Case X78

TE Barnett SM

Administrative Appeals Tribunal

Decision date: 21 August 1990.

T.E. Barnett (Senior Member)

The applicant in this matter was employed by a United States company P(US) Incorporated (P(US)) to act on secondment in Australia as director and general manager of its wholly owned Australian registered subsidiary company P(Australia) Ltd. (P(Australia)) which is involved in petroleum exploration. The terms of his employment included a tax equalisation arrangement whereby P(US), which paid his salary, also managed the applicant's tax affairs in America and in Australia. This was in order to ensure that the employee was not disadvantaged (or advantaged) from the fact that he would be liable to pay income tax in both countries. The details of the arrangement are set out in a Tax Equalisation Handbook which was accepted in evidence. The handbook is apparently issued to all expatriate employees of P(US) either at the time of their engagement or prior to departure on a foreign assignment. It explains how the aim is to calculate an employee's total tax liability in America and in the foreign country on income derived from all sources, including tax payable on salary and benefits received from employment in the foreign country, and then to ensure that the employee's total tax liability would be the same as if he had been employed in the United States.

The tax equalisation arrangement is a complicated scheme whereby P(US) withholds monthly amounts from the expatriate employee's salary known as ``tax equalisation factor'' instalments (TEF) which are based on average tax deductions of domestic employees calculated on base salary. The TEF instalment is not payment of a tax liability but is an

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amount to be held by P(US) in respect of the expatriate's future tax liabilities to be met by P(US). The employee's United States tax returns covering actual income derived from all overseas and domestic sources are prepared and lodged on his behalf by P(US)'s tax agent at the end of each United State tax year. After assessment the employee's final tax obligation in America would be calculated and an annual reconciliation statement would be prepared to adjust matters between P(US) and the employee which could result in the employee receiving a tax reimbursement from P(US) of excess TEF instalments paid or, alternatively, in the employee contributing more towards payment of his United States tax. (P(US) took the opportunity to ensure that the employee was reimbursed for tax payable in United States of America on various overseas allowances which it had intended the employee to receive free of tax.) Pursuant to the tax equalisation agreement between the employee and P(US) the employee's tax liability in the foreign country on income derived from his employment by P(US) would be paid by the foreign subsidiary pursuant to an arrangement between it and P(US). How the burden of the employee's foreign (Australian) tax payment was shared between P(US) and the foreign subsidiary was said to be a matter for internal accounting arrangement between the two companies.

The Tax Equalisation Handbook tendered in evidence was dated 1989, which was after the applicant's secondment to P(Australia) but there was evidence that the same arrangements were in force during the period of his employment in Australia. No details were given of any special agreement regarding the payment of the applicant's Australian income tax.

The applicant ceased his secondment to P(Australia) and returned to America on 29 May 1985 and after that date he was a resident employee of P(US) in America. He visited Australia briefly for seven days in 1986 doing a different short-term task for P(US). At no time was it suggested that the applicant was a resident of Australia during the 1985/1986 year of income.

On 14 November 1985, after the applicant had ceased to be a resident of Australia, P(Australia) paid his Australian tax liability which had been assessed on income earned during the 1984/1985 year of income. The respondent treated the amount of tax paid on behalf of the applicant as a lump sum payment of income derived by the applicant in the 1985/1986 year and assessed it for tax at the normal rate pursuant to sec. 25(1) of the Income Tax Assessment Act 1936 (``the Act''). The applicant objected but the objection was disallowed. The applicant now applies to the Tribunal for a review of the respondent's decision to disallow his objection.

The basic facts were not in dispute and they were simply set out in a statement of agreed facts as follows:

The only witness called was Mr A.R.T. who is presently the financial controller and a director of P(Australia). The documentary evidence included the documents prepared pursuant to sec. 37 of the Administrative Appeals Tribunal Act 1975, the applicant's Australian tax returns for the years 1984/1985 and 1985/1986, the applicant's United States tax returns for the calendar years 1985 and 1986, tax reconciliation statements issued by P(US), correspondence from that company and its agent Arthur Young & Co. and the Australian tax return for P(Australia) for the year 1985/1986.

