Edited version of your private ruling

Authorisation Number: 1012437466869

Ruling

Subject: Foreign sourced income

Questions and answers:

1. Is the discount that you received from your employee share scheme assessable in Australia?

No.

2. Is any capital gain or loss that results from the disposal of your company ABC shares assessable in Australia?

Yes.

3. Are the performance cash payments that you receive as a result of your previous employment assessable in Australia?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on:

1 July 2012

Relevant facts

You were an employee of company ABC in country X.

At the time of your employment you were a resident of country X.

You accepted a voluntary redundancy package from company ABC and immediately were paid a voluntary redundancy package.

After a short period you and your family migrated to Australia.

To provide long term incentive and employee retention, company ABC offers it employees deferred bonus payments.

The key features of the scheme are as follows:

· all company employees are eligible to participate in the share plan,

· employees are not required to pay for any shares, and

· an employee receives entitlement to shares and cash once they leave the organisation (subject to departure provisions).

Company ABC distributes an employee's entitlement to the shares and cash once a year.

The entitlements are distributed are as follows;

· Shares - a portion of the employee's share entitlements are sold with the proceeds being paid to country X authorities for tax purposes. The remaining shares are distributed to the taxpayer.

· Cash - a portion is paid to county X for taxation purposes and remainder distributed to the taxpayer.

The entitlements are such that their value is adjusted based on the firms return on equity.

Relevant legislative provisions

Income Tax Assessment Act 1997, Subsection 6-5(2)

Income Tax Assessment Act 1997, Subsection 6-5(3)

Income Tax Assessment Act 1997, Division 83A

Income Tax Assessment Act 1997, Section 102-20

Income Tax Assessment Act 1997, Section 108-5

Income Tax Assessment Act 1997, Subsection 221A(1)

Reasons for decision

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a foreign resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Shares - employee share scheme

An employee share scheme (ESS) is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

Division 83A of the ITAA 1997 taxes discounts on ESS interests acquired either upfront, for example at acquisition, or on a deferred basis. The method will depend on the nature of the employee share scheme rather than at the election of the employee, as was the case under Division 13A of the Income Tax Assessment Act 1936.

Generally, where there is a real risk of forfeiture (RRF) the discount on the ESS interest is included in the employee's assessable income at the deferred taxing point.

The main features of Division 83A of the ITAA 1997 provisions in relation to deferred schemes are as follows:

Deferral of tax to a later income year is available for taxpayers who participate in schemes where the ESS interests are at "real risk of forfeiture", or where employees can acquire ESS interests at 100% discount by salary sacrificing a maximum of $5,000. The "real risk of forfeiture" test does not apply to salary sacrifice schemes. The shorthand term used for this principle is "deferred" taxation:

Where deferred taxation applies to options, the deferred taxing point is the earliest of:

· Seven years after you acquired the option;

· When you cease the employment in respect of which you acquired the option;

· When there is no real risk of forfeiting the option and the scheme no longer genuinely restricts disposal of the option; or

· When there is no real risk of forfeiting the option or underlying share, and the scheme no longer genuinely restricts exercise of the option or disposal of the resulting share.

· Refunds of tax paid on ESS interests that are later forfeited are available where the taxpayer had no choice but to forfeit the ESS interests, or where the taxpayer made a choice to resign from employment; and

· Refunds are not available where the scheme is structured to protect employees from market risk, or where the forfeiture is intentional due to market conditions (eg the taxpayer chooses not to exercise rights because the exercise price exceeds the prevailing share price).

In your case, the deferred taxing point occurred when you ceased employment with company

ABC. As at the time that you ceased employment with company ABC you were a non-resident of Australia for tax purposes, any discount that you received is not assessable under section 6-5(3) of the ITAA 1997.

Capital gains tax - shares

Section 102-20 of the ITAA 1997 provides that a capital gain or capital loss arises if a capital gains tax (CGT) event happens to a CGT asset.  

A CGT asset is any kind of property, or a legal or equitable right that is not property. Shares are a CGT asset under section 108-5 of the ITAA 1997. 

The most common CGT event happens if you dispose of part of an asset or an interest in an asset to someone else, the disposal of a CGT asset causes a CGT event A1 to happen. You make a capital gain if your proceeds are greater than your cost base, you make a capital loss if your reduced cost base is greater than your proceeds.

