True or false: If the “foreign income tax” paid in a financial year by a taxpayer is less than $1,000, they are automatically entitled to a foreign income tax offset (“FITO”) for the full amount?
Answer: false
It is commonly understood there is no need to perform the FITO limit calculation in section 770-75 of the Income Tax Assessment Act 1997 when the foreign income tax paid in the financial year by a taxpayer is less than $1,000. This is correct.
If the foreign income tax paid is less than $1,000, it is also often assumed that the entire amount can automatically be claimed as a FITO. This is not necessarily the case.
What is often forgotten is that one of the basic requirements to claim a FITO is that the income on which the foreign income tax is paid must have been included in the taxpayer’s assessable income.
Therefore, even if the foreign income tax paid is less than $1,000 in a financial year, it must still be paid on an amount that is included in the taxpayer’s assessable income before an entitlement to a FITO arises.
Consider the following:
Foreign capital gains and foreign income tax paid less than $1,000
Suppose your client makes a $3,000 capital gain on the sale of an asset located overseas. This asset is subject to tax in the overseas country at a rate of 25% (i.e. the tax paid is $750).
Assume your client has a capital loss of $1,000 and is eligible for the 50% CGT discount.
For Australian income tax purposes, the net capital gain is calculated as follows:
Gross capital gain $3,000
Less: capital loss ($1,000)
$2,000
Less: 50% CGT discount ($1,000)
Net capital gain $1,000
Only the net capital gain is included in the taxpayer’s assessable income, so the FITO potentially claimable will have to be proportionately reduced, even though the total foreign income tax paid was less than $1,000.
As only $1,000 of the $3,000 gross capital gain was included in the taxpayer’s assessable income because of the application of capital losses and the 50% CGT discount, only that same proportion of the foreign income tax paid is potentially available as a FITO (i.e. $1,000 / $3,000 × $750 = $250) subject to the FITO limit (see section 770-10(1)).
The FITO limit allows the taxpayer to claim the greater of $1,000 and the amount calculated under the formula in section 770-75. However, this must be read in the context of the basic entitlement to a FITO which, as discussed above, is only available to the extent that it is paid in respect of an amount that is included in the taxpayer’s assessable income. Therefore, even before considering the FITO limit, the maximum amount of FITO potentially claimable is limited to $250.
As the maximum potentially claimable FITO of $250 is already below $1,000, there is no need to calculate the amount available under the formula. The FITO available will be $250 in such circumstances provided all of the other requirements for a FITO are satisfied.
