Application of the law

The FITO limit is determined by section 770-70 of the ITAA 1997, requiring a comparison between Australian tax payable and Australian tax that would be payable if certain income and deductions related to that income were disregarded. Disregarded income is stated in subsection 770-75(4)(a) to include:

I. so much of any amount included in your assessable income as represents an amount in respect of which you paid *foreign income tax that counts towards the *tax offset for the year; and

II. any other amounts of *ordinary income or *statutory income from a source other than an *Australian source…

TD 2020/7 sets out that the Commissioner’s view that a taxpayer’s net capital gain is considered to be relevant statutory income without a source. The view is that the provision does not allow for the disaggregation of a net capital gain to identify specific foreign sourced capital gains.

What is required?

Review FITO limit positions and ensure compliance going forward.

Who does it impact?

All taxpayers that have foreign capital gains.

Important dates

TD 2020/7 applies both before and after the date of issue, being the 26 August 2020.

How can we assist?

SW can assist in preparing Australian tax returns and/or analysing foreign taxes paid and calculating the FITO limit.

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This decision should prompt taxpayers claiming FITO’s on foreign capital gains to ensure that they are only claiming the FITO on the amount of the capital gain that is assessable in Australia, rather than the amount of capital gain assessable in a foreign jurisdiction.

Background of the case

Under s 770-10 of the ITAA 1997, a taxpayer is entitled to claim a FITO in relation to foreign income tax paid. Specifically, an amount of foreign income tax counts towards the FITO if it is paid in respect of an amount that is all or part of an amount included in the taxpayers assessable income.

It was on this basis that the taxpayer claimed an eligibility to a FITO equal to 100% of the US taxes paid on the gain which arose on the sale of US investments. However, the issue of contention was that only half of the capital gain was included in the taxpayers Australian assessable income.  This is because the capital gain in question was eligible for the 50% Capital Gains Tax discount.

The Court considered the operation of Division 770 and in particular whether the amount of the foreign tax taken into account in working out the FITO is all the US income tax arising on the capital gain, or merely half of the tax on the basis that only half of the gain was included in assessable income and subject to Australian taxation.

The Full Court was also required to have regard to the impact of Article 22(2) of the USA – Australian Double Tax Agreement (DTA), which allows for taxes paid on sources of US income to be allowed as a credit against Australian tax payable in respect of the income.

Findings of the Court

On the basis that a FITO can only be used to offset assessable income for Australian income tax purposes, the Full Court concluded that the amount of US taxes paid in respect of the 50% of capital gains which was not included in the taxpayers Australian assessable income (i.e. the discount component) did not give rise to a FITO.

The judgement was consistent with the Federal Court’s single judge decision in 2018 as well as the ATO view detailed in ATO ID 2010/175.

Key takeaways

• When investing overseas it is important to factor in the potential foreign tax leakage that can occur when paying foreign tax on capital gains eligible for the CGT discount
• This case is one of many changes to the interpretation of tax law relating to the domestic taxation of foreign investment.  Accordingly investors need to be well advised from an income tax point of view when considering their foreign investment strategy
• Parties deriving foreign income need to be aware of both Australian domestic tax laws and international DTAs and their interactions.

Get in touch

Our experts can assist with further information.

The post Burton and Federal Commissioner of Taxation [2018] FCA 1857 appeared first on SW Accountants & Advisors.