Acquisition on becoming a resident

If an individual becomes an Australian resident for capital gains tax (CGT) purposes, special cost base and acquisition rules apply in respect of each CGT asset owned by the taxpayer just before becoming a resident.

Under the special cost base rule, the first element of the cost base and reduced cost base of an asset at the time the taxpayer becomes a resident is its market value at that time. Under the special acquisition rule, the taxpayer is treated as having acquired the asset at the time of becoming a resident.

Your circumstances

In your case, after you ceased your employment in country ABC you and your family migrated to Australia where you became an Australian resident for income tax purposes. As a result you are assessable on your worldwide income and therefore subject to CGT provisions upon disposal of your shares. The first element of the cost base of your shares will be the value of the shares at the time you became a resident of Australia for income tax purposes.

Annual lump sum payments

As previously stated, a taxpayer who is an Australian resident for income tax purposes is liable to Australian income tax on ordinary income, derived directly or indirectly from all sources, whether in or out of Australia, during the income year under subsection 6-5(2) ITAA 1997.

Under subsection 6-5(2) of the ITAA 1977, remuneration or rewards for personal services, whether received in the capacity of employee or in connection with employment or personal services, are income according to ordinary concepts.

Income derived from personal services include salary, wages, commission long service leave pay, holiday pay, directors' fee, etc. The term 'salary and wages' is defined in subsection 221A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to include salary, wages, commissions, bonuses or allowances, or, any remuneration paid to an eligible taxpayer under a contract which is wholly and principally for the labour of the person.

In your case you are in receipt of annual lump sum payments which are a directly related to your prior employment with company ABC. Therefore as these payments are remuneration or rewards in connection with your previous employment they are considered income according to ordinary concepts.

Accordingly, the annual lump sum payments are assessable in Australia, under section 6-5 of the ITAA 1997.

Double Tax Agreement (DTA)

In determining your liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreements.

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the ITAA 1936 and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The country X Agreement is listed in section 5 of the Agreements Act.

The country X agreement is located on the Austlii website (www.austlii.edu.au) in the Australian Treaties Series database. Country X agreement operates to avoid the double taxation of income received by residents of Australia and country X.

Disposal of shares

Article KH of the country X agreement advises that income or gains derived by a resident of Australia from the alienation of any shares or any other interests in a company that is principally attributable to real property situated in country X, may be taxed in country X.

Therefore any capital gain or loss that results from the disposal of your shares may also be taxed by the country X authorities.

Ordinary income

Article KY of the country X agreement advises that salaries, wages and other similar remuneration derived by a resident of Australia shall be taxable only in Australia unless the employment is exercised in the country X. If the employment is exercised in the country X then the income may also be taxed in country X.

Therefore, the annual lump sum payments that you receive may also be taxed by the country X authorities.

DTA relief

Article KZ of the country X Agreement provides that a credit against Australian tax will be allowed for any tax paid in the country X where tax has been paid under country X law.

According to Division 770 of the ITAA 1997, a foreign tax credit can be allowed where: 

· the assessable income of a resident taxpayer includes foreign sourced income, and

· the taxpayer has paid foreign tax in respect of this income. 

The foreign tax credit allowed against Australian income tax is the lesser of: 

· the amount of that foreign tax paid, reduced in accordance with any relief available to the taxpayer under the law relating to that tax; or

· the amount of Australian tax payable in respect of the foreign income.  

As country X tax has been withheld by the country X authorities, you are eligible for a foreign tax credit against your Australian income tax.

Further information

When a taxpayer becomes a resident of Australia for taxation purposes, there are certain rules which affect the way that they calculate their capital gains.

If a taxpayer owns assets that do not have the necessary connection with Australia, you are taken to have acquired these assets for their market value at the time that you became a resident. That is, the first element of the assets cost base will be the market value of the asset of the time the taxpayer becomes a resident. Assets such as foreign property, rights or shares would not be considered to have the necessary connection with Australia and are therefore subject to the market value substitution rule.

When lodging your income tax return you be required to include any capital gain or loss that results from the disposal of your company ABC shares in the capital gains label in the supplementary section of your income tax return. The annual lump sum cash payments will be required to be included in the foreign sourced label of the supplementary section of your income tax return.

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