CPD SEMINAR When is a taxpayer subject to double taxation? BURTON - - PowerPoint PPT Presentation
CPD SEMINAR When is a taxpayer subject to double taxation? BURTON v COMMISSTIONER OF TAXATION [2019] FCAFC 141 CHAIR Greg Davies QC Speaker James Strong Liability limited by a scheme approved under professional standards legislation
BURTON v COMMISSTIONER OF TAXATION [2019] FCAFC 141
Liability limited by a scheme approved under professional standards legislation
CPD: Burton v Commissioner of Taxation – Overview
CPD: Burton v Commissioner of Taxation – Overview
CPD: Burton v Commissioner of Taxation – Facts
Mr Burton (Benficiary)
Burton Family Trust
Australia US
Sale of ‘NEPA Investment’
properties in 2004
beneficiary of Trust for year ended 30 June 2011 US Tax treatment
authorised US taxation
15% vs. normal rate of 35%
US$23.6m gain US$3.5m tax
CPD: Burton v Commissioner of Taxation – Facts
Mr Burton (Benficiary)
Burton Family Trust
Australia US
Australian tax treatment
included capital gain on sale
Mr Burton by Trustee (Subdiv 115-C)
US$1.8m due to appreciation of A$)
A$22.8m (vs US gain US$23.6m)
assessable income (s 102-5) = $22.8m x 50% discount = A$11.4m
$5.1m
US$23.6m gain A$22.8m ‘discount capital gain’ A$11.4m net CG A$5.1m tax (gross)
CPD: Burton v Commissioner of Taxation – Facts
Mr Burton (Benficiary)
Burton Family Trust
Australia US
Australian FITO claim
US$3.5m against Aust tax of A$5.1m
paid on amount (50%) not included in net capital gain History of the dispute
770 and Article 22 of US Convention
granted for ‘appeal’ to Federal Court.
Court (Burton v CoT [2018] FCA 1857)
US$23.6m gain US$3.5m tax A$11.4m net CG A$5.1m tax (gross)
CPD: Burton v Commissioner of Taxation – Taxpayer Appeal
1. Entire amount of A$22.8m capital gain was ‘included in assessable income’ for the purposes of s 770- 10(1) as it was taken into account in the calculation of net capital gain 2. Alternatively, entire amount of US tax was paid ‘in respect of’ the amount included in assessable income 770-10 Entitlement to foreign income tax offset 770-10(1) You are entitled to a *tax offset for an income year for *foreign income tax. An amount
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
CPD: Burton v Commissioner of Taxation – Taxpayer Arguments
Object reflects Australia’s obligation to relieve juridical double taxation ‘Double taxation’ arises where the ‘same income’ is subject to tax in two countries’ (OECD Commentary) 770-5 Object (1) The object of this Division is to relieve double taxation where: (a) you have paid foreign income tax on amounts included in your assessable income; and (b) you would, apart from this Division, pay Australian income tax on the same amounts. (2) To achieve this object, this Division gives you a tax offset to reduce or eliminate Australian income tax otherwise payable on those amounts. ‘Amounts’ should be considered the ‘same’ despite differences between basis of taxation in Australia and US (Anson v HMRC [2015] UK Supreme Court – ‘pragmatic approach’)
CPD: Burton v Commissioner of Taxation – Taxpayer Arguments
If s 770-10(1) only allowed a FITO for amounts that were included in assessable income (as contended by the Commissioner) – what was the statutory purpose of s 121EG(3A)?
Note 3 [to 770-10(1)]: For
banking units, the amount of foreign income tax paid in respect
banking income is reduced: see subsection 121EG(3A)
the Income Tax Assessment Act 1936. 121EG(3A)…this Act applies to an OBU as if
the eligible fraction
each amount
foreign income tax (within the meaning
the Income Tax Assessment Act 1997 ) the OBU paid in respect of an amount of assessable OB income had been paid in respect of that income.
CPD: Burton v Commissioner of Taxation – Commissioner
Commissioner Arguments – 50% FITO 1. Amount “included in assessable income” can only refer to amount included in net capital gain 2. Only part (50%) of US tax is paid “in respect of” that amount Note 2 to 770-10(1): If the foreign income tax has been paid on an amount that is part non-assessable non-exempt income and part assessable income for you for the income year, only a proportionate share
share that corresponds to the part that is assessable income) will count towards the tax
(excluding the
subsection (2).
CPD: Burton v Commissioner of Taxation – Arguments - Division
Section 102-5 Assessable income includes net capital gain (1) Your assessable income includes your net capital gain (if any) for the income year. You work out your net capital gain in this way: Working out your net capital gain Step 1. Reduce the *capital gains you made during the income year by the *capital losses (if any) you made during the income year.
Note 1: You choose the order in which you reduce your capital gains.
Step 2. Apply any previously unapplied *net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction under step 1….. Step 3. Reduce by the *discount percentage each amount of a *discount capital gain remaining after step 2 (if any).
Step 4 [not relevant]
Step 5. Add up the amounts of *capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.
CPD: Burton v Commissioner of Taxation – Taxpayer Appeal
Article 22 (extract) Relief from Double taxation “(2)…..United States tax paid under the law of the United States and in accordance with this Convention….in respect of income derived from sources in the United States by…..a resident of Australia shall be allowed as a credit against Australian tax payable in respect of the income.
The credit shall not exceed the amount of Australian tax payable
Subject to these general principles, the credit shall be in accordance with the provisions and subject to the limitations of the law of Australia …. in force from time to time.”
CPD: Burton v Commissioner of Taxation – Commissioner
Commissioner’s Arguments - Art 22(2) not inconsistent with Div 770
Credit is limited to Australian tax on “the income” (i.e. the assessable income) Article 22(2) is not an operative provision No “double taxation” where Australia excludes part of capital gain from tax “Income derived from sources in the US” means “assessable income” under Australian law 1 2 3 4
CPD: Burton v Commissioner of Taxation – Findings of Full
Logan J at [87]: “….all that s 770-10 “counts towards” the tax offset is, in the circumstances of this case, the amount of US tax paid by Mr Burton in this instance “in respect of” the net capital gain as calculated in accordance with the 1997 Act. “ Logan J at [86]: “As a matter of ordinary language flowing from the text of s 770-10 and, in turn, s 102-5(1), it is only the net capital gain which is, in each instance, included in …assessable income…There is no contextual warrant for construing “included in” as extending to an amount which is used for computation of an amount that is included in assessable income.”
Appeal Ground 1 – refused (3-0) Appeal Ground 2 – refused (3-0)
CPD: Burton v Commissioner of Taxation – Findings of majority
Steward J at [121]:
than 50% credit to get relief from double taxation
“same amount” is taxed twice: but only if what is taxed is the “same thing” Steward J at [120]:
what income Australia taxes?
income = 50% of total US tax
Appeal Ground 3 – refused (2-1)
CPD: Burton v Commissioner of Taxation – Findings of Logan J
Logan J at [52]:
law of either country.
