Burton’s case [Burton v Commissioner of
Taxation  FCAFC 141] has set an interesting precedent for claiming
foreign tax credits on capital gains made from the sale of overseas investments
in the United States.
In simple terms, if you own a capital asset in the USA, and you are taxed in the US the capital gain, then you may not be able to claim all the US tax paid as credit in Australia.
The reason for this is because the ATO will only allow you to claim the foreign tax offset that relates to the portion of taxable discounted capital gain being declared in your Australian tax return. The Australia-US Double Taxation Agreement will not assist you in this regard.
Since Burton’s application to appeal the decision was denied on 14 February 2020, the position under the law has been clarified in a situation where an Australian taxpayer makes a capital gains on US real estate (or other assets which are considered effectively connected with the USA).
While some articles claim that this case means the ATO is clawing back the 50% discount on Australian residents with foreign held assets, this isn’t strictly true. It’s actually that not all of the US tax paid would be creditable here.
To understand the situation let’s consider the example of Jack, an Australian taxpayer who sells a long-term capital asset held in the US, NZ and Australia.
The US taxes capital gains in full, however they tax the capital gain at a different tax rate. NZ does not tax capital gains. Including NZ as a comparison makes it clear that the ruling from Burton does not claw back the discounted 50% capital gain.
For our purposes Jack is an Australian tax resident.
|US owned Asset (AUD$)||NZ owned Asset (AUD$)||Australian owned Asset (AUD$)|
|a.||Foreign Taxable gain after applying any discounts for assessing tax on capital gains||$1,000,000||0||–|
|b.||Foreign tax paid |
NZ NA on capital gains
|c.||Australian Capital Gain||$1,000,000||$1,000,000||$1,000,000|
|d.||Portion of capital gain eligible for discount in Australian assessment||$500,000||$500,000||$500,000|
|e.||Net taxable Australian gain to be taxed (c – d)||$500,000||$500,000||$500,000|
|f.||Australian tax at $47% (including Medicare levy)||$235,000||$235,000||$235,000|
|g.||Net foreign tax paid that is eligible to be claimed as an offset against the Australian taxable portion of the capital gain US: b x 50% |
All others: b
|h.||Australian net tax payable (f – g)||$135,000||$235,000||$235,000|
|Total foreign & Australian tax (b + h)||$335,000||$235,000||$235,000|
|Global Tax Paid||33.5%||23.5%||23.5%|
As you can see from this example, Jack ends up paying more tax on the US asset. This is because the US taxes the full gain at a discounted rate. Australia then taxes half of the gain at the Australian tax rate and only allows the 50% portion of the foreign income tax credits to be applied.
The net impact of applying this precedent is that Australian taxpayers will end up paying up to 33.5% income tax on capital gains made on US investments that are held for more than 12 months. This is in contrast to the 23.5% income tax that they will pay on capital gains that are limited to only paying Australian income tax.