How does Class Calculate the Foreign Income Tax Offset (FITO)?
The Class Support Team is frequently asked 'Why does Class write off foreign income tax credits (FTC) when the SMSF has an actuarial pension exemption percentage?'
Class has designed its calculation of Foreign Income Tax Offset (FITO) using the following references:
Section 770-10 of ITAA97 Entitlement to foreign income tax offset, in particular Note 2: If the foreign income tax has been paid on an amount that is part non-assessable non-exempt income and part assessable income for you for the income year, only a proportionate share of the foreign income tax (the share that corresponds to the part that is assessable income) will count towards the tax offset (excluding the operation of subsection (2)).
ITAA97 [Section 770-10 Entitlement to foreign income tax offset]
770-10(1) You are entitled to a *tax offset for an income year for foreign income tax. An amount of foreign income tax counts towards the tax offset for the year if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year.
Note 1: The offset is for the income year in which your assessable income included an amount in respect of which you paid foreign income tax — even if you paid the foreign income tax in another year.
Note 2: If the foreign income tax has been paid on an amount that is part non-assessable non-exempt income and part assessable income for you for the income year, only a proportionate share of the foreign income tax (the share that corresponds to the part that is assessable income) will count towards the tax offset (excluding the operation of subsection (2)). (Published by CCH)
2. Tax Determination
The example on the ATO website is inconsistent with the legislation noted in point 1. Where an example is inconsistent with the legislation, even if it is on the ATO's website, it should be ignored.
As a point of comparison, in the ATO Determination ATO ID 2010/175, a taxpayer paid foreign income tax on the whole of a foreign capital gain but only 50% of the gain is included in the assessable income because the taxpayer is entitled to the CGT discount, so only 50% of the foreign income tax counts towards the FITO under subsection 770-10(1) of the ITAA 1997. This is despite the fact that an example in the Explanatory Memorandum clearly allows the full FTC as FITO on discounted foreign capital gain. The Commissioner’s key reasoning was that the example "is not consistent with the words and purpose of the legislation and accordingly should be disregarded…"
3. Tax Ruling (Private)
This Private Ruling (Authorisation Number: 1011813374641) specifically addresses this question: Are you (as a SMSF) entitled to 100% of the foreign tax paid as a foreign income tax offset, where a percentage of the foreign income for which foreign income tax was paid is exempt current pension income?
The short answer is NO. The SMSF is not entitled to 100% of the foreign tax paid as foreign income tax offset when X% of your foreign income is part of exempt income and hence not assessable income. You are only entitled to the same percentage of foreign tax paid in respect of the foreign income that is not exempt and therefore included in the assessable income under subsection 770-10(1) of the ITAA 1997. We understand that the private ruling is only binding on the taxpayer who applies for the ruling; however the discussion and reasoning behind it suggest the Commissioner's view on this specific issue.
4. Tax Laws Amendment (2007 Measure No. 4) Bill 2007 Explanatory Memorandum
If the total foreign income tax paid is less than or equal to $1,000 (the $1,000 de minimis cap), the taxpayer is not required to calculate the foreign tax offset cap [Schedule 1, item 1, paragraph 770-75(2)(a) and note 1 in subsection 770-75(2)]. Provided the requirements in section 770-10 are satisfied, the taxpayer's tax offset will equate to the total foreign income tax paid on the double-taxed amounts included in assessable income [Schedule 1, item 1, section 770-70].
The requirement 770-10 basically reinforced the fundamental principle:
- Is the foreign income included in your assessable income for that year?
- Has the foreign income tax been paid?
Quarterly Tax Update Special Topic November 2011
Refer to below flowchart:
CPA Australia released a Quarterly Tax Update on Taxation of International Amounts, see attached. It provides a detailed flowchart (Page 91) on establishing entitlement to a FITO. Basically, the listed steps to claim FITO the foreign income must be assessable in Australia, if the answer is No, then there is no foreign tax offset to be claimed. This is well before you even consider whether de minimus rule ($1,000 FITO) comes into play in the first place.
FITO Limit Calculation
Based on the above statutory and ATO reference, Class has therefore taken a more conservative approach to cater for the FITO calculation using the following methodology:
- Step 1:
Total Foreign Tax Credits available for the fund x (1 – Actuarial Pension Exempt Factor)
If the amount calculated is less than $1,000 (de minimis cap), then the FITO limit calculation is not required and the tax offset will be equal to the total foreign tax paid on the amount included in the assessable income.
- Step 2:
If [Total Foreign Tax Credits available for the fund x (1 – Actuarial Pension Exempt Factor)] > $1,000
Then we perform FITO limit calculation. This is calculated by
Net Foreign Income x 15% x (1 - Actuarial Pension Exempt Factor)
This is the new foreign income tax offset limit with any excess amount being lost.
- Step 3: Use the lesser of the amounts calculated in Step 1 and 2.
Using a simple example, foreign Income of $10,000 includes Foreign Tax Credits of $2,000 and the pension exemption is equal to 60%. Therefore,
The total FTC = $2,000. To calculate $2,000 x (1-60%) = $800 < $1,000
Then the SMSF can claim $800 FITO.
However, let's change the foreign exemption factor from 60% to 40%, while all other information remains unchanged.
- Step 1: $2,000 x (1-40%) = $1,200
As this is > $1,000 the FITO must be calculated. The maximum that you can claim is the de minimis cap of $1,000.
- Step 2: The foreign income offset limit calculation = $10,000 x 15% x (1-40%) = $900
- Step 3: Therefore, as $1,000 > $900, the $1,000 will be used to reduce income tax payable. The other $1000 will be the FTC write-off expense.
Still Want to Claim?
If you’d still like to claim the FITO despite Class’ conservative approach, then you will need to:
- Manually change the provision for income tax (taking into account the FITO you are claiming), e.g. $1,000 FITO means you need to decrease the provision for income tax for $1,000;
- Manually change Section D of the SMSF Annual Return > C1 Foreign Income Tax Offset. Please note FITO is not a refundable tax offset, it cannot increase the amount of refund if there is no tax payable.