authorised to tax pursuant to Article 13(1) Logan at [74]:
CPD: Burton v Commissioner of Taxation – Overview
CPD: Burton v Commissioner of Taxation – Insight One
Division 18 of Part III ITAA 1936)
gains under Division 18 (IT 2562)
Statutory Interpretation: Use of legislative history and extrinsic material? (Consolidated Media Holdings v Commissioner of Taxation (2012) 250 CLR 503)
CPD: Burton v Commissioner of Taxation – Insight Two – CGT
US capital gain (A$): A$23.6m less FX gain in cost base: (A$800k) Aust CG (s 104-10): A$22.8m less discount (102-5): (A$11.4m) Aust Net CG (s 102-5): A$11.4m Net CG/US capital gain: 48.3% FITO allowed: 50%
NEPA Investment (FX gain)
CPD: Burton v Commissioner of Taxation – Insight Two – CGT
US capital gain (A$): A$23.6m Aust CG (s 104-10): A$23.6m less Capital loss (102-5): (A$800k) Subtotal: A$22.8m Less discount (102-5): (A$11.4m) Aust Net CG (s 102-5): A$11.4m Net CG/US capital gain: 48.3% FITO allowed: 48.3%
NEPA Investment – (capital loss)
CPD: Burton v Commissioner of Taxation – Insight Two – CGT
US capital gain (A$): A$23.6m less cost base step up (855-40): (A$12.2m) Aust CG (s 104-10): A$11.4m less discount (102-5): (A$5.7m) Aust Net CG (s 102-5): A$5.7m Net CG/US capital gain: 24% FITO allowed: 50%
NEPA Investment – Migration Case
CPD: Burton v Commissioner of Taxation – Insight Three –Relief
Model
from double taxation:
– Exemption method – Credit method
Taxpayer’s position
domestic law
(1) Where a resident of a Contracting State derives income … which, in accordance with the provisions of this Convention, may be taxed in the
mentioned State shall allow: a) as a deduction from the tax on the income of that resident, an amount equal to the income tax paid in that
(extract) Article 23B of OECD Model Convention
CPD: Burton v Commissioner of Taxation – Insight Four –
implement ‘credit’ required by Article 22(2)
Resource Capital Fund IV LP [2019] FCAFC 51
CPD: Burton v Commissioner of Taxation – Q&A
Liability limited by a scheme approved under professional standards legislation
Liability Limited by a scheme approved under Professional Standards Legislation. 1
TAX BAR ASSOCIATION CPD Burton v Commissioner of Taxation [2019] FCAFC 141 21 October 2019 James Strong, Barrister Dever’s List Rm 0417 Owen Dixon Chambers East jstrong@vicbar.com.au PH: 9225 6390 Clerk: 9225 7999 To what extent is a Taxpayer subject to “double taxation” when deriving a gain which is concessionally taxed in Australia and the United States? Introduction This case concerns the application of what is known as juridical double taxation. This is described in the Commentary on Article 23A and 23B of the 2010 OECD Model Double Taxation Convention
taxed in the hands of the same person by more than one State.” Juridical double taxation may be distinguished from economic double taxation - which the Commentary describes as: “where two different persons are taxable in respect of the same income or capital.” The Taxpayer, Mr Burton derived a capital gain from the disposal of US real property interests which was eligible for concessional tax treatment in both the United States (US) and Australia. In the US the whole of the gain was taxed at (just under) 50% of the applicable tax rate, whereas in Australia (just under) 50% of the gain was taxed at the whole of the applicable tax rate. Recalling the observations of Fullagar J in Mutual Life and Citizens’ Assurance Co Ltd v Commissioner of Taxation (1959) 100 CLR 537, 550 that: If you impose tax on a proportion
x, you are taxing x, and, if x includes y, you are taxing y”, the Taxpayer argued that the whole of the discount capital gain ought to be taken as being brought to tax in Australia and thus he ought be eligible to relief from the US tax paid on the entire gain. The Full Court found that the decision taken in Australia to provide a capital gains tax concession by excluding 50% of a discount capital gain from the amount of a net capital gain (and thus from assessable income) meant that a Foreign Income Tax Offset (FITO) was only available for the US tax paid on that part of the discount capital gain that was not excluded from assessable income.
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Further, the majority of the Full Court (Logan J dissenting) considered this was not inconsistent with Article 22(2) of the Australia-US Tax Convention (regarding relief from double taxation). From Australia’s perspective, Article 22(2) of the Convention adopted a model informed by the text of Article 23B of the OECD Model Convention and the Commentary to that Article. The decision confirms – contrary to the suggestion in the relevant Explanatory Memorandum – that the gateway FITO provision in s 770-10(1) of the Income Tax Assessment Act 1997 is more limited in relation to capital gains than the equivalent foreign tax credit provision in former s 160AF(1) of the Income Tax Assessment Act 1936. In that respect, the decision is an example
materials cannot displace the meaning of the statutory text” (Commissioner of Taxation v Consolidated Media Holdings (2012) 250 CLR 503, 519). The majority (Steward and Jackson JJ) disagreed with Logan J as to the proper application of the Convention in relieving double taxation and its interaction with the provisions of the domestic law. The Taxpayer has applied for special leave to appeal to the High Court on both grounds. One
conclusion as to their effect. In relation to the argument as to the application of the Convention, the High Court may see that as an opportunity to re-confirm principles for interpretation of this key relieving provision, common across all of Australia’s international tax treaties. Assuming the treatment of Div 770 is correct, the Taxpayer’s alternative argument regarding the Convention, if accepted by the High Court, would expand the scope of a tax concession in relation to part only of a single item of income or gain covered by Convention beyond that provided for by Div 770. The challenge for the Taxpayer is to convince the Court that such expansion is necessary for the Convention to realise the object of providing relief from double taxation. Relevant Facts 1. Mr Burton (Taxpayer) was the resident individual trustee of an Australian resident discretionary trust, the CI Burton Family Trust (Trust). He was also a discretionary object of the Trust. The Trust had acquired three investments in the United States (US). The main investment - described as the NEPA Investment - related to rights over certain oil and gas wells located in Pennsylvania, US. Two smaller investments - described as Strega 1 and Strega 2 - were also acquired by the Trust. As the issues in the case for all three investments were the same, it is only necessary to describe the relevant background to the NEPA Investment. 2. The NEPA Investment had been acquired by the Trust in 2004. The total cost of the investment was USD1,864,355. In September 2010, the Taxpayer in his capacity as trustee
generated a gain (measured in USD terms) for the Trust of USD23,570,360.
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3. On 30 June 2011, the Taxpayer, as trustee of the Trust resolved to distribute amounts, including the ‘discount capital gain’ on the NEPA Investment, to himself as an object of the Trust. US tax treatment of disposal of NEPA Investment 4. The Trust was not a resident of the United States. However, the gain on disposal of the NEPA Investment was liable to US Federal Income Tax as a long-term capital gain arising from the disposal of a US real property interest (the gain being deemed to be income of a foreign person that was “effectively connected” with the conduct of a US trade or business). The rate of tax was 15% (instead of the usual rate of 35%) and was imposed on the Taxpayer directly – as he was the beneficiary entitled to the gain on disposal. For the year ended 31 December 2010, in respect of the instalments paid in that year the gain was calculated to be US$8,985,565. The US tax paid was US$1,347,834. For the year ended 31 December 2011, the gain was calculated to be US$14,584,795. The US tax paid was US$2,187,720. The total US tax paid over the period was US$3,535,554. Australian tax treatment of disposal of NEPA Investment 5. As an Australian resident beneficiary who was presently entitled to a share of the income of the Trust estate for the purposes of s 97 of the ITAA 1936, the Taxpayer was required to include in his assessable income that share of the net income of the Trust for the year ended 30 June 2011. (Although the “income of the Trust estate” is a trust law concept, here that income included all ‘discount capital gains’ derived by the Trust for the year). 6. Subject to the operation of Division 115-C of the ITAA 1997 (discussed below), the net income
1936 as the assessable income of the Trust calculated on the basis that the Trust was a taxpayer who was a resident, less allowable deductions. 7. The receipt of the proceeds of sale of the NEPA Investment was a capital receipt and therefore was not ordinary income of the Trust assessable pursuant to s 6-5 of the ITAA
constituted CGT Event A1 happening for the Trust (s 104-10 ITAA 1997). Accordingly, the Trust was required to calculate the capital gain from CGT Event A1 happening and was (initially at least) required to take that gain into account in the computation of the net capital gain of the Trust for the year as statutory income pursuant to s 102-5 of the ITAA 1997. 8. The capital gain was calculated as the then AUD equivalent of the USD sale proceeds (being AUD25,322,008 based on a USD/AUD exchange rate of 1.004) less the then AUD equivalent
for a total capital gain of AUD22,754,321. 9. Because the Trust had owned the NEPA Investment for more than 12 months, the capital gain arising on its disposal was a discount capital gain dealt with pursuant to Division 115 of
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the ITAA 1997. Specifically, the effect of Subdivision 115-C of the ITAA 1997, together with Subdivision 6E of the ITAA 1936, was to remove the discount capital gain from the net income
the Taxpayer’s assessable income pursuant to s 97) and instead include it as part of the computation of the net capital gain derived by the Taxpayer directly pursuant to s 102-5 of the ITAA 1997.
NEPA Investment by the Trust that was included in the net capital gain of the Taxpayer (and therefore in his assessable income for the year) was found to be AUD11,366,1611. On this amount he was liable to pay Australian tax of AUD5,114,7722. Relief from double taxation
AUD3,414,207) against his Australian tax liability of AUD5,114,772 either as a Foreign Income Tax Offset (FITO) pursuant to Division 770 of the ITAA 1997 or, alternatively as a foreign tax credit pursuant to Article 22(2) of the Convention between the Government of Australia and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, signed in 1982 ([1983] ATS 16) (Convention) as incorporated into Australian law pursuant to s 5 of the International Tax Agreements Act 1953 (ITAA 1953).
capital gains differed to his approach to the availability of foreign tax credits under the provisions of the former Division 18 of the ITAA 1936. The Commissioner’s view as to the application of new law was set out in ATOID 2010/1753. Consistent with that view (but contrary to his view regarding the operation of the former Division 18 as expressed in IT 25624) the Commissioner denied the Taxpayer a FITO for the full amount of the US tax paid and instead issued amended assessments5 which allowed a FITO for only 50% of that amount on the basis that only 50%6 of the capital gain from the sale was included in the net capital gain which formed part of the Taxpayer’s assessable income.
