Edited version of private ruling

Authorisation Number: 1011608154904

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Ruling

Subject: Foreign income tax offset

1. Are you entitled to claim foreign income tax offset where your income will include capital gains from the disposal of assets located in foreign countries and no foreign tax is paid but you have unused qualifying pre-commencement excess foreign income tax ?

Yes.

2. Does a capital gain made by you from the disposal of a capital asset located outside of Australia constitute 'statutory income' from a source other than an Australian source for the purposes of subparagraph 770-75(4)(a)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

This ruling applies for the following period

Income year ended 30 June 2010

Income year ending 30 June 2011

Income year ending 30 June 2012

Income year ending 30 June 2013

Income year ending 30 June 2014

Relevant facts

You have unused, excess foreign tax credits which were derived in the four preceding income years.

You and your ex-spouse jointly own a number of residential properties which derived rental income in foreign countries.

You also own vacant land in a foreign country. These properties and land have always been held on capital account and were acquired post introduction of capital gains tax (CGT).

Under the tax law of the jurisdictions where these properties are to be sold, no local income tax or equivalent would be payable. However, under Australian tax law, the net capital gains on the disposal of these properties would be included in their assessable income.

You plan to sell these properties in the 2010-11 and 2011-12 income years and you expect that substantial net capital gains will arise from their disposal.

Relevant legislative provisions

Income Tax assessment Act 1997 Subsection 770-10(1)

Income Tax assessment Act 1997 Section 770-70

Income Tax (Transitional Provisions) Act 1997 section 770-230

Income Tax (Transitional Provisions) Act 1997 Subsection 770-230 (2)

Income Tax (Transitional Provisions) Act 1997 Subsection 770-230 (3)

Income Tax (Transitional Provisions) Act 1997 Subsection 770-230 (4)

Income Tax assessment Act 1997 Subsection 770-75 (1)

Income Tax assessment Act 1997 Subsection 770-75 (2)

Income Tax assessment Act 1997 Subsection 770-75 (4)

Income Tax assessment Act 1997 section 995

Income Tax assessment Act 1997 section 6-10

Income Tax assessment Act 1997 section 10-5

Income Tax assessment Act 1997 section 102-5

Income Tax assessment Act 1997 subparagraph 770-75(4)(a)(ii)

Reasons for decision

From 1 July 2008 under subsection 770-10 (1) of the ITAA 1997 you are entitled to a tax offset in an income year for foreign income tax paid in respect of an amount that is all or part of an amount included in your assessable income for the year.

The amount included in your assessable income includes income, profit or gains (including gains of a capital nature). Foreign income is no longer quarantined into separate classes to work out the amount of the tax offset. All types of income are treated as the same for the purposes of working out the foreign income tax offset.

Under section 770-70 of the ITAA 1997, the amount of your income tax offset for the year is the sum of the foreign income tax you paid that counts towards the offset for the year.

Note 2 in this subsection provides that the amount of foreign income tax you paid may be affected by subdivision 770-C of the ITAA 1997 and the amount of the offset might be increased under section 770-230 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA), if you have pre-commencement excess foreign income tax.

Under subsection 770-230(2) of the ITTPA your tax offset for an income year (the current year) is increased in accordance with this section if:

(a) the amount of your tax offset worked out under section 770-70 of the 1997 Act falls short of your offset limit under section 770-75 of that Act, and

(b) you have pre-commencement excess foreign income tax (see section 770-220) from an earlier year of income that is one of the most recent five income years ending before the current year.

Under subsection 770-230(3) of the ITTPA you can increase your tax offset for the current year by adding your pre-commencement excess foreign income tax covered by paragraph (2)(b) to the amount of your tax offset worked out under section 770-70 of the ITAA 1997.

Under subsection 770-230(4) of the ITTPA you only increase the offset to the extent of the shortfall worked out under paragraph (2)(a) of the ITAA 1997.

In this case, you will have capital gains included in your assessable income from sales of properties located in foreign countries made under foreign contracts. No tax will be payable in the foreign countries for these capital gains that arose from the disposal. However, you have pre-commencement unused excess foreign income tax within the five year limitation rule under subsection 770-220(1) of the ITTPA.

Subsection 770-230(2) of the ITAA 1997 allows you to utilise your eligible unused pre-commencement excess foreign income tax to make up the short fall between the tax paid and the foreign tax offset limit of the income year.

Given the five year limitation rule, you should use pre-commencement excess foreign income tax on a first in first out basis. Any pre-commencement excess foreign income tax that has not been used within the five year time limit cannot be offset as it has expired (Guide to foreign income tax offset rules 2009-10).

The tax offset limit

Under subsection 770-75(1) of the ITAA 1997 if you claim an offset of $1,000 or less, you only need to record the actual amount of foreign income tax paid on your assessable income (up to $1,000).

If claiming a foreign income tax offset of more than $1,000, you will 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 (subsection 770-75(2) of the ITAA 1997).

Under subsection 770-75(2) of the ITAA 1997 the amount of income tax that would be payable by you is calculated as if the assumptions in subsection (4) of this section 770-75 were made.

Subsection 770-75 (4) assumes that:

(a) your assessable income did not include:

(i) so much of any amount included in your assessable income as represents an amount in respect of which you paid foreign income tax that counts towards the tax offset for the year, and

(ii) any other amounts of ordinary income or statutory income from a source other than an Australian source.

Statutory income is defined in section 995 of the ITAA 1997 as having the same meaning given in section 6-10 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that statutory income is not ordinary income but is included by provisions about assessable income. The list of assessable income in section 10-5 of the ITAA 1997 includes capital gains assessable under section 102-5 of the ITAA 1997.

Australian source is defined in section 995 of the ITAA 1997 as ordinary or statutory income derived from a source in Australia for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936).'Other than an Australian source' would therefore be ordinary or statutory income derived from a source outside of Australia.

The concept of source is absent form the CGT legislation. Generally, Australian residents are assessable on their world wide capital gains. Part 3-1 and 3-3 of the ITAA 1997 broadly claims jurisdiction in respect of all 'capital gains derived by Australian residents.

The leading Australian authority on the source of profits from the sales of shares is Australian Machinery and Investments Company Ltd v. Deputy Commissioner of Taxation (WA) (1946) 180 CLR 9; 3 AITR 359; (1946) 8 ATD 81, where it was held that where shares are situated outside Australia and sold outside Australia the profit on sale is derived wholly from a source outside Australia.

In this case, the rental properties and vacant lands are situated overseas and the contract of sale will be made overseas. In view of the above reasoning, the capital gain made by you from assets located outside of Australia constitute statutory income from a source other than an Australian source for the purposes of subparagraph 770-75(4)(a)(ii) of the ITAA 1997.

Consequently, you are entitled to a FITO for capital gains made from the disposal of assets located in foreign countries included in your assessable income as:

· the calculation of foreign income tax amount allows you utilise eligible unused pre-commencement foreign tax to the extent of the short-fall between the foreign tax paid and the tax offset limit, and

· the income disregarding rules in calculating the tax offset limit allows you to exclude capital gains made from properties located in foreign countries, from foreign contracts, where no foreign tax has been paid as statutory income from a source other than an Australian source under subparagraph 770-75(4)(a)(ii) of the ITAA 1997.

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