Foreign Income Tax Offset: refunds from a New Zealand income equalisation account

Is a taxpayer who is a participant in a New Zealand Income Equalisation Scheme entitled to a foreign income tax offset under section 770-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of New Zealand tax paid on refunds from their New Zealand income equalisation account?

Yes. The taxpayer is entitled to a foreign income tax offset under section 770-10 of the ITAA 1997 in respect of New Zealand tax paid on refunds from their New Zealand income equalisation account.

The taxpayer is a resident of Australia and is not a company.

The taxpayer carries on a forestry business in New Zealand.

The taxpayer is a participant in a New Zealand income equalisation scheme (NZ IES).

The NZ IES is a form of forward tax averaging in New Zealand, designed to enable primary producers to even out the effects of fluctuating incomes on their tax liabilities over a period of five years.

Under the NZ IES, a taxpayer who derives income from forestry may deposit amounts from that income into a New Zealand income equalisation account, and may apply to withdraw amounts from the account. The New Zealand legislation refers to withdrawals as refunds.

The taxpayer derived income ($100,000) from the forestry business in the 2008-09 income year, and deposited $55,000 of that income into an income equalisation account.

In New Zealand, the income was assessable in that year, and the taxpayer was entitled to a deduction equal to the amount deposited in the income equalisation account.

In the 2009-10 income year, the taxpayer applied for a refund of $20,000 from the account and received the refund.

The taxpayer's account was credited with $1,650 interest on 31 March 2010.

In the 2010-11 income year, the taxpayer applies for a refund of $36,650 (the remainder of the deposit and the interest) and receives the refund.

A refunded amount is treated as income in New Zealand in the year of the application, and forms part of the taxpayer's taxable income in New Zealand in that year.

The taxpayer pays New Zealand income tax on the refunded amounts.

The New Zealand income tax is 'foreign income tax' for the purpose of subsection 770-10(1) of the ITAA 1997.

In Australia, the income from the forestry business was assessable under subsection 6-5(2) of the ITAA 1997 for the 2008-09 income year (see ATO ID 2010/200). The interest income was assessable under that section in Australia for the 2009-10 income year (see ATO ID 2010/201).

Subsection 770-10(1) of the ITAA 1997 provides: You are entitled to a tax offset for an income year for foreign income tax. An amount of foreign income tax counts towards the tax offset for the year if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year.

In respect of

In order to determine whether the taxpayer is entitled to a foreign income tax offset, it is necessary to determine whether the New Zealand tax is paid 'in respect of' the amounts which were included in their assessable income in Australia in 2008-09 and 2009-10 income years.

The meaning of the phrase 'in respect of' was considered in Taxation Ruling TR 2009/6 Income tax : entitlement to foreign income tax offsets under section 770-10 of the Income Tax Assessment Act 1997 where income is derived from investing in fiscally transparent foreign entities . Paragraph 72 of TR 2009/6 explains that the phrase 'in respect of' in subsection 770-10(1) of the ITAA 1997 is intended to draw a nexus between foreign income tax paid and an amount included in a taxpayer's Australian assessable income, where the imposition of such foreign income tax would, apart from the application of Division 770 of the ITAA 1997, result in the taxpayer being exposed to double taxation in respect of that income.

All of the taxpayer's forestry income and interest are taxed in Australia in the year in which they are derived, and, in effect, the taxpayer's forestry income deposited into the New Zealand income equalisation account and interest accrued in that account are taxed in New Zealand in the year in which the amounts are refunded from the account.

Therefore, if Australia were to tax the forestry income and interest and not provide a foreign income tax offset, the taxpayer would effectively bear double taxation on the income.

The New Zealand tax is paid on the amounts refunded from the New Zealand income equalisation account, rather than on the income which was derived from the forestry business and interest. However, the amounts deposited into the account are from income derived from the forestry operations, and interest on that income. Consequently refunds from the account represent amounts of previously deposited forestry income or the interest on such deposits.

Therefore, there is sufficient nexus, for the purposes of subsection 770-10(1) of the ITAA 1997, between the New Zealand income tax paid on the refunded amounts and the amount of forestry income and interest which was included in the taxpayer's assessable income in Australia.

Timing

The entitlement to a foreign income tax offset does not arise until the taxpayer has included an amount in their assessable income for an income year and has also paid foreign income tax in respect of that amount.

The taxpayer has $100,000 included in their assessable income in Australia in 2008-09 income year.

However, when the taxpayer lodges their Australian 2008-09 tax return, they have not paid foreign income tax on the amount that is deposited into the New Zealand income equalisation account (because they were entitled to a deduction in New Zealand equal to the amount deposited).

The taxpayer has interest of $1,650 included in their assessable income in Australia in 2009-10 income year.

However, the taxpayer has not paid foreign income tax on the interest, when they lodge their Australian 2009-10 tax return (because it is not taxed in New Zealand until it is withdrawn).

Foreign income tax is paid in respect of the income derived from the forestry business and interest in New Zealand in the income year in which the taxpayer applies for a refund from the New Zealand income equalisation account (the 2009-10 and 2010-11 income years).

The taxpayer satisfies the requirements of subsection 770-10(1) of the ITAA 1997 when the New Zealand tax is paid on the refund.

The foreign income tax offset is for the income year in which the amount is included in their assessable income in Australia (the 2008-09 and 2009-10 income years).

Therefore, the taxpayer must request an amendment of their assessments for the income years in which the forestry income and interest were included in their assessable income in Australia in order to claim the foreign income tax offset in respect of the tax paid in New Zealand on the withdrawals.

At the time when the taxpayer prepares their Australian income tax return for 2008-09 income year, the taxpayer would have had assessable income of $100,000 and a foreign income tax offset in respect of the New Zealand tax paid in that year on the $45,000 which was not deposited into their account.

Once the taxpayer had paid tax in New Zealand on the first refund of $20,000, they could apply to have their 2008-09 assessment amended to include a foreign income tax offset in respect of the New Zealand tax paid on the additional $20,000.

Once the taxpayer had paid tax in New Zealand on the second refund of $36,650, they could apply to have their 2008-09 assessment amended again to include a foreign income tax offset in respect of the New Zealand tax paid on the additional $35,000, and their 2009-10 assessment amended to include a foreign income tax offset in respect of the New Zealand tax paid on the additional $1,650.

The assessments can be amended at any time during the period of four years starting immediately after the taxpayer pays the foreign tax (section 770-190 of the ITAA 1997).