10 of the ITAA 1997 for the US tax paid on that part of the capital gain which was not included
1 In fact, 50% of AUD22,754,321 is AUD11,377,160.50 2 This is 45% of AUD11,366,161. There is no mention of the 2% Medicare levy. 3 ATO ID 2010/175. Income Tax. Foreign income tax offset: entitlement where foreign capital gain is only
partly assessable in Australia
4 Taxation Ruling no. IT 2562 Income Tax : Foreign Tax Credit System: Interaction of Foreign Tax Credit
Provisions with Capital Gains and Capital Losses Provisions of Part IIIA
5 The sale of the other investments had similar consequences for the 2012 year. 6 In fact the FITO allowed for the 2012 year was for less than 50% of the capital gain due to the
availability of capital losses of the Taxpayer.
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in assessable income as the plain reading of s 770-10(1) did not support the Taxpayer’s construction and the object of the FITO provisions as set out in s 770-5 (1) was to provide relief from double taxation and there was no double taxation in such a case. The Commissioner described his position as the “proportionate approach”.
provide a foreign tax credit for more than 50% of the US tax. Relevant Law
Guide to Division 770 770-1 What this Division is about You may get a non-refundable tax offset for foreign income tax paid on your assessable income. There is a limit on the amount of the tax offset. A resident of a foreign country does not get the offset for some foreign income taxes. You may also get the offset for foreign income tax paid on some amounts that are not taxed in Australia. 770-5 Object (1) The object of this Division is to relieve double taxation where: (a) you have paid foreign income tax on amounts included in your assessable income; and (b) you would, apart from this Division, pay Australian income tax on the same amounts. (2) To achieve this object, this Division gives you a tax offset to reduce
amounts. Subdivision 770-A—Entitlement rules for foreign income tax offsets Table of sections Basic entitlement rule for foreign income tax offset 770-10 Entitlement to foreign income tax offset 770-15 Meaning of foreign income tax, credit absorption tax and unitary tax Basic entitlement rule for foreign income tax offset
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770-10 Entitlement to foreign income tax offset (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 income year. Note 2: If the foreign income tax has been paid on an amount that is part non-assessable non-exempt income and part assessable income for you for the income year, only a proportionate share of the foreign income tax (the share that corresponds to the part that is assessable income) will count towards the tax offset (excluding the operation of subsection (2). Note 3: For offshore banking units, the amount of foreign income tax paid in respect of offshore banking income is reduced: see subsection 121EG(3A) of the Income Tax Assessment Act 1936.
…. (Emphasis added)
102-5 Assessable income includes net capital gain (1) Your assessable income includes your net capital gain (if any) for the income year. You work out your net capital gain in this way: Working out your net capital gain Step 1. Reduce the *capital gains you made during the income year by the *capital losses (if any) you made during the income year.
Note 1: You choose the order in which you reduce your capital gains. You have a net capital loss for the income year if your capital losses exceed your capital gains: see section 102-10. Note 2: Some provisions of this Act (such as Divisions 104 and 118) permit or require you to disregard certain capital gains or losses when working out your net capital gain. Subdivision 152-B permits you, in some circumstances, to disregard a capital gain on an asset you held for at least 15 years.
Step 2. Apply any previously unapplied *net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of *capital gains under step 1 (including any capital gains not reduced under that step because the *capital losses were less than the total of your capital gains).
Liability Limited by a scheme approved under Professional Standards Legislation. 7 Note 1: Section 102-15 explains how to apply net capital losses. Note 2: You choose the order in which you reduce the amounts.
Step 3. Reduce by the *discount percentage each amount
Note: Only some entities can have discount capital gains, and only if they have capital gains from CGT assets acquired at least a year before making the gains. See Division 115.
Step 4. If any of your *capital gains (whether or not they are *discount capital gains) qualify for any of the small business concessions in Subdivisions 152-C, 152-D and 152-E, apply those concessions to each capital gain as provided for in those Subdivisions.
Note 1: The basic conditions for getting these concessions are in Subdivision 152-A. Note 2: Subdivision 152-C does not apply to CGT events J2, J5 and
J6.
Step 5. Add up the amounts of *capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.
Note: For exceptions and modifications to these rules: see section 102-30.
(Emphasis added)
Relief from double taxation (1) Subject to paragraph (4) and in accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), in the case
(a) the United States shall allow to a resident or citizen of the United States as a credit against United States tax the appropriate amount of income tax paid to Australia;….. Such appropriate amount shall be based upon the amount of income tax paid to Australia….. (2) Subject to paragraph (4), United States tax paid under the law of the United States and in accordance with this Convention, other than United States tax imposed in accordance with paragraph (3) of Article 1 (Personal Scope) solely by reason of citizenship or by reason of an election by an individual under United States domestic law to be taxed as a resident of the United States, in respect of income derived from sources in the
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United States by a person who, under Australian law relating to Australian tax, is a resident of Australia shall be allowed as a credit against Australian tax payable in respect of the income. The credit shall not exceed the amount of Australian tax payable on the income or any class thereof or on income from sources outside Australia. Subject to these general principles, the credit shall be in accordance with the provisions and subject to the limitations of the law of Australia as that law may be in force from time to time. …….. (Emphasis added.)
“Incorporation of Assessment Act (1) Subject to subsection (2), the Assessment Act is incorporated and shall be read as
(2) The provisions of this Act have effect notwithstanding anything inconsistent with those provisions contained in the Assessment Act (other than Part IVA of the Income Tax Assessment Act 1936) or in an Act imposing Australian tax.” (Notes excluded) Objection and first instance litigation
Taxpayer sought and was granted test case funding under the ATO’s Test Case Litigation
pursuant to s 14ZZ of the Taxation Administration Act 1953 (TAA 1953).
relieve double taxation as expressed in s 770-5 and to the extrinsic material - contemplates that an amount is ‘included in’ assessable income when it is part of the calculation of assessable income. A capital gain is relevantly “included in assessable income” in this context even though it may be subject to a discount or reduced by unrelated capital losses.
ultimate assessable income figure, again having regard to the object and extrinsic material, the Taxpayer paid the US tax ‘in respect of’ such an amount (in terms of s 770- 10(1)), even though the taxed amounts in the two countries were not identical.
with the requirement of Article 22(2) of the Convention that Australia grant the Taxpayer
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a credit for the US tax paid on the gains and by operation of s 4(2) of the Agreements Act, the provisions of the Convention must prevail.
arguments and upheld the amended assessments on the basis that the “proportionate approach” adopted by the Commissioner was correct and was not inconsistent with the terms
The Taxpayer appealed that decision to the Full Court. Disposition of the Appeal
All three judges rejected the Taxpayer’s two arguments as to the application of Div 770. In relation to the first argument, Logan J stated at [86]: “As a matter of ordinary language flowing from the text of s 770-10 and, in turn, s 102- 5(1), it is only the net capital gain which is, in each instance, included in Mr Burton’s assessable income. Regard to ss 6-5, 6-10 and 102-5 highlights that the phraseology “included in your assessable income” is pervasive in the 1997 Act………..There is no contextual warrant for construing “included in” as extending to an amount which is used for computation of an amount that is included in assessable income. The learned primary judge (at [113] – [114]) reached just such a conclusion. That conclusion was correct, for the reasons given by his Honour.”
“….all that s 770-10 “counts towards” the tax offset is, in the circumstances of this case, the amount of US tax paid by Mr Burton in this instance “in respect of” the net capital gain as calculated in accordance with the 1997 Act. Again as a matter of language, flowing from the text of s 770-10, the relevant connection, is with, materially, each net capital gain, as it is that amount which is included in Mr Burton’s assessable income, not with the integers which the 1997 Act prescribes for the calculation of that net capital gain. True it is that the capital gain is one such integer but that is not the connecting point.”
“In my view, the effect of applying the discount percentage to an amount of a capital gain is to exclude an amount of that gain from inclusion the taxpayer’s assessable income.”
Commissioner on the Div 770 grounds was consistent with: a. The ordinary meaning of the words “included in assessable income” and “in respect of”: b. The object of Div 770 as expressed in the objects clause in s 770-5; c. The “note” to s 770-10(1), in particular, note 2; and
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d. Paragraph 1.40 of the Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No.4) Bill 2007 (Cth) (2007 Explanatory Memorandum).
