Taxation Ruling IT 2562 - Income tax : foreign tax credit system : interaction of foreign tax credit provisions with capital gains and capital losses provisions of Part IIIA

What this ruling is about: This Ruling is designed to clarify in general the interaction of the foreign tax credit provisions of Division 18 of Part III of the Income Tax Assessment Act (the Assessment Act) with the capital gains and capital losses provisions of Part IIIA of that Act. 2. The matter needs to be considered against the background that -


Ruling: 3. Subsection 6AB(1) refers to income (not assessable income) and therefore does not operate to generally require references to foreign income in the Assessment Act to be read as including foreign capital gains. The purpose, therefore, of subsection 160AE(2) is to complement subsection 6AB(1), for foreign tax credit purposes, by operating where - | Determination of foreign tax credit relief in respect of foreign capital gains: 4. It follows that such an amount of a foreign capital gain falls, together with other relevant foreign income derived by a taxpayer, to be treated as the class of income described as "other income" in subsection 160AF(7). A resident taxpayer is thus entitled to a foreign tax credit in relation to such "other income" and attributable foreign taxes, as determined on a worldwide basis, pursuant to subsection 160AF(1). 5. In broad terms, a foreign capital gain realised on disposal of an asset acquired before 20 September 1985, or such a gain realised on disposal of an asset acquired on or after that date in respect of which foreign tax is not payable, is not treated under subsection 160AE(2) as foreign income for the purposes of Division 18. Such a gain does not therefore fall to be aggregated with other relevant foreign income, and foreign capital gains that have suffered foreign tax, when determining a taxpayer's foreign tax credit entitlement (on a worldwide basis) with respect to the class of income described as "other income" in subsection 160AF(7). 6. The references to "foreign income" in Taxation Ruling No. IT 2508 - which deals generally with aggregation of the various classes of income for foreign tax credit purposes and provides for all foreign income, whether or not subject to foreign tax, to be taken into account for those purposes - needs to be read accordingly (i.e. in the light of paragraphs 4 and 5 of this Ruling.) 7. As indicated earlier, a foreign capital gain (or capital loss in respect of the disposal of an asset situated outside Australia) remains to be brought to account for assessment purposes in accordance with the provisions of Part IIIA. This means, for example, that where in a year of income a taxpayer incurs both foreign and domestic capital losses that are completely absorbed by a domestic capital gain derived in the same year of income by the taxpayer, it is only the resultant net capital gain which is included in the taxpayer's assessable income for the relevant year of income in accordance with the provisions of Part IIIA (as indicated later in this Ruling, the foreign capital loss would not be treated as subject to the foreign loss quarantining provisions of the FTCS). 8. It follows that as the amount to be included in a taxpayer's assessable income under Part IIIA is the amount of the worldwide "net capital gain" (as determined under that Part) that accrues to a taxpayer in respect of a year of income, subsection 160AE(2) has to be read as deeming to be foreign income only the whole or the part of any foreign capital gain (or gains), in respect of which foreign tax is payable, that is included in the amount of that "net capital gain" of a resident taxpayer for a year of income. 9. This amount could be greater or smaller than the amount of relevant capital gain (or gains) taken into account for purposes of imposition of the foreign tax. In any event, the foreign tax would in many cases have been imposed on a different basis than that which applies in Australia under Part IIIA with respect to capital gains. Consistent, however, with the approach reflected in paragraph 16 of Taxation Ruling No. IT 2527, the actual amount of foreign tax paid in respect of the relevant foreign capital gain (or gains) is to be taken into account when determining the taxpayer's foreign tax credit entitlement under section 160AF in respect of the deemed foreign income (i.e. the relevant foreign capital gain component of the "net capital gain" which forms part of the taxpayer's assessable income for the year of income). 