30 November 2018
In the case of Burton v Federal Commissioner of Taxation, the Federal Court confirmed the ATO’s position in that a foreign income tax offset (FITO) is reduced to the extent that the assessable portion of a foreign capital gain is reduced by the CGT discount or capital losses. However, it would seem that a FITO will not be reduced merely because the amount subject to tax in the foreign country is different because it is calculated in the local currency.
Mr Burton made a number of capital gains (via trusts) in respect of assets that were United States real property interests. Those gains (calculated in USD) were subject to tax in the United States. Although concessional rates applied to some of the gains, the whole USD gain amount was subject to tax in the United States.
In calculating his Australian capital gain, Mr Burton applied the 50% CGT discount and, in one year, also applied capital losses. The Australian capital gain was calculated by translating the USD cost into AUD at the time of acquisition of the asset and USD capital proceeds into AUD at the time of disposal. The net capital gain attributed to Mr Burton reflected an implicit foreign exchange loss attribution to the appreciation of the AUD between 2004 and 2010.
The ATO’s position was that a FITO was only available if foreign tax was paid "in respect of an amount that is all or part of an amount included in your assessable income for the year". As the amount included in Mr Burton’s assessable income was the amount of any gain after the application of any capital losses and then the CGT discount, only the foreign tax that related to this reduced amount could give rise to a FITO.
The ATO did not appear to argue that Mr Burton’s FITO entitlement was affected by the reduction in the AUD capital gain attributable to foreign currency movements. That is, but for the CGT discount and the capital losses, Mr Burton would have been entitled to a 100% FITO despite the fact that the AUD amount included in his assessable income was less than the AUD equivalent of the USD gain taxed in the United States.
Mr Burton argued that the whole amount of United States tax (which was less than the gross Australian tax otherwise payable) was available as a FITO. In making this argument, he noted that the entire capital gain "forms part of the calculation of assessable income" in a broad sense (i.e., it is an integer that leads to assessable income). Mr Burton also noted that revenue losses could have the same effect as capital losses but would not compromise the entitlement to FITOs as it was clear that they did not affect assessable income. It would be inconsistent for one form of loss to reduce FITOs but not the other. Mr Burton also claimed that his entitlement to a FITO was mandated by the Australia-US DTA.
Ultimately, the Court sided with the Commissioner and concluded that the FITO was reduced by 50% where the CGT discount applied. The purpose of the FITO provisions was to reduce double taxation and there could be no double taxation if an amount was excluded from assessable income. It was not sufficient that the gross capital gain went into the method statement that ultimately produced the assessable amount and the treaty did not compel a different result.
The Court did not address the treatment of capital losses, but affirmed the assessments issued by the Commissioner that reduced the FITOs where capital losses applied.
Aside from capital gains, the ATO’s now-confirmed position is also relevant to FITOs that flow from CFCs. If an existing entity becomes a CFC it will usually pay tax in its home jurisdiction based on historic cost bases. However, the CFC may receive a higher market value cost base for the purposes of determining attributable income under the Australian CFC rules. In these circumstances, only a portion of the foreign tax will be available as a FITO.