Edited version of your written advice

Authorisation Number: 1051369174393

Date of advice: 11 May 2018

Ruling

Subject: Foreign income tax offsets

Question 1

Are the Social Insurance Fund and Reduction of Emoluments amounts withheld from your salary in Country A considered to be amounts of foreign income tax?

Answer

No.

Question 2

Are you entitled to a foreign income tax offset for the Social Insurance Fund and Reduction of Emoluments amounts withheld from your salary?

Answer

No.

This ruling applies for the following period:

1/07/20XX - 30/06/20XX

The scheme commences on:

3/08/20XX

Relevant facts and circumstances

1. You were employed by a Country A public sector agency between 201X and 201Y in Country A.

2. During this time, you were an Australian tax resident and not a resident of Country A for tax purposes. You were assessable in Australia on the wages paid to you by the agency under section 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997).

3. Australia has no tax treaty with Country A, so there was no agreement having the force of law under the International Tax Agreements Act 1953 in place in respect of the wages paid to you by the agency.

4. After your period of employment with the agency ended, you returned to Australia.

5. The financial year in Country A runs from 1 January to 31 December.

6. You were issued with a payment summary by the Tax Department of Country A for each of the 201X and 201Y financial years of Country A.

7. The payment summaries for the Years 201X and 201Y show the following amounts were contributed or deducted from the gross total remuneration:

a. Amounts contributed for Country A Social Insurance Fund (CSIF); and

b. Amounts deducted for Reduction of Emoluments (ROE).

8. The payment summaries for the Years 201X and 201Y show that no P.A.Y.E. Income tax was withheld from total gross remuneration.

Income tax in Country A

9. Residents and non-residents of Country A are liable to tax in respect of income sourced in Country A, in accordance with the Income Tax Law of Country A (Country A Income Tax Law). The Country A Income Tax Law states that individuals and companies resident in Country A are liable to income tax in respect of their worldwide income. The Country A Income Tax Law is administered by the Country A Tax Department of the Ministry of Finance.

10. The Country A Income Tax Law imposes tax to be levied on the taxable income acquired by each individual and company during the fiscal year.

11. The Country A Income Tax Law lists the sources of income that individuals and companies must include in their assessable income in a fiscal year:

a. Profits or other benefits from a business or pursuit;

b. Profits or other benefits in respect of paid employment to a person or any member of their family;

c. Dividends, interest or discounts;

d. Pensions, income paid by decision of a court or in accordance with a term in a will and other remittances;

e. Rent, or other payments in relation to ownership (e.g. intellectual property rights) including the value of the benefit the owner obtains from building works undertaken by the tenant; and

f. Any amounts of trade goodwill.

12. The Country A Income Tax Law notes that individuals and companies not resident in the Country A who derived income from sources within Country A must include:

a. Any profits or other benefits earned through a permanent establishment in Country A;

b. Profits or other benefits in respect of paid employment in Country A paid to a person or any member of their family;

c. Pensions in respect of employment in Country A, income paid by decision of a court in connection with an agreement or contract in Country A, annuities payable directly or indirectly to a person in Country A (excepting those paid from the Country A government or local authority);

d. Rent, or other payments in relation to ownership (e.g. intellectual property rights) including the value of the benefit the owner obtains from building works undertaken by the tenant;

e. Any amount or consideration for goodwill; and

f. Any income derived by any person from any profession or vocation, which includes entertainers for theatrical and musical performances and other public entertainers (e.g. football clubs and other athletic performances) for services/performances in Country A.

13. The Country A Income Tax Law stipulates various exemptions, provided certain conditions are satisfied. The income tax rates are set by the Country A Income Tax Law.

Country A Social Insurance Scheme

14. The current Social Insurance Scheme in the Country A applies compulsorily to all workers (employed and self-employed). Individuals who were compulsorily insured under the scheme who have had their employment terminated have the right to continue to be insured on a voluntary basis if they make contributions to the scheme each year up to a required minimum amount.

15. Payment of amounts under the Social Insurance Scheme must be made in accordance with the Social Insurance Law (Social Insurance Law) of Country A. The Social Insurance Scheme is administered by the Department of Social Insurance Services of the Ministry of Labour, Welfare and Social Insurance.

16. The Country A Social Insurance Scheme is financed by compulsory contributions paid by the employers (where applicable), the insured persons and the State, imposed as a percentage on the insurable earnings of the individual up to a maximum amount. The maximum amount of insurable earnings for the purpose of payment of contributions is fixed by Regulations. In the case that the wage or salary exceeds the maximum amount of insurable earnings, no contribution is paid on the excess.

17. The insurable earnings of an employee, i.e. the earnings that are taken into consideration for social insurance purposes, include the basic wage or salary, cost of living allowance, overtime, commissions, etc.

