Edited version of your written advice

Authorisation Number: 1012911959738

Date of advice: 16 November 2015

Ruling

Subject: Derivation of Income

Questions and Answers

1. Does your assessable income from foreign employment include the full amount of hypothetical Australian tax deducted from gross remuneration and not paid until a subsequent year?


No

2. Does your assessable income include the amount of the hypothetical tax remitted to the Country X taxation authorities in accordance with their laws?

Yes

3. Are you entitled to a Foreign Income Tax Offset?

Yes

4. Will the Commissioner apply Part IVA to deny any tax benefit obtained as a result of the arrangement?


No

This ruling applies for the following period

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2011

Relevant facts

You are an Australian resident for tax purposes.

You entered into a contract of employment with an Australian resident company.

Your position is a secondment to a Country X resident company.

There were at least three, possibly four, entities with whom you had an employment relationship:

● The Australian Entity (you state that you never worked for them in Australia)

● Two Country X entities

● A Joint Venture parent company of the two Country X entities, registered in Country Y, which ratify and approve your employment and salary and benefits

You have been paid by the two Country X entities that do not have a connection with Australia. As a result, under Australian tax law, there is no legal requirement for them to withhold tax amount from the salary and wages paid to you.

In relation to the power to “withhold”:

● The Letter of Offer from the Australian Entity provides that they will “withhold” an amount as required by law;

● The Letter of Appointment from one of the Country X entities which provides that they will “withhold” so much as required by Country X law;

Under the employment contract you are entitled to gross remuneration amount plus incentives and non-cash remuneration. (All non-cash remuneration is included in your Australian assessable income).

Because you are also liable to tax in Country X, the Country X employer withholds a notional tax amount calculated on the basis of the Australian tax on your total income.

The Country X employer lodges a resident tax return in Country X and pays the Country X tax out of the hypothetical tax amount withheld from the employee.

The Country X employer may lodge the Australian tax return for its employees. The employer calculates the Australian assessable income as follows: (approximate amounts used to demonstrate methodology).

Gross remuneration under contract: (a) $A 500,000

Incentives and non-cash benefits: (b) $A 250,000

Total: (c) $A 750,000

Less - Hypothetical Aust. Tax: (d) $A 300,000

Plus - Country X tax paid (e) $A 150,000

Employer calculation of Aust. assessable income (f) $A 600,000 (c - d + e)

The Country X employer pays the taxpayer the Australian tax payable on the $600,000 less the Foreign Income Tax Offset in a subsequent year.

You have provided the following examples of the industry practice.

Employee in Australia on salary of $180,000 would pay tax of $54,547 plus $3,600 Medicare. Net take home after tax and M/care is $121,853.

● Employee moves to Country A (and is classed as non-resident in Australia) where tax is say $60,000. Employer deducts $58,147 from employee income and pays $58,147 + $1,853 (total $60,000) to foreign state. Employee net income remains $121,853.

● Employee moves to Country B and remains resident in Australia.  Employer deducts $58,147 from salary. Pays tax of say $36,000 in Country B and refunds $22,147 to employee.  Employee is liable to Australian tax on $180,000 = $58,147 less FTC of $36,000 remainder payable is $22,147.  Employee net income remains $121,853.

● Employee moves to Country C (and is classed as non-resident in Australia) Employer deducts $58,147 from salary. Employer pays tax of $36,000 to Country C. Assuming that the Employee has no other tax liabilities in respect of the employment income, the Employer retains the difference. Employee net salary remains at $121,853.

Assumptions

In relation to the power to “withhold”:

● It is assumed that the Letter of Appointment from the second Country X employer also provides that they will “withhold” so much as required by Country X law (as it has withheld amounts according to information provided)

● It is assumed that either there is no Letter of Appointment from the Joint Venture Company, or there are no terms or conditions in the Letter of Appointment from this Company that requires it to “withhold” any other amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

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

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 Section 770-10

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

Summary

Your assessable income includes amounts you have received during the income year and amounts paid to the Country X tax authority on your behalf.

You are entitled to a Foreign Income Tax Offset.

