Tax must have been paid, or deemed to have been paid
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To count towards a tax offset, the foreign income tax must have actually been paid by the taxpayer or be deemed to have been paid by them. It is not enough that the tax is payable.
If the taxpayer is entitled to a refund of the foreign income tax, or if another benefit worked out by reference to the amount of the foreign income tax (other than a reduction in the amount of the foreign tax) is received as a result of a tax payment, the tax is not considered to have been paid.
It is not necessary for you to have paid the foreign income tax in the same income year in which the income or gain on which the tax has been paid is included in your assessable income. The tax could be paid before or after the income year in which you derive the assessable income. However, the offset can only arise when the foreign income tax is paid, and it is applied to the income year in which the relevant income or gain is included in your assessable income
- see Special amendment rules for foreign income tax offsets.
A resident taxpayer holds a qualifying security (Division 16E of Part III of the ITAA 1936) for the income years ending 30 June 2010 through to 30 June 2015. The taxpayer pays foreign income tax on the income from the security in the income year ending 30 June 2015.
Under Australian tax law, the taxpayer includes amounts in their assessable income for the 2010-15 income years on an accruals basis. Only when the taxpayer pays the foreign income tax are they eligible for a tax offset. However, the offset arises in each of the income years in which the taxpayer's assessable income includes an amount on which foreign income tax is later paid.
Once the foreign tax is paid, the taxpayer is required to apportion the paid foreign income tax among the income years in which the amount is included in their assessable income. As a result, once they have paid the foreign income tax they will need to lodge amended assessments for the earlier income years in order to claim an offset for the foreign income tax paid.
Tax paid by someone else
A taxpayer is treated as having paid foreign income tax on all or part of their assessable income where the tax has been paid in respect of that income by someone else on their behalf under an arrangement with the taxpayer or under the law relating to that tax.
This tax-paid deeming rule ensures that the right taxpayer obtains the tax offset. It applies in situations where the foreign income tax has actually been paid by someone else in a representative capacity for the taxpayer, with the latter bearing the economic burden of the tax. Specifically, it applies where foreign income tax has been paid by:
- deduction or withholding
- a trust in which the taxpayer is a beneficiary
- a partnership in which the taxpayer is a partner, or
- the taxpayer's spouse.
Tim, an Australian resident, derives interest income of $1,000 from a foreign country. As that country's laws require the payer of the interest to withhold tax at a rate of 10%, Tim receives $900 (that is, $1,000 less tax of $100). Although he has not directly paid the foreign income tax, Tim is taken to have paid that tax because it was paid under the law relating to the foreign income tax. Tim includes $1,000 in his Australian assessable income and claims a tax offset of $100.
A partnership of two Australian partners with equal interests in all income of the partnership derives net income of $1,000 on which $100 of foreign income tax is paid.
Each partner includes $500 in their assessable income, being their share of the net income of the partnership. They will both be entitled to a tax offset to the extent that foreign income tax is paid on the amount that is part of their assessable income.
The foreign income tax paid is apportioned according to each partner's share of the net income of the partnership included in their assessable income. As a result, each claims an offset for $50 of foreign income tax, as this is the proportionate amount of foreign income tax they are taken to have paid on the amount included in their assessable income - that is, (500 1,000) $100.
Married couple Arthur and Lucy, both Australian residents, derive net rental income from a foreign country. Under that country's laws, joint filing of tax returns is allowed. Consequently, the net rental income is included in their jointly-filed return and income tax is paid jointly on that income. However, under Australian tax law, each person must show their share of the net rental income in their own tax return. Although the foreign income tax has been jointly paid under the laws of the foreign country, Arthur and Lucy are each deemed to have paid their relevant share of the foreign income tax that has been paid jointly.
The S trust estate derives rental income from commercial property investments in a foreign country, on which the trustee pays foreign income tax. Samantha, an Australian resident, is the sole beneficiary of the S trust estate and is presently entitled to all of its income. As such, she is assessed on the whole of the trust's net income. Although Samantha hasn't directly paid the foreign income tax, she is deemed to have paid it.
Special tax-paid deeming rules for trust estate beneficiaries
A specific rule deems a taxpayer to have paid the relevant foreign income tax where they are presently entitled to a share of the trust income that can be directly or indirectly attributed to income received by the trust on which foreign income tax has already been paid by an entity other than the trust itself. This tax-paid deeming rule applies where:
- section 6B of the ITAA 1936 treats an amount of assessable income as being attributable to another amount of income having a particular character or source
- foreign income tax has been paid in respect of the other amount of income
- the assessable income attributed under section 6B is less than it would have been if the foreign income tax had not been paid.
These rules ensure that a beneficiary of a trust can be deemed to have paid the relevant tax on its share of trust income that is attributable to income that flows through the trust (or chain of trusts) on which foreign income tax is paid by another entity.
The amount of the foreign income tax that is taken to have been paid by the taxpayer is the amount by which the income included in their assessable income has been reduced because of the payment of the foreign income tax.
Holly is the sole beneficiary of the B trust estate and is presently entitled to all of its income. B derives foreign dividend income of $100,000, on which foreign dividend withholding tax of $10,000 is paid. B subsequently distributes all its income to Holly (that is, $90,000 net of withholding). As Holly's share of the trust income is attributable to the dividend income received by B (by virtue of section 6B of the ITAA 1936), she can treat the withholding tax paid on the dividend as having been paid by her. Holly also includes $100,000 in her assessable income.
Tim, an Australian resident, is the only unit holder in Managed Fund A, which in turn is the only unit holder in Managed Fund B, which has an interest in a US company. Both managed funds are unit trusts. The US company pays a dividend of $1,000 to Managed Fund B, on which withholding tax of $150 is payable, making the net distribution $850. This amount of $850 flows through both managed funds to Tim. The terms and conditions of the two managed funds are such that Tim is the beneficial owner of the shares on which the dividend was paid.
Tim grosses up the $850 by the amount of the $150 withholding tax and includes $1,000 in his assessable income. As Tim's share of the trust income is attributable to the dividend income received by Managed Fund B, he can treat the withholding tax paid on the dividend as having been paid by him (even though the amount included in his assessable income is attributable to the dividend income that has flowed through a chain of trusts).
Foreign income tax not treated as paid by the taxpayer
A taxpayer is not entitled to a tax offset for foreign income tax to the extent they, or any other entity, are entitled to:
- a refund of the foreign tax, or
- any other benefit worked out by reference to the amount of foreign income tax (other than a reduction in the amount of the foreign income tax).
The entitlement to a benefit may arise from the exploitation of arbitrage opportunities resulting from mismatches in debt and equity classifications and the different status granted to foreign hybrid entities - for example, where an enhanced yield is obtained by a taxpayer entering into a structured financing arrangement.
However, the taxpayer may still be entitled to a tax offset where the only benefit is a reduction in the tax liability of the taxpayer or another entity - such as that provided by an imputation credit, a rebate of tax or a similar type of concession - provided that the concession does not result in a refund to the taxpayer or other entity.
In a foreign country, Austco derives net rental income on which income tax of $50,000 is paid in that country.
Austco later finds out that it is entitled to a special concession in the foreign country, under which the $50,000 is fully refunded. Accordingly, Austco is taken to not have paid foreign income tax on that income.