Issue
Is a taxpayer that is a member of a United States of America (US) Limited Partnership (LP) entitled to a foreign tax credit under section 160AF of the Income Tax Assessment Act 1936 (ITAA 1936) for tax imposed by the US on the taxpayer's share of the profits of the LP, where: • the LP is a foreign hybrid limited partnership according to section 830-10 of the Income Tax Assessment Act 1997 (ITAA 1997) solely deriving income from a US corporate limited partnership (CLP) which is not a foreign hybrid limited partnership, and • the taxpayer is assessable on their share of the profits of the LP under section 92 of the ITAA 1936?
Decision
Yes. The taxpayer is entitled to a foreign tax credit under section 160AF of the ITAA 1936 for tax imposed by the US on the taxpayer's share of the profits of the LP, to the extent LP's assessable income does not include an amount under section 529 of the ITAA 1936.
Facts
The taxpayer, the trustee of an Australian resident superannuation fund, invests in a US LP, which was formed in the US. The LP is a foreign hybrid limited partnership according to section 830-10 of the ITAA 1997. The LP is therefore treated as a partnership for Australian tax law purposes.
The LP's only investment is in CLP, also formed in the US. The only income derived by the LP is from the investment in the CLP. Disregarding section 485AA of the ITAA 1936, the LP's investment in the CLP is a foreign investment fund (FIF) interest.
The CLP is a corporate limited partnership within the meaning of subsection 94D of the ITAA 1936, and is therefore treated as a company for Australian tax law purposes, pursuant to Division 5A of the ITAA 1936. The CLP is not a foreign hybrid limited partnership within the meaning of section 830-10 of the ITAA 1997 as the LP has not made an election under section 485AA of the ITAA 1936. The CLP invests in various assets that give rise to income derived from sources in the US.
As both the LP and the CLP are taxed as partnerships under US tax law, neither pays US tax itself, that is, both are fiscally transparent. Instead, the US imposes tax on the partners in respect of their share of the income, profits or gains of the partnership.
At the end of each accounting period, the whole of CLP's partnership profits are either distributed to the partners or credited to the partner's capital account. The same occurs in respect of LP's partnership profits.
As the partners are not resident in the US, the LP is obliged to withhold US tax from the partner's share of the net income of the partnership (whether distributed or not). The rate of withholding depends on the character of the income in the hands of the partner under US tax law and the USA Convention contained in Schedule 2 to the International Tax Agreements Act 1953 (the USA Convention).
The profits of the CLP that are either distributed to the LP or credited to the LP's capital account are treated as dividend income and are included in the net income of the LP under section 44 of the ITAA 1936. The taxpayer's assessable income includes its interest in the net income of the LP under section 92 of the ITAA 1936.
Reasons for Decision
Entitlement to claim a foreign tax credit is determined in accordance with subsection 160AF(1) of the ITAA 1936, which provides: 160AF(1) If: (a) the assessable income of a year of income of a resident taxpayer includes: (i) income that is foreign income; or (ii) income, or a profit or gain, that is derived from a source in an area covered by an international tax sharing treaty to the extent to which that income, profit or gain is taxed in Australia; and (b) the taxpayer has paid foreign tax in respect of that income, profit or gain; and (c) the taxpayer was personally liable for that tax; the taxpayer is, subject to this Act, entitled to a credit of: (d) the amount of that foreign tax, reduced in accordance with any relief available to the taxpayer under the law relating to that tax; or (e) the amount of Australian tax payable in respect of that income, profit or gain; whichever is the less.
Where the partnership profits are either distributed or credited to the partner's capital account, Australian tax law deems the CLP to have paid a dividend to the LP under sections 94L or 94M of the ITAA 1936. As the LP is treated as a partnership for Australian tax law purposes, such dividends are included in the LP's net income pursuant to section 90 of the ITAA 1936. This is because if the LP was itself a resident taxpayer, the dividends would be included in its assessable income under section 44 of the ITAA 1936. The taxpayer will then include in assessable income its interest in the net income of the LP, pursuant to section 92 of the ITAA 1936.
