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Ruling

Subject: Foreign income tax offset

Question

Can foreign tax paid on foreign income be offset against general interest charge (GIC) outstanding on your account?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

You are a professional and operate a business as a sole trader.

For a number of years you have been exporting your services, mainly in one overseas region and especially to country X.

You work mainly in Australia but your clients and the projects are based in country X. You are paid from country X into your Australian bank account, and your client in country X deducts tax from your gross invoice and pays it to the tax authorities of country X on your behalf, before paying you the net amount.

You are paid rarely but in relatively large amounts for your export services (several times a year).

You have paid taxes in country X during the relevant years of income.

GIC has accrued on your account due to an outstanding debt, and your GIC account has a current amount outstanding.

Relevant legislative provisions

International Tax Agreements Act 1953 Section 3AAA

International Tax Agreements Act 1953 Section 5

Income Tax Assessment Act 1997 Section 770-5

Income Tax Assessment Act 1997 Subsection 770-5(2)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Income Tax Assessment Act 1997 Section 4-10

Taxation Administration Act 1953 Section 8AAA

Reasons for decision

Summary

Where foreign tax is paid in relation to income derived by an Australian resident from foreign sources, a credit (called a foreign income tax offset) may be allowed against the Australian income tax payable on that foreign income. GIC is not income tax but is a separate charge, therefore any foreign income tax offset that you are entitled to can not be used to offset the GIC outstanding on your account.

Detailed reasoning

In determining liability to Australian tax on foreign sourced income it is necessary to consider not only the income tax laws but also any applicable double tax agreement.

The current double tax agreements that Australia has with various countries are listed in section 3AAA of the International Tax Agreements Act 1953 (the Agreements Act). These double tax agreements are given the force of law in Australia under section 5 of the Agreements Act.

Australia has a double tax agreement with country X (the country X Agreement).

Article 23 of the country X Agreement deals with the elimination of double taxation. It provides that, subject to the provisions of the law of Australia which relate to the allowance of a credit against Australian tax of tax paid in a country outside Australia, tax paid in country X under the law of country X and in accordance with the country X Agreement, in respect of income derived by a resident of Australia from sources in country X shall be allowed as a credit against Australian tax payable on that income.

Article 3 of the country X Agreement contains definitions, and states that in the country X Agreement:

· the term 'tax' means Australian tax or country X tax , but does not include any penalty or interest imposed under the law of either country relating to its tax

· the term 'Australian tax' means tax imposed by Australia, being tax to which the Agreement applies by virtue of Article 2 (that is, income tax and resource rent tax in respect of offshore projects relating to exploration for, or of, petroleum resources, imposed under the federal law of Australia), and

· the term 'country X tax' means tax imposed by country X, being tax to which the Agreement applies by virtue of Article 2 (that is, income tax, profit tax and withholding tax).

Under Article 23 of the country X Agreement, if country X tax is paid in relation to income derived by an Australian resident from sources in country X, a credit may be allowed against the Australian tax payable on that income.

However, penalty or interest is not included in the definition of 'tax' in the country X Agreement, so Australian tax payable for the purposes of the Agreement does not include GIC payable in Australia. Australian tax is defined for the purposes of the country X Agreement as meaning income tax and resource rent tax. Consequently, a credit for the tax paid in country X is allowable to you against the Australian income tax payable on your income from country X, but not against your outstanding GIC.

The application of Article 23 is subject to the provisions of the law of Australia which relate to the allowance of a credit against Australian tax of tax paid in a country outside Australia (this credit is now called a foreign income tax offset). Therefore, it is also necessary to consider the foreign income tax offset provisions of the Australian income tax law.

Foreign income tax offsets

The foreign income tax offset provisions, which apply to income years from 1 July 2008, are set out in Division 770 of the Income Tax Assessment Act 1997 (ITAA 1997).

Section 770-5 of the ITAA 1997 states that the object of Division 770 is to relieve double taxation where you have paid foreign income tax on amounts included in your assessable income, and you would apart from Division 770, pay Australian income tax on the same amounts. Subsection 770-5(2) states:

'To achieve this object, this Division gives you a tax offset to reduce or eliminate Australian income tax otherwise payable on those amounts.'

The term 'income tax' is defined in subsection 995-1(1) of the ITAA 1997 to mean income tax imposed by any of these:

· the Income Tax Act 1986

· the Income Tax (Diverted Income) Act 1981

· the Income Tax (Former Complying Superannuation Funds) Act 1994

· the Income Tax (Former Non-resident Superannuation Funds) Act 1994

· the Income Tax (Fund Contributions) Act 1989.

Section 4-10 of the ITAA 1997 sets out the method to work out how much income tax you have to pay. It provides that income tax is worked out by reference to taxable income (that is, assessable income less deductions) for the income year, and that:

Income tax = (Taxable income x Rate/s that apply) - Tax offsets

GIC is not worked out by reference to taxable income, but is a charge that is worked out under Part IIA of the Taxation Administration Act 1953. Section 8AAA of that Part states that usually, a person is liable to pay the charge if an amount that the person must pay to the Commissioner (for example, income tax) is not paid on time. GIC is payable on the unpaid amount/s, and is imposed on a daily compounding basis.

A foreign income tax offset allowable under Division 770 of the ITAA 1997 reduces the Australian income tax otherwise payable on foreign income included in assessable income. As GIC is not income tax but is a separate interest charge, any foreign income tax offset that you are entitled to cannot be used to offset the GIC outstanding on your account.

For further information on claiming a foreign income tax offset, please refer to our publication Guide to foreign income tax offset rules 2010-11, which is available on our website at www.ato.gov.au