ATO Interpretative Decision

ATO ID 2006/164 (Withdrawn)

Income tax

• This ATO Interpretative Decision is withdrawn.
  Sections 79D and 160AFD of the Income Tax Assessment Act 1936 do not apply for income years commencing on or after 1 July 2008. Despite its withdrawal, this ATO Interpretative Decision continues to be a precedential view in respect of those provisions for income years up to, and including, the 2007/2008 income year.
  The Japanese Agreement referred to in this Interpretative Decision has been replaced by a new Japanese Agreement which, in relation to income tax, applies to income years commencing on or after 1 July 2009. Despite its withdrawal this Interpretative Decision continues to be a precedential view in relation to the application of the former Japanese Agreement for income years up to, and including, the 2008/2009 income year.
  This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Does section 79DA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deny a deduction to an Australian resident taxpayer for prior year tax losses where the taxpayer derives assessable income that is treated, by virtue of Article 17(4) of the Australia - Japan Double Taxation Agreement (Japanese Agreement) , as income derived from sources in Japan?

Decision

Yes. Section 79DA of the ITAA 1936 will deny the taxpayer a deduction for their prior year losses.

Facts

The taxpayer is an Australian resident company.

The taxpayer derived Australian source income.

The taxpayer and a Japanese company are associated enterprises under Article 5 of the Japanese Agreement.

As a result of non-arm's length dealings between the taxpayer and the Japanese company, transfer pricing adjustments were made in accordance with Article 5 of the Japanese Agreement to the Japanese company to increase their profits (the 'adjusted profits').

Under Article 17, double tax relief is provided to the taxpayer by treating the Australian resident company as having derived the adjusted profits (which would otherwise be considered Australian sourced profits) from a source in Japan and by providing credit relief in accordance with Australia's domestic laws.

In the years of income that the transfer pricing adjustments were made, the taxpayer made deductions for prior year losses in accordance with Division 36 of the Income Tax Assessment Act 1997 (ITAA 1997).

Reasons for Decision

Section 79DA of the ITAA 1936 provides that a prior year tax loss is not allowable as a deduction from a taxpayer's assessable foreign income of the year of income, unless an election has been made by the taxpayer.

The term 'assessable foreign income' takes its meaning from section 160AFD of the ITAA 1936. Amongst other things, it refers to 'foreign income' which, in turn, is defined in subsection 6AB(1) of the ITAA 1936 as being, in part, a 'reference to income derived from sources in a foreign country'.

In determining liability to Australian tax involving transactions with another foreign country, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (Agreements Act).

Section 4 of the Agreements Act incorporates the ITAA 1936 and the ITAA 1997 so that those Acts are read as one with the Agreements Act. By virtue of subsection 4(2), the Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited situations).

Schedule 6 to the Agreements Act contains the Japanese Agreement. The Japanese Agreement operates to avoid the double taxation of income received by Australian and Japanese residents.

Article 17(4) of the Japanese Agreement provides that, for the purposes of relieving double taxation, where profits of the taxpayer are also included in the profits of its associated Japanese company as a result of Article 5 of the treaty, then those profits will be treated as having a Japanese source and relief is provided by Australia for the Japanese tax imposed on those profits.

As there is an inconsistency between the source of the adjusted profits under the treaty and under domestic law (by virtue of the 'foreign income' definition in subsection 6AB(1) of the ITAA 1936), the treaty source rule will apply. This means that the taxpayer's adjusted profits will be considered to be foreign income for the purposes of providing relief from double taxation under domestic law.

As section 79DA of the ITAA 1936 is part of the process for providing relief from double taxation, the adjusted profits will be taken to be foreign income for the purposes of that section. Accordingly, no prior year losses of the taxpayer are allowable as a deduction against such income, unless the taxpayer so elects.

Year of income:  2001 year of income

Legislative References:
International Tax Agreements Act 1953
   section 4
   Schedule 6, Article 5
   Schedule 6, Article 17(4)

Related Public Rulings (including Determinations)
Taxation Ruling TR 2000/16

Keywords
Carry forward losses
Excess foreign tax credits
Foreign tax credits
International mutual agreement procedures

Business Line:  Public Groups and International

Date of publication:  7 July 2006

ISSN: 1445-2782