Calculating and claiming your foreign income tax offset

You can claim the foreign income tax offset in your income tax return. Before you calculate your net income, you must convert all foreign income deductions and foreign tax paid to Australian dollars.

To claim a foreign income tax offset of up to $1,000, you only need to record the actual amount of foreign income tax paid on your assessable income (up to $1,000). If you are claiming a foreign income tax offset of more than $1,000, you have to work out your foreign income tax offset limit. This may result in your tax offset being reduced to the limit. Any foreign income tax paid in excess of the limit is not available to be carried forward to a later income year and cannot be refunded to you. If you paid foreign income tax after the year in which the related income or gains have been included in your assessable income, you may amend your assessment for that year to claim the offset.

As a non-refundable tax offset, the foreign income tax offset reduces your income tax payable (including Medicare levy and Medicare levy surcharge).

Under the tax offset ordering rules, the foreign income tax offset is applied after all other non-refundable tax and non-transferable offsets. Once your tax payable has been reduced to nil, any unused foreign income tax offset is not refunded to you, nor can it be carried forward to later income years.

Calculating your offset limit

If you are claiming a foreign income tax offset of more than $1,000, you will first need to work out your foreign income tax offset limit. This amount is based on a comparison between your tax liability and the tax liability you would have if certain foreign-taxed and foreign-sourced income and related deductions were disregarded.

Step 1

Work out the income tax payable by you (including Medicare levy and Medicare levy surcharge) for the relevant income year, excluding penalties and interest and disregarding any tax offsets.

Step 2

Work out the income tax that would be payable by you (including Medicare levy and Medicare levy surcharge) excluding penalties and interest and disregarding any tax offsets, if the following assumptions were made:

• your assessable income did not include
• any amount included in your assessable income on which foreign income tax has been paid that counts towards your foreign income tax offset
• any other income or gains from a non-Australian source
• you were not entitled to the following (where such deductions are actually allowable)
• debt deductions attributable to your overseas permanent establishment
• any other deductions (other than debt deductions) that are reasonably related to any amount covered by the first dot point above
• an amount of the foreign loss component of one or more tax losses deducted in the income year.

For the purpose of this step, where deductions relate exclusively to the disregarded income amounts, you should assume that you were not entitled to the deductions.

Whether a deduction is reasonably related to the disregarded assessable income amounts will be a question of fact depending on the circumstances of the taxpayer. The meaning of ‘reasonably related to’ is broad and it includes a relationship that may either be direct or indirect, provided that the relationship consists of a real connection. However, a merely remote relationship is insufficient.

Where deductions relate to both disregarded income amounts and other assessable income (as would typically be the case with head office and general administration expenses) you will need to apportion the deductions on a reasonable basis.

Allowable deductions for items such as gifts, contributions, superannuation and tax agent’s fees are not considered to be reasonably related to any amount on which foreign income tax has been paid or other non-Australian source income.

Where foreign income is subject to averaging (for example, where the special professional income rules or primary production income rules apply) only the foreign income for the current year is excluded at this step. It is not necessary to separate the Australian and foreign amounts for prior years.

Step 3

Take away the result of step 2 from step 1. If the result is greater than $1,000, this is your offset limit.

Example

Anna, an Australian-resident taxpayer for the year ended 30 June 2013, has income and expenses and pays foreign income tax for the income year as follows:

Employment income from Australia                                                                               22,000

Employment income from United States                                                                         6,000

Employment income from United Kingdom                                                                    4,000

Rental income from United Kingdom                                                                             1,000

Dividend income from United Kingdom                                                                         600

Interest income from United Kingdom                                                                            400

Total assessable income                                                                                               34,000

 

Expenses incurred in deriving employment income from Australia                                   2,000

Expenses incurred in deriving employment income from United States                             450

Expenses incurred in deriving rental income from United Kingdom                                 250

Interest (debt deduction) incurred in deriving dividend income from United Kingdom       70

Expenses (debt deduction) incurred in deriving interest income from United Kingdom      30

Gift to deductible gift recipient                                                                                      70

Total allowable deductions                                                                                          2,870

Taxable income                                                                                                           31,130

Foreign income tax paid

Employment income from United States                                                                        1,800               

Employment income from United Kingdom                                                                   1,200

Dividend income from United Kingdom                                                                         60

Interest income from United Kingdom                                                                            40

Rental income from United Kingdom                                                                             300

Total foreign income tax paid                                                                                      3,400

Anna calculates her foreign income tax offset limit as follows:

Step 1: Work out the tax payable on her taxable income

Tax on $31,130 (includes Medicare levy):                                                                      $2,923.65

Step 2: Work out the tax that would be payable if:

• Her assessable income does not include any of the following amounts of foreign income:

Employment income from United States                                                             6,000

Employment income from United Kingdom                                                        4,000

Rental income from United Kingdom                                                                 1,000

Dividend income from United Kingdom                                                             600

Interest income from United Kingdom                                                                400

Total                                                                                                                12,000

• Certain expenses are disregarded.

These are any expenses that relate to amounts included in her assessable income on which foreign income tax has been paid, provided that tax counts towards her foreign income tax offset, or expenses relating to other non-Australian amounts that are part of her assessable income (excluding debt deductions).

Expenses incurred in deriving employment income from United States                 450

Expenses incurred in deriving rental income from United Kingdom                     250

Total expenses                                                                                                        700

 

Note: that the debt deductions of $100 that relate to the United Kingdom dividend and interest income are not disregarded, as Anna does not have an overseas permanent establishment. Nor is the deduction of $70 for the gift to a deductible gift recipient disregarded, as it does not reasonably relate to the excluded assessable income amounts at step 2(a).

Calculation

Taxable income (disregarding step 2(a) amount):                                                            $22,000

Less allowable deduction (disregarding step 2(b) amount):                                              2,170

Taxable income under step 2 assumptions:                                                                     19,830

Tax on $19,830 (includes Medicare levy):                                                                      $352.30

Step 3: Take away the result of step 2 from step 1

$2,923.65 – $352.30 = $2,571.35

This is Anna’s foreign income tax offset limit. Although she has paid foreign income tax of $3,400, her foreign income tax offset is limited to $2,571.35.

The difference between the foreign income tax that Anna has paid and the offset limit cannot be refunded or carried forward to a future income year.