You claim the foreign income tax offset in your income tax return.
Before you calculate your net income, you must convert all foreign income deductions and foreign tax paid to Australian dollars; see Converting foreign income to Australian dollars.
To claim a foreign income tax offset of up to $1,000, you only need to record the actual amount of foreign income tax paid that counts towards the offset (up to $1,000).
If you are claiming a foreign income tax offset of more than $1,000, you have to work out your foreign income tax offset limit. This may result in your tax offset being reduced to the limit. Any foreign income tax paid in excess of the limit is not available to be carried forward to a later income year and cannot be refunded to you.
If you paid foreign income tax after the year in which the related income or gains have been included in your assessable income, you may amend your assessment for that year to claim the offset.
As a non-refundable tax offset, the foreign income tax offset reduces your income tax payable (including Medicare levy, Medicare levy surcharge and temporary budget repair levy).
Under the tax offset ordering rules, the foreign income tax offset is applied after all other non-refundable tax and non-transferable offsets. Once your tax payable has been reduced to nil, any unused foreign income tax offset is not refunded to you, nor can it be carried forward to later income years.
Calculating your offset limit
If you are claiming a foreign income tax offset of more than $1,000, you will first need to work out your foreign income tax offset limit. This amount is based on a comparison between your tax liability and the tax liability you would have if certain foreign-taxed and foreign-sourced income and related deductions were disregarded.
Step 1
Work out the income tax payable by you (including Medicare levy, Medicare levy surcharge and temporary budget repair levy) for the relevant income year, excluding penalties and interest and disregarding any tax offsets.
Step 2
Work out the income tax that would be payable by you (including Medicare levy, Medicare levy surcharge and temporary budget repair levy) excluding penalties and interest and disregarding any tax offsets, if the following assumptions were made:
- your assessable income did not include
- any amount included in your assessable income on which foreign income tax has been paid that counts towards your foreign income tax offset
- any other income or gains from a non-Australian source
- you were not entitled to the following (where such deductions are actually allowable)
- debt deductions attributable to your overseas permanent establishment
- any other deductions (other than debt deductions) that are reasonably related to any amount covered by the first dot point above
- an amount of the foreign loss component of one or more tax losses deducted in the income year.
For the purpose of this step, where deductions relate exclusively to the disregarded income amounts, you should assume that you were not entitled to the deductions.
Whether a deduction is reasonably related to the disregarded assessable income amounts will be a question of fact depending on the circumstances of the taxpayer. The meaning of ‘reasonably related to’ is broad and it includes a relationship that may either be direct or indirect, provided that the relationship consists of a real connection. However, a merely remote relationship is insufficient.
Where deductions relate to both disregarded income amounts and other assessable income (as would typically be the case with head office and general administration expenses) you will need to apportion the deductions on a reasonable basis.
Allowable deductions for items such as gifts, contributions, superannuation and tax agent’s fees are not considered to be reasonably related to any amount on which foreign income tax has been paid or other non-Australian source income.
Where foreign income is subject to averaging (for example, where the special professional income rules or primary production income rules apply) only the foreign income for the current year is excluded at this step. It is not necessary to separate the Australian and foreign amounts for prior years.
Step 3
Take away the result of step 2 from step 1. If the result is greater than $1,000, this is your offset limit.
Example
Anna, an Australian-resident taxpayer for the year ended 30 June 2016, has income and expenses and pays foreign income tax for the income year as follows:
Income and deductions |
(A$) |
|---|---|
Employment income from Australia |
22,000 |
Employment income from United States |
6,000 |
Employment income from United Kingdom |
4,000 |
Rental income from United Kingdom |
1,000 |
Dividend income from United Kingdom |
600 |
Interest income from United Kingdom |
400 |
Total assessable income |
34,000 |
Expenses incurred in deriving employment income from Australia |
2,000 |
Expenses incurred in deriving employment income from United States |
450 |
Expenses incurred in deriving rental income from United Kingdom |
250 |
Interest (debt deduction) incurred in deriving dividend income from United Kingdom |
70 |
Expenses (debt deduction) incurred in deriving interest income from United Kingdom |
30 |
Gift to deductible gift recipient |
70 |
Total allowable deductions |
2,870 |
Taxable income |
31,130 |
Tax paid |
(A$) |
|---|---|
Employment income from United States |
1,800 |
Employment income from United Kingdom |
1,200 |
Dividend income from United Kingdom |
60 |
Interest income from United Kingdom |
40 |
Rental income from United Kingdom |
300 |
Total foreign income tax paid |
3,400 |
Anna calculates her foreign income tax offset limit as follows:
Step 1: Work out the tax payable on her taxable income
Tax on $31,130: $2,923.65 (includes Medicare levy)
Step 2: Work out the tax that would be payable if:
(a) Her assessable income does not include any of the following amounts of foreign income:
Tax paid |
(A$) |
|---|---|
Employment income from United States |
6,000 |
Employment income from United Kingdom |
4,000 |
Rental income from United Kingdom |
1,000 |
Dividend income from United Kingdom |
600 |
Interest income from United Kingdom |
400 |
Total |
12,000 |
(b) Certain expenses are disregarded. These are any expenses that relate to amounts included in her assessable income on which foreign income tax has been paid, provided that tax counts towards her foreign income tax offset, or expenses relating to other non-Australian amounts that are part of her assessable income (excluding debt deductions).