Part IVA would not apply to the proposed transactions.

Detailed reasons

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

Income from employment, such as salary, wages or other payments to employees for services rendered, is generally derived only when received. That is, on a cash receipts basis.

Subsection 6-5(4) of the ITAA 1997 provides that, in working out whether, and when, an amount of ordinary income is derived, the amount is taken to have been received as soon as it is applied or dealt with in any way on the taxpayer's behalf or as the taxpayer directs. For instance, if an amount is credited to an employee in the books of his employer and can be drawn by the employee at any time, it is derived at the time it was so credited and made available to the employee.

There were at least three, possibly four, entities with whom you had an employment relationship:

● The Australian Entity (but you state that you never worked for them in Australia)

● Two Country X entities

● A Joint Venture parent company of the two Country X entities, registered in Country Y, which ratify and approve your employment and salary and benefits

You have been paid by the two Country X entities that do not have a connection with Australia. As a result, under Australian tax law, there is no legal requirement for them to withhold tax amount from the salary and wages paid to you.

In relation to the power to “withhold”:

● The Letter of Offer from the Australian Entity provides that they will “withhold” an amount as required by law;

● The Letters of Appointment from the Country X entities which provide that they will “withhold” so much as required by Country X law;

● There is either no Letter of Appointment from the Joint Venture Company, or there are no terms or conditions in the Letter of Appointment from this company that requires it to “withhold” any other amount.

There appears to be no agreement that the payers can or will “withhold” the “Hypothetical tax”, exceeding the amount required to be withheld under Country X law, or what will happen to the amount of “Hypothetical tax” “withheld”.

However, the parties appeared to have implicitly agreed that:

● The “Hypothetical tax” should reflect the amount that the payers would have withheld from the salary and wages, if the payers had a connection to Australia

● The net pay you receive will be calculated by reducing the base salary and location allowance by, amongst other things, “Hypothetical tax”

● When you lodge and are required to pay tax, the payers will pay you an amount equivalent to what an employee with no other income or deduction will be required to pay to the Australian Taxation Office. Coincidentally, this amount should equate to the difference between the “Hypothetical tax” and the Country X tax paid.

In the current context, a 'hypothetical tax' amount is simply a component of a standard 'tax equalisation' approach in managing employees on secondment, i.e. that employees are paid no more or no less because of secondment to another jurisdiction where taxes may be higher or lower. Because of these tax equalisation approaches, the employee continues to receive the same 'net of tax' regular base pay amount. After the end of the year the employer either pays the employee's tax liability directly or pays an amount to 'cover' his tax liability. The employer does not necessarily actually withhold or deduct amounts of tax because the 'hypothetical tax' is, as the name infers, 'hypothetical', and only a construct used to calculate an identical rate of actual pay on secondment to his actual take home pay in the home country. In the context of a tax equalisation secondment agreement there will necessarily be a benchmark component in the take home pay calculation that is referenced to the 'required to be legally withheld' tax amount - calculated as if the taxpayer had (hypothetically) remained in the home country. However, it is a separate issue as to what extent any tax has actually been legally required to have been withheld under Australian tax law.

Conclusion

As you did not receive an amount until a subsequent income year, that amount is not derived until the subsequent income year. There is no information to support the amount has been applied or dealt with on your behalf or as directed by you, you are not taken to have received the amount. Consequently, your assessable income includes amounts you have received as salary and wages and amounts paid to the Country X tax authority on your behalf.

Foreign Income Tax Offset

A foreign income tax offset (FITO) is a non-refundable tax offset, and will reduce the Australian tax that is payable on the foreign income which has already been subjected to foreign income tax.

Under section 770-10 of the ITAA 1997, to qualify for an offset, you must have paid foreign income tax on an amount that is included in your Australian assessable income for that year.

As the payment from Country X is assessable to you in Australia, the tax you paid on this income in Country X is used to calculate your allowable Foreign Income Tax Offset in Australia.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

● there is a scheme (see section 177A);

● a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and

● the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

It is determined that Part IVA would not apply to the proposed transactions.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).