UK dividends - Foreign Tax Credit for UK tax paid by the UK Company

Is a resident taxpayer entitled, under Schedule 1 of the International Tax Agreements Act 1953 (the Agreements Act), to a credit for foreign tax paid, where they receive a dividend from a United Kingdom (UK) company which has been grossed up to include tax paid by the company on the profits out of which the dividend was paid?

Yes. A resident taxpayer is entitled, under Schedule 1 of the Agreements Act, to a credit for foreign tax paid, where they receive a dividend from a (UK) company which has been grossed up to include tax paid by the company on the profits out of which the dividend was paid

The individual taxpayer is an Australian resident for taxation purposes.

The taxpayer owns shares in a UK company. They received a dividend from the shares and are the beneficial owner of the dividends. The taxpayer has not personally paid any UK tax on the dividends.

The UK Company has paid UK tax on the profits out of which the dividends were paid.

UK resident shareholders that receive dividends from the UK Company include the amount of the dividend plus a grossed up amount reflecting the amount of tax paid by the company on the profits out of which the dividends were paid. The UK resident shareholder is then entitled to a tax credit for the amount of tax paid by the company.

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. The assessable income of an Australian resident includes statutory income from all sources, whether in or out of Australia (subsection 6-10(4) of the ITAA 1997).

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with dividends. Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder of a company (whether the company is a resident or a non-resident) shall include dividends paid by the company out of profits derived by it from any source.

In determining liability to Australian tax on foreign source income it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the Agreements Act.

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Schedule 1 to the Agreements Act contains the double tax agreement between Australia and the UK (the UK Agreement). The UK Agreement operates to avoid the double taxation of income received by Australian and UK residents.

Schedule 1A to the Agreements Act contains a Protocol to the UK Agreement (the Protocol) which amends the UK Agreement with regard to dividends.

Article 8 of the UK Agreement (as amended by the Protocol) deals with dividends. Paragraph (1) of Article 8 provides that dividends paid by a UK company to a resident of Australia may be taxed in Australia.

The taxpayer must therefore include the amount of the dividend received from the UK Company in their assessable income.

Subsection 160AF(1) of the ITAA 1936 provides that where the assessable income of a resident contains foreign sourced income and foreign tax has been paid, by the taxpayer, on that income a foreign tax credit will be allowed. The foreign tax credit allowed against Australian income is the lesser of: • The amount of that foreign tax paid, reduced in accordance with any relief available to the taxpayer under the law relating to that tax; or • The amount of Australian tax payable in respect of the foreign income.

However the taxpayer has not paid the UK tax personally, it is tax that has been paid by the UK Company on profits out of which the dividend has been paid. If read in isolation subsection 160AF(1) of the ITAA 1936 would seem to provide that in these circumstances no credit would be allowed to the taxpayer for the UK tax paid by the UK company.

However, paragraph (2) of Article 8 of the UK Agreement provides that an Australian resident individual who receives dividends from a UK resident company shall, providing they are the beneficial owner of the dividends, be entitled to the same tax credit in respect of the dividends as would be available to a individual UK resident if the dividends were received by them. The credit to which the Australian resident individual is entitled is to be treated as part of their assessable income for Australian tax purposes (subsection 5A(3) of the Agreements Act).

Paragraph (2) of Article 8 of the UK Agreement is inconsistent with and therefore overrides subsection 160AF(1) of the ITAA 1936. The effect of paragraph (2) of Article 8 of the UK Agreement is that the taxpayer will be entitled to a tax credit for the tax paid by the UK Company. The taxpayer will however have to include the amount of the UK tax paid in their assessable income.