Foreign income tax offsets: distributions from a USA Corporate Limited Partnership to a foreign hybrid limited partnership - section 770-10 of the ITAA 1997

Is a taxpayer that is a member of a United States of America (US) Limited Partnership (LP) entitled to a foreign income tax offset under section 770-10 of the Income Tax Assessment Act 1997 (ITAA 1997) 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 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 profits of the LP under section 92 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The taxpayer is entitled to a foreign income tax offset under section 770-10 of the ITAA 1997 for tax imposed by the US on the taxpayer's share of the profits of the LP to the extent that LP's assessable income does not include an amount under section 529 of the ITAA 1936.

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).

LP, a foreign hybrid limited partnership, is treated as an Australian partnership pursuant to section 472 of the ITAA 1936 as it has at least one resident partner (the taxpayer). As LP has not made an election under section 485AA of the ITAA 1936 in respect of CLP, CLP is treated as a company. Therefore, for the purposes of calculating LP's net income under section 90 of the ITAA 1936, LP is treated as having an interest in a foreign investment fund (FIF) (see sections 485 and 485A of the ITAA 1936).

None of the exemptions in Division 2 - 14 of Part XI of the ITAA 1936 apply. Thus, subject to section 530 of the ITAA 1936, the LP would include the relevant attributable income in their assessable income under section 529 of the ITAA 1936. This would result in the taxpayer being denied a foreign income tax offset for foreign income tax withheld by CLP as the conditions in section 770-135 of the ITAA 1997 have not been met (see paragraph 15 of Taxation Ruling TR 2009/6).

However, 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. This results in an attribution account payment to LP from CLP (see combined effect of section 94J, section 94L and paragraph 603(1)(a) of the ITAA 1936) and any amount otherwise attributable to LP under section 529 of the ITAA 1936 is reduced by the amount of the attribution account payment under section 530 of the ITAA 1936. The relevant assessing provision when calculating LP's assessable income is section 44 (and not section 529).

To the extent of this attribution account payment, the taxpayer's entitlement to claim a foreign income tax offset is therefore determined in accordance with subsection 770-10(1) of the ITAA 1997, which provides: 770-10(1) 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. Note 1: The offset is for the income year in which your assessable income included an amount in respect of which you paid foreign income tax - even if you paid the foreign income tax in another year.

As explained above, 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. Accordingly, 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.

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.

Section 770-130 of the ITAA 1997 applies to treat a taxpayer as having paid foreign income tax, in circumstances where the tax is actually paid by someone else. It provides: 770-130(1) This Act applies to you as if you had paid an amount of *foreign income tax in respect of an amount (a taxed amount ) that is all or part of an amount included in your *ordinary income or *statutory income if you are covered by subsection (2) or (3) for an amount of foreign income tax paid in respect of the taxed amount. 770-130(2) You are covered by this subsection for an amount of *foreign income tax paid in respect of a taxed amount if that foreign income tax has been paid in respect of the taxed amount by another entity under an *arrangement with you or under the law relating to the foreign income tax. Example: You are a partner in a partnership and the partnership pays foreign income tax on the partnership income.

Although the foreign tax is payable by the LP under US tax law (rather than by the taxpayer), such tax has been paid in respect of the same amount that is included in the taxpayer's assessable income under section 92 of the ITAA 1936. That is, the taxpayer has borne the economic burden of that tax as it has been paid in respect of an amount included in the taxpayer's assessable income. Accordingly, section 770-130 of the ITAA 1997 will deem the taxpayer to have paid the foreign tax.

As the taxpayer is taken to have paid foreign income tax in respect of an amount included in its assessable income, the taxpayer is entitled to a foreign income tax offset under section 770-10 of the ITAA 1997.

The amount of the offset will be the amount of foreign income tax paid, subject to the taxpayer's foreign income tax offset limit worked out under section 770-75 of the ITAA 1997.

In determining the availability of a foreign income tax offset 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.

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. Therefore, 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 2005 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 Tax Convention and Commentary may be considered in interpreting double tax agreements).

To the extent that the US has taxed the income in accordance with the Convention, as interpreted by it as the State of source, Australia is obliged to provide relief in respect of such tax in accordance with the machinery provisions for the granting of a foreign income tax offset under section 770-10 of the ITAA 1997.

Accordingly, the taxpayer will be entitled to a foreign income tax offset 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 income tax offset 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.