18. Contributions to the Country A Social Insurance Scheme are not referred to in the Country A Social Insurance Law as a “tax” or a “tax on income.”

19. The employer is obliged to pay both the employer’s contributions and the employee’s contributions. The employer is entitled, however, to deduct the rate of contribution of the employee from the employee’s wages or salary on the day the employer pays the employee. If the employer fails to deduct the contribution of the employee on the day the employer pays the employee, the employer has no right to deduct it for future wages or salaries.

20. Contributions to the Social Insurance Fund are paid by employers into the Social Insurance, Annual Holidays with Pay, Redundancy, Human Resource Development and Social Cohesion Funds for the purposes as specified in the Social Insurance Law. The benefits payable by the Social Insurance Scheme are financed through the contributions made to it.

21. The Country A Income Tax Law does not refer to contributions to the Social Insurance Scheme as a “tax”.

22. The Social Insurance Scheme provides for payments and benefits to those individuals who qualify under the conditions for the following circumstances:

a. Marriage

b. Maternity

c. Funeral

e. Sickness

f. Unemployment

g. Invalidity

h. Old-age

i. Widows

j. Orphans

k. Missing persons

l. Employment injury

23. Insurance conditions for payments of the above benefits also apply - for example minimum levels of payments or minimum time employed must be reached before some benefits may be payable to a person (or their spouse or parent, in certain circumstances).

Reduction of Emoluments

24. The Reduction of Emoluments amounts withheld are only relevant to those currently or formerly employed in the public sector. It is not imposed on those not meeting these criteria, such as private sector employees and self-employed persons.

25. Due to continued economic and budgetary difficulties in Country A, the Country A Government enacted laws providing for the reduction in incomes and pensions of employees and pensioners of the public sector.

26. The amount of income reduced under the Reduction of Emoluments law is calculated by applying the relevant marginal rate to the “Gross monthly earnings and/or monthly pension” of an employee or pensioner of the public sector.

27. The amount resulting from the reduction in the incomes and pensions of the public sector (reduction of emoluments) is paid to the Fixed Fund of the Government.

28. The Reduction of Emoluments amount is deducted from assessable income of the relevant person in calculating their taxable income.

29. You are not entitled to a refund of the Social Insurance Fund and Reduction of Emoluments amounts, or to any other benefit in respect of the amounts.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 770-15

Income Tax Assessment Act 1997 Section 770-10

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Question 1

Summary

The Social Insurance Fund and Reduction of Income amounts withheld from your salary in Country A are not considered to be amounts of foreign income tax.

Detailed reasoning

Legal Background

A taxpayer is entitled, under subsection 770-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997), to a foreign income tax offset in respect of foreign income tax paid on an amount that is included in their assessable income.

Subsection 770-15(1) gives the following definition of foreign income tax:

(1) Foreign income tax means tax that:

(a) is imposed by a law other than an * Australian law; and

(b) is:

(i) tax on income; or

(ii) tax on profits or gains, whether of an income or capital nature; or

(iii) any other tax, being a tax that is subject to an agreement having the force of law under the International Tax Agreements Act 1953.

Note: Foreign income tax includes only that which has been correctly imposed in accordance with the relevant foreign law or, where the foreign jurisdiction has a tax treaty with Australia (having the force of law under the International Tax Agreements Act 1953 ), has been correctly imposed in accordance with that tax treaty.

The requirements to withhold amounts for the Social Insurance Fund and Reduction of Income are imposed by the laws of Country A, which are laws other than an Australian law. However these amounts must also satisfy one of the criteria in paragraph 770-15(1)(b) to meet the definition of ‘foreign income tax’.

The amounts contributed to the Social Insurance Fund and deducted according to the Reduction of Income are not taxes on profits or gains (subparagraph 770-15(1)(b)(ii)). Nor are they taxes subject to a tax treaty (subparagraph 770-15(1)(b)(iii)), as one does not exist between Australia and Country A. Therefore, the determinative issue is whether the amounts meet the definition of ‘tax on income’ under subparagraph 770-15(1)(b)(i).

The definitions of ‘tax’ and ‘income tax’ in section 995-1 of the ITAA 1997 refer to tax imposed under Australian law, and do not assist with the meaning of ‘tax on income’ imposed by a foreign law. Absent a statutory definition, we turn to the ordinary meaning of these words.

The Macquarie Dictionary (online) defines ‘tax’ as:

noun 1. a compulsory monetary contribution demanded by a government for its support and levied on incomes, property, goods purchased, etc.

and ‘income tax’ as:

noun 1. a tax levied on incomes.

2. an annual government tax on personal incomes, usually graduated and with certain deductions and exemptions.

