Updated: Sep 4, 2022
Australia is a land of migrants where more than half the population has foreign ties. It is not uncomment for Australians to either have bought foreign investments, or inherited foreign assets from loved ones.
Australia also operates a wide network of double taxation agreements which primarily seek to avoid double taxation. For assets held in countries where Australia does not have a double taxation agreement, Australia has international tax rules which also seek to help taxpayers from paying double tax. However what is commonly considered as "double tax" can vary between the taxpayers who are paying the taxes, and the ATO, receiving the taxes.
In a recent landmark case involving the sale of foreign assets in the United States, an Australian resident was challenged by the ATO all the way to the Federal Court of Australia. Unfortunately, the taxpayer lost the appeal and not all taxes paid in the United States were allowed to be claimed as offsets against Australian taxes.
How Can This Happen ?
The issue of alleviating double tax in Australia after suffering foreign taxes, is addressed in Foreign Income Tax Offset (FITO) regulations available under section 770-10 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Where the asset was taxed in a country which has a double taxation agreement with Australia, the FITO rules are also supplemented with the application of the treaty.
Both of the above rules operate to allow a credit only on the foreign income, to the extent it is subject to Australian tax.
If for example, a taxpayer held an overseas asset for more than a year and qualified for the 50% Capital Gains Tax Discount in Australia, then only 50% of the gains would be subject to Australian tax.
If the same asset were held long term in the United States and sold, the US IRS would apply a reduced long term capital gains tax to the value of the asset. Even if this capital gains tax rate is reduced for assets held long term, the "reduced rate" applies to the "full value" of the capital gains.
The difference of the above may appear as semantics to most taxpayers, however the outcome creates a significant difference, such that in Australia, the ATO will ignore 50% of any taxes paid overseas just as it ignores 50% of the capital gains due to the 50% CGT discount.
The rules governing international taxation are getting increasingly more complex and vary from person to person based on their personal set of circumstances. If you are planning to sell assets overseas, it is best to know what the implications will before being faced with unpleasant surprises, contact us for advice.
Key Findings in a Recent Case Involving Sale of Foreign Assets
The Federal Court of Australia Full Court in the case of Burton v Commissioner of Taxation  FCAFC 141 rejected the taxpayer’s appeal in relation to an earlier Federal Court decision to deny the taxpayer claiming the full foreign Income Tax Offset (FITO).
The Commissioner denied the taxpayer’s claim that it was entitled to the FITO for the tax paid in the United States. Instead, the Commissioner determined that the taxpayer was only entitled to the FITO on the 50% of the capital gain that was included in the taxpayer’s assessable income. The taxpayer disagreed and applied to the Federal Court to have the Commissioner’s determination overruled. The Federal Court found in favour of the Commissioner and the taxpayer subsequently appealed to the Full Court.
In dismissing the appeal, Justice Stewart, with whom Justice Jackson agreed (Justice Logan dissenting), upheld the decision of the trial judge, having regard to the following factors:
The FITO is only available for foreign tax paid on an amount included in the taxpayer’s assessable income and not amounts that are excluded by operation of statute.
The FITO provisions operate to relieve double taxation where ‘you have paid foreign income tax on amounts included in your assessable income.’ It would therefore be inconsistent with the legislation to extend the FITO to the 50% of the capital gain that was not included in the taxpayer’s assessable income.
Note 2 to section 770-10 of the ITAA 1997 provides an example where foreign income tax has been paid on an amount that is partly non-assessable non-exempt income and partly assessable income; the FITO will only be available for the proportion of foreign income tax that was paid on the amount included in the taxpayer’s assessable income. While this example relates to non-assessable non-exempt income, Stewart J held that it was logical that this approach should also apply to exempt income which is excluded from the taxpayer’s assessable income by the 50% CGT discount.
The explanatory memorandum to the Tax Laws Amendment (2007 Measures No.4) Bill 2017 (Cth) to the FITO provisions, states that an entitlement to a tax offset will only arise when, and to the extent that, foreign income tax has been paid on an amount included in assessable income. This indicates that foreign tax paid on an amount excluded from the taxpayer’s assessable income will not contribute to the calculation of the available FITO.
Denying the taxpayer from claiming the FITO on foreign tax paid on the 50% of the capital gain excluded from the taxpayer’s assessable income was also consistent with the Double Taxation Agreement between Australia and the United States.