Summary
On 27 November 2018, McKerracher J of the Federal Court handed down his decision in Burton v CoT (2018) FCA 1857 (Burton).
In dispute was, where an Australian tax resident pays foreign income tax on the whole of a foreign capital gain which is only partly assessable in Australia, does only a proportionate share of the foreign income tax count towards the foreign income tax offset (FITO) under subsection 770-10(1) of the Income Tax Assessment Act 1997?
The decision affirms that question and explains that the purpose of Division 770 is to only provide a FITO on an amount that is included in assessable income in Australia and subject to taxation in both countries. That is, if Australian assessable income does not include the full amount of the foreign income, the Australian taxpayer can only claim a partial FITO. This was described in Burton as the 'apportionment approach'.
A further issue was whether, properly construed, section 770-10(1) and Article 22(2) of the Australia-United States of America (US) Double Taxation Convention (DTA) are consistent? Mr Burton said that if, contrary to his primary argument, the provisions are inconsistent then, by reason of section 4(2) of the International Tax Agreements Act 1953, Article 22(2) prevails and the assessments (disallowing part of the FITO) were excessive for that reason.
The Court held that the Commissioner’s construction of section 770-10(1) is not inconsistent with Article 22(2).
Background
Mr Burton is an Australian resident and derived capital gains in the US on which tax was paid at the long-term discount US tax rate of 15% rather than 35%. That is, the US tax was 15% of the full amount of the gain.
Mr Burton also included those capital gains as assessable income in Australia as part of net capital gains after allowance for the 50% capital gains tax (CGT) discount for assets held for more than 12 months. Mr Burton was entitled to a FITO for the US tax paid, the question was how much?
The Commissioner denied Mr Burton 50% of the FITO on the US tax paid on the basis that only 50% of the gain was included in his Australian assessable income after the allowance for the CGT discount.
Australia’s FITO provisions are set out in Division 770. Tax offsets, including FITOs and other offsets, reduce the amount of income tax payable by a taxpayer in respect of a year of income.
Section 770-10(1) states:
Entitlement to foreign income tax offset
(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.
...
(Emphais added).
Article 22(2) states:
… United States tax paid under the law of the United States and in accordance with this Convention, other than United States tax imposed in accordance with paragraph (3) of Article 1 (Personal Scope) solely by reason of citizenship or by reason of an election by an individual under United States domestic law to be taxed as a resident of the United States, in respect of income derived from sources in the United States by a person who, under Australian law relating to Australian tax, is a resident of Australia shall be allowed as a credit against Australian tax payable in respect of the income.
…
(Emphais added).
That is, section 770-10(1) and Article 22(2) seek to eliminate double taxation on the same amount of income.
The Commissioner’s position was that while section 770-10(1) and Article 22(2) provide relief against double taxation, double taxation only occurs where a person pays both foreign and Australian tax on the same amount. The Commissioner argued that Mr Burton had not suffered double taxation to the extent of 50% of the capital gain excluded because of the CGT discount.
Mr Burton argued the FITO provisions in Division 770 contemplate that an amount is ‘included in’ assessable income when it is part of the calculation of assessable income. Under the method statement in section 102-5 of the ITAA97 for calculating the net capital gain included in assessable income, Step 1 includes the full amount of the gain, Step 2 reduces the gain by any capital losses (Mr Burton’s net capital gain also included a reduction due to capital losses under Step 2), and Step 3 applies the CGT discount.
Additionally, it was contended that the capital gain was included in assessable income even though it may be subject to a discount or reduced by unrelated capital losses with this position supported by the context and purpose of section 770-10.
Lastly, he argued the construction of section 770-10 was inconsistent with Article 22(2) .
Decision
McKerracher J accepted that, for the purposes of Division 770, Mr Burton only included 50% of the capital gain in his assessable income and therefore tax was only paid "in respect of" that 50%. Double taxation did not occur because as 50% of the capital gain was excluded under Australian law, that amount did not form part of ‘assessable income’ and therefore, the DTA did not apply.
Further, it was held that the construction of section 770-10(1) was consistent with Article 22(2) because:
under Australian law, the only income which forms part of the assessable income is 50% of the capital gain on which tax is paid in the US. Therefore, where Article 22(2) refers to Australian tax payable in respect of income, the income is only 50% of the capital gain.
Article 22(2) only allows a tax credit but does not determine the amount of such a credit. Thus, the credit is subject to the provisions of Australian tax law.
Conclusion
The object of Division 770 is to give relief from double taxation where Australian income tax would otherwise be payable. However, the Court held in this case that double taxation does not arise where Australian tax was not payable in respect of an amount.
As we said in our recent article on the Satyam case, the interactions of Australian tax laws with those in foreign jurisdictions and under double tax agreements is complicated and parties deriving foreign income need to be aware of both Australian domestic and international tax rules and the interactions.
To discuss or for further information please contact:
Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: nbrydges@sladen.com.au
Kelvin Yuen
Lawyer
Sladen Legal
T +61 3 9611 0177
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: kyuen@sladen.com.au
Annabell Rehmer
Law Clerk
Sladen Legal
T +61 3 9611 0196
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: arehmer@sladen.com.au
