Guide to foreign income tax offset rules 2023

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Foreign income tax paid by a controlled foreign company

Foreign income tax paid by a controlled foreign company

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:

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for a resident company that is an attributable taxpayer with a CFC interest and includes an amount in its assessable income under sections 456 or 457 of the ITAA 1936

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for resident taxpayers that receive a distribution that is treated as non-assessable non-exempt (NANE) income under sections 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.

Resident company with interest in a 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:

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their assessable income includes an amount under sections 456 or 457 of the ITAA 1936 in relation to their CFC interest

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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

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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

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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:

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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)

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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 foreign income 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.

Tax-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 sections 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.

Foreign 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 non-assessable non-exempt (NANE) income of the taxpayer, under sections 23AI or 23AK of the ITAA 1936.

For more information, see Chapter 1 and 4 of the Foreign income return form guide .

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.

Where 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 foreign investment fund (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.

References

ATO references:
NO QC 72280