Guide to foreign income tax offset rules 2023
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Special circumstances
Special circumstances
There are some special circumstances that apply in calculating the FITO for:
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- Superannuation funds
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- Consolidated groups
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- Life insurance companies
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- Offshore banking units
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- Foreign residents
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- Australian source income
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:
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- from a complying superannuation fund to a non-complying superannuation fund, or
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- from a non-resident superannuation fund to a resident superannuation fund.
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.
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 2 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 .
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Example 22: Life Insurance company derives income from different classes
Life Insurance Co derives the following assessable income in each class of income:
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:
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 2 income amounts on which foreign income tax has been paid that need to be excluded from assessable income for the purposes of this step:
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:
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 2 income amounts is $700,000, the foreign income tax offset available to Life Insurance Co is limited to $600,000 (that is, offset of the $100,000 foreign income tax paid is denied). |
Foreign income tax paid on NANE income derived from segregated exempt assets does not count towards a tax offset.
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.
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Example 23: OBU derived foreign income
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: Big Bank Ltd
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. |
Changes to Australia's Offshore Banking Unit Regime in 2023-24
As a result of changes to the Offshore Banking Unit (OBU) regime , an OBU's assessable offshore banking income will be taxed at its relevant corporate tax rate from the commencement of its 2023-24 income year. Rules that deem an OBU to have only paid one-third of its foreign income tax on its offshore banking income will also no longer apply meaning that its FITO will be calculated using the ordinary rules. The changes will have effect from the commencement of an OBU's 2023-24 income year. For example, for an OBU whose income year end is 31 December, the new rules have effect from 1 January 2023. For an OBU whose income year end is 30 June, they have effect from 1 July 2023.
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.
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Example 24: Foreign resident derived foreign income in Australian PE
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. |
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 Timor-Leste 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.
References
ATO references:
NO QC 72280
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