Type of expense incurred |
(A$) |
|---|---|
Expenses incurred in deriving employment income from United States |
450 |
Expenses incurred in deriving rental income from United Kingdom |
250 |
Total expenses |
700 |
Note: The debt deductions of $100 that relate to the United Kingdom dividend and interest income are not disregarded, as Anna does not have an overseas permanent establishment. Nor is the deduction of $70 for the gift to a deductible gift recipient disregarded, as it does not reasonably relate to the excluded assessable income amounts at step 2(a).
Taxable income calculation |
(A$) |
|---|---|
Taxable income (disregarding step 2(a) amount): |
22,000 |
Less allowable deduction (disregarding step 2(b) amount): |
2,170 |
Taxable income under step 2 assumptions: |
19,830 |
Tax on $19,830: $309.70
Step 3: Take away the result of step 2 from step 1
$2,923.65 − $309.70 = $2,613.95
This is Anna’s foreign income tax offset limit. Although she has paid foreign income tax of $3,400, her foreign income tax offset is limited to $2,613.95.
The difference between the foreign income tax that Anna has paid and the offset limit cannot be refunded or carried forward to a future income year.
End of exampleDeferred non-commercial business losses
If a current year foreign business loss is required to be deferred because of the non-commercial business loss rules, then step 2 in the foreign income tax offset limit calculation needs to be adjusted for the amount of any foreign business loss that is deferred. This is done before working out the amount of foreign income and expenses to be disregarded.
Note that to be eligible for the foreign income tax offset where you have a net foreign business loss there must be other foreign income included in assessable income on which foreign income tax has been paid.
To work out the amount of foreign income and expenses to disregard at step 2, add back the foreign component of the current year deferred non-commercial business loss to the net foreign income amount, and then subtract the net foreign income from taxable income.
If the net foreign amount is zero or negative after adding back the deferred foreign loss component, then the foreign income tax offset amount will be the lower of the foreign income tax paid or the default foreign income tax offset limit amount of $1,000.
Example
Assume for the year ended 30 June 2017 that Karen has an Australian salary of $60,000 and a $7,000 business loss made up of $4,000 Australian loss and $3,000 foreign loss, and the current year loss is required to be deferred as it does not meet one of the four non-commercial loss tests. There is also $20,000 of other foreign income on which foreign income tax of $2,000 has been paid. The net foreign income is ($20,000 − $3000) = $17,000.
Taxable income calculation |
(A$) |
|---|---|
Salary |
60,000 |
Australian component of net business loss |
(4,000) |
Foreign component of net business loss |
(3,000) |
Other foreign income (tax paid $2,000) |
20,000 |
Net foreign income |
17,000 |
Deferred loss added back |
7,000 |
Taxable income |
80,000 |
Net foreign income after adding back foreign component of deferred loss |
(17,000 + 3000) |
Taxable income disregarding any foreign income and expenses |
(80,000 − 20,000) |
Step 1: Work out the tax payable on her taxable income
Tax on $80,000: $18,747 (includes Medicare levy)
Step 2: Work out the tax that would be payable based on the stated assumptions
Taxable income under step 2 assumptions: $60,000
Tax on $60,000: $11,947 (includes Medicare levy)
Step 3: Take away the result of step 2 from step 1
$18,747 − $11,947 = $6,800
In this situation, all the foreign income tax of $2,000 would be available as a tax offset as the foreign income tax offset limit exceeds the foreign income tax paid.
End of exampleSpecial amendment rules for foreign income tax offsets
Differences between the Australian and foreign tax systems may lead to you paying foreign income tax in a different income year to that in which you include the related income or gains in your income for Australian income tax purposes.
If you paid foreign income tax after the year in which the related income or gains have been included in your income, you can amend your assessment for that year to claim the offset. You can lodge an amended assessment within four years of paying foreign income tax that counts towards your tax offset. This time period applies irrespective of when the income or gains were included in your income for Australian income tax purposes. In this situation, the foreign income tax must be paid after you have lodged your Australian income tax return for the relevant year.
The four-year amendment period also applies where there has been an increase or decrease in the amount of foreign income tax paid that counts towards your tax offset. The special amendment rules also apply to amendments initiated by us, which may have the effect of extending the normal period of review. In these cases, the four-year period starts when the increase in foreign income tax has been paid or when the foreign income tax has been reduced, for example, by way of a refund.
The special amendment rules apply only where you have paid foreign income tax or there has been an increase or decrease in the tax paid that counts towards your tax offset. In all other circumstances, the normal amendment rules apply.
For example, where an audit by us has detected an incorrect calculation of the foreign income tax offset limit affecting the amount of the foreign income tax offset previously claimed, we can only amend a taxpayer’s assessment within the usual time limits set out in section 170 of the ITAA 1936.
Example
Aust Co, an Australian resident company, sells a rental property in the US, making a gain in 2015–16. The gain is taxed in the US and Australia. Aust Co pays the US income tax before lodging its Australian return for 2015–16.
In February 2017, Aust Co receives a refund of part of the US tax paid because of the favourable outcome of a dispute over the calculation of the gain. An amendment to Aust Co’s 2015–16 assessment to reflect the reduction in US tax paid, and consequently its foreign income tax offset, can be made on or before February 2020.
End of example