To be entitled to a foreign income tax offset:
- the foreign tax must be foreign income tax
- you must have actually paid, or be deemed to have paid, the foreign income tax
- the income or gain on which you paid foreign income tax must be included in your assessable income (or your NANE income under section 23AI or 23AK of the ITAA 1936) for Australian income tax purposes.
The offset is available in the income year in which the income or gain (on which the foreign income tax has been paid) forms part of your income in Australia.
To count towards a tax offset, foreign income tax must be imposed under a law other than an Australian law and be:
- a tax on income
- a tax on profits or gains, whether of an income or capital nature, or
- any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953.
The foreign income tax includes taxes similar to Australian withholding tax that is imposed in place of a tax on the net amount of income.
The foreign income tax must be correctly imposed under the relevant foreign law and in accordance with any tax treaty the country has with Australia. For example, if country A is limited under a tax treaty to taxing interest derived in that country by an Australian resident at a rate of up to 10%, but country A imposes a domestic tax rate of 25% for interest derived by all foreign residents, only 10% of the tax counts towards the tax offset. The taxpayer would need to seek a refund of the balance (that is, 15%) from country A’s tax authority.
See Attachment A for a list of countries and other jurisdictions that have a tax treaty with Australia.
The foreign income tax may be imposed at a national, state, provincial, local, municipal or supra-national level; an example of a supra-national tax is that imposed by the European Union on pensions paid to its former employees.
The following types of foreign tax do not count towards a foreign income tax offset:
- inheritance taxes
- annual wealth taxes
- net worth taxes
- taxes based on production
- credit absorption taxes, that is, a tax that is payable only because the taxpayer or another entity is entitled to foreign income tax offset in Australia
- unitary taxes, that is, a tax on income, profits or gains of a company derived from sources within the country where the tax is imposed that takes into account income, losses, outgoings or assets of the company (or of an associated company) derived, incurred or situated outside that country, except where the tax only takes those factors into account
- if such an associated company is a resident of the foreign country for the purposes of the law of the foreign country, or
- for the purposes of granting any form of relief for tax imposed on dividends received by one company from another company.
Penalties, fines and interest do not qualify as foreign income tax.
If you are unsure about whether a specific foreign tax is a foreign income tax, you can write to us and request a private binding ruling.
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 income for Australian income tax purposes. The tax could be paid before or after the income year in which you derive the 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 (or your NANE income under section 23AI or 23AK); see Special amendment rules for foreign income tax offsets.
Example 1: Foreign income tax paid in following income year
A resident taxpayer holds shares overseas for the income year ending 30 June 2020. The taxpayer receives dividends from these shares during that income year. The taxpayer pays foreign income tax on the income from the shares in the income year ending 30 June 2021.
Under Australian tax law, the taxpayer must include income from the dividends in their assessable income for 2019–20. However, only when the taxpayer pays the foreign income tax are they eligible for a tax offset.
Once the foreign tax is paid, the taxpayer lodges an amended 2019–20 tax return to claim an offset for the foreign income tax paid.End of example
A taxpayer is treated as having paid foreign income tax on all or part of their 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.
Example 2: Foreign income tax withheld and paid by someone else
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 foreign income tax offset of $100.End of example
Example 3: Foreign income tax paid on partnership net income
A partnership of two Australian partners with equal interests in all income of the partnership derives net income of $1,000 from a foreign country 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 foreign income 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.End of example
Example 4: Foreign income tax paid on joint income
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.End of example
Example 5: Foreign income tax paid by trustee
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.End of example
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.
Example 6: Foreign withholding tax on income of trust
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.End of example
Example 7: Foreign withholding tax deemed paid by ultimate beneficiary
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).End of example
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.
Example 8: Foreign income tax refunded not treated as paid by the taxpayer
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.
When Austco lodges its Australian tax return, it will not claim the foreign income tax offset in relation to this amount.
If Austco had lodged its Australian tax return before finding out about the special concession in the foreign country and being refunded the tax, it would request an amended assessment to reduce its foreign income tax offset claim by the full amount.End of example
To count towards a tax offset, the foreign income tax must have been paid on income, profits or gains that are included in your income for Australian income tax purposes.
For example, where a person receives a dividend from a foreign company, the foreign income tax on the underlying company profits (the source of the dividend) is not paid in respect of the shareholder’s dividend income. Similarly, a person receiving a pension from a foreign superannuation fund has not paid the foreign income tax levied on the income of the superannuation fund. In both of these cases, the tax that has been paid relates to the income or gains of the other entity, which is being taxed in its own right.
