You will not be able to work out your foreign tax credit if you have shown exempt foreign employment income at N item 19 on your tax return (supplementary section). The Tax Office will work it out for you.
If this is the case, print Schedule of additional information-Question 19 on the top of a separate piece of paper and explain your situation. Include:
- your name, address and tax file number
- each type and amount of foreign income received, and
- any foreign tax paid.
Print X in the YES box at Taxpayer's declaration question 2a on page 8 of your tax return.
Sign and attach your schedule to page 3 of your tax return.
If you do not have exempt foreign employment income, work through the following steps to find out your foreign tax credit. A practical example is available later in this guide.
Step 1: Work out your taxable income
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 will need to fill in the rest of your tax return before you can do this. Your taxable income is the amount at $ 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
Refer to the calculation pages in TaxPack 2004.
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
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 taxpayer.
A description of these offsets can be found in the tax offsets sections of TaxPack 2004 and TaxPack 2004 supplement. Step 3 of the practical example shows you how to work out your average rate of Australian tax.
Step 4: Work out if you have foreign income from more than one class
Foreign income is divided into different classes for the purpose of allowing a foreign tax credit. These are:
- passive foreign income
- lump sum payments from non-resident superannuation funds that are taxed under section 27CAA of the Income Tax Assessment Act 1936 (ITAA 1936)
- other foreign income.
Most taxpayers will only have 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
- attributed foreign income.
If you paid foreign tax in respect of a foreign capital gain, you will 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 17 on your income tax return). This will depend on:
- the amount of the capital gain calculated for Australian tax purposes
- how you have applied any capital losses and net capital losses from earlier years
- whether any capital gains tax (CGT) concessions apply to the capital gain (for example, the CGT discount or small business concessions).
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 may choose to offset losses first against domestic capital gains or foreign gains in respect of which you have not paid tax.
You sell a property that you acquired in January 2000 in a foreign country. Under that country's tax laws, you make a capital gain of $12,000 and you pay tax in relation to that gain. For Australian tax purposes, your capital gain calculated in accordance with parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997) is $10,000.
You have made a capital loss of $2,000 in relation to the sale of another property in Australia. You must apply this loss against your foreign capital gain. You then apply the CGT discount to the remaining capital gain. Your net capital gain is $4,000. 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 that is included in working out your passive foreign income.
What are lump sum payments from non-resident superannuation funds?
Certain lump sum payments made from non-resident superannuation funds are subject to special tax rules under section 27CAA of ITAA 1936. 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, salary or wages and most pensions.
Step 5: Work out your net income for each class of foreign income
Net foreign income is so much of your assessable income as is foreign income of that class, less the following deductions:
- expenses directly related to that class of foreign income other than relevant debt deductions
- any domestic loss carried forward from a previous year that you have elected to use against your foreign income
- other deductions relating 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 and maintaining debt finance. The term is defined in section 820-40 of ITAA 1997. Examples of debt deductions include interest, amounts in the nature of interest and fees in respect of debt.
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 practical example shows you how to work out your net income for each class of foreign income.
Step 6: Work out the adjusted net foreign income (ANFI) for each class of foreign income
This involves allocating any apportionable deductions that you are able to claim between each class of foreign income. Apportionable deductions are those deductions of a concessional nature which do not relate directly to income-producing activities-for example, gifts to eligible charitable organisations.
If you don't have any apportionable deductions, your ANFI will equal your net foreign income.
There are three methods for working out ANFI. Where net foreign income is less than the sum of taxable income and apportionable deductions, as is most often the case, ANFI for each class of income equals:
Net foreign income
taxable income + apportionable deductions
The other methods of working out 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 income.
Step 7: Work out the foreign tax credit limit for each class of foreign income
The foreign tax credit that you are entitled to 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:
average rate of Australian tax.
The amount of credit you are able to claim in Australia may be further limited by a double tax agreement Australia has with the country in which you earned the income. If you received income from a country which has a double tax agreement with Australia and that agreement 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 agreement. If the foreign country has deducted more tax than is permitted under the agreement, you will need to seek a refund of the excess tax from the tax authority of that country. The double tax agreements can be found as Schedules to the International Tax Agreements Act 1953. This Act is available on the Tax Office's legal database at www.ato.gov.au
For further information, phone the Tax Office on 13 28 61.
If you receive a foreign pension or annuity which is taxable in Australia and tax has been deducted from the payment by the country that paid it, you may have to claim a refund of that tax rather than a foreign tax credit. This would be the case if tax was deducted from a pension or annuity you received but, because of a double tax agreement Australia has with that country, Australia is the only country allowed to tax your pension. Claiming a refund generally involves filling in a special claim form. This is available from the tax authority of the country that paid the pension or annuity. Step 7 of the practical example will show you how to work out your foreign tax credit limit.
Step 8: Enter your foreign tax credit amount on your tax return
Write the amount of credit you are able to claim-from step 7-at O item 19 on your tax return (supplementary section).
Last modified: 16 Mar 2007QC 27544