Burton – Full Federal Court of Australia confirms that a foreign tax credit was reduced by ½ when only ½ of a capital gain was brought into taxable income
An Australian-resident individual was taxed at the 15% long-term U.S. capital gains rate on his gains on the disposal of U.S. oil and gas drilling rights. For Australian purposes a 50% discount was applied to the capital gain before imposing tax at a rate of around 45% on it. The Australian foreign tax credit (FITO) provision provided a credit for foreign income tax “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.” The Commissioner successfully took the position that as only half of the U.S. gain had been included in the individual’s income, he was entitled to the FITO for only half of the U.S. tax.
Art. 22(2) of the Australia-U.S. Convention provided that U.S. tax “shall be allowed as a credit against Australian tax payable in respect of the income” but went on to provide that: “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.” Art. 22(2) did not help. The Full Court accepted that “income” could refer to the full (100%) gain. The problem was in the last quoted sentence, which referenced Australian tax law. Jackson J stated:
The term that is used to indicate a connection between the relevant amount of income, whatever that may be, and each of the United States tax and the Australian tax is 'in respect of'. That is indeterminate. No doubt, in each case the connection cannot be a distant, arbitrary or illogical one. But to the extent that it is necessary to identify the connection more precisely, that must be done in accordance with the provisions of the law of Australia. That is what the [quoted] sentence of Art 22(2) requires.
In considering the present case, it does not stretch the language of the article to read 'Australian tax payable in respect of the income' as referring to capital gains tax payable in Australia on assessable income being an amount equal to only 50% of the gain.
The CRA approach is to allow the U.S. tax on 100% of the gain to be taken into account in computing the Canadian foreign tax credit on the Canadian taxable capital gain (see. e.g., Folio S5-F2-C1, para. 1.89).