However, where an entity has been formed under a foreign country’s laws and profits are taxed in the hands of its members then income tax imposed by that country on a distribution to an Australian member may be counted towards their tax offset. This is the case even where the entity is treated as a company for Australian tax purposes and the distribution is characterised as a dividend.
Example 9: Foreign partnership treated as company and foreign income tax deemed to have paid for the dividend distribution
Aust Super Fund is a trustee of a complying superannuation entity and an Australian resident taxpayer with a 2% interest in a US limited partnership.
Under US tax law, the US limited partnership is treated as fiscally transparent, that is, it is not taxed on its profits, but tax is instead borne by the partners on their share of the partnership distribution.
Aust Super Fund’s share of the US limited partnership’s profits is $1 million, on which tax of $350,000 is withheld by the partnership (under US tax law). The tax is imposed in accordance with the Australia–US tax treaty.
Under Australian tax law, Aust Super Fund has not made an election under former subsection 485AA(1) of the ITAA 1936 or paragraph 830-10(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to treat the US limited partnership as a foreign hybrid limited partnership. Accordingly, the US limited partnership is taxed under Australian tax law as a company in accordance with Division 5A of Part III of the ITAA 1936.
The net amount of $650,000 received by Aust Super Fund is characterised as a dividend for Australian tax law purposes and is included in its assessable income. Although Aust Super Fund has not paid the US tax of $350,000 personally (as the US limited partnership has been taxed on the distribution on a withholding basis) it will be treated as having paid it, as the US tax is imposed on the distribution, rather than on the underlying profits, of the US limited partnership out of which the distribution is made.
Aust Super Fund is also required to gross-up its assessable income by the $350,000 of foreign income tax that it is deemed to have paid in relation to the dividend distribution.End of example
Example 10: Foreign income tax paid on foreign property
A resident taxpayer receives rental income of $5,000 from foreign property, on which $1,000 of income tax is paid in the foreign country. As the resident taxpayer includes the $5,000 of rental income in their Australian assessable income, the requirement for the foreign income tax to be paid on income included in the resident taxpayer's Australian income has been met.End of example
Foreign income tax paid on part of an amount included in your income
In some situations, only part of an amount on which foreign tax has been paid is included in Australian assessable income. When this occurs, only that proportion of the foreign income tax which equates to the proportion of foreign income included would be available as a tax offset.
In other situations, the foreign income tax paid relates to only part of an amount included in the taxpayer’s income for Australian income tax purposes. This typically applies where a foreign source gain on which foreign income tax has been paid is part of a net amount included in a taxpayer’s assessable income. When this occurs, the foreign income tax counts towards the tax offset only to the extent that it is paid in respect of that part of the amount that is included in the taxpayer’s assessable income.
For example, this may be relevant where a taxpayer has both a capital gain and a capital loss, and only the net amount is included in their assessable income. Under the rules applying to capital gains and capital losses, a taxpayer can choose the order in which capital losses are offset against gains. In particular, a taxpayer can choose to offset capital losses (whether current year or prior-year unapplied net capital losses) firstly against domestic capital gains or foreign gains on which no foreign tax has been paid. Such an ordering of the losses maximises the foreign source capital gain component of a net capital gain on which foreign income tax has been paid.
If only part of a foreign capital gain is assessable in Australia (for example, the gain is subject to the discount capital gains concessions in Division 115 of the ITAA 1997) the foreign tax paid on the gain must be apportioned accordingly.
Example 11: Foreign income tax paid on part of an amount included in assessable income
Company C derives the following capital gains and losses on disposals of assets during the year:
Domestic capital gain on land
Foreign capital gain on asset B
$50,000 (no foreign tax paid)
Foreign capital gain on asset C
$20,000 (on which foreign income tax of $2,000 is paid)
Domestic capital loss on asset A
Net capital gain
As the foreign income tax offset can only apply where foreign income tax has been paid on an amount included in the taxpayer assessable income, company C chooses to offset its domestic capital loss on asset A of $160,000; firstly against the domestic gain on land of $100,000; then $50,000 against the foreign capital gain on asset B on which no foreign income tax has been paid; and the balance of $10,000 against the foreign capital gain on asset C. Therefore, the net capital gain of $10,000 relates to the foreign capital gain on asset C. As this is the amount included in assessable income on which foreign income tax has been paid, the proportionate share of tax paid of $1,000 (that is, (10,000 ÷ 20,000) × 2,000) counts towards company C’s foreign income tax offset.End of example
Where foreign income tax is paid on a foreign source gain, but the taxpayer is in an overall capital loss situation for the income year because of other capital losses, none of the foreign income tax paid counts towards a tax offset because the gain is not included in the taxpayer’s assessable income.
