Transitional rules allow taxpayers to use certain excess foreign tax credits that existed when the foreign tax offset rules came into effect on 1 July 2008.
At this time, taxpayers with unused excess foreign tax credits belonging to any class of foreign assessable income from the previous five income years can convert these amounts to one bundle of pre-commencement excess foreign income tax for each of those five years, subject to the following limits:
- for company taxpayers, excess foreign tax credits in the 'other income' class cannot be converted where they relate to amounts that would be non-assessable non-exempt income if derived in the commencement year
- for offshore banking units, existing excess foreign tax credits in the 'offshore banking income' class are converted by multiplying them by the offshore banking eligible fraction (currently one-third).
Using pre-commencement excess foreign income tax
A taxpayer must use pre-commencement excess foreign income tax within five years of the year of income in which the pre-commencement excess foreign income tax arises. For example, any pre-commencement excess foreign income tax that relates to the 2007–08 income year can only be used up to the 2012–13 income year. The 2012-13 income year is the last year that any pre-commencement excess foreign income tax can be used.
The amount used in any one income year cannot exceed the amount by which the foreign tax paid for that year is less than the taxpayer’s foreign income tax offset limit. In effect, the taxpayer can top-up the amount of foreign income tax paid to the foreign tax offset limit using pre-commencement excess foreign income tax amounts.
Given the five-year limitation rule, taxpayers should use pre-commencement excess foreign income tax on a first-in first-out basis. For example, a taxpayer with pre-commencement excess foreign income tax relating to both the 2006–07 and 2007–08 income years should have used those that relate to the 2006–07 income year first, as they expired in 2011–12. Any pre-commencement excess foreign income tax that has not been used within the five-year time limit cannot be offset because it has expired.
Example
Austco is an Australian resident company that converts excess foreign tax credits of $5,000 relating to the 2006–07 income year into pre-commencement excess foreign income tax of $5,000 for that income year.
For the 2010–11 income year, Austco pays foreign income tax of $7,000 on income included in its assessable income and calculates its foreign income tax offset limit as $10,000. As the tax offset of $7,000 (before the application of the pre-commencement excess foreign income tax) is less than the tax offset limit of $10,000, Austco can add pre-commencement excess foreign tax of $3,000 to the tax offset for 2010–11.
This leaves $2,000 of unused pre-commencement excess foreign tax.
For the 2011–12 income year, Austco pays foreign income tax of $4,000 on income included in its assessable income and calculates its foreign income tax offset limit as $5,000. As the tax offset of $4,000 (before the application of any pre-commencement excess foreign income tax) is less than the tax offset limit of $5,000, Austco can add pre-commencement excess foreign income tax of $1,000 to the tax offset for 2011–12.
This leaves $1,000 of unused pre-commencement excess foreign income tax.
For the 2012–13 income year, Austco pays foreign income tax of $8,000 on income included in its assessable income and calculates its foreign tax offset limit as $10,000. Although the tax offset of $8,000 (before the application of any pre-commencement excess foreign income tax) is less than the tax offset limit by $2,000, the unused $1,000 of pre-commencement excess foreign income tax cannot be used to increase the tax offset for 2012–13 as it expired in the previous year.End of example