Foreign tax credit on UK dividends paid by UK resident company to an Australian resident individual taxpayer

Is an Australian resident individual taxpayer entitled to a credit under subsection 160AF(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for foreign tax paid on dividends received from a United Kingdom (UK) company?

Yes. An Australian resident individual taxpayer is entitled to a credit for foreign tax paid on dividends received from a UK company pursuant to the interaction of Article 8(2) of Schedule 1 to the International Tax Agreements Act 1953 (the Agreements Act) and subsection 160AF(1) of ITAA the 1936.

The individual taxpayer is a resident of Australia for income tax purposes.

The taxpayer owns shares in a UK resident company.

The taxpayer received a dividend from the UK resident company.

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

The dividend received from the UK company has an attached 'tax credit' of 1/9th of the dividend.

Under the dividend system introduced in the UK in 1999, a UK resident individual who receives a dividend from a UK company is entitled to a 'tax credit' of 1/9th of the dividend.

The taxpayer has not personally paid any UK tax on the dividend.

Subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a resident taxpayer's assessable income includes statutory income from all sources, whether in or out of Australia.

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is subsection 44(1) of the ITAA 1936 which deals with dividends.

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder in a company (whether the company is resident or non-resident) will include dividends paid by the company out of profits derived by it from any source.

In determining liability to Australian tax on foreign sourced 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 situations).

Schedule 1 to the Agreements Act contains the double tax agreement between Australia and the United Kingdom of Great Britain and Northern Ireland (the UK Agreement). Schedule 1A to the Agreements Act contains the Protocol amending the UK Agreement (the UK Protocol). The UK Agreement and the UK Protocol operate to avoid the double taxation of income received by Australian and UK residents.

Article 8(2) of the UK Agreement (amended by Article II of the UK Protocol) states that: An Australian resident individual who receives dividends from a company which is resident in the United Kingdom shall, provided he is the beneficial owner of the dividends, be entitled to the tax credit in respect thereof to which an individual resident in the United Kingdom would have been entitled had he received those dividends, and to the payment of any excess of such credit over his liability to United Kingdom tax. Any such credit shall be treated for the purposes of Australian tax as assessable income from sources in the United Kingdom.

Article 8(2) of the UK Agreement (amended by Article II of the UK Protocol) therefore has the effect of including the tax credit on dividends received from the UK within the Australian resident individual taxpayer's assessable income.

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

For the taxpayer to be entitled to a tax credit, they must have been personally liable for the foreign tax paid (paragraph 160AF(1)(b) of the ITAA 1936).

In the case of the dividend paid from the company resident in the UK to the Australian resident individual taxpayer, the tax credit in respect of the dividend represents 1/9th of the dividend. It is considered that the tax credit represents foreign tax paid and the Australian resident taxpayer is personally liable for the tax paid in the UK through the interaction of Article 8(2) of Schedule 1 to the Agreements Act and subsection 160AF(1) of the ITAA 1936.

Accordingly, the Australian resident individual taxpayer is required to gross up the dividend received from the UK company by the amount of the corresponding tax credit and include the grossed-up amount in their assessable income. The taxpayer is then eligible to claim a credit for the foreign tax paid under subsection 160AF(1) of the ITAA 1936 equal to 1/9th of the dividend paid by the UK company to the taxpayer.

As the taxpayer is a resident of Australia for income tax purposes, the dividend received from the UK company will be assessable under subsection 44(1) of the ITAA 1936. Accordingly, the dividend received from the UK company will form part of the assessable income under subsection 6-10(4) of the ITAA 1997.