The Oxford Dictionary (online) defines ‘tax’ as:

noun 1. A compulsory contribution to state revenue, levied by the government on workers' income and business profits, or added to the cost of some goods, services, and transactions.

and ‘income tax’ as:

noun 1. Tax levied directly on personal income.

In Re Applicant and the FC of T [2014] AATA 961 (Case 8/2014), the AAT considered whether the taxpayer, an Australian citizen who had been employed in Ireland for 12 months, could claim a foreign income tax offset under s 770-10(1) for compulsory contributions of Pay Related Social Insurance (PRSI) deducted from his Irish salary. At issue was whether these contributions constituted a “substantially similar tax” to Irish income tax for the purposes of Article 2(2) of the double taxation treaty between Ireland and Australia. This case was decided in relation to that article of the treaty for the purposes of determining whether subparagraph 770-15(1)(b)(iii) was satisfied. Although the case is not directly on point, it does give guidance on what factors are relevant in determining what is “substantially similar” to an income tax. In finding that PRSI was not a “substantially similar tax” to Irish income tax, Deputy President FJ Alpins set out the following factors at paragraphs 67 and 68:

(a) Pay Related Social Insurance is not imposed by [Ireland’s Taxes Consolidation Act 1997] and is not referred to in [Ireland's Social Welfare Consolidation Act 2005] or apparently in any other legislation as a "tax";

(b) Irish income tax covers an expansive field of taxpayers, both individuals and entities not subject to the corporation tax, while Pay Related Social Insurance is mandated with respect to particular classes of persons, being employed contributors (and also relevant employers of those employed contributors) and self-employed contributors;

(c) Liability to make PRSI contributions arises in connection with a contributor's employment status, while income tax is imposed in respect of property, profits or gains arising in respect of an expansive range of economic activities, extending well beyond the earning of salary and wages;

(d) PRSI contributions are calculated by reference to complex factors including the "reckonable earnings" of an employed contributor, the rates varying according to the nature of the employed contributor's employment, while Irish income tax is calculated by applying the relevant rate to a taxpayer's taxable income;

(e) while PRSI, like Irish income tax, is collected through the PAYE system, the former is paid into the Fund for its purposes as specified under Part 2 of the SWCA 2005, while the latter flows into general revenue - what matters in that regard is not the conduit used, but rather the destination of the funds and the purposes for which they may be used.

68. Contrary to the applicant's submission, the fact that the imposition of PRSI and Irish income tax are both mandated by law does not assist in demonstrating that the former is a "substantially similar tax" to the latter. Nor is the fact that both are controlled and disbursed by the Irish government. Neither of those factors indicates substantial similarity between the two imposts.

Taxation Ruling No. IT 2437 Income Tax: Foreign tax credit system - foreign taxes eligible for credit against Australian income tax (IT 2437) gives the following guidance as to the meaning of “foreign tax” for the purposes of the former section 6AB in the Income Tax Assessment Act 1936 (ITAA 1936):

5. Essentially, foreign tax must be imposed on a basis substantially equivalent to that on which the Income Tax Assessment Act operates. That is, it must be imposed on the basis of a taxpayer's net income or gains, whether of an income or capital nature, or be a withholding tax on outgoing payments (imposed as a final tax and not be later creditable against the ultimate foreign tax liability of the taxpayer) similar to the Australian withholding tax on the gross amount of outgoing dividends and interest payments. This has been the basis which has been used in the past to measure whether a foreign tax qualifies as a tax that would render an Australian resident recipient of the income upon which it is imposed eligible for the exemption from Australian tax provided by paragraph 23(q) of the Assessment Act.

IT 2437 relates to the now-repealed foreign tax credit system as provided for in the former section 6AB in the ITAA 1936. This has been replaced by the foreign income tax offset system in Division 770 of the ITAA 1997. However, the concept for “foreign income tax” applies to the foreign income tax offset system as it did to the foreign tax credit system, and so IT 2437 is of assistance in interpreting the meaning of “foreign income tax” in Division 770.

The Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No. 4) Bill 2007, the Bill which introduced Division 770 into the ITA 1997, gives a comparison of the old foreign tax credit system and the new foreign income tax offset system.

This comparison confirms that the definitions of “foreign income tax” and “foreign tax” for the purpose of Division 770 and the former section 6AB are consistent.

