Burton v Commissioner of Taxation, [2019] FCAFC 141

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 concurring with Steward J that the Commissioner’s approach accorded with Art. 22(2), Jackson J stated (at paras. 166, 168-169):

The general principle expressed in the first sentence of Art 22(2) is that if a person who is an Australian resident for the purposes of Australian taxation law pays United States tax in respect of income (including a gain) derived from sources in the United States, the Australian government must allow a credit against Australian tax payable in respect of that income. …

The requirement that the amount of income be the same in the case of each of the United States tax paid and the Australian tax payable emerges from the syntax of Art 22(2). But it does not follow that this amount of income must be all the income derived from a given source in the United States that is also subject to taxation in Australia. 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 third 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. So reading 'the income' as referring to 50% of the gain derived in the United States is consistent with the general principle in the first sentence of Art 22(2) (acknowledging there will also be differences, such as treatment of capital losses, in the way the laws of different countries calculate the gain).

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 affirming the decision below to confirm the Commissioner’s denial of a FITO for half of the U.S. tax, Logan J stated (at para. 86):

As a matter of ordinary language flowing from the text of s 770-10 … it is only the net capital gain which is … included in Mr Burton’s 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.