(Note: while LP is treated as having an interest in a FIF, the deemed payment of a dividend to LP and inclusion in its net income under section 90 of the ITAA 1936 results in an attribution account payment under paragraph 603(1)(a) of the ITAA 1936. This means that any income that would otherwise be included in LP's net income under section 529 of the ITAA 1936 is reduced by the amount of the attribution account payment under section 530 of the ITAA 1936. To the extent of the reduction, the relevant assessing provision when calculating LP's assessable income is therefore section 44, not section 529.)
As the LP's net income consists of deemed dividends paid by the CLP out of profits derived from sources in the US, the taxpayer's assessable income will include foreign income, such that paragraph 160AF(1)(a) of the ITAA 1936 is satisfied.
Under US tax law, tax is imposed on the taxpayer's share of the partnership profits calculated for US tax purposes. US tax law treats the CLP as a partnership, rather than a company, such that the amount included in LP's partnership profits for US tax purposes is a share of the partnership profits of CLP, rather than a deemed dividend.
The LP is required to remit income tax on behalf of the taxpayer, in respect of the taxpayer's share of the partnership income for US tax purposes. This tax has been paid in respect of the same income that is subject to tax in the hands of the taxpayer under section 92 of the ITAA 1936. Although the foreign tax is payable by the LP, the taxpayer has borne the economic burden of that tax insofar as the tax has been paid in respect of an amount included in the taxpayer's assessable income. Accordingly, subsection 6AB(3) of the ITAA 1936 operates to deem the taxpayer to have peen personally liable for and to have paid that foreign tax (as noted above, because the profits of CLP are included in LP's net income under section 44 of the ITAA 1936, and not under section 529 of the ITAA 1936, subsection 6AB(3A) of the ITAA 1936 is not applicable). Paragraphs 160AF(1)(b) and 160AF(1)(c) of the ITAA 1936 are therefore satisfied.
As the taxpayer's assessable income includes foreign income and the taxpayer is taken to have paid and been personally liable for foreign tax in respect of that foreign income, the requirements in section 160AF of the ITAA 1936 are satisfied, such that the taxpayer is entitled to a foreign tax credit.
The amount of the credit is the lesser of the foreign tax paid or the Australian tax payable in respect of that foreign income (paragraphs 160AF(1)(d) and (e) of the ITAA 1936).
In determining the availability of a foreign tax credit it is also necessary to consider the USA Convention contained in Schedule 2 to the International Tax Agreements Act 1953 (Agreements Act). Subsection 4(1) of the Agreements Act provides that the ITAA 1936 and the ITAA 1997 must be read as one with the Agreements Act.
Article 22(2) of the USA Convention provides that where US tax has been imposed in respect of US-sourced income in accordance with the USA Convention, a credit against Australian tax payable on that income will be allowed.
As the LP and the CLP are treated as 'flow-through' entities under US tax law, any treaty benefits are applied at the level of the partner and not the LP by the US for the purposes of applying the US convention.
As the income that flows through the CLP and the LP to the partner retains its character in the hands of that person for the purposes of US tax law, the extent to which the US exercises its source country taxing right under the Convention will be determined by the character of that income (for example tax on interest income shall not exceed 10% under Article 11 of the US Convention).
However, Australia, as the country of residence of the taxpayer, treats the relevant income taxed by the US under the Convention as dividend income paid by the CLP to which the taxpayer is beneficially entitled as a partner in the LP. This difference in treatment of income as between the State of source (US) and the State of residence of the taxpayer (Australia) is commonly referred to as a Conflict of Qualification. Where the difference in treatment is solely referable to differences in the respective domestic laws of the State of source and the State of residence of the taxpayer, it is considered that the State of source has taxed in accordance with the Convention and that the State of residence of the taxpayer is obliged to provide relief in accordance with Article 22(2) (see paragraphs 32.1 to 32.3 of the OECD Commentary on Article 23A and 23B. The Commissioner's view expressed at paragraph 104 of Taxation Ruling TR 2001/13 is that the OECD Model Taxation Convention may be considered in interpreting double tax agreements).
Accordingly, the taxpayer will be entitled to a foreign tax credit for US taxes paid in respect of its share of the partnership income of LP, even though, for Australian tax law purposes, the taxpayer's share of the partnership profits is calculated on the basis that the LP has derived a dividend. The foreign tax credit will be allowable in the income year in which the partnership income is assessable, whether the foreign tax was paid in the same, or an earlier, income year.