As an Australian taxpayer, you may have income from foreign sources, which could result in double taxation. To alleviate this burden, the Australian government provides a Foreign Income Tax Offset (FITO) that allows you to claim a tax offset for foreign tax paid on income earned in another country. This comprehensive guide will provide you with all the information you need to understand the eligibility criteria, calculation methods, and application of the FITO.
IN THIS ARTICLE
- Eligibility for the Foreign Income Tax Offset
- Calculate the Foreign Income Tax Offset
- Deferred Non-Commercial Business Losses
- Special Amendment Rules for FITO
- Applying FITO against Medicare Levy and Surcharge
- Record Keeping for FITO
- Special Circumstances
- Understanding When the FITO Applies
- Foreign income tax paid by a controlled foreign company.
- Foreign income tax paid on NANE income
- Calculating the Offset
Eligibility for the Foreign Income Tax Offset
The Foreign Income Tax Offset (FITO) provides relief from double taxation for individuals with assessable income from overseas. To be eligible for the offset, you must have paid foreign income tax on income or gains included in your Australian assessable income. The offset is subject to a limit in some cases. Differences in tax systems may result in foreign tax being paid in a different year from when the income or gains are included in your Australian tax return. You can claim the offset by requesting an amended assessment within 4 years of paying the foreign income tax. Amendments should also be made for changes in the amount of foreign tax paid that counts towards the offset.
The FITO applies to all forms of income and all taxpayers, including individuals and other entity types. While mainly applicable to Australian residents, foreign persons, or non-residents whose foreign income is taxed in Australia may be eligible for the offset in certain circumstances. In rare cases, foreign tax imposed on Australian source income may contribute to the FITO.
It’s important to be aware that Australia’s new hybrid mismatch rules, effective from January 1, 2019, may impact your tax return by denying deductions or including amounts in assessable income based on specific requirements being met.
Calculate the Foreign Income Tax Offset
Step 1: Determine Your Income Tax Payable
Calculate your income tax payable for the relevant year, including Medicare levy and Medicare levy surcharge. Exclude any penalties, interest, and tax offsets from this calculation.
Step 2: Calculate Tax Payable with Certain Foreign Income Disregarded
Calculate the income tax that would be payable if certain foreign income and related deductions were disregarded. This calculation assumes that your assessable income does not include the specified foreign income amounts or related deductions. Deductions that exclusively relate to the disregarded income amounts should be assumed to be not applicable. For deductions related to both disregarded and other assessable income, reasonable apportionment is required.
Step 3: Determine Your Offset Limit
Subtract the result of Step 2 from Step 1. If the difference is greater than $1,000, this is your offset limit.
Deferred Non-Commercial Business Losses
If you have a current year foreign business loss that needs to be deferred under the non-commercial business loss rules, adjust Step 2 of the offset limit calculation accordingly. This adjustment considers the amount of any deferred foreign business loss before considering foreign income and expenses to be disregarded.
Special Amendment Rules for FITO
Differences between the Australian and foreign tax systems may result in paying foreign income tax in a different income year than when the related income or gains are included in your Australian income tax return. If you paid foreign income tax after the year in which the income or gains were included, you can amend your assessment to claim the offset within four years of paying the foreign income tax.
Applying FITO against Medicare Levy and Surcharge
FITO not only reduces your tax liability but can also be applied against the Medicare levy and Medicare levy surcharge. If there is any remaining offset after reducing your tax payable, it can be used to offset your liability for these healthcare-related charges. When you lodge your tax return, the offset is automatically applied by the Australian Taxation Office (ATO) system.
Record Keeping for FITO
To claim a foreign income tax offset (FITO) and support your tax affairs, you must maintain written evidence that can be provided upon request. If the required information is held overseas, you will receive written notification, allowing you time to provide the necessary documentation. If you use a tax agent, inform them about any income on which foreign income tax has been paid and provide proof of tax payment.
The written evidence of foreign tax paid should include details such as the amount of foreign income or gains, the foreign tax year, the nature and amount of foreign tax, the date of tax payment, and whether it represents an advance, installment, or final payment. Acceptable evidence of foreign tax payment includes statements from the foreign tax authority, certificates for deduction of withholding tax, distribution statements from trustees, pay slips or payment summaries, foreign income tax returns accompanied by receipts, or a letter from the foreign tax authority confirming tax payment.
Although you don’t need to provide the evidence with your tax return, you must retain the original documents as they may be requested later. Generally, you must keep records for 5 years after their preparation or acquisition or after completing relevant transactions, whichever is later.
The tax assessment may be amended within 2 years for individuals and small to medium businesses, or 4 years for other taxpayers. The period of review can be extended by court order or consent. Keep records for 5 years or until the end of the review period.
You don’t need to keep records if the Commissioner of Taxation has specified that they are not required or if your company has been liquidated and dissolved.
If the tax authority believes relevant information is held overseas, you may receive an offshore information notice requesting you to obtain the information within 90 days. You can apply in writing for an extension if needed.
Calculating the Foreign Income Tax Offset (FITO) involves considering various special circumstances. Superannuation funds, consolidated groups, life insurance companies, offshore banking units, foreign residents, and Australian source income each have specific rules and considerations when determining the FITO. In this article, we will explore these special circumstances and how they impact the calculation of FITO.