Jackson J agreed) held that Article 22(2) of the Convention was not inconsistent with Div 770 and thus no further entitlement to relief from double taxation under that Article arose. Steward J stated at [121]: “…..if the taxpayer’s interpretation were to prevail, the taxpayer would get more protection or relief than he truly needs. Here, it would permit Mr Burton to claim as a credit against Australian tax payable, US tax paid on income (50% of the net proceeds) never brought to tax in Australia. I do not think that this was the intended outcome. In my view, “double taxation” takes place in the context of Art 22(2) when the same amount is taxed by different countries twice. However, it is not double taxation if one jurisdiction seeks to tax more aspects of a singular transaction than the other; it is only double taxation when they both seek to tax the same thing….”
relief) must be given to the Taxpayer by the Commissioner for all of the US tax payable “in respect of” the income (in this case gain) arising on the sale. At [74] His Honour explained: “What Art 22(2) states is that a credit is to be allowed for “United States tax paid under the law of the United States … in respect of income [a “gain”] derived from sources in the United States”. For the reasons given above, Mr Burton paid the whole of the US tax “in respect of” the gains. That is the amount of the foreign tax credit. An error in [the trial judge’s] statement is in the understanding of the effect in context of “in respect of”. A further error is that, in effect, such a construction rewrites Art 22(2) so that it obliges the allowance of a credit only of so much of the gain as constitutes a discount capital gain for Australian taxation law purposes. That construction is more than the text, read in context, can bear.” 28. Reference to the comments of Fullagar J in Mutual Life, above were not taken to be decisive by the Court on any ground.
Full Court. At the time of writing this paper, that application had not been heard. Analysis: Approach to statutory construction – Division 770
“gateway provision” in s 770-10(1). The Court considered that the ordinary meaning of the words “amount included in assessable income” and “ in respect of” meant that the Taxpayer could not succeed. Thus, the Taxpayer’s success or failure depended on convincing the Court to read those words in their context and with regard to the legislative history and extrinsic material.
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regard must be had in its interpretation to s 15AA and s 15AB of the Acts Interpretation Act 1901 (Cth).
“Interpretation best achieving Act's purpose or object In interpreting a provision of an Act, the interpretation that would best achieve the purpose or object of the Act (whether or not that purpose or object is expressly stated in the Act) is to be preferred to each other interpretation.”
“(1) Subject to subsection (3), in the interpretation of a provision of an Act, if any material not forming part of the Act is capable of assisting in the ascertainment of the meaning of the provision, consideration may be given to that material: (a) to confirm that the meaning of the provision is the ordinary meaning conveyed by the text of the provision taking into account its context in the Act and the purpose
(b) to determine the meaning of the provision when: (i) the provision is ambiguous or obscure; or (ii) the ordinary meaning conveyed by the text of the provision taking into account its context in the Act and the purpose or object underlying the Act leads to a result that is manifestly absurd or is unreasonable.”
“(3) In determining whether consideration should be given to any material in accordance with subsection (1), or in considering the weight to be given to any such material, regard shall be had, in addition to any other relevant matters, to: (a) the desirability of persons being able to rely on the ordinary meaning conveyed by the text of the provision taking into account its context in the Act and the purpose
(b) the need to avoid prolonging legal or other proceedings without compensating advantage.”
by the High Court in Alcan (NT) v Commissioner of State Revenue (NT) (2009) 239 CLR 27 at [47] where French CJ said: “Historical considerations and extrinsic materials cannot be relied on to displace the clear meaning of the text. The language which has actually been employed in the text of legislation is the surest guide to legislative intention. The meaning of the text may require consideration of the context, which includes the general purpose and policy of a provision, in particular the mischief it is seeking to remedy.”
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by notable cases such as Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355.
ITAA 1936, the High Court (French CJ, Hayne, Crennan, Bell and Gageler JJ) in Commissioner of Taxation v Consolidated Media Holdings (2012) 250 CLR 503 stated at [ ]: "This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [FN removed]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic
the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.” Legislative history and extrinsic material
(Amending Act). The Amending Act also repealed the foreign tax credit provisions of the former Division 18 of the ITAA 1936. The new provisions were intended to replace the former foreign tax credit regime with a tax offset regime. They also made other changes, including removing the ‘quarantining’ of foreign tax credits to certain categories of income as well as removing the ability of a taxpayer to carry forward excess credits for future use.
be contrasted with the provisions in the former Division 18 of the ITAA 1936 which they
had been introduced by the Taxation Laws Amendment (Foreign Tax Credits) Act 1986 (C’th). The Explanatory Memorandum to the Taxation Laws Amendment (Foreign Tax Credits) Bill 1986 (1986 Explanatory Memorandum) explained that the purpose of that Bill was to: “amend the Income Tax Assessment Act 1936 to replace, with effect from the commencement of the 1987-88 income year, the various double taxation relief provisions of the income tax law with a general world-wide foreign tax credit system under which foreign source income (apart from certain salary and wages) derived by Australian resident individuals and companies will be subjected to Australian income tax. Credit for foreign income tax paid by the Australian resident on the foreign income will be allowed against, and up to the amount of, the Australian tax payable on that income (September 1985 Tax Reform announcement): and amend the Income Tax (International Agreements) Act 1953 to repeal those provisions relating to allowance of credit for foreign tax on certain income to which Australia's agreements for the avoidance of double taxation apply that will no longer be required once the general foreign tax credit system is in place.”
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doing, conform with Australia’s obligations under bilateral double tax agreements to which Australia was a party. It would be surprising if Division 18 was intended to provide relief that was less than what those bilateral obligations required - nothing in the 1986 Explanatory Memorandum suggests that. Similarly, there is nothing to suggest what was intended was to provide relief that was greater than necessary.
“Credits in respect of foreign tax 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; (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.” (Emphasis added)
“(2) Where an amount is included in the assessable income of a taxpayer of a year of income, being an amount consisting of profits or gains derived from sources in a foreign country, being profits or gains of a capital nature in respect of which foreign tax is payable, the amount so included shall, for the purposes of this Division (other than section 160AFD), be deemed to be income derived by the taxpayer in the year of income from sources in that country.”
partially exempt income was dealt with differently in former Division 18 compared with Div
For example s 160AF(6) as originally introduced provided:
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"(6) For the purposes of this Division, where, during a year of income, a taxpayer derives foreign income of which- (a) part is exempt under section 23AG; and (b) part is included in the taxpayer's assessable income of the year of income, the amount of foreign tax that would, but for this sub-section, be taken to be paid by the taxpayer in respect of that foreign income shall be reduced by the sum that bears to that amount the same proportion that the exempt part of that foreign income bears to the whole of that foreign income.”
“Sub-section 160AF(6) will ensure that where only a part of any income earned in
service was for a continuous period of less than 365 days (see notes on clause 8) (paragraph (6)(a)), and the remaining part of that income is included in the taxpayer's assessable income (paragraph (6)(b)), credit will be allowed for only a proportion of the foreign tax paid in respect of those foreign earnings. In such cases, the limited amount of creditable foreign tax will be calculated in the same proportion as the amount of assessable foreign earnings income bears to the total foreign earnings.”
rules, to the extent that certain dividends were treated as non-assessable non-exempt income under those provisions, a foreign tax credit was given. The reason for this was that those provisions applied to the extent that the dividend represented a distribution of income which had been previously attributed to the Australian resident under the CFC provisions in Part X of the ITAA 1936 or the FIF provisions in Part XI of the ITAA 1936 respectively. Particularly after the further reform of the foreign income rules in 2004, the balance of any dividends received would very often be treated as non-assessable non-exempt income pursuant to s 23AJ ITAA 1936.
that such dividends would be treated as assessable foreign income for the purposes of Division 18 – but only to the extent that they qualified as non-assessable non-exempt income pursuant to s 23AI. Section 160AFCD(1)(b) then set down the apportionment of the foreign tax credit which would be allowed.
gateway provision in the former Division 18 did not limit the the foreign tax paid “in respect
in assessable income.
foreign tax paid in relation to partly exempt amounts to only the foreign tax paid on the
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assessable component was thought to be in compliance with Australia’s bilateral treaty
Treatment of capital gains under former Division 18 ITAA 1936
by the Commissioner in his ruling IT 2562. The Commissioner observed that where no part
available capital losses to offset the entire capital gain), no foreign tax could be said to have been paid in respect of amounts which were so included and therefore no foreign tax credit could be allowed. Although different from the result arising from the application of revenue losses, this difference was acknowledged as a function of the manner in which capital gains were included in assessable income only after capital losses were applied.
current year or prior year capital losses against current year capital gains. The Commissioner indicted that he accepted that this choice could be exercised so as to provide the maximum
domestic capital gains, then foreign capital gains on which no foreign tax had been paid and finally to foreign capital gains on which foreign tax had been paid.
