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.
See also:
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 NANE income of the taxpayer, under sections 23AI or 23AK of the ITAA 1936.
See also:
- Chapter 1 and 4 of the Foreign income return form guide 2018
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.
Special circumstances
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 1997, 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.
See also:
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 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.
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 |
$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 × 30% = $1.5 million
- Complying superannuation class: $5 million × 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 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) × 30% = $1.2 million
- Complying superannuation class: ($5 million − $2 million) × 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
Big Bank Ltd is an Australian resident bank that is declared an OBU. Big Bank Ltd derives offshore banking income and pays foreign income tax of $21,000 in respect of such income as follows:
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 × 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 exampleForeign 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.