Foreign Tax Credit: Employee share options - UK tax paid on part of a gain accrued after the taxpayer became a resident of Australia

Is a taxpayer entitled to a foreign tax credit under subsection 160AF(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for United Kingdom (UK) tax paid on a gain arising from the exercise of employee share options where the UK tax was calculated in part on a gain that accrued after the taxpayer became a resident of Australia?

Yes. The taxpayer is entitled to a foreign tax credit under subsection 160AF(1) of the ITAA 1936 to the extent that Australia and the UK have taxed the same amount.

While a resident of the UK, the taxpayer was granted employee share options in an Australian public company on the condition that they continue their employment in the company for a period of years before exercising them. The taxpayer satisfied these conditions while working in the UK.

The taxpayer subsequently relocated to Australia, continuing their employment with the Australian public company, and became an Australian resident. The taxpayer then exercised the options and sold the acquired shares on the same day.

The UK taxed a portion of the overall gain realised on the options at exercise that was attributable to the period the taxpayer was employed in the UK.

In Australia, the gain that accrued on the exercise of the options was taken into account in determining the taxable gain arising from the disposal of the acquired shares. Only the gain that accrued after the employee became a resident of Australia was taxable.

The employee share options increased in value to a greater extent after the taxpayer became a resident of Australia. This has led to both the UK and Australia taxing part of the same gain.

Subsection 160AF(1) of the ITAA 1936 provides that a resident taxpayer, whose assessable income includes foreign income on which the taxpayer has personally paid foreign tax, is entitled to a credit against the Australian tax payable of the amount of that foreign tax, up to the amount of Australian tax payable on the foreign income.

The issue in this case is whether the part of the gain that was also taxed in the UK has a foreign source and thus whether a credit can be claimed against the Australian tax payable for the UK tax paid on the gain.

In determining whether a credit will be allowed for the UK tax paid, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the Income Tax Assessment Act 1997 (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 UK (the UK Agreement). The UK Agreement operates to avoid the double taxation of income received by Australian and UK residents.

Article 19(2)(a) of the UK Agreement specifies that relief must be provided by Australia where the UK has imposed tax, 'in accordance with this Agreement'. The Article also specifies that Australia's foreign tax credit provisions are to be used to determine this relief.

UK tax was imposed in accordance with Article 12 of the UK Agreement (refer to ATO Interpretative Decision ATO ID 2003/562). The part of the gain also taxed by the UK is thus deemed to have a UK source under Article 12(1) of the UK Agreement.

The taxpayer is entitled to a foreign tax credit calculated in accordance with subsection 160AF(1) of the ITAA 1936. This credit is available under the UK Agreement even though the UK and Australia have taxed gains from the disposal of different assets. A credit will thus be available for the UK tax paid on the gain from the exercise of the options to the extent that the gain was also taxed in Australia on the sale of the acquired shares.