Analysis

Contributions to the Country A Social Insurance Fund (CSIF)

In considering contributions to the CSIF in light of the factors listed in Case 8/2014, as extracted above, it is clear that they are not a “tax on income”:

a) The payment of contributions to the SIF is imposed by the Country A Social Insurance Law, not by the Country A Income Tax Law, which imposes income tax on the taxable income of each person. The Social Insurance Law does not refer to contributions to the CSIF as a “tax”.

b) Country A income tax covers a wide field of taxpayers, including corporations and employed and unemployed individuals, while contributions to the CSIF are payable by particular classes of persons, being employed contributors (and also the employers of those employed contributors) and self-employed contributors.

c) Liability to make contributions to the CSIF arises in connection with a contributor's employment status on their “insurable earnings” (i.e. basic wage or salary, cost of living allowance, overtime, commissions, etc), while income tax is imposed by the Country A Income Tax Law in respect of a wide range of sources of income, such as profits and other benefits from any enterprise or paid employment, dividends, interest, pensions, and rent, arising from an expansive range of economic activities. This extends well beyond “insurable earnings”.

d) Contributions to the CSIF are calculated on the basis of insurable earnings of an employed contributor, with contributions made by the employer, employee, and the Consolidated Fund of Country A. Where the wage or salary is higher than the maximum amount of insurable earnings, no contribution is paid on the excess. Contrastingly, Country A income tax is calculated on a progressive basis by applying the relevant marginal rates to a taxpayer’s entire taxable income, with no contributions made by employers or the government.

e) Contributions to the CSIF are paid by employers into the Social Insurance, Annual Holidays with Pay, Redundancy, Human Resource Development and Social Cohesion Funds for the purposes as specified in the Social Insurance Law. The benefits payable by the Social Insurance Scheme are financed through the contributions made to it. Further, the receipt of some benefit types is dependent on a person (or their spouse or parents, in certain circumstances) having made contributions to the CSIF to a minimum level and for a minimum length of time. The payment of income tax does not build entitlement to certain benefits.

All of these factors indicate that contributions to the CSIF are not a “tax on income”.

As such, contributions to the CSIF do not meet the definition of foreign income tax as per subsection 770-15(1).

Reduction of Emoluments (ROE)

The ROE was implemented as a scaled reduction of the incomes of the public sector, in an effort to alleviate Country A’ budget deficit. It is a reduction in government spending, not a tax on income. The ROE only applied to the public sector with no private sector, or self-employed equivalent law.

Considering the ROE in light of the factors listed in Case 8/2014 also supports the conclusion that the ROE is not a “tax on income”:

a) The ROE is imposed by the ROE Law, not by the Foreign Income Tax Law and is not referred to in the ROE Law as a “tax on income” but rather a reduction in earnings and pensions paid to officials and employees, etc, of the public sector.

b) The Country A income tax covers a wide field of taxpayers, including corporations and employed and unemployed individuals, while the ROE applies to particular classes of persons, being officials, employees and pensioners of the public sector.

c) The ROE arises in connection with a contributor's status as an official, employee or pensioner of the public sector and reduces their earnings or pension, while income tax is imposed by the Country A Income Tax Law on a wide range of sources of income, such as profits and other benefits from any enterprise or paid employment, dividends, interest, pensions, and rent.

d) The amount of income reduced under the ROE Law is calculated by applying the relevant marginal rate to the “Gross monthly earnings and/or monthly pension” of an employee or pensioner of the public sector. These rates and thresholds differ to the Country A income tax, which is calculated by applying the relevant marginal rate to the entirety of a taxpayer's taxable income.

e) The amount resulting from the reduction in wages, salaries and pensions under the ROE Law is paid to the Fixed Fund of the Republic in a way set out in a Circular of the Minister of Finance.

Further, the ROE is deducted from a person’s assessable income in calculating their income tax. The ROE was not considered a payment of income tax under the relevant legislation in Country A.

All of these factors indicate that the ROE is not a “tax on income”.

As such, the ROE does not meet the definition of a foreign income tax as per subsection 770-15(1).

Conclusion

The Social Insurance Fund and Reduction of Emoluments amounts withheld from your salary in Country A are not considered to be amounts of foreign income tax for the purposes of the foreign income tax offset.

Question 2

Summary

You are not entitled to a foreign income tax offset for the Social Insurance Fund and Reduction of Emoluments amounts withheld from your salary.

Detailed reasoning

Section 770-10 of the ITAA 1997 provides for the entitlement to a foreign income tax offset. Subsection 770-10(1) states:

(1) You are entitled to a * tax offset for an income year for * foreign income tax. An amount of foreign income tax counts towards the tax offset for the year if you paid it in respect of an amount that is all or part of an amount included in your assessable income for the year.

A taxpayer will only be entitled to a foreign income tax offset in relation to foreign income tax that they have paid.

As concluded for Question 1, the Social Insurance Fund and Reduction of Emoluments amounts withheld from your salary in Country A are not considered to be amounts of foreign income tax.

As such, you are not entitled to a foreign income tax offset for the Social Insurance Fund and Reduction of Income amounts withheld from your salary.

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).