Appendix E to the ruling (see Appendix 1 to this paper). In that worked example, the amount
remaining after application of that loss against other capital gains on which no foreign tax was paid. The worked example in Appendix E shows the taxpayer being entitled to a foreign tax credit for 100% of the foreign tax paid on that capital gain, despite the amount included in assessable income as a net capital gain having been reduced by the capital loss.
difference between reduction of an amount of a discount capital gain by the application of the discount to a reduction of the gain by application of a capital loss. It follows that under the former Division 18 of the ITAA 1936, Mr Burton would have been entitled to a foreign tax credit for the entire US tax paid on his discounted capital gain. Structure of Division 770
economical and simpler way. Both provisions use the phrase “in respect of” in describing the necessary link between the foreign tax and the income that is included in assessable income in Australia. However – the new provision included three Notes. – These read
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 income year.
Liability Limited by a scheme approved under Professional Standards Legislation. 16 Note 2: If the foreign income tax has been paid on an amount that is part non- assessable non-exempt income and part assessable income for you for the income year, only a proportionate share of the foreign income tax (the share that corresponds to the part that is assessable income) will count towards the tax offset (excluding the operation of subsection (2) Note 3: For offshore banking units, the amount of foreign income tax paid in respect of offshore banking income is reduced: see subsection 121EG(3A) of the Income Tax Assessment Act 1936.
Explanatory Memorandum references the treatment of non-assessable non-exempt income
“1.40 Entitlement to the tax offset will only arise when, and to the extent that, the foreign income tax has been paid on an amount included in assessable income [Schedule 1, item 1, subsection 770-10(1)]. Foreign income tax paid on non- assessable non-exempt amounts (except for section 23AI and 23AK amounts) is
included in assessable income will double taxation, and consequently relief from double taxation, arise. If only part of an amount on which an amount of foreign income tax has been paid is included in assessable income (eg, foreign income tax paid on the foreign branch income of an Australian company), only the same fraction of the foreign income tax counts towards the tax offset [Schedule 1, item 1, note 2 in subsection 770-10(1)] .” (Emphasis added)
equivalent to that in s 160AFCD(1)(b) to apportion the foreign tax paid - instead it used the same phrase “in respect of” to link the foreign tax to the 23AI or 23AK non-assessable non- exempt income amounts. That section provided: “Taxes paid on section 23AI or 23AK amounts (2) An amount of * foreign income tax counts towards the * tax offset for you for the year if you paid it in respect of an amount that is your * non-assessable non- exempt income under either section 23AI or 23AK of the Income Tax Assessment Act 1936 for the year. (Emphasis added)
respect of an amount” required apportionment of the foreign tax to conform to that paid only
in the Offshore Banking Unit (OBU) provisions – in new s 121EG(3A). OBU income other than the eligible fraction is a category of specific non-assessable non-exempt income
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and therefore would appear to be caught by the general rule expressed in Note 2. Thus, there does not appear to be any need for s 121EG(3A) if a general apportionment is provided by the words in s 770-10(2). The Taxpayer argued that the only conclusion to be drawn from the existence of s 121EG(3A) was that no general apportionment of foreign tax was required by the gateway provision in s 770-10(1). In support of this position the Taxpayer referred to the 2007 Explanatory Memorandum which explained that s 121EG(3A) was necessary
previously the case under Division 18). This position appears to directly contradict Note 2 and the wording in paragraph 1.40 of the 2007 Explanatory Memorandum.
121EG(3A) was rejected by the Full Court.
1.42 In general, the new law maintains the current treatment with respect to net capital gains. Only foreign income tax paid on the whole or part of a capital gain (or capital gains) that is (are) included in the taxpayer's net capital gain in accordance with section 102-5 will be eligible for a tax offset [Schedule 1, item 1, subsection 770- 10(1)] . Namely, where the taxpayer has paid foreign income tax on the whole or part of a capital gain that is included in their net capital gain, the requirement that the foreign income tax be paid in respect of an amount that is all or part of an amount included in assessable income will be satisfied. 1.43 If the taxpayer has a net capital loss for the year, the taxpayer will not be able to
net capital gain included in assessable income. That is, the taxpayer is not subject to double taxation on its capital gain. [Schedule 1, item 1, subsection 770-10(1)]
Example 1.2 A resident taxpayer makes a gain of $10,000 on the sale of a foreign asset which is subject to tax in a foreign country at a rate of 20 per cent. The taxpayer also realises a capital loss
in the taxpayer's assessable income, the taxpayer is not eligible for a tax offset in respect of the foreign income tax paid on the sale of the foreign asset.
1.44 A foreign taxed gain that is treated as a capital loss in Australia (due to differences in the calculation of gains and losses), will not be regarded as a double-taxed amount nor will the foreign income tax be eligible for a tax offset. This is because the capital loss is not included in the taxpayer's assessable income, consequently, there is no double taxation of the loss and entitlement to a tax offset does not arise. [Schedule 1, item 1, subsection 770-10(1)] 1.45 Under the current law (subsection 102-5(1)), a taxpayer can choose the order in which capital gains are reduced by any capital losses. A taxpayer can continue to apply any capital loss or prior-year net capital loss firstly against those capital gains on which no foreign tax is paid and to which no Australian discount applies. The taxpayer may then apply the excess (if any) against those capital gains that attract an Australian discount and
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finally against those gains that have been subject to foreign tax. Ordering the application
taxpayer.”
foreign tax credit in relation to a capital gain should be apportioned to reflect only so much of that amount was included in the net capital gain pursuant to s 102-5. To the contrary, it appears that the current treatment under Division 18 - which was to grant the credit for the full amount provided at least some part of the capital gain was included in the net capital gain
Example 1.20 in the 2007 Explanatory memorandum – which adopted the precise facts and calculations contained in the example in Appendix 5 to the Commissioner’s Ruling IT 2562 (see Appendix 2)7. Example 1.20 contained the tax offset calculation in relation to the facts in Example 1.3. That example read:
“Example 1.20 Assume the same facts from Example 1.3. The amount of net capital gain included in the taxpayer's assessable income relates solely to the foreign capital gain in respect of which foreign tax has been paid. Therefore, the whole amount of foreign income tax is counted for foreign tax offset purposes. The taxpayer is entitled to an offset for the lesser of the foreign tax paid ($39,000) and the Australian tax payable in respect of the foreign net capital gain that is included in assessable income (even though only part of the capital gain on foreign asset D is included in the taxpayer's net capital gain). The Australian tax payable is calculated as follows: $125,000 * 0.30 = $37,500. Therefore, the taxpayer is entitled to an offset of $37,500.”
(Emphasis added)
treatment of partially untaxed capital gains with that of partially exempt income.
first publicly expressed the view, contrary to that suggested by the 2007 Explanatory Memorandum, that the operation of Div 770 to capital gains differed from that in former Division 18. In this regard, the Commissioner noted: “The Commissioner's view is that the statement above from Example 1.20 in the Explanatory Memorandum is not consistent with the words and purpose of the legislation and accordingly should be disregarded as relevant context to the extent that it implies that an apportionment approach would not apply to the allowance of a foreign income tax offset in such circumstances.
7With one minor change being that the Australian corporate tax rate was updated from 39% (as was the
rate at the time IT 2562 was published) to 30%, being the rate in 2007.
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The rest of the Explanatory Memorandum, in particular, paragraph 1.18 and other similar passages are still considered to be relevant contextual guidance because they are consistent with the words and purpose of the legislation and they consistently confirm that the meaning of the phrase 'in respect of an amount that is all or part of an amount included in your assessable income for the year' in subsection 770-10(1) of the ITAA 1997 requires an apportionment approach.”
and structure of Div 770 to allow a only a partial tax offset for partially exempt income but a full tax offset for a discount capital gain.
Explanatory Memorandum and to the specific example therein nor (other than a brief reference by Steward J at [108]) to the legislative history of the former s 160AF. To the extent it was relevant the members of the Court considered the 2007 Explanatory Memorandum was supportive of the Commissioner’s approach (or of no assistance to the Taxpayer). Objects clause
770-10(1). In particular the Taxpayer noted that the objective of Div 770 was to provide relief from double taxation where foreign tax was paid on amounts included in assessable income and but for Div 770 Australian tax would be payable on those same amounts.
Model Convention that juridical double taxation occurs “where the same income or capital is taxed in the hands of the same person by more than one State.”
impose double taxation of the capital gain arising from the NEPA Investment without providing full relief by way of a FITO for all of the US tax paid on that capital gain and that this was contrary to the 2007 Explanatory Memorandum and to the Objects clause.
taxation – and given that Division 18 had previously provided relief in conformity with Australia’s Treaty obligations, that Div 770 should also be interpreted according to its terms ((ignoring the operation of s 4(2) of the Agreements Act) in a manner consistent with those
double tax relief in relation to equivalent article to Article 22 of the Convention were relevant to the domestic law construction of Div 770. These cases included:
23 of the US-United Kingdom (UK) Double Tax Convention. In that case the question
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was whether tax was imposed on the “same income” in both States for the purposes of that Article -being income derived by a Delaware Limited Liability Company (LLC) of which the UK resident taxpayer was a member.
