60,000

    Tax on $60,000: $12,450 (includes Medicare levy but excludes any Flood levy applicable)

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

    $18,750 - $12,450 = $6,300

    In this situation, all the foreign income tax of $2,000 would be available as a tax offset as the foreign income tax offset limit exceeds the foreign income tax paid.

      Last modified: 28 Jun 2012QC 25661