1. Superannuation Funds
Superannuation funds face limitations on the foreign income tax offset when transitioning from a complying to a non-complying fund or from a non-resident to a resident fund. If a fund includes an amount in assessable income under specified items and has paid foreign income tax on that amount, it is not entitled to a tax offset for the foreign income tax paid.
2. Consolidated Groups
Only the head company of a consolidated group or multiple entry consolidated (MEC) group is eligible for the foreign income tax offset. If a subsidiary member pays foreign income tax on income or gains included in the head company’s assessable income, the head company is deemed to have paid the tax.
3. Life Insurance Companies
Foreign income tax offset rules also apply to life insurance companies. As these companies are taxed at different rates based on different income classes, it is necessary to determine the assessable income and foreign income tax paid for each class when calculating the FITO.
4. Offshore Banking Units (OBUs)
OBUs have specific rules for calculating the tax offset on foreign income tax paid on assessable offshore banking income. Only one-third of the tax paid is considered for the FITO calculation, aligning with the treatment of assessable offshore banking income.
5. Foreign Residents
Although the FITO primarily applies to residents, foreign residents may also be eligible for an offset if their foreign income is taxed in Australia. This applies when a foreign resident pays income tax in a foreign country on an amount included in their assessable income under Australian tax law, provided the tax is imposed because the income is sourced in that country.
6. Australian Source Income
While Australian residents are generally taxed on their foreign source income, the FITO can apply to all income on which foreign income tax has been correctly applied. In specific cases, such as income derived from activities in the Joint Petroleum Development Area of the Timor Sea, foreign income tax imposed by another country on Australian residents’ assessable income can count towards the FITO.
Understanding When the FITO Applies
To determine when FITO applies, certain conditions must be met. The foreign tax must be foreign income tax imposed under a law other than an Australian law. It should be a tax on income, profits, gains (including capital gains), or any other tax covered by an agreement under the International Tax Agreements Act 1953. The foreign income tax should be correctly imposed under the relevant foreign law and tax treaty.
Foreign income tax paid by a controlled foreign company
If you have attributed foreign income from a controlled foreign company (CFC) in which you hold an interest, you may be eligible for a foreign income tax offset. This offset can be claimed for foreign income tax, income tax, or withholding tax paid by the CFC. The foreign income tax offset may apply to 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. It may also apply to resident taxpayers who receive a distribution treated as non-assessable non-exempt (NANE) income under sections 23AI or 23AK of the ITAA 1936.
Under these circumstances, the attributable taxpayer is considered to have paid foreign income tax on their CFC interest, and the tax paid contributes towards their tax offset. The section 456 and 457 amounts must be adjusted by adding the amount of the foreign income tax deemed to have been paid.
For a resident company with a CFC interest, they can treat foreign income tax as paid if certain conditions are met. These conditions include the inclusion of an amount under sections 456 or 457 in their assessable income, payment of foreign income tax, income tax, or withholding tax by the CFC, and an attribution percentage of 10% or more.
If the conditions are satisfied, the amount of foreign income tax deemed to have been paid is calculated based on the taxes paid by the CFC multiplied by the attributable taxpayer’s attribution percentage. This amount counts towards the resident company’s foreign income tax offset, and section 456 and 457 amounts must be adjusted accordingly.
The tax-paid deeming rule applies only to resident companies that are directly subject to attribution under sections 456 or 457. If a resident company is a partner in a partnership or a beneficiary in an Australian trust with a controlled foreign company (CFC) interest, they are assessed based 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 such cases, the partnership or Australian trust is considered the attributable taxpayer, and it includes the relevant attribution amount in its net income under sections 456 or 457. Since 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 be applied to the CFC interests held by the resident company through a partnership or Australian trust.
Foreign income tax paid on NANE income
Resident taxpayers can claim a foreign income tax offset for foreign income tax paid on non-assessable non-exempt (NANE) income under sections 23AI or 23AK of the ITAA 1936.
The tax offset only applies to foreign income tax paid on income that falls under sections 23AI or 23AK as NANE income. The tax-paid deeming rules, which apply to previously attributed income amounts, do not affect the calculation of foreign income tax paid on distributions.
Typically, the foreign income tax paid will be in the form of withholding tax on dividend distributions. In such cases, if the tax is paid by someone else under the foreign country’s tax laws, the tax-paid deeming rules can be applied, considering the attributable taxpayer as having paid the foreign income tax. However, it must be demonstrated that the tax is paid in relation to the section 23AI or 23AK amounts. The tax offset limit is increased by the amount of foreign income tax paid on section 23AI or 23AK income.
Calculating the Offset
The calculation of the FITO depends on the amount of foreign income tax paid. For offsets of $1,000 or less, you only need to record the actual amount of foreign income tax paid. If the offset amount exceeds $1,000, you need to calculate the FITO using the formula provided by the Australian Taxation Office (ATO). The formula is as follows:
FITO = (Foreign income × Australian taxable income) ÷ Worldwide income × Foreign tax paid
Here’s a breakdown of the components of the formula:
- Foreign income: This refers to the income you earned from foreign sources that is included in your Australian assessable income or non-assessable non-exempt income.
- Australian taxable income: This is your total income from all sources that is subject to Australian tax.
- Worldwide income: This includes your total income from both Australian and foreign sources.
- Foreign tax paid: This is the amount of tax you paid to the foreign country on your foreign income.
By applying this formula, you can calculate the amount of FITO you are eligible to claim. It’s important to note that the FITO cannot exceed the amount of Australian tax payable on the foreign income.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.