10. Consistent also with subsection 160AF(3), the Australian tax payable on the amount of that deemed foreign income is calculated by multiplying that amount by the average rate of tax applicable to the taxable income of the taxpayer for the year of income. Simplified examples are given in Appendix A and Appendix B. 11. Those examples and the comments in paragraphs 9 and 10 presuppose that the deemed foreign income constitutes the whole of the class of income in relation to the taxpayer described as "other income" in subsection 160AF(7). However, as indicated earlier in this Ruling, where the taxpayer has derived other foreign income of the same class during the income year, the worldwide basis for determining foreign tax credits would require that foreign income and attributable foreign tax to be taken into account also when determining the taxpayer's foreign tax credit entitlement under section 160AF in relation to that class of income. 12. It follows also from paragraph 8 of this Ruling that situations may arise where the disposal by a resident taxpayer of an asset in a foreign country produces a capital gain which is subject to tax in that country but there is no amount of deemed foreign income pursuant to subsection 160AE(2), and thus no foreign tax credit entitlement under subsection 160AF(1) with respect to the foreign tax paid. This would be the case should the application in relation to the year of income of Part IIIA with respect to that asset disposal (and any other capital gains realised or capital losses incurred by the taxpayer) result in a "net capital loss" for that year for the purposes of that Part. 13. Further examples relating to the operation of the provisions of Part IIIA and Division 18 are at Appendix C and Appendix D. | Ordering of offset of capital losses against capital gains when determining a "net capital gain": 14. As already indicated, the FTCS provisions do not override the operational effect of the provisions of Part IIIA of the Assessment Act, the broad scheme of which is that worldwide capital gains that accrue to a resident taxpayer during a year of income and worldwide capital losses that are incurred during the year for the purposes of that Part are "netted" to arrive at the amount of the "net capital gain" or "net capital loss" of the taxpayer for the year. It follows that a foreign capital gain or foreign capital loss for purposes of Part IIIA is not taken into account for purposes of the foreign loss quarantining provisions of former subsection 51(6), section 79D or section 160AFD of the Assessment Act; those provisions are concerned only with losses arising by reason of an excess of allowable deductions over assessable income derived from a "foreign source", within the special meaning of that expression in subsection 160AFD(7), and the offsetting of such losses against income derived in a subsequent year of income from such a "foreign source" from a business or other income-producing activity. 15. Accordingly, where a resident taxpayer disposes of an asset situated outside Australia and incurs in a year of income a foreign capital loss for purposes of Part IIIA, that amount is available under that Part, together with any domestic capital loss, for offset against any worldwide capital gains derived by the taxpayer in that year when determining the "net capital gain" of the taxpayer for the year. If no such capital gains have been derived, or a "net capital loss" otherwise results, the amount of that loss for the year (determined on a worldwide basis) is available to be carried forward to the next succeeding year of income for the purpose of calculating the taxpayer's "net capital gain" or "net capital loss" for that year. 16. Given that situation, it would be appropriate for priority to be given, when determining the "net capital gain" to be included in a taxpayer's assessable income (or the "net capital loss" of the taxpayer) for a year of income under Part IIIA, to ensuring maximum foreign tax credit relief is available to the taxpayer. 17. Accordingly, any foreign and/or Australian "sourced" capital losses (of the same year of income or available for carry forward from previous years pursuant to Part IIIA) are to be offset against the sum of Australian "sourced" capital gains and foreign capital gains in respect of which no foreign tax is paid, with only the excess (if any) being offset against foreign capital gains subject to foreign tax. This approach will afford maximum foreign tax credit relief with respect to the latter gains - see example at Appendix E. It is noted that this approach is broadly consistent with the design under the FTCS of the domestic carry forward loss election provisions of subsections 80(2B) and (2C) of the Assessment Act. COMMISSIONER OF TAXATION 14 December 1989




