myIR, payments and more
We have identified the following issues with some of the software used by tax agents to prepare income tax returns where their client has:
- FIF income
- Foreign Tax Credits (FTC), and
- Excess imputation credit (ICA).
Section BC 8 and LA 4 of the Income Tax Act 2007 (Act) prescribe how your clients' income tax liabilities will be satisfied (ordering rule). The ordering rule is:
- first, a non-refundable tax credit, ie FTC credits:
- second, a tax credit for a supplementary dividend:
- third, a tax credit for an imputation credit:
- fourth, a refundable tax credit:
Where your client is entitled to foreign tax credits and also has excess imputation credits your software should apply section BC 8 and LA 4 of the Act and firstly offset the FTC, then the ICA and convert the excess ICA into a loss carried forward.
In some cases we have found that the losses carried forward from the year ending 31 March 2008 differ from the returns prepared.
It may be that the software is not applying the ordering rule or calculating the foreign tax credits correctly. At this stage we are unable to confirm if the errors identified arose because of the ordering rules or the maximum of allowable foreign tax credits.
Foreign tax credit
The tax return which has been prepared by the software includes the foreign tax credits. The underlying tax calculation prepared by the software showed the amount reduced to nil. Prima facie this might be a result of ignoring the ordering rule or reducing the FTC due to the overall losses.
Whether or not the foreign tax credits are claimable has to be considered on a segment by segment basis and not on the overall offshore income basis. The legislative background for that calculation is section LJ4 of the Act.
To calculate the allowable foreign tax credits you have to do the following step by step test:
- Verify that there is New Zealand income tax payable on the total net income (New Zealand and foreign sourced). If the answer is no, then no foreign tax credits can be claimed.
- If there is New Zealand tax payable, identify the segments as follows:
- for FIF interests - each attributing interest that has FIF income is a segment
- for dividends - generally the segment will be Australia unless using AP or BE methods (note the AP and BE methods are not available for income years beginning on or after 1 July 2011)
- for interest - generally the segment will be by country
- for other income - the segment will be by country and by source or nature.
- Identify the information for each segment and determine if there is net income for the segment.
- Identify the foreign tax credit(s) associated with the segment.
- Total all the segments' income (don't offset segments with losses) and compare to the total net income. If the total income of segments (excluding those in loss) is greater than the total net income then an apportionment of foreign tax paid is required.
- Calculate the notional income tax liability on net income by multiplying it by the person's basic tax rate. Note this net income is after claiming losses brought forward and before allowing any tax credits.
- If apportionment of foreign tax paid is required (see step 5), determine the apportionment ratio by first treating the New Zealand income as a segment, calculate an additional amount of notional tax and add this to the amount(s) of notional tax calculated for foreign sourced income under step 6. The total is called the New Zealand tax.
Calculate the ratio by dividing the notional income tax liability (gross tax to pay) by the New Zealand tax. Apply this ratio to reduce each foreign sourced segment’s amount calculated under step 6.
- For each segment, calculate the maximum foreign tax credit. This will be either the notional income tax liability by segment, or if apportionment is required, the notional income tax liability by segment multiplied by the apportionment ratio, as calculated at step 7.
- For each segment, you can claim the lesser of the foreign tax actually paid for the segment and the maximum foreign tax credit for the segment, as calculated under step 8.
If the overall net income includes allowable losses for investments which are falling within the scope of section EX 46(10) of the Act and other segments (see above point 2) with net income and foreign tax credits you have to do the FTC calculation as shown in the step by step calculation above. It might be that these foreign tax credits are allowed as foreign tax credits even if the overall offshore income is a loss.
If the overall net income includes nil income from portfolio interests you have to analyse each attributing interest of the portfolio to verify if there is net income. This calculation is required even if the overall income is a loss which will be reduced to nil in terms of section EX 51(7) and (8) of the Act. It might be that foreign tax credits are deductible even if the overall offshore income is nil.
Your tax calculation might not be correct and all assessments will differ from the returns filed. Further to this the losses carried forward are calculated incorrectly and we will have to manually clear all returns from error.