Example 12: No foreign income tax offset - foreign income not included in assessable income
On the sale of an asset, an Australian-resident taxpayer makes a foreign source capital gain of $10,000, on which foreign income tax of $2,000 has been paid.
The taxpayer also realises a capital loss of $10,000 on the disposal of an Australian asset.
The loss of $10,000 is offset against the foreign gain of $10,000, which results in no net capital gain being included in the taxpayer's assessable income. As their assessable income does not include an amount on which foreign income tax has been paid, the taxpayer is not eligible for a foreign income tax offset for the foreign income tax paid on the foreign source capital gain.End of example
The same principle applies where foreign income tax has been paid on an amount that forms part of a partnership or trust’s assessable income, but because there is an overall partnership or trust loss for the year (rather than there being net income) the relevant foreign income is not included in the partner or beneficiary’s assessable income.
Foreign income tax paid on foreign source business income counts towards a foreign income tax offset, regardless of whether there is a net business loss from the activity, because all foreign business income forms part of the taxpayer's assessable income. In this respect, the treatment of business losses differs from the treatment of a net capital gain where only the net amount is included in assessable income.
However, when calculating the offset limit similar principles apply for deferred business losses as apply for capital losses.
If a taxpayer has both Australian and foreign source income and prior-year deferred losses, from the same or similar business activity, they can choose whether the losses are taken to be a deduction against the business income from the Australian source or the foreign source. For example, they can choose to offset deferred losses firstly against Australian business income, until the Australian business income is reduced to nil, and then against the foreign business income.
Offsetting the losses in this way maximises the foreign source component of the net business income, which will maximise any claim for the foreign income tax offset.
Foreign income tax paid on amounts that are exempt or non-assessable non-exempt (NANE) income in Australia does not count towards a foreign income tax offset, except where the taxpayer derives NANE income under section 23AI or 23AK of the ITAA 1936.
Example 13: No foreign income tax offset - NANE income
Austco, an Australian-resident company, wholly owns Foreignco, which pays a dividend of $10 million to Austco, out of which foreign income tax of $2 million is paid. This dividend is not paid out of previously attributed income. As the dividend is NANE income of Austco under section 768-5 of the ITAA 1997, the foreign income tax paid of $2 million does not count towards Austco’s tax offset.End of example
Where you have paid foreign income tax on an amount that forms part of your assessable income, you must include the gross amount (including any tax paid by you) in your assessable income on your tax return.
Example 14: Grossing up foreign income
An Australian-resident taxpayer invests directly in a foreign company which pays a dividend of $100, from which it deducts $15 withholding tax.
The taxpayer must gross-up the net distribution of $85, adding the foreign income tax withheld of $15, to show $100 in their tax return as assessable income. This is the amount on which the taxpayer is assessed for income tax purposes.End of example
A special grossing-up rule applies to attributable taxpayers that are deemed to have paid foreign income tax that is actually paid by their controlled foreign company (CFC). In respect of the attributed income of a CFC, a notional deduction is allowed for any foreign income tax, income tax or withholding tax it pays. The attributable taxpayer includes in their assessable income this net amount multiplied by their attribution percentage. As a result, the attributable taxpayer is effectively entitled to a deduction for foreign income tax, income tax or withholding tax paid on an amount included in the CFC's attributed income.
Where the attributable taxpayer is deemed to have paid the foreign income tax that is actually paid by the CFC and counts that towards their tax offset, they have to gross-up their attributed income by the amount of foreign income tax (including withholding tax) they are deemed to have paid.
There are special rules for claiming an offset for foreign income tax paid on attributed income.
Example 15: Grossing up foreign income - attributed income
A Co is an Australian-resident company with a 100% interest in Y Co, a controlled foreign company (CFC). Y Co works out its notional assessable income as $1.2 million and claims a notional allowable deduction of $200,000 for foreign tax paid by it, resulting in attributed income of $1 million. A Co includes the amount of $1 million in its assessable income under section 456 of the ITAA 1936, as its attribution percentage is 100%. A Co is also required to treat the foreign income tax paid by Y Co as having been paid by it under the special tax-paid deeming rules that apply to attributable taxpayers. As a result, A Co is required to gross-up its attributed income of $1 million by the $200,000 of foreign income tax that it is deemed to have paid.End of example