Inland Revenue has released a new interpretation statement – IS 16/05: Income tax – foreign tax credits – how to claim a foreign tax credit where the foreign tax paid is covered by a Double Tax Agreement.
While the title might leave you breathless, the statement offers some useful analysis and examples which may provide more clarity in this fairly complex area.
A flow chart is provided outlining the broad framework for analysing the tax credit issue. Where it has been established that a taxpayer has paid tax offshore, the first key step is to establish that the taxpayer is eligible to claim a foreign tax credit under domestic law (Section LJ 1 and LJ 2 of the Income Tax Act). This includes an example on how the Commissioner would apply the LJ criteria to a transitional resident. The Statement also provides some guidance on how to interpret and apply the DTA, with much of the analysis focused on the “substantially similar” test, which is generally provided within most DTA’s.
Capital gains tax is specifically considered, which has been an uncomfortable area as NZ technically has no capital gains tax. As such the question often arises as to whether capital gains tax paid in Australia could be claimed in NZ. The Commissioner states that capital gains tax paid in a DTA country, and specifically covered in the DTA will provide a foreign tax credit provided the same income is also taxable in NZ. Also, where capital gains tax has been “integrated” into Income Tax as in the New Zealand/Australia DTA, a credit might be available if the income is also subject to tax in NZ such as new section CB 6A, which is shown in Example 7 in the report.
Other useful examples are provided, stepping through the actual calculations required, how to deal with timing differences, dealing with the US/NZ DTA or where there is no DTA.
In summary the statement is very comprehensive and offers more clarity in regard to Foreign Tax Credits arising in DTA countries.