When a foreign income tax offset applies

To be entitled to a foreign income tax offset:

• the foreign tax must be foreign income tax
• you must have actually paid, or be deemed to have paid, the foreign income tax
• the income or gain on which you paid foreign income tax must be included in your assessable income in Australia.

The offset is available in the income year in which the income or gain (on which the foreign income tax has been paid) forms part of your assessable income in Australia.

Foreign tax must be foreign income tax

To count towards a tax offset, foreign income tax must be imposed under a law other than an Australian law and be:

• a tax on income
• a tax on profits or gains, whether of an income or capital nature, or
• any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953 (Agreements Act).

The foreign income tax includes taxes similar to Australian withholding tax that is imposed in place of a tax on the net amount of income.

For examples, see Foreign taxes where offset is available.

The foreign income tax must be correctly imposed under the relevant foreign law and in accordance with any tax treaty the country has with Australia. For example, if country A is limited under a tax treaty to taxing at a rate of up to 10% interest derived in that country by an Australian resident, but country A imposes a domestic tax rate of 25% for interest derived by all foreign residents, only 10% of the tax counts towards the tax offset. The taxpayer would need to seek a refund of the balance (that is, 15%) from country A’s tax authority.

The foreign income tax may be imposed at a national, state, provincial, local, municipal or supra-national level; an example of a supra-national tax is that imposed by the European Union on pensions paid to its former employees.

Foreign taxes not included

The following types of foreign tax do not count towards a foreign income tax offset:

• inheritance taxes
• annual wealth taxes
• net worth taxes
• taxes based on production
• credit absorption taxes, that is, a tax that is payable only because the taxpayer or another entity is entitled to foreign income tax offset in Australia
• unitary taxes, that is, a tax on income, profits or gains of a company derived from sources within the country where the tax is imposed that takes into account income, losses, outgoings or assets of the company (or of an associated company) derived, incurred or situated outside that country, except where the tax only takes those factors into account
  • if such an associated company is a resident of the foreign country for the purposes of the law of the foreign country, or
  • for the purposes of granting any form of relief for tax imposed on dividends received by one company from another company.
   

Penalties, fines and interest do not qualify as foreign income tax.

If you are unsure about whether a specific foreign tax is a foreign income tax, you can write to us and request a private binding ruling.

Foreign taxes where offset is available

A foreign income tax offset may be available for the foreign taxes imposed by Australia's major trading partners, as listed below. This list is not exhaustive, nor does it include local or state taxes, except for India.

Argentina

Income tax (Impuesto a las ganancias)

Canada

Income taxes imposed by the Government of Canada under the Income Tax Act.

China

Income tax

France

Income tax and corporation tax, including any related tax or advance payment

Germany

Income tax (einkommensteuer)

Corporation tax (korperschaftsteuer)

India

Income tax, including any surcharge

Capital gains tax

Non-resident withholding tax

State government imposed taxes on various agriculture incomes

Italy

Individual income tax (l'imposta sul reddito delle persone fisiche)

Corporate income tax (l’imposta sul reddito delle società, formerly l’imposta sul reddito delle persone giuridiche)

Japan

Income tax

Corporation tax

New Zealand

Income tax

Non-resident withholding tax

Tax on profits from property sales

Singapore

Income tax

South Africa

Normal tax

Non-resident withholding tax

South Korea

Income tax

Corporations tax

Inhabitant tax

United Kingdom

Income tax

Capital gains tax

Corporations tax

United States

Federal income taxes imposed by the Internal Revenue Code.

Tax must have been paid, or deemed to have been paid

To count towards a tax offset, the foreign income tax must have actually been paid by the taxpayer or be deemed to have been paid by them. It is not enough that the tax is payable.

If the taxpayer is entitled to a refund of the foreign income tax, or if another benefit worked out by reference to the amount of the foreign income tax (other than a reduction in the amount of the foreign tax) is received as a result of a tax payment, the tax is not considered to have been paid.

It is not necessary for you to have paid the foreign income tax in the same income year in which the income or gain on which the tax has been paid is included in your assessable income. The tax could be paid before or after the income year in which you derive the assessable income. However, the offset can only arise when the foreign income tax is paid, and it is applied to the income year in which the relevant income or gain is included in your assessable income; see Special amendment rules for foreign income tax offsets.

Tax paid by someone else

A taxpayer is treated as having paid foreign income tax on all or part of their assessable income where the tax has been paid in respect of that income by someone else on their behalf under an arrangement with the taxpayer or under the law relating to that tax.

This tax-paid deeming rule ensures that the right taxpayer obtains the tax offset. It applies in situations where the foreign income tax has actually been paid by someone else in a representative capacity for the taxpayer, with the latter bearing the economic burden of the tax. Specifically, it applies where foreign income tax has been paid by:

• deduction or withholding
• a trust in which the taxpayer is a beneficiary
• a partnership in which the taxpayer is a partner, or
• the taxpayer’s spouse.

Special tax-paid deeming rules for trust estate beneficiaries

A specific rule deems a taxpayer to have paid the relevant foreign income tax where they are presently entitled to a share of the trust income that can be directly or indirectly attributed to income received by the trust on which foreign income tax has already been paid by an entity other than the trust itself. This tax-paid deeming rule applies where:

• section 6B of the ITAA 1936 treats an amount of assessable income as being attributable to another amount of income having a particular character or source
• foreign income tax has been paid in respect of the other amount of income
• the assessable income attributed under section 6B is less than it would have been if the foreign income tax had not been paid.

These rules ensure that a beneficiary of a trust can be deemed to have paid the relevant tax on its share of trust income that is attributable to income that flows through the trust (or chain of trusts) on which foreign income tax is paid by another entity.

