Foreign Tax Credit: New Zealand tax incorrectly paid on pension income

Is the taxpayer, an Australian resident, entitled to a foreign tax credit under section 160AF of the Income Tax Assessment Act 1936 (ITAA 1936) for tax paid in New Zealand on workers' compensation payments that are a pension for the purposes of Article 19 of Schedule 4 of the International Tax Agreements Act 1953 (Agreements Act)?

No. The taxpayer is not entitled to a foreign tax credit under section 160AF of the ITAA 1936 for tax paid in New Zealand on workers' compensation payments that are a pension for the purposes of Article 19 of Schedule 4 of the Agreements Act.

The taxpayer is an Australian resident for income tax purposes.

The taxpayer receives weekly workers' compensation payments from the Accident Compensation Corporation (ACC) in New Zealand after sustaining loss or injury while employed in New Zealand prior to becoming an Australian resident.

The taxpayer has paid tax in New Zealand on these payments.

These payments are a pension for the purposes of Article 19 of Schedule 4 of the Agreements Act.

The New Zealand Inland Revenue has decided under New Zealand law to refund the amount of tax paid by the taxpayer in respect of these payments.

Subsection 160AF(1) of the ITAA 1936 provides that a resident taxpayer: • whose assessable income includes foreign income • who has paid foreign tax in respect of the foreign income, and • who was personally liable for the 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.

Paragraph 6AB(5A)(a) of the ITAA 1936 provides that a taxpayer is taken, for the purposes of this Act, not to have been personally liable for, or to have paid foreign tax where a refund of the foreign tax becomes liable to be made to the taxpayer or any other person.

The New Zealand Inland Revenue has decided to refund the amount of tax withheld in respect of these payments because the taxing rights under the Agreements Act in respect of these payments are allocated to Australia only (see below). The taxpayer is liable to receive the refund for subsection 6AB(5A) of the ITAA 1936 purposes. As a consequence, the taxpayer is taken not to be personally liable for, or to have paid, the foreign tax. No foreign tax credit is allowable under subsection 160AF(1) of the ITAA 1936.

In determining liability to tax on foreign sourced income received by an Australian resident taxpayer, it is necessary to consider not only the domestic income tax laws but also any applicable tax treaty contained in the Agreements Act.

Schedule 4 to the Agreements Act contains the tax treaty between Australia and New Zealand (New Zealand Agreement). The New Zealand Agreement operates to avoid the double taxation of income received by Australian and New Zealand residents.

Subsection 6B(1A) of the Agreements Act gives the New Zealand Agreement the force of law in Australia. Section 4 of the Agreements Act incorporates the ITAA 1936 into the Agreements Act so that both those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 where there are inconsistent provisions (except for some limited situations).

Article 24(2) of the New Zealand Agreement provides that, subject to the provisions of the law of Australia , a credit for any New Zealand tax paid under the law of New Zealand and in accordance with the New Zealand Agreement will be allowed against Australian tax payable on income from New Zealand sources.

Therefore, the New Zealand Agreement makes the Elimination of Double Taxation Article subject to the prevailing domestic foreign tax credit system of each country. As the New Zealand Inland Revenue has decided to refund the tax, the taxpayer has not 'paid' any New Zealand tax for Australian domestic law purposes. Hence, no credit for New Zealand tax paid will be allowable under Article 24(2) of the New Zealand Agreement.

Further, Article 19 of the New Zealand Agreement deals with the taxation treatment of pensions (including government pensions) and annuities. Article 19(1) of the New Zealand Agreement provides that pensions (including pensions sourced in New Zealand) paid to a resident of Australia shall be taxable only in Australia. Given that the workers' compensation payments are a pension for the purposes of Article 19(1) of the New Zealand Agreement, Australia has the exclusive taxing right over these payments.

Article 24 of the New Zealand Agreement requires crediting for foreign tax paid only where the tax is properly imposed under the law of a country and in accordance with the New Zealand Agreement. Foreign tax is not properly imposed under the law of either country, where it is imposed in contravention of that country's taxing rights under the New Zealand Agreement.

Thus, for the purposes of Article 24 of the New Zealand, even if the New Zealand Inland Revenue did not refund the New Zealand tax paid, the workers' compensation payments would not have been taxed by New Zealand 'in accordance with the New Zealand Agreement'. Therefore, the New Zealand tax would not have been paid 'under the law of New Zealand'. Accordingly, the New Zealand tax paid could not be allowed as a credit against Australian income tax payable under Article 24(2) of the New Zealand Agreement.

The workers' compensation payments (being pension income) are taxable only in Australia. Hence, Article 24(2) of the New Zealand Agreement will not require Australia to allow a foreign tax credit in respect of New Zealand tax withheld from a pension paid to an Australian resident taxpayer. There is no inconsistency between the Agreements Act and the ITAA 1936 and the New Zealand Agreement does not prevail over subsection 160AF(1) of the ITAA 1936 to allow the taxpayer a foreign tax credit.