ATO Interpretative Decision
ATO ID 2007/173
Income Tax
Employee Share Options: foreign tax credit relief to an Australian resident taxpayer where an employee share option benefit is taxed by the United StatesFOI status: may be released
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Note: This ATO ID has been amended to remove references to repealed legislation dealing with foreign tax credit rules. With effect from 1 July 2008 the foreign tax credit system is replaced by the foreign income tax offset system.
This ATO ID contains references to repealed provisions, some of which may have been re-enacted or remade. The ATO ID is current in relation to the re-enacted or remade provisions.
Australia's tax treaties and other agreements except for the Taipei Agreement are set out in the Australian Treaty Series. The citation for each is in a note to the applicable defined term in sections 3AAA or 3AAB of the International Tax Agreements Act 1953.
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is Australia obliged to provide credit relief pursuant to Article 22 of the tax treaty between Australia and the United States of America (US Convention) contained in Schedule 2 to the International Tax Agreements Act 1953 (Agreements Act) to an Australian resident taxpayer where:
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- a gain is made by the taxpayer on the exercise of employee share options
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- such gain is taxed by the United States (US) on the basis that it relates to options granted as a reward for past employment exercised by the taxpayer in the US, and
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- Australia taxes at least part of the gain under its capital gains tax provisions?
Decision
Yes. Australia is required to provide credit relief in accordance with Article 22 of the US Convention as the employee share option gain relates to a period of employment exercised wholly within the US and the US is entitled to tax the whole of the employee share option gain under Article 15 of the US Convention.
Facts
While the taxpayer was a resident of the US, the taxpayer was granted employee share options in a US public company.
The taxpayer subsequently relocated to Australia and became an Australian resident.
The taxpayer continued to work for an associate of the US Company in Australia until they exercised the options. The shares acquired as a result of the options were disposed of immediately.
The employee share options were granted in January of each year based on the employee's performance over the prior financial year.
While the options required a three year holding period prior to vesting, there were no other conditions attached to the employee share options. Accordingly, it is accepted that the employee share options were granted as a reward for past service which was exercised entirely in the US.
Reasons for Decision
Article 15 of the US Convention provides that salaries, wages and other similar remuneration derived by a resident of Australia in respect of an employment shall be taxed only in Australia unless the employment is exercised in the US. If the employment is exercised in the US, such remuneration may be taxed in the US. The employee share options fall within the definition of 'salaries, wages or other similar remuneration' for the purposes of Article 15 of the US Convention. This view is consistent with paragraph 2.1 of the Commentary on Article 15 of the OECD Model Tax Convention on Income and on Capital (OECD Commentary).
The OECD Commentary further explains at paragraph 12.2 on Article 15 that taxing rights under that Article can be exercised by the source country in respect of an employee share option gain up to the time of exercise of the option. As the US has sought to tax only that part of the employee share option gain up to the time of exercise, the extent of its taxing rights under the treaty is governed by Article 15.
The OECD Commentary also provides guidance on the extent to which source country taxing rights can be exercised pursuant to Article 15. It states at paragraph 12.6 that:
The determination of whether and to what extent an employee stock-option is derived from employment exercised in a particular State must be done in each case on the basis of all the relevant facts and circumstances, including the contractual conditions associated with that option ...
Paragraph 12.11 of the OECD Commentary further explains that options should only be considered to relate to services rendered before the time when it is granted to the extent that such grant is intended to reward the provision of services for a specific period. As the options were awarded on the basis of the taxpayer's prior service, it is considered that the period of employment for which the option relates occurred solely in the US, notwithstanding that the options were exercised in Australia.
Accordingly, as the whole employment period is in the US, the US has source country taxing rights under Article 15 of the US Convention in respect of the employee share option gain up to the time of exercise.
As the source country taxing rights in respect of the gain on the employee share option has been correctly exercised in accordance with the US Convention, Australia, as the country of residence of the taxpayer, is required to provide credit relief in accordance with Article 22 of the US Convention.
Article 22(2) of the US Convention provides that a credit (in accordance with Australian tax law) against Australian tax payable in respect of income derived by a resident taxpayer shall be allowed where such income is derived from sources in the US and has been taxed under US law and in accordance with the US Convention.
As the gain on the employee share option has been correctly taxed by the US under the US Convention, and Australia has also taxed the gain under the capital gains tax provisions, the taxpayer is entitled to relief under Article 22 of the US Convention.
Year of income: Year ended 30 June 2000
Legislative References:
International Tax Agreements Act 1953
Schedule 2, Article 15
Schedule 2, Article 22(2)
The Act Related ATO Interpretative Decisions
ATO ID 2007/174
Other References:
OECD Model Tax Convention on Income and on Capital
Keywords
Double tax agreements
Employee share schemes & options
Foreign tax credits
United States
ISSN: 1445-2782