Double Tax on U.S sourced Capital Gains

The ATO have successfully argued in the Federal Court of Australia in the case of Burton v Commissioner of Taxation [2019] FCAFC 141 that only half of the foreign tax credits paid on a U.S. sourced capital gain generated by a U.S. limited liability company (LLC) are creditable under Australian law. The reason for this is that, as only half the gain is taxable in Australia (the other half being exempt), the taxpayer should only get a credit for foreign tax paid on the taxable component of the gain.

To highlight just how offensive this is, it helps to consider the tax rates on gains flowing from California or Delaware LLCs to an Australian resident beneficiary (via an Australian trust).

Pre Burton – California 33.3%

Post Burton – California 40.15%

Pre Burton – Delaware 23.5%

Post Burton – Delaware 33.5%

While the rationale for this position is logical when you break down the rules and two out of three of the sitting Justices agreed with the ATO, the commercial reality of this decision is a knife in the gut of the people that are working hard to make Australia relevant on the global stage.

The purpose of foreign tax credits and double tax agreements is to ensure that tax relief exists when there is alignment on tax policy. Both the U.S. and Australia are aligned on the idea that residents of both countries who earn capital gains should be taxed at rates that are lower than ordinary income tax rates. This policy should motivate entrepreneurs to innovate.

This is an example of a government cash grab and even if technical support exists for this outcome it does not mean that the ATO needed to litigate this issue when it clearly was not the intention of the legislation. Whoever within the ATO has pursued this case needs to take the sugar out of their mouths, as this is unAustralian. I hope the rest of the tax community is as concerned about this case as I am and fights to make sure judgments like this are not the norm.

It is hard for me to draw the conclusions that I am drawing as they really are counter to the policy that is supposed to relieve taxpayers from double tax. However, there are two very simple solutions for entrepreneurs that are impacted by this decision. Solution one, don’t run businesses in the US through LLCs and solution two, if you do need to run a business through an LLC, don’t live in Australia.