The amount of the foreign income tax that is taken to have been paid by the taxpayer is the amount by which the income included in their assessable income has been reduced because of the payment of the foreign income tax.

Foreign income tax not treated as paid by the taxpayer

A taxpayer is not entitled to a tax offset for foreign income tax to the extent they, or any other entity, are entitled to:

• a refund of the foreign tax, or
• any other benefit worked out by reference to the amount of foreign income tax (other than a reduction in the amount of the foreign income tax).

The entitlement to a benefit may arise from the exploitation of arbitrage opportunities resulting from mismatches in debt and equity classifications and the different status granted to foreign hybrid entities, for example, where an enhanced yield is obtained by a taxpayer entering into a structured financing arrangement.

However, the taxpayer may still be entitled to a tax offset where the only benefit is a reduction in the tax liability of the taxpayer or another entity (such as that provided by an imputation credit, a rebate of tax or a similar type of concession) provided that the concession does not result in a refund to the taxpayer or other entity.

Foreign income tax must have been paid on assessable income

To count towards a tax offset, the foreign income tax must have been paid on income, profits or gains that are included in your assessable income.

For example, where a person receives a dividend from a foreign company, the foreign income tax on the underlying company profits (the source of the dividend) is not paid in respect of the shareholder’s dividend income. Similarly, a person receiving a pension from a foreign superannuation fund has not paid the foreign income tax levied on the income of the superannuation fund. In both of these cases, the tax that has been paid relates to the income or gains of the other entity, which is being taxed in its own right.

However, where an entity has been formed under a foreign country’s laws that treat the entity as 'fiscally transparent' (that is, its profits are taxed in the hands of its members) then income tax imposed by that country on a distribution to an Australian member may be counted towards their tax offset. This is the case even where the entity is treated as a company for Australian tax purposes and the distribution is characterised as a dividend.

For example, this situation could arise where an Australian taxpayer is a member of a US limited liability company (LLC) that is treated as fiscally transparent under US tax law, but under Australian tax law the Australian member of the US LLC does not elect to treat the LLC as a foreign hybrid.

Foreign income tax paid on part of an amount included in assessable income

In some situations, only part of an amount on which foreign tax has been paid is included in Australian assessable income. When this occurs, only that proportion of the foreign income tax which equates to the proportion of foreign income included would be available as a tax offset.

In other situations, the foreign income tax paid relates to only part of an amount included in the taxpayer’s assessable income. This typically applies where a foreign source gain on which foreign income tax has been paid is part of a net amount included in a taxpayer’s assessable income. When this occurs, the foreign income tax counts towards the tax offset only to the extent that it is paid in respect of that part of the amount that is included in the taxpayer’s assessable income.

For example, this may be relevant where a taxpayer has both a capital gain and a capital loss, and only the net amount is included in their assessable income. Under the rules applying to capital gains and capital losses, a taxpayer can choose the order in which capital losses are offset against gains. In particular, a taxpayer can choose to offset capital losses (whether current year or prior-year unapplied net capital losses) firstly against domestic capital gains or foreign gains on which no foreign tax has been paid. Such an ordering of the losses maximises the foreign source capital gain component of a net capital gain on which foreign income tax has been paid.

Where foreign income tax is paid on a foreign source gain, but the taxpayer is in an overall capital loss situation for the income year because of other capital losses, none of the foreign income tax paid counts towards a tax offset because the gain is not included in the taxpayer’s assessable income.

The same principle applies where foreign income tax has been paid on an amount that forms part of a partnership or trust’s assessable income, but because there is an overall partnership or trust loss for the year (rather than there being net income) the relevant foreign income is not included in the partner or beneficiary’s assessable income.

Deferred non-commercial business losses

Foreign income tax paid on foreign source business income counts towards a tax offset, regardless of whether there is a net business loss from the activity, because all foreign business income forms part of the taxpayer's assessable income. In this respect, the treatment of business losses differs from the treatment of a net capital gain where only the net amount is included in assessable income.

However, when calculating the offset limit similar principles apply for deferred business losses as apply for capital losses.

If a taxpayer has both Australian and foreign source income and prior-year deferred losses, from the same or similar business activity, they can choose whether the losses are taken to be a deduction against the business income from the Australian source or the foreign source. For example, they can choose to offset deferred losses firstly against Australian business income, until the Australian business income is reduced to nil, and then against the foreign business income.

Offsetting the losses in this way maximises the foreign source component of the net business income, which will maximise any claim for the foreign income tax offset.

Exempt or non-assessable non-exempt income

Foreign income tax paid on amounts that are exempt or non-assessable non-exempt (NANE) income in Australia does not count towards a tax offset, except where the taxpayer derives NANE income under section 23AI or 23AK of the ITAA 1936.

Foreign income must be grossed up

Where you have paid foreign income tax on an amount that forms part of your assessable income, you must include the gross amount (including any tax paid by you) in your assessable income on your tax return.

Attributed income

A special grossing-up rule applies to attributable taxpayers that are deemed to have paid foreign income tax that is actually paid by their controlled foreign company (CFC). In respect of the attributed income of a CFC, a notional deduction is allowed for any foreign income tax, income tax or withholding tax it pays. The attributable taxpayer includes in their assessable income this net amount multiplied by their attribution percentage. As a result, the attributable taxpayer is effectively entitled to a deduction for foreign income tax, income tax or withholding tax paid on an amount included in the CFC's attributed income.

Where the attributable taxpayer is deemed to have paid the foreign income tax that is actually paid by the CFC and counts that towards their tax offset, they have to gross-up their attributed income by the amount of foreign income tax (including withholding tax) they are deemed to have paid.

There are special rules for claiming an offset for foreign income tax paid on attributed income.