Calculating your offset limit

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, and
  • any other income or gains from a non-Australian source, and
   
• 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, and
  • 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 reasonably relates to the disregarded assessable income amounts will be a question of fact depending on the circumstances of the taxpayer. 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.

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, has income and expenses and pays foreign income tax for the income year as follows:

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)

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:

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).

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).

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.

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.

Example

Foreign income tax offset limit and net capital gains

Resident company X's taxable income for the income year is worked out as follows, including the realisation of the following capital gains and losses from a mix of domestic and foreign sources:

Foreign country B does not impose tax on capital gains made on the disposals of assets.

To calculate the net capital gain, the taxpayer can choose the order in which capital gains are reduced by any capital losses to yield the greatest foreign tax offset as follows:

The company calculates the net capital gain to ensure the maximum foreign income tax offset by:

Finally, as this yields a capital loss of $5,000, the taxpayer deducts this amount from the foreign capital gain on which foreign tax has been paid. Accordingly, the net capital gain of $125,000 relates entirely to the foreign source gain component on which foreign income tax has been paid.

The foreign income tax offset limit calculation is as follows:

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

$165,000 x 0.30 = $49,500

Step 2:Work out the tax that would be payable if the net capital gain on which foreign income tax has been paid is not included in the taxpayer's assessable income.

As all of the net capital gain relates to the foreign source gain component on which foreign income tax has been paid, the amount of $125,000 is treated as if it is not included in assessable income.

There are no deductions that need to be disregarded.

Thus, the taxable income under this step would be $165,000 - $125,000 = $40,000.

Tax payable on $40,000 would be 0.30 x $40,000, that is $12,000.

This is the result of step 2.

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

$49,500 - $12,000 = $37,500

This is X's foreign income tax offset limit. Although X has paid foreign income tax of $39,000 on the net capital gain included in its assessable income, its foreign income tax offset is limited to $37,500.