Burton v Commissioner of Taxation, [2018] FCA 1857, aff'd [2019] FCAFC 141

The taxpayer was an Australian resident who was taxed at the 15% long-term U.S. capital gains rate on his gains on 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 (s. 770-10) provided:

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.

In confirming the Commissioner’s denial of a FITO for (leaving aside the effect of complicating adjustments) half of the U.S. tax, and after stating (at para. 95) that "that ‘included’ is a word that in different contexts may receive different applications," McKerracher J stated (at para. 109) his agreement with the Commissioner’s position (summarized at para. 4) that “double taxation occurs where a person pays both foreign tax and Australian tax on the same amount” and “an amount not included in assessable income (namely, 50% of the capital gain) cannot, by definition, be doubly taxed,” and added (at para. 114) that “the words ‘in respect of an amount’ mean an amount which is itself assessable.”

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:

… 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. … 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.

In rejecting a submission that Art. 22(2) required Australia to grant an undiscounted FITO, McKerracher J stated (at paras. 126-127):

Under Australian law, the only income forming part of the assessable income is 50% of the capital gain on which tax is paid in the US. Where Art 22(2) refers to Australian tax payable in respect of income, the income is only 50% of the capital gain.

Secondly, the word ‘all’ does not appear before the words ‘United States tax paid’ in the first line of Art 22(2). The Article does not suggest that a credit is allowed against Australian tax payable for the whole amount of the US tax paid. … It does not prescribe how much is to be allowed as a credit. The credit is subject to the provisions and limitations of Australian law.