We are frequently asked "Why does Class write off foreign tax credits (FTC) when the SMSF has an actuarial pension exemption percentage?"
Let's answer this question and explain the approach adopted by Class.
Legislative Reference
Class has designed its calculation of Foreign Income Tax Offset (FITO) using the following references:
1. Legislation
Section 770-10 of ITAA1997 Entitlement to foreign income tax offset:
Subsection (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)).
*This particularly explained how foreign income tax offset should be counted and can be described as an apportionment approach to the FITO.
2. ATO Interpretative Decision
Where an example is inconsistent with the legislation, it should be disregarded even if it is from the ATO website or Explanatory Memorandum of a Bill that received royal assent.
As a point of comparison, the ATO Interpretative Decision (ATO ID 2010/175 - Foreign income tax offset: entitlement where foreign capital gain is only partly assessable in Australia) states "...where a resident of Australia pays 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." The ATO then pointed out example 1.20 at paragraph 1.150 of the Explanatory Memorandum which allows the full FTC as FITO on discounted foreign capital gain, but the Commissioner’s view such example "...is not consistent with the words and purpose of the legislation and accordingly should be disregarded…"
3. ATO Private Binding Ruling
There is an ATO Private Binding Ruling (Authorisation Number: 1011813374641) specifically addresses a taxpayer's 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 ATO responded "No... you are (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
A new law was introduced from this bill and commence to take effect from 1 July 2008 that explains in what situation where a taxpayer could elect to use the $1,000 de minimis cap and not needed to calculate the FITO limit (cap). Furthermore, paragraph 1.127 of the Explanatory Memorandum stated "If the total foreign income tax paid is less than or equal to $1,000 as shown in Note 1 of Subsection 770-75(2) of ITAA 1997 Foreign income tax offset limit. Provided the (FITO entitlement) requirements in section 770-10 of ITAA 1997 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."
Additional Reference
TaxBanter Quarterly Tax Update Special Topic November 2011
Refer to below flowchart:
TaxBanter released a Quarterly Tax Update on Taxation of International Amounts and provided a detailed flowchart (Page 91) on establishing entitlement to a FITO. 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 applies well before you even consider whether the de minimus cap of $1,000 for FITO is relevant in the first place.
FITO Limit Calculation
Based on the above statutory and ATO reference, Class has taken the following approach to cater for the FITO calculation using the following methodology:
Step 1: FITO calculation
Total Foreign Tax Credits available for the fund x (100% - Actuarial Pension Exempt %)
If [Total Foreign Tax Credits available for the fund x (100% - Actuarial Pension Exempt %)] <= $1,000, then the FITO limit calculation is not required and this will be the FITO amount.
If [Total Foreign Tax Credits available for the fund x (100% - Actuarial Pension Exempt %)] > $1,000, then Class performs the FITO limit calculation shown in Step 2.
Step 2: FITO Limit calculation
Net Foreign Income x 15% x (100% - Actuarial Pension Exempt %)
This is the new foreign income tax offset limit with any excess amount being lost.
Step 3: The greater of FITO Limit calculated in Step 2 and $1,000
Examples
Example 1
An SMSF has foreign income of $10,000 which included foreign tax credits of $2,000 and the actuarial pension exemption is equal to 60% for an income year.
Step 1: FITO calculation
$2,000 x (100% - 60%) = $800
As the amount is below the $1,000 de minimis cap, there is no need to calculate FITO limit and the SMSF can claim $800 of FITO.
Example 2
Let's use another scenario by only changing the pension exemption percentage to 40% while all other information remains unchanged.
Step 1: FITO calculation
$2,000 x (100% - 40%) = $1,200
As the FITO is over the $1,000 de minimis cap, the FITO limit must be calculated.
The maximum that you can claim is the de minimis cap of $1,000.
Step 2: FITO Limit calculation
$10,000 x 15% x (100% - 40%) = $900
Step 3: The greater of FITO Limit calculated in Step 2 and $1,000
The greater of FITO Limit calculated in Step 2 and $1,000 is $1,000 and it will be used to reduce income tax payable.
While the balance of $200 (difference between Step 1 and Step 3) will be recorded as Excessive Foreign Tax Credit Written Off.
Still Want To Claim A Different Amount Of FITO?
If you’d still like to claim a different amount of FITO despite of Class’s approach, then you will need to:
- Manually change the provision for income tax by taking into account the FITO you intend to claim (e.g. $1,000 FITO means you need to decrease the provision for income tax for $1,000); &
- Manually change the amount at Section D of the SMSF Annual Return, item 13 label C1 Foreign Income Tax Offset. Please note FITO is not a refundable tax offset, so it cannot increase the amount of refund if there is no tax payable. Once your tax payable has been reduced to nil, any unused foreign income tax offset is not refunded, and cannot be carried forward to later income years.
ATO Reference: Calculate your FITO or offset limit