[1965] 1 WLR 680 regarding an equivalent article on the UK – New Zealand Double Tax Treaty
in the New Zealand – China Double Tax Treaty.
cases referred to did not assist the Taxpayer in his construction of Div 770 – or were supportive of the Commissioner’s view. Logan J did however rely on them in support of his construction of Article 22(2) of the Convention.
four judges to have considered Div 770 may be viewed as a traditional application of the principle, expressed in Consolidated Media Holdings, of giving primacy to the words of the statutory text. Article 22(2) of the US Convention.
sentence in Article 22(2) of the Convention. The key parts of that sentence provided: “United States tax paid…in accordance with this Convention in respect of income derived from sources in the United States by a person who, under Australian law relating to Australian tax, is a resident of Australia shall be allowed as a credit against Australian tax payable in respect of the income.”
whole of the US tax on the capital gain to which the US was allocated the right to tax by Article 13 (as Logan J determined?) or was it - as was determined by the majority - limited to the tax paid on so much of that income as was subject to tax in Australia?
“the parties were in agreement that in construing Art 22(2) regard should be had to the Vienna Convention on the Law of Treaties, opened for signature on 23 May 1969, [1974] ATS 2 (entered into force on 27 January 1980) (the “Vienna Convention”) and in particular Art 31 of that Convention. In McDermott Industries (Aust) Pty Ltd v Commissioner of Taxation (2005) 142 FCR 134, the Full Court of this Court summarised the applicable principles arising from that Convention at 143 [38] as follows: The application of the Convention has been discussed by McHugh J in
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Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225 and in Thiel v Commissioner of Taxation (1990) 171 CLR 338, the latter case being concerned with the interpretation of the double taxation agreement between Australia and Switzerland. The leading authority in this Court on interpretation of double taxation agreements is Lamesa. It is unnecessary here, to set out again what is there said. The following principles can be said to be applicable: Regard should be had to the “four corners of the actual text”. The text must be given primacy in the interpretation process. The ordinary meaning of the words used are presumed to be “the authentic representation of the parties’ intentions”: Applicant A at 252-253. The courts must, however, in addition to having regard to the text, have regard as well to the context, object and purpose of the treaty
International agreements should be interpreted “liberally”. Treaties often fail to demonstrate the precision of domestic legislation and should thus not be applied with “taut logical precision”.
derived from sources in United States?” referred to in the first sentence. This was crucial to the disposition of the appeal as all judges agreed that it was the US tax paid on “that income” which Australia must allow a credit.
Court in considering the equivalent Article in the UK-US Convention in Anson, Logan J considered that the income was the entire gain from the real property transaction which the US as the State of source had the right to tax in accordance with Article 13 of the Convention. This was the “same income” which was taxed in the US and Australia (albeit at concessional rates) and, accordingly the Article required that Australia give credit for the US tax paid up to the limit of the Australian tax. Given the primacy of the Convention over the provisions of the domestic law under s 4(2) of the Agreements Act, in His Honour’s view this was dispositive
assessable income under Australian law. However at [120] His Honour effectively applied the Convention as if that position were correct in the sense that he stated that the “income” was referring to only to a particular amount that Australia sought to bring to tax.
not to impose tax but merely to allocate taxing rights and then, in circumstance where an item
income on which Australian tax was paid was not the “same income” and nothing in Anson
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Convention suggested otherwise. OECD Model Tax Convention and Commentary
Article 23B. Article 23 of the OECD Model Convention states as follows: “METHODS FOR ELIMINATION OF DOUBLE TAXATION ARTICLE 23 A CREDIT METHOD
accordance with the provisions of this Convention, may be taxed in the other Contracting State, the first-mentioned State shall allow: a) as a deduction from the tax on the income of that resident, an amount equal to the income tax paid in that other State; b) as a deduction from the tax on the capital of that resident, an amount equal to the capital tax paid in that other State. Such deduction in either case shall not, however, exceed that part of the income tax
case may be, to the income or the capital which may be taxed in that other State.”
which are common to all double tax treaties and are, in the author’s view, instructive in understanding the context and object of the Convention and Article 22 as regards relief from double taxation. Some reference was made in the judgment to the introductory words in the Commentary to the 1995 Model Tax Convention – but no reference can be found to the specific comments as to Article 23A and 23B.
Convention was signed. No support was given for the position that the Commentary represented an expression of customary international law and as such, the most recent Commentary (which was the 2010 Commentary) would be relevant to the current interpretation of the Convention negotiated many years before. This position is consistent with statements of the High Court in Thiel, particularly Dawson J. These were summarised by Einfeld J in Lamesa Holdings v FCT 97 ATC 4229 at 4237: “Further extrinsic material, referred to in Thiel as permissible by Mason CJ, Brennan and Gaudron JJ, who agreed with McHugh J, is consideration of the 1977 OECD Model and Commentaries in construing a double tax agreement. Dawson J added an important caveat to this view, namely that the OECD model and
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commentaries are only applicable to those bilateral treaties subsequently concluded.”
Commentary on those articles has changed little since 1982. For convenience, I will refer to the 2010 Commentary in this paper.
three cases: a) where each Contracting State subjects the same person to tax on his worldwide income (concurrent full liability to tax); b) where a person is a resident of a Contracting State (R) and derives income from, or
that income or capital [as occurred in this case]; or c) where each Contracting State subjects the same person, not being a resident of either Contracting State to tax on income derived from, or capital owned in, a Contracting State.”
whether a person will be a resident of one contracting state or the other.
“5. The conflict in case b) may be solved by allocation of the right to tax between the Contracting States. Such allocation may be made by renunciation of the right to tax either by the State of source or situs (S) or of the situation of the permanent establishment (E), or by the State of residence (R), or by a sharing of the right to tax between the two States. The provisions of the Chapters III and IV of the Convention, combined with the provisions of Article 23 A or 23 B, govern such allocation.
the Contracting States, and the relevant Article states that the income or capital in question "shall be taxable only" in a Contracting State. The words "shall be taxable
double taxation is avoided. The State to which the exclusive right to tax is given is normally the State of which the taxpayer is a resident within the meaning of Article 4, that is State R…
exclusive, and the relevant Article then states that the income or capital in question "may be taxed" in the Contracting State (S or E) of which the taxpayer is not a resident within the meaning of Article 4. In such case the State of residence (R)
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must give relief so as to avoid the double taxation. Paragraphs 1 and 2 of Article 23 A and paragraph 1 of Article 23 B are designed to give the necessary relief.
income from, or owns capital in, the other Contracting State E or S (not being the State of residence within the meaning of the Convention) and that such income or capital, in accordance with the Convention, may be taxed in such other State E or
prescribe how the other Contracting State E or S has to proceed.” (Emphasis added)
eliminated:
elimination of double taxation by the State of which the taxpayer is a resident….
income which according to the Convention may be taxed in State E or State S…..
basis of the taxpayer's total income including the income from the other State E or S which, according to the Convention, may be taxed in that other State (but not including income which shall be taxable only in State S; see paragraph 6 above). It then allows a deduction from its own tax for the tax paid in the other State.
a) State R allows the deduction of the total amount of tax paid in the other State
b) the deduction given by State R for the tax paid in the other State is restricted to that part of its own tax which is appropriate to the income which may be taxed in the other State; this method is called "ordinary credit".
methods look at income, while the credit methods look at tax.
Commentary makes the following observations:
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rules on how the exemption or credit is to be computed, this being left to the domestic laws and practice applicable. Contracting States which find it necessary to settle any problem in the Convention itself are left free to do so in bilateral negotiations. “E. Conflicts of qualification 32.1 Both Articles 23 A and 23 B require that relief be granted, through the exemption or credit method, as the case may be, where an item of income or capital may be taxed by the State of source in accordance with the provisions of the Convention. Thus, the State of residence has the obligation to apply the exemption or credit method in relation to an item of income or capital where the Convention authorises taxation of that item by the State of source.” [Emphasis added] “II. Commentary on the provisions of Article 23 B (credit method) Paragraph 1 - A. Methods
the State of residence (R) allows, as a deduction from its own tax on the income
S) on the income derived from, or capital owned in, that other State E (or S), but the deduction is restricted to the appropriate proportion of its own tax…….
levied in the other State E (or S) on an item of income or capital depends on whether this item may be taxed by the State E (or S) in accordance with the Convention……
detailed rules on the computation and operation of the credit. This is consistent with the general pattern of the Convention. Experience has shown that many problems may arise. Some of them are dealt with in the following paragraphs. In many States, detailed rules on credit for foreign tax already exist in their domestic
convention], therefore, contain a reference to the domestic laws of the Contracting States and further provide that such domestic rules shall not affect the principle laid down in Article 23 B…..
effectively paid in accordance with the Convention in the other Contracting
the year for which it is levied but on the income of a preceding year or on the average income of two of more preceding years. Other problems may arise in connection with different methods of determining the income or in connection with changes in the currency rates (devaluation or revaluation). However, such problems could hardly be solved by an express provision in the Convention.
