If you have attributed foreign income, you may be entitled to a foreign income tax offset for foreign income tax, income tax or withholding tax paid by the controlled foreign company (CFC) in which you hold an interest.
Specifically, a foreign income tax offset may arise:
- for a resident company that is an attributable taxpayer with a CFC interest and includes an amount in its assessable income under section 456 or 457 of the ITAA 1936
- for resident taxpayers that receive a distribution that is treated as non-assessable non-exempt (NANE) income under section 23AI or 23AK of the ITAA 1936.
In these circumstances, the attributable taxpayer is deemed to have paid foreign income tax in respect of their CFC interest, with the tax paid counting towards their tax offset. In their assessable income, the section 456 and 457 amounts must be grossed up by the amount of the foreign income tax that is deemed to have been paid.
For more information on the tax treatment of attributed income, see Attributed foreign income.
Resident company with interest in CFC
A resident company with a CFC interest can treat foreign income tax as having been paid by them in respect of their attributed income if the following conditions are met:
- their assessable income includes an amount under sections 456 or 457 of the ITAA 1936 in relation to their CFC interest
- where the income is included in the company’s assessable income under section 457, foreign income tax, income tax, or withholding tax has been paid by the CFC
- where the income is included in the company’s assessable income under section 456, foreign income tax, income tax or withholding tax has been paid by the CFC on part or all of its notional assessable income for its relevant statutory accounting period
- they have an attribution percentage of 10% or more, worked out at the end of the CFC’s statutory accounting period for a section 456 amount or at residence-change time for a section 457 amount.
If these conditions are met, the amount of foreign income tax they are deemed to have paid is worked out as follows:
- for a section 456 amount; the sum of the foreign income tax, income tax or withholding taxes paid for the statutory accounting period of the CFC multiplied by the attributable taxpayer’s attribution percentage (worked out at the end of the CFC’s statutory accounting period)
- for a section 457 amount; the sum of the foreign income tax, income tax or withholding taxes paid, to the extent that they are attributable to the section 457 amount included in the company’s assessable income.
The tax that is deemed to have been paid by the resident company counts towards its tax offset. The section 456 and 457 amounts must be grossed up by the amount of the foreign income tax that is deemed to have been paid.
Example
Austco owns 50% of the paid-up capital of Foreignco, a CFC. Foreignco’s attributable income for the statutory accounting period is worked out as $1 million, which takes into account a notional allowable deduction for foreign income tax that Foreignco has paid of $200,000. As Austco’s attribution percentage is 50%, it includes $500,000 under section 456 in its assessable income for the income year in which the CFC’s statutory accounting period ends.
Austco meets the conditions for the tax-paid deeming rules to apply for its interest in the CFC because:
- it is a resident company
- foreign income tax has been paid by the CFC in respect of the amount included in its notional assessable income for the relevant statutory accounting period
- it has an attribution percentage of 10% or more at the end of the relevant statutory accounting period.
The amount of foreign income tax that Austco is deemed to have paid on its attributed income is the $200,000 paid by Foreignco, multiplied by Austco’s attribution percentage of 50%, that is, $100,000. Austco must also gross-up its assessable income by the $100,000 of foreign income tax that it is deemed to have paid.
End of exampleTax-paid deeming rule applies only to a resident company directly subject to attribution
The tax-paid deeming rule only applies to resident companies that are directly subject to attribution under section 456 or 457. Where a resident company is a partner in a partnership or a beneficiary in an Australian trust with a CFC interest, the resident company is assessed on their share of the partnership or trust net income under sections 92 or 97 of the ITAA 1936, rather than under sections 456 or 457.
In this case, the partnership or Australian trust is the attributable taxpayer and it includes in its net income the relevant attribution amount under sections 456 or 457. As the partnership or Australian trust is not a resident company and the resident company is not the attributable taxpayer, the tax-paid deeming rules cannot apply to the CFC interests held by the resident company through a partnership or Australian trust.
Example
Oz Co Pty Ltd, a Part X Australian resident, has a 50% interest in partnership X formed in Foreign Country 1. Partnership X wholly owns For Co, a company that is resident in Foreign Country 2. For Co is a CFC for Australian tax purposes.
During the income year, For Co pays income tax under the laws of Country 2.
The relationship between Oz Co, Partnership X and For Co
As partnership X is a partnership for Australian income tax purposes, Oz Co’s assessable income will include its share of the partnership’s net income, calculated as if it were an Australian resident.
As For Co is a CFC and partnership X is an attributable taxpayer by virtue of its being an Australian partnership for the purposes of Part X of the ITAA 1936, the partnership net income includes attributed income under section 456 of the ITAA 1936.
In calculating For Co’s attributed income, a notional allowable deduction is allowed for the foreign income tax paid. However, the foreign income tax paid by For Co does not count towards Oz Co’s foreign income tax offset for the relevant income year because Oz Co is not treated, pursuant to section 770-135 of the ITAA 1997, as having paid the foreign income tax for the purposes of subsection 770-10(1) of the ITAA 1997.
End of exampleForeign income tax paid on NANE income
Resident taxpayers are entitled to a foreign income tax offset for foreign income tax they pay on an amount that is non-assessable non-exempt (NANE) income of the taxpayer, under sections 23AI or 23AK of the ITAA 1936.
For more information on how the attribution account rules apply to attributable taxpayers with CFC or former foreign investment fund (FIF) interests, see chapter 1 and chapter 4 of the Foreign income return form guide.
Only foreign income tax amounts that are paid in respect of income that is NANE under sections 23AI or 23AK count towards a tax offset. Also, the amount of foreign income tax taken to be paid on the distribution is not affected by the tax-paid deeming rules that apply to previously attributed income amounts included in the taxpayer’s assessable income.
Usually, the foreign income tax will be a withholding amount on a dividend distribution. In such a case, where the tax is paid by someone else under the law of a foreign country, the tax-paid deeming rules apply to treat the attributable taxpayer as having paid the foreign income tax, providing it can be demonstrated that such tax is paid in respect of the section 23AI or 23AK amounts.
The tax offset limit is increased by the relevant amount of foreign income tax paid in respect of section 23AI or 23AK amounts.
Example
Lynette owns 100% of Forco paid-up capital. She has previously included in her assessable income $1 million in respect of Forco, under section 456. Forco subsequently declares and pays a dividend of $1 million to Lynette, on which withholding tax of $100,000 is imposed.
As the dividend amount does not exceed her attribution account surplus in relation to Forco, it is treated as her NANE income under section 23AI. Lynette is also deemed to have paid the $100,000 foreign income tax withheld (which counts towards her tax offset) as it is paid in respect of the dividend income.
End of exampleWhere a resident taxpayer is a partner in a partnership or a beneficiary of an Australian trust with a CFC interest, the partnership or trust is the attributable taxpayer. These entities include, in their net income, the relevant attributed amount under sections 456 or 457. In turn, the partner or beneficiary includes, in their assessable income, their share of the partnership or trust net income that relates to the attributed amount.
However, where a CFC makes a distribution to the partnership or trust out of profits that have been previously subject to attribution, the attribution account rules ensure that the resident partner or beneficiary with an interest in the partnership or trust will get the benefit of section 23AI.
Where a foreign entity that was previously treated as a FIF makes a distribution to an Australian resident out of profits that have been previously subject to attribution, the attribution account rules ensure that the income received by the Australian resident will get the benefit of section 23AK. If the distribution is subject to foreign income tax, the amount of foreign tax paid counts towards a foreign income tax offset.