EXAMPLE - Resident individual taxpayer: Purchase price of foreign asset X | Sale price of foreign asset X | Gain on sale of foreign asset X | LESS Deductions allowable under foreign law | Gain on sale of domestic asset Y (1) | Gain on sale of foreign asset X (2) | Deductions allowable in respect of professional services | Australian tax payable (4) | Foreign tax credit (FTC) entitlement (6) | Net Australian tax payable | NOTES: A = tax at ordinary resident rates on $15,000 (the reduced taxable income) | = 5 * [(tax at ordinary resident rates on a taxable income of $15,000 + 20% of $13,000) - A] | = 5 * [(tax at ordinary resident rates on $17,600) - A] | ($7,000 * 0.17 [average rate of Australian tax payable]) = $1,190. | LESS Deductions allowable under country X's law | Net foreign gain on foreign asset X | Purchase price of foreign asset Y | Sale price of foreign asset Y | Gain on sale of foreign asset Y | Foreign country Y does not impose tax on capital gains made on disposals of assets. | Gain on disposal of domestic asset (1) | Deductions allowable in respect of product sales | NOTES: ($14,000 * 0.39) = $5,460. | A resident company taxpayer in a year of income derives a foreign capital gain that is subject to foreign tax, a foreign capital loss, "interest income" as defined in subsection 160AE(3) and contract fees from its Australian operations. | Purchase price of foreign asset E | Sale price of foreign asset E | Gain on sale of foreign asset E | Deductions allowable under Country E's law | Net foreign gain on foreign asset E | Foreign capital gains tax paid (20%) | Foreign income tax paid (10%) | Purchase price of foreign asset F | Sale price of foreign asset F | Net loss on sale of foreign asset F | Deductions allowable in respect of contract fees | - Australian tax payable (25,000 * 0.39) | - Australian tax payable (10,000 * .39) | Accordingly, the total FTC allowable is $9,750 + $1000 = | A resident company taxpayer in a year of income disposes of a foreign asset resulting in the realisation of a foreign capital gain that is subject to foreign tax. However, for Australian assessment purposes the disposal of the foreign asset results in a capital loss. No other foreign sourced income is derived but the taxpayer also derives a domestic sourced capital gain from the disposal of an Australian asset. The taxpayer also derives management fees from its Australian operations. | Purchase price of foreign asset D | Sale price of foreign asset D | Gain on sale of foreign asset D | Deductions allowable under country D's laws | Net foreign gain on foreign asset D | Loss on disposal of foreign asset D (2) | Deductions allowable in respect of management fees | Australian tax payable (39%) (3) | EXAMPLE - Resident company taxpayer: The taxpayer realises the following capital gains and losses during the income year: | Foreign tax payable (30%) | Foreign country E does not impose tax on capital gains made on disposals of assets. | Loss on sale of foreign asset F | Indexed cost base of asset G | Reduced cost base of asset H | * No expenses were incurred in relation to the holding or disposal of the assets. | Deductions allowable in respect of machinery sales | NOTES: (1) The "Net capital gain" is calculated as follows: | Gain on sale of foreign asset D (in respect of which foreign tax has been paid) | Gain on sale of foreign asset E (in respect of which no foreign tax has been paid) | Gain on sale of Australian asset G | Loss on sale of Australian asset H | The net capital gain has been calculated so as to ensure maximum allowable foreign tax credit relief to the taxpayer. This is achieved by adding the domestic sourced capital loss and the foreign sourced capital loss together and deducting this amount from firstly, the sum of the domestic sourced capital gain and the foreign sourced capital gain in respect of which NO foreign tax has been paid and secondly, as this results in a capital loss, from the foreign sourced capital gain in respect of which foreign tax has been paid. | Foreign source capital gains and capital losses for Australian assessment purposes are calculated in accordance with Part IIIA. However, for ease of illustration, in this example the foreign capital gains and losses have been treated as being the same for those purposes as the amounts taken into account in the foreign countries. | (2) In this example the amount of the "net capital gain" included in the taxpayer's assessable income relates solely to the foreign capital gain in respect of which foreign tax has been paid. The whole amount qualifies, therefore, to be treated as foreign income for foreign tax credit purposes pursuant to subsection 160AE(2). | ($125,000 * 0.39) = $48,750. | Date of effect: Immediate


Related rulings: IT 2508 IT 2527
Legislative references: 6AB(1) 6AB(2) 51(6), 79D, 160AE(2) 160AE(3), 160AF, 160AFD PART IIIA
Subject references: FOREIGN TAX CREDITS CAPITAL GAINS AND CAPITAL LOSSES