Foreign income tax offset: distribution from New Zealand unit trust

Is an Australian taxpayer who is assessed under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) on foreign income distributed by a resident discretionary trust, entitled to a foreign income tax offset under subsection 770-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) where that income originated from a New Zealand (NZ) unit trust which paid tax on that income in NZ?

Yes. An Australian taxpayer who is assessed under section 97 of the ITAA 1936 on foreign income distributed by a resident discretionary trust is entitled to a foreign income tax offset under subsection 770-10(1) of the ITAA 1997 where that income originated from a NZ trust which paid tax on that income in NZ.

The taxpayer is an Australian resident for income tax purposes.

The taxpayer is a potential beneficiary under an Australian family discretionary trust.

The Australian discretionary trust holds units in a NZ unit trust.

The NZ unit trust derives NZ sourced income from carrying on a business in NZ. The NZ unit trust is taxed as a company in NZ and therefore pays NZ tax on the income that it derives.

The NZ unit trust distributes income to the Australian discretionary trust. No NZ withholding tax is paid on that income.

The Australian discretionary trust exercises its discretion and distributes a share of the trust income to the taxpayer before the end of the income year.

The taxpayer is presently entitled to the share of the trust income and is not under any legal disability.

Section 97 of the ITAA 1936 provides that an Australian resident beneficiary who is not under any legal disability and is presently entitled to a share of the income of a trust estate must include in their assessable income that share of the trust estate's net income. As a result, the taxpayer who received income from the Australian discretionary trust is assessable on that income under section 97 of the ITAA 1936.

Subsection 6B(2A) of the ITAA 1936 deems income beneficially derived by a person (including where the person derived the income as a beneficiary in a trust estate) to be derived from the source to which the income can be directly or indirectly attributed. In the present case, as the taxpayer received distributions from the Australian discretionary trust which in turn received NZ sourced income from a NZ unit trust carrying on a business in NZ, the taxpayer's income is deemed to have a NZ source.

Hence, for Australian tax purposes the taxpayer has derived NZ sourced business income.

In determining liability to Australian tax on NZ sourced income, it is necessary to consider the 2009 NZ Convention in Schedule 4 to the International Tax Agreements Act 1953 , which entered into force on 19 March 2010.

The 2009 NZ Convention does not disturb Australia's right to tax the NZ sourced income derived by the Australian resident taxpayer. Nor is there anything in the 2009 NZ Convention which restricts or alters NZ's right to tax the NZ sourced income of the NZ unit trust.

Article 23(1) of the 2009 NZ Convention provides that, subject to Australian law, credit shall be allowed against Australian income tax payable on income for taxes paid under the law of NZ and which are levied in accordance with the 2009 NZ Convention. As the 2009 NZ Convention does not prevent NZ taxing the profits of the business, the NZ tax on the income of the NZ unit trust is levied in accordance with the 2009 NZ Convention.

In addition, Article 23(3) of the 2009 NZ Convention states that where, in accordance with Article 1(2), an item of income is taxed in a Contracting State in the hands of a person that is fiscally transparent under the laws of the other State, and is also taxed in the hands of a resident of that other State as a participant in such person, that other State shall provide relief in respect of taxes imposed in the first-mentioned State on that item of income in accordance with the provisions of Article 23.

In the present case, NZ treats the NZ unit trust as a company and taxes the NZ unit trust on the business income it derives, while Australia treats the same business income as having been derived by the beneficiaries of the trust and taxes that income in the hands of the Australian resident beneficiary. As a result, Article 23 applies to require Australia to provide relief from double taxation in respect of taxes imposed by NZ on that income, subject to Australian domestic law.

Subsection 770-10(1) of the ITAA 1997 provides that where a taxpayer has paid foreign income tax on an amount that is included in their assessable income, a tax offset will be allowed.

Section 770-15 of the ITAA 1997 defines 'foreign income tax' to include a tax on income that is imposed by a law other than an Australian law. Hence, the income tax paid in NZ by the NZ unit trust is foreign income tax for the purposes of section 770-10 of the ITAA 1997.

In this case, the taxpayer has not paid foreign income tax directly. However NZ income tax has been paid by the NZ unit trust, on the income which was subsequently included in the taxpayer's assessable income under section 97 of the ITAA 1936.

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, relevantly, 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) ... 770-130(3) You are covered by this subsection for an amount of foreign income tax paid in respect of the taxed amount to the extent that: (a) the taxed amount is taken, because of section 6B of the Income Tax Assessment Act 1936 (the 1936 Act ), to be attributable to another amount of income of a particular kind or source; and (b) foreign income tax has been paid in respect of the other amount of income; and (c) the taxed amount is less than it would have been if that tax had not been paid.

As noted above, subsection 6B(2A) of the ITAA 1936 applies to deem the income to be attributable to a NZ source. Paragraph (a) of subsection 770-130(3) of the ITAA 1997 is therefore satisfied.

Although the tax is paid by the NZ unit trust, treated as a taxable entity in NZ but fiscally transparent in Australia, it is paid in respect of the same income included by Australian law under section 97 of the ITAA 1936, in the taxpayer's assessable income. That is, the taxpayer has borne the economic burden of the tax. Paragraph (b) of subsection 770-130(3) of the ITAA 1997 is therefore satisfied.

Lastly, the taxed amount is less than it would have been had the NZ tax not been paid and so paragraph (c) of subsection 770-130(3) of the ITAA 1997 is satisfied.

Accordingly, section 770-130 will apply to deem the taxpayer to have paid the foreign income tax paid by the NZ unit trust, in respect of the amount included in the taxpayer's assessable income that is attributable to the distribution of income by the NZ unit trust to the Australian discretionary trust.

Consequently the Australian resident taxpayer satisfies the requirements of subsection 770-10(1) of the ITAA 1997 and is entitled to a foreign income tax offset in relation to the income which originated from the NZ unit trust. The amount of the foreign income tax offset is calculated in accordance with Subdivision 770-B of the ITAA 1997.