Foreign investment funds guide

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Chapter 7: Avoiding double taxation - relief for foreign taxes under the calculation method

This chapter applies only if you use the calculation method to decide the amount of FIF income to include in your assessable income.

Overview of the foreign tax credit system

Under the foreign tax credit system, foreign source income derived by Australian residents - apart from certain dividends and listed country branch profits, salary and wages - is generally subjected to Australian income tax. A credit for foreign tax paid, up to the amount of the Australian income tax applying to the foreign income, is allowed against the Australian tax payable. Credit is allowable for foreign taxes imposed by central, state and local governments, provided the taxes are equivalent in nature to Australia's income tax. [ SECTION 160AF ]

Resident taxpayers - whether corporate or non-corporate - who include in their assessable income the whole or part of a dividend from a non-resident company are entitled to a credit for the direct foreign tax paid on that dividend. For example, the foreign company may have paid a dividend withholding tax . The Australian resident is entitled to credit for the withholding tax.

Non-portfolio dividends paid to resident corporate taxpayers from the exempting receipts of a CFC do not attract foreign tax credits. [ SECTION 23AJ and SUB SECTION 160AFC(5A) ]

An Australian resident company that receives a dividend from a related foreign company is also allowed a credit for taxes paid by the foreign company on that portion of the profits from which the dividends are paid - that is, the underlying foreign tax. [ SECTION 160AFC ]

Related companies

A foreign company is related to an Australian company if the Australian company has a direct voting interest of at least 10 per cent of the voting power of the foreign company. This relationship could extend through any number of tiers of foreign companies if each company in the chain has at least a 10 per cent voting interest in the company in the tier below, and the Australian company has a direct or indirect voting interest of at least 5 per cent in the foreign company. [ SECTION 160AFB ]

Market value and deemed rate of return methods

There will be no credits for foreign taxes where the FIF income is worked out under the market value or deemed rate of return methods.

In these cases, credits for foreign tax will apply only when distributions are received from the FIF. The current foreign tax credit system rules, as outlined above, apply to these distributions.

Calculation method

The foreign tax credit system has been altered to cater for taxpayers who use the calculation method to decide the amount of FIF income to include in their assessable income. However, the changes have been limited to situations where:

• the FIF is a company which is related to a company taxpayer [SECTIONS 160AFCE and 160AFCF]
• the taxpayer is a beneficiary of a FIF which is a trust estate. [SECTIONS 160AFCG and 160AFCH]

This is consistent with the general treatment of foreign taxes paid on underlying income under the foreign tax credit system and is also consistent with the CFC measures.

Changes to the foreign tax credit system - company FIFs

Credits on attribution from company FIFs

Under the foreign tax credit system, a foreign tax credit may be allowed for a share of the foreign tax paid by a first tier FIF on its income and gains where:

• a resident company and the FIF are related companies and
• the resident company has used the calculation method to decide the FIF income for the company's interest in the FIF.

In addition, a credit for tax paid by the second tier FIF may be given where the resident company:

• has used the calculation method to decide the FIF income of the second tier FIF
• the taxpayer and the first and second tier FIFs are companies and
• the taxpayer is related to both the first and second tier FIFs.

In this case, a foreign tax credit may be allowed in accordance with the foreign tax credit system for a share of the foreign tax paid by the second tier FIF on its income and gains.

A credit will be allowed only where the resident company and the FIF or FIFs are related companies. This is consistent with the general treatment of foreign taxes paid on underlying income under the foreign tax credit system and is also consistent with the CFC measures.

Credits on distribution from corporate FIFs

The allowance of credits on distribution - that is, by way of a dividend - follows the credits allowed under the existing foreign tax credit system. In addition, you are allowed a credit where the dividend is exempt because the profits out of which the dividend has been paid have been subject to attribution in a previous year. The credit is allowed on a similar basis to the credit allowed where a dividend is assessable but is limited to the amount not already allowed as a credit at the time of attribution of the FIF income. [ SECTION 160AFCJ ]

Further, the provisions of the Act which allow for excess foreign tax credits to be carried forward for up to five years apply where excess foreign tax credits arise in relation to an interest in a FIF and, where appropriate, an indirect interest in a second tier FIF. As under the existing foreign tax credit system, there is no carry back of credits. [ SECTION 160AFE ]

Changes to the foreign tax credit system - trust FIFs

Credits on attribution from trust FIFs

Under the foreign tax credit system, the treatment of foreign taxes paid by the trustee of a foreign trust is different to that of companies. The beneficiary of the trust is deemed to have paid the foreign tax paid by the trustee. In general, this distinction is maintained for taxpayers with an interest in a trust FIF. [ SECTION 6AB ]

Where the calculation method is used at first tier

Consistent with the treatment of company FIFs, where you have used the calculation method to work out attributable income of a trust FIF, a foreign tax credit is allowed for the foreign tax paid by the trustee of the trust on the income and gains of the trust FIF. The calculation is made in the same way as for a related company FIF. [ SECTION 160AFCG ]

Where the calculation method is used at second tier

Where you used the calculation method for the second tier trust FIF, a foreign tax credit is allowed for the foreign tax paid by the trustee of the trust on the income and gains of the trust FIF. The calculation is made in the same way as for a related company FIF. [ SECTION 160AFCH ]

Credits on distribution from trust FIFs

The allowance of credits on distribution is similar to the credits under the existing foreign tax credit system. Broadly, this means that, if the amount of the distribution is included in assessable income, both companies and other taxpayers are allowed a credit for foreign taxes paid:

• directly by the taxpayer - for example, a withholding tax on a dividend - and
• by the trustee of the trust - including accruals-type taxes in respect of lower tier entities.

In addition to the normal operation of the foreign tax credit system, you are allowed a credit where the trust distribution is exempt because it has been subject to attribution of FIF income in a previous year. This is limited to the amount not already allowed as a credit at the time of attribution when the calculation method was used. [ SECTION 160AFCJ ]

FIF attributed tax accounts

Overview

FIF attributed tax accounts ensure that a credit you can claim for foreign tax paid by a FIF when an amount is included in your assessable income under the calculation method cannot be claimed again when you receive a distribution from the FIF. In other words, they ensure that you cannot claim a foreign tax credit twice for the same amount of foreign tax paid by a FIF. [SECTIONS 608 to 612]

There are no foreign tax credits for foreign taxes where FIF income is worked out under the market value and deemed rate of return methods. In practice, you will need to maintain FIF attributed tax accounts only where you use the calculation method for working out the amount to include in your assessable income under the FIF measures and either:

• the FIF is a company which is related to the company taxpayer [SECTIONS 160AFCE and 160AFCF] or
• you are a beneficiary of a FIF which is a trust estate. [SECTIONS 160AFCG and 160AFCH]

The system for the maintenance of FIF attributed tax accounts parallels that for FIF attribution accounts. That is, when income which has been previously attributed is distributed to you, the foreign tax credit you can claim is initially worked out on the basis that no foreign tax credit was allowed for foreign tax paid on the attributed income at the time it was attributed. The foreign tax credit worked out in this way is then reduced by the foreign tax credit allowed at the time the attributable income of the FIF - that is, FIF income - was included in your assessable income.

The FIF attributed tax accounts trace the foreign tax credit that was allowed at the attribution stage so that this reduction may be made.

ATO references:
NO NAT 2130