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23 B, the deduction which the State of residence (R) is to allow is restricted to that part of the income tax which is appropriate to the income derived from the State S,
computed either by apportioning the total tax on total income according to the ratio between the income for which credit is to be given and the total income, or by applying the tax rate for total income to the income for which credit is to be given……..For the same reasons mentioned in paragraphs 42 and 43 above, it is preferable also for the credit method not to propose an express and uniform solution in the Convention, but to leave each State free to apply its own legislation and technique. This is also true for some further problems which are dealt with below.
the latter State, according to its tax laws imposes tax only on one of these items, the maximum deduction which State R is to allow will normally be that part
State S. However, other solutions are possible…….
income from State E (or S), may have a loss in State R, or in State E (or S) or in a third State. For purposes of the tax credit, in general, a loss in a given State will be set off against other income from the same State……When the total income is derived from abroad, and no income but a loss not exceeding the income from abroad arises in State R, then the total tax charged in State R will be appropriate to the income from State S, and the maximum deduction which State R is to allow will consequently be the tax charged in State R. Other solutions are possible.
practice, and the solution must, therefore, be left to each State. In this context, it may be noted that some States are very liberal in applying the credit method. Some States are also considering or have already adopted the possibility of carrying over unused tax credits. Contracting States are, of course, free in bilateral negotiations to amend the Article to deal with any of the aforementioned problems.” Discussion
income which the State of Source (the US) may tax in accordance with the Convention. That obligation is limited to the amount of tax on that income levied by Australia.
to apply the limitation. Here, the same transaction is taxed differently in the different
effectively treated as exempt income in Australia (or at least income which is excluded from assessable income) by operation of the method statement in s 102-5 of the ITAA
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afforded in State R is to be limited to a portion of the tax paid in State S. To the contrary the Commentary suggests that the limitation is the tax paid in State R. This position accords with the application of the former Division 18 of the ITAA 1936. The Commentary
adopted the form of Article 23B) would be to grant a credit for the total amount of US tax (up to the limit of the Australian tax). This was the approach taken by Logan J.
the domestic laws of each State. Partially exempt income
given that Australia did not seek to bring to tax the balance of the gain. Thus the credit to be applied should be limited to the US tax payable on that portion of the income which was made taxable in Australia.
for both types of relief from double taxation suggested by the OECD in respect of a discount capital gain:
described in Article 23A); and
(consistent with the method in Article 23B)
relief from double taxation in its domestic law using a combination of the two methods accepted by the OECD commentary as appropriate to that object. No mechanism in Convention to independently grant relief 96. At the conclusion of the hearing the parties were asked to provide written submissions to the Court as to the specific mechanism for relief in the event that Div 770 on its terms provided for a FITO for only 50% of the US tax but Article 22(2) mandated that Australia as the State of Residence provide relief for the entire US tax paid. 97. After considering the Taxpayer’s arguments, Steward J formed the view that the only mechanism available for the provision of relief was Div 770. In His Honour’s view nothing in s 4(2) required the Commissioner to grant an additional FITO pursuant to Div 770, even where the Taxpayer’s construction of Artcile 22(2) to be preferred. His Honour explained at [144]-[145]: “…….Three observations may be made: (a) No obligation is imposed by Art 22(2) on the Commissioner. Rather, it is imposed on “Australia”. That term is relevantly defined in Art 3(1)(k) as the
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“Commonwealth of Australia” and, when used in a geographical sense, includes certain geographic areas, such as Norfolk Island. That term does not include the
“competent authority” of each Contracting State. That term is defined in Art 3(1)(e)(ii) as meaning “the Commissioner of Taxation or his authorized representative”. Art 22(2) does refer to the competent authority of either Contracting State; (b) Article 22(2), as already mentioned, expressly contemplates that the means of conferring a “credit” will be the enactment of separate domestic law. The credit which is allowable “shall be in accordance with the provisions and subject to the limitations of the law of Australia” (emphasis added); and (c) Article 22(2) does not allocate taxing power (unlike, for example, Art 7). It thus cannot be invoked as a “shield”.
Commissioner as a competent authority, strongly suggests that the intention here was to impose obligations at the level of two sovereign states. The obligation relevantly owed is to the Republic of the United States as a sovereign nation by the Commonwealth of Australia. That conclusion is consistent with the second
domestic legislation. Here that is Div 770. This conclusion does not foreclose the availability of relief were Australia to be in breach of its obligation in Art 22(2). It may, for example, be open to a citizen of Australia to seek declaratory relief in this Court to determine whether Australia had complied with Art 22(2). But that citizen could not, in such proceedings, seek a credit outside the terms
to grant the FITO sought and the Treaty is no other source of power to do so. What he has said in TR 2000/16 makes no difference to that outcome. (Emphasis added) Declaratory relief?
Court invoking the broad jurisdiction of the Federal Court under s 39B(1A)(c) of the Judiciary Act and s 21 of the Federal Court Act.8
Resource Capital Fund IV LP [2019] FCAFC 51 at [75] regarding the potential availability
that declaratory relief may be, however the Court appears to be inviting Taxpayers to consider the utility of that legal process in treaty matters. CGT Cost base differences – an anomoly?
8 For an excellent discussion of the nature of practical issues associated with declaratory relief refer to the
paper presented by Andrew Broadfoot QC – Availability of Declaratory Relief in Revenue Disputes, Tax Bar Association Seminar, 20 September 2017
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100. One difference in the amount of the capital gain subject to tax in the US and in Australia which was the foreign exchange component of the Australian capital gains tax
currency translation rules in Subdivision 960-C ITAA 1997, the foreign exchange “loss” attributable to the increase in value of the Australian dollar relative to the USD over the period to the investment was reflected in a higher CGT cost base in the investment in Australia compared to the US. 101. Thus, the full amount of the USD gain (on which US tax was paid) was not included in the capital gain in Australia because of the higher cost base – and therefore smaller capital gain – allowed under Australian law. There is no reference to argument on this aspect in the judgment in the appeal or at first instance – it is possible that the matter was not argued as the Commissioner did not take the point. 102. It appears therefore that a reduced capital gain in Australia attributable to an increase in CGT cost base recognized in Australia (but not in the foreign jurisdiction) may not result in any reduction in the foreign tax considered to be paid on the reduced amount included in assessable income. One reason for this could be that, notwithstanding that the amount is not “included in assessable income” US tax is paid “in respect of” it. 103. If correct, this has important consequences for taxpayers, where an Australian capital gain has been reduced by means of a “step-up” in the cost base of a foreign CGT
for a foreign resident pursuant Subdivision 855-B on becoming a resident of Australia. Suppose the Trust had been a US resident Trust for a period before the oil and gas assets were sold and only became an Australian resident a some later time? Ignoring the application of the CGT discount, if the market value of the foreign assets had increased such that one half of the commercial gain was sheltered by higher cost base – would the Trust (or Mr Burton as beneficiary) have been entitled to the full FITO for all of the US tax paid on the capital gain? On the basis that the higher FX cost base did not affect the portion of US tax said to have been paid “in respect” of the capital gain, the result in the Full Court, it appears that he would be so entitled. 21 October 2019 JR STRONG
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Deductions allowable in respect of management fees $ 5,000 Taxable income $24,000 Australian tax payable (39%) (3) $ 9,360 NOTES (1) The gain realised on the sale of the domestic asset is calculated in accordance with Part IIIA. (2) The loss incurred on the sale of foreign asset D is calculated for Australian tax assessment purposes in accordance with Part IIIA. In this example, even though a gain was realised on the disposal of foreign asset D under foreign country D's laws, for Australian assessment purposes the disposal resulted in a capital loss due to the effects of indexation of the cost base of the asset and the allowance under Australia's law of a different quantum of incidental expenses deductions relating to its disposal. (3) In this example, the taxpayer is not entitled to any foreign tax credit relief in relation to the foreign tax paid with respect to the foreign gain realised on the disposal of asset D because, for Australian assessment purposes, the disposal of foreign asset D resulted in the realisation of a capital loss. Accordingly, no part of the foreign capital gain in respect of which foreign tax has been paid was included in the net capital gain which formed part of the assessable income. It therefore follows that subsection 160AE(2) is not called into operation. Appendix E
