Superannuation funds
Limits apply to the foreign income tax offset allowed for foreign income taxes paid by a superannuation fund or approved deposit fund where the fund changes:
- from a complying superannuation fund to a non-complying superannuation fund, or
- from a non-resident superannuation fund to a resident superannuation fund.
Where a non-complying fund or a resident fund includes an amount in assessable income under items 2 and 3 in the table in section 295-320 of the ITAA 1997External Link, and the fund paid foreign income tax on that amount (before the start of the income year) the fund is not entitled to a tax offset for the foreign income tax paid by the provider.
Consolidated groups
Only the head company of a consolidated group or multiple entry consolidated (MEC) group is entitled to a foreign income tax offset for foreign income tax paid on income or gains that are included in its assessable income under the single entity rule. Where a subsidiary member pays foreign income tax on income or gains included in the head company’s assessable income, the head company is treated as having paid the tax.
The head company’s foreign income tax offset is determined in the same way as for taxpayers outside the consolidation regime.
More detailed information on the operation of the foreign income tax offset rules for consolidated groups or MEC groups is in the Consolidation reference manual.
Life insurance companies
The core rules for the foreign income tax offset also apply to life insurance companies. As the income of life insurance companies is taxed at two different rates (ordinary class, taxed at 30%; and complying superannuation/FHSA class, taxed at 15%), it is necessary to determine the amount of assessable income in each class on which foreign income tax has been paid at step 2 of the foreign income tax offset limit calculation.
Example
Income Class |
Assessable Income (includes income subject to Foreign Income Tax) |
Assessable Income subject to Foreign Income tax |
Foreign Income Tax Paid |
|---|---|---|---|
Ordinary |
$5 million |
$1 million |
$250,000 |
Complying superannuation/FHSA |
$5 million |
$2 million |
$450,000 |
Assuming there are no allowable deductions in relation to the classes of assessable income, the foreign income tax offset limit is worked out as follows:
Step 1: Work out the tax payable on Life Insurance Co’s taxable income
Tax in the:
- Ordinary Class: $5 million x 30% = $1.5 million
- Complying superannuation/FHSA Class: $5 million x 15% = $750,000
Total tax payable for step 1 is $2.25 million.
Step 2: Work out the tax that would be payable if the income of the two classes on which foreign income tax has been paid is not included in Life Insurance Co’s assessable income
There are two income amounts on which foreign income tax has been paid that need to be excluded from assessable income for the purposes of this step:
- $1 million that belongs to the assessable income in the ordinary class; and
- $2 million that belongs to the assessable income in the complying superannuation/FHSA class.
In working out the tax that would have been payable had these amounts not been included in assessable income, it is necessary to identify the relevant class to which such amounts belong as follows:
Tax on assessable income excluding the income amount on which foreign income tax has been paid:
- Ordinary class: ($5 million – $1 million) x 30% = $1.2 million
- Complying superannuation/FHSA class: ($5 million – $2 million) x 15% = $450,000
Total tax that would be payable for step 2 is $1.65 million.
Step 3: Determine the foreign income tax offset limit
Step 1 less step 2: $2.25 million – $1.65 million = $600,000
This is the foreign income tax offset limit.
As the actual foreign income tax paid on the two income amounts is $700,000, the foreign income tax offset available to Life Insurance Co is limited to $600,000 (i.e. offset of the $100,000 foreign income tax paid is denied).
End of exampleForeign income tax paid on non-assessable non-exempt income derived from segregated exempt assets does not count towards a tax offset.
Offshore banking units
Specific rules apply to calculating the tax offset for foreign income tax paid on the assessable offshore banking income of an offshore banking unit (OBU).
The foreign income tax paid on the offshore banking income of an OBU is taken to be one-third (the current offshore banking eligible fraction) of the amount of tax actually paid. This approach mirrors the tax treatment of assessable offshore banking income, which results in only one-third of that amount actually being included in assessable income, with the other two-thirds being treated as non-assessable non-exempt income.
Example
Source |
Income |
Expenses |
Foreign tax paid |
|---|---|---|---|
Borrowing and lending activity: commission |
15,000 |
900 |
1,500 |
Borrowing and lending activity: interest |
20,000 |
600 |
3,000 |
Advisory activity |
50,000 |
6,000 |
16,500 |
Total foreign income tax paid on assessable offshore banking income |
85,000 |
7,500 |
21,000 |
The amount of foreign income tax paid on the assessable portion of offshore banking income is the amount of foreign income tax paid, multiplied by the eligible fraction:
$21,000 x 10 ÷ 30 = $7,000
This is the amount of foreign income tax that counts towards Big Bank Ltd’s tax offset for the income year.
End of example
Foreign residents
While the offset mainly applies to residents, where the foreign income of a foreign resident is taxed in Australia they may be able to claim an offset.
These circumstances apply where a foreign resident pays income tax in a foreign country on an amount that is included in their assessable income (under Australian tax law) and such tax is imposed because the income is sourced in that country. By contrast, where a foreign country imposes tax on the amount included in an entity’s assessable income merely because it is a resident of that country (that is, residence-based taxation) a foreign income tax offset entitlement does not arise if the tax is imposed on income from a source outside the foreign country.
Example
XYZ PLC is a United Kingdom resident that carries on a business through a permanent establishment (PE) in Australia. In carrying on such activities, it derives US source income, which is subject to tax in that country. The US source income is derived in connection with the PE activity in Australia, and a combination of Articles 7 and 21 of the Australia–UK tax treaty permits Australia to tax the income and treat it as being derived from sources within Australia, and therefore subject to Australian tax. Given that the US source income is taxed in that country on a source basis, the US tax paid counts towards a tax offset in Australia.
If XYZ pays UK tax on the US source income that is attributable to the Australian PE activity, the tax would be imposed on a residence basis on the non-UK sourced income and would not count towards the taxpayer’s tax offset.
End of exampleAustralian source income
While Australian residents are normally subject to foreign income tax only on their foreign source income, the foreign income tax offset applies to all income on which foreign income tax has been correctly applied. This situation will arise in very limited circumstances.
For example, foreign income tax imposed by East Timor in accordance with Annexure G (the taxation code) of the Timor Sea treaty (see the Petroleum (Timor Sea Treaty) Act 2003) on assessable income derived by an Australian-resident taxpayer from certain activities carried out in the Joint Petroleum Development Area of the Timor Sea will count towards the taxpayer’s tax offset.