EXAMPLE - Resident company taxpayer The taxpayer realises the following capital gains and losses during the income year:
FOREIGN COUNTRY D ASSESSMENT Purchase price of foreign asset D $ 50,000 Sale price of foreign asset D $200,000 Gain on sale of foreign asset D $150,000 LESS Deductions allowable under country D's laws $ 20,000 Net foreign gain on foreign asset D $130,000 Foreign tax payable (30%) $ 39,000 FOREIGN COUNTRY E (NIL ASSESSMENT) Purchase price of foreign asset E $ 50,000 Sale price of foreign asset E $ 65,000
APPENDIX A
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Gain on sale of foreign asset E $ 15,000 Foreign country E does not impose tax on capital gains made on disposals of assets. FOREIGN COUNTRY F Purchase price of foreign asset F $ 90,000 Sale price of foreign asset F $ 50,000 Loss on sale of foreign asset F $(40,000) AUSTRALIA Indexed cost base of asset G $ 90,000 Sale price of asset G $150,000 Gain on sale of asset G $ 60,000 * Reduced cost base of asset H $ 65,000 Sale price of asset H $ 25,000 Loss on sale of asset H $(40,000)* * No expenses were incurred in relation to the holding or disposal of the assets. AUSTRALIAN ASSESSMENT INCOME DOMESTIC FOREIGN TOTAL Machinery sales $ 60,000 $ 60,000 "Net capital gain"(1) $125,000 $125,000 Gross assessable income $185,000 LESS Deductions allowable in respect of machinery sales $ 20,000 Taxable income $165,000 Australian tax 39% $ 64,350 LESS FTC entitlement (2) $ 39,000 Net Australian tax payable $ 25,350
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NOTES (1) The "Net capital gain" is calculated as follows: Gain on sale of foreign asset D (in respect of which foreign tax has been paid) $130,000 LESS/ADD Gain on sale of foreign asset E (in respect of which no foreign tax has been paid) $ 15,000 Gain on sale of Australian asset G $ 60,000 $ 75,000 Loss on sale of foreign asset F $ 40,000 Loss on sale of Australian asset H $ 40,000 ($80,000) ($ 5,000) Net Capital Gain $125,000 The net capital gain has been calculated so as to ensure maximum allowable foreign tax credit relief to the
together and deducting this amount from firstly, the sum of the domestic sourced capital gain and the foreign sourced capital gain in respect of which NO foreign tax has been paid and secondly, as this results in a capital loss, from the foreign sourced capital gain in respect of which foreign tax has been paid. Foreign source capital gains and capital losses for Australian assessment purposes are calculated in accordance with Part IIIA. However, for ease of illustration, in this example the foreign capital gains and losses have been treated as being the same for those purposes as the amounts taken into account in the foreign countries. (2) In this example the amount of the "net capital gain" included in the taxpayer's assessable income relates solely to the foreign capital gain in respect of which foreign tax has been paid. The whole amount qualifies, therefore, to be treated as foreign income for foreign tax credit purposes pursuant to subsection 160AE(2). Accordingly, the taxpayer is entitled to a credit for the lesser of the foreign tax paid ($39,000) and the Australian tax payable in respect of the foreign capital gain that is included in assessable income
($125,000 * 0.39) = $48,750.
References
ATO references: NO L.87/3334-1
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Example 1.3 The taxpayer realises the following capital gains and losses during the income year: Foreign country D assessment Purchase price of foreign asset D $70,000 Proceeds from sale of foreign asset D $200,000 Net foreign gain on sale of foreign asset D $130,000 Foreign tax payable (30%) $39,000 Foreign country B (nil assessment ) Purchase price of foreign asset B $50,000 Proceeds from sale of foreign asset B $65,000 Gain on sale of foreign asset B $15,000 Foreign country B does not impose tax on capital gains made on the disposals of assets Foreign country L Purchase price of foreign asset L $90,000 Proceeds from sale of foreign asset L $50,000 Loss on sale of foreign asset L ($40,000) Australia Cost base of asset A $90,000 Capital proceeds from sale price of asset A $150,000 Gain on sale of asset A $60,000 Reduced cost base of asset H $65,000 Capital proceeds of asset H $25,000 Loss on sale of asset H ($40,000) Australian assessment Income Domestic Foreign Total Machinery sales - revenue $60,000 $60,000 Net capital gain * $125,000 $125,000 Gross assessable income $185,000 Less Allowable deductions from sales revenue (under Australian law) $20,000 Taxable income $165,000 Australian tax (30%) $49,500 Less
APPENDIX B
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Foreign tax offset entitlement ** $37,500 Net Australian tax payable $12,000 * The net capital gain is calculated as follows (assuming gains and losses on foreign assets are the same under Australian tax law as under the foreign laws):** For the calculation of the foreign tax offset cap see Example 1.20. Capital gain on sale of foreign asset D $130,000 Plus Capital gain on sale of foreign asset B $15,000 Capital gain on sale of Australian asset A $60,000 Capital loss on sale of foreign asset L ($40,000) Capital loss on sale of Australian asset H ($40,000) ($5,000) Net capital gain $125,000 The taxpayer calculates net capital gain to ensure maximum allowable foreign tax offset. · First, the taxpayer adds the domestic capital loss and the foreign capital loss together. · Second, the taxpayer deducts this from the sum of the domestic capital gain and the foreign capital gain on which no foreign tax has been paid. · Finally, since this yields a capital loss, the taxpayer deducts this amount from the foreign capital gain in respect of which foreign tax has been paid.
Australian residents - foreign income tax paid on non-assessable non-exempt income 1.46 The current foreign tax credit system provides taxpayers with a credit for certain foreign income taxes paid on distributions made out of previously attributed income that are treated as non-assessable non-exempt income under either section 23AI or 23AK of the ITAA 1936. The current mechanism that provides relief for foreign income taxes paid on this previously attributed income is voluminous, highly complex and disproportionate to its degree of utilisation and compliance. Currently, to claim a credit for foreign income tax paid on previously attributed income, taxpayers are required to maintain attributed tax accounts. These accounts effectively trace the foreign tax paid on the attributed amounts and on the distribution as it makes its way to the taxpayer through a chain of offshore
benefit in return. 1.47 For these reasons, entitlement to relief for foreign income taxes paid on previously attributed income has been substantially rewritten and simplified. In particular, taxpayers will no longer need to maintain complex and costly attributed tax accounts. [Schedule 1, items 77, 79 to 81, 89, 91 to 93, 123 to 126, 164 to 175, section 317, paragraphs 401(1)(d) and 461(1)(f) of the ITAA 1936, section 717-200, paragraph 717-205(c), section 717-235, paragraph 717-240(c)]
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under section 23AH of the ITAA 1936. In contrast, other debt deductions are not disregarded for the purposes of the second element of the cap calculation. This preserves the existing treatment of debt deductions as falling
1.149 The exclusion of deducted convertible foreign losses when calculating the second income tax payable amount has the effect of reducing the foreign tax offset cap by the tax effect of the amount of utilised convertible foreign loss. Of course, the deducted foreign losses will also reduce the first tax payable figure. A convertible foreign loss is subject to special deductibility rules during the five-year transitional period. (See paragraphs 1.228 to 1.298, which deal with the transitional rules for converting a foreign loss of a particular class of assessable foreign income into a tax loss and the utilisation of such losses.) Consequently, utilised convertible foreign losses will only influence the calculation for this five-year period. 1.150 This is an integrity rule ensuring that the tax offset limit reflects the reduced amount of assessable income upon which foreign tax has been paid, after taking into account utilised convertible foreign losses in that year. This approach is similar to existing subsection 160AFD(4) of the ITAA 1936 which reduces the assessable foreign income of a particular class for the purposes of the cap rule to the extent that a loss of that particular class has been applied to reduce assessable foreign income of that class in the relevant income year.
Example 1.20 Assume the same facts from Example 1.3.The amount of net capital gain included in the taxpayer's assessable income relates solely to the foreign capital gain in respect of which foreign tax has been paid. Therefore, the whole amount of foreign income tax is counted for foreign tax offset purposes.The taxpayer is entitled to an offset for the lesser of the foreign tax paid ($39,000) and the Australian tax payable in respect of the foreign net capital gain that is included in assessable income (even though only part of the capital gain on foreign asset D is included in the taxpayer's net capital gain). The Australian tax payable is calculated as follows:
$125,000 * 0.30 = $37,500
Therefore, the taxpayer is entitled to an offset of $37,500. Example 1.21 Austco is an Australian resident company that derives the following taxable income for the 2008-09 income year: Portfolio dividend (from Foreign Country A) (foreign income tax paid of $100,000) $1,000,000 Interest income (from Foreign Country B) (no foreign tax paid) $1,000,000 Australian-sourced income $1,000,000 Total assessable income $3,000,000 Less : Interest expense * $500,000 Other expenses related to Australian-sourced income $500,000 Total allowable deductions $1,000,000 Taxable income $2,000,000