Mr Sweidan, who appeared for the applicant, put his case under three main headings. First, he submitted that the $86,292 which was paid to the respondent by P(Australia) on behalf of the applicant was not income derived by the applicant. He claimed that it was merely a disbursement made on behalf of the applicant which would be adjusted later in the United States between the applicant and his employer P(US). In point of fact no such adjustment occurred as under the Tax Equalisation arrangement between P(US) and its expatriate employees, of whom the applicant was one, all foreign taxes are met exclusively by P(US). Mr Sweidan further claimed that the payment was made pursuant to the arrangement set out in the Tax Equalisation Handbook which was incorporated as a term of the applicant's employment with P(US). The amount did not count as a benefit for the applicant as it would be readjusted in the United States as part of the process of equalising his taxation under that arrangement. For this reason, he said, it was not income received in the tax year ending 30 June 1986 and was therefore not assessable for tax under the Act.

Mr Sweidan's second submission was that, should the Tribunal find against him on that point and find that the $86,292 was income, then it should be treated as exempt from tax under the terms of sec. 23(r) of the Act. That section is in the following terms:

``23 The following income shall be exempt from income tax: -

  • ...
  • (r) income derived by a non-resident from sources wholly out of Australia;''

There is no doubt that the applicant was a non-resident in the 1985/1986 income year and the only question for consideration is whether the $86,292 was derived from sources wholly out of Australia. Mr Sweidan argued that, when dealing with income derived from employment, it is not necessary to infer that the source of income is the country where the performance of duties occurred. In support he referred to dicta in
F.C. of T. v. French (1957) 98 C.L.R. 398 and
F.C. of T. v. Mitchum (1965) 113 C.L.R. 401 at pp. 406-409 and said that in the circumstances of this application the source is clearly the United States as set out in the Tax Equalisation Handbook. He said that the applicant was in Australia to perform services for P(US) and that P(Australia) had no obligation whatsoever to pay his Australian income tax. This obligation was incurred by P(US) under the employment contract which had been executed in the United States and so, although the amount was actually paid by P(Australia), clearly it was done ``on behalf of'' P(US). Mr Sweidan also referred to the fact that income was derived in 1985/1986 during which year the applicant spent only about seven days in Australia so clearly he did not derive the income from employment in Australia during the 1985/1986 year. For tax purposes, he claimed, the income should be considered to be derived in the year in which it is received. He said that the payment therefore was certainly not income derived from service in Australia during 1985/1986. Its source was the employment contract entered into in the United States.

Mr Sweidan's third argument was that even should the Tribunal find that the amount was income received in the year 1985/1986 and that it was from sources within Australia, nevertheless it should be exempt from Australian taxation under Art. 15 of the Double

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Tax Treaty between Australia and the United States of America. The provisions of Art. 15 are as follows:

``(1) Subject to the provisions of Articles 18 (Pensions, Annuities, Alimony and Child Support) and 19 (Governmental Remuneration), salaries, wages and other similar remuneration derived by an individual who is a resident of one of the Contracting States in respect of an employment or in respect of services performed as a director of a company shall be taxable only in that State unless the employment is exercised or the services performed in the other Contracting State. If the employment is so exercised or the services so performed, such remuneration as is derived from that exercise or performance may be taxed in that other State.

(2) Notwithstanding the provisions of paragraph (1), remuneration derived by an individual who is a resident of one of the Contracting States in respect of an employment exercised in the other Contracting State or in respect of services performed in the other Contracting State as a director of a company shall be taxable only in the first-mentioned State if:

  • (a) the recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in the taxable year or year of income of that other State;
  • (b) the remuneration is paid by, or on behalf of, an employer or company who is not a resident of that other State; and
  • (c) the remuneration is not deductible in determining taxable profits of a permanent establishment, a fixed base or a trade or business which the employer or company has in that other State.''

The effect of sub-art. (2) is that if remuneration was derived by the applicant while he was a resident of the United States (and not Australia) in respect of employment in Australia it would be taxable only in the United States if:

It is agreed that the applicant satisfies the provisions of para. (a) and (c) and that the argument on the application of the treaty centres on whether or not the $86,292 was paid by P(Australia) ``by or on behalf of'' P(US). Mr Sweidan pointed to the provisions of the Tax Equalisation Handbook and to the evidence of Mr A.R.T. in support of his contention that P(Australia) paid the money to the respondent on behalf of P(US) and he asserted that this payment would later be taken into account when settling the financial arrangements between P(Australia) and its American parent company.

Mr Buss, for the respondent, challenged all of these arguments. First he argued that the payment was income derived by the applicant because it was directly related to his employment duties and had those duties not been performed no liability for taxation would have arisen. Next he argued that the applicant was receiving both salary and money's worth within the meaning of
Hartland v. Diggines (1926) All E.R. 573 because part of his employment conditions included an indemnity against paying Australian income tax. As Australian tax was to be paid on his behalf then his income included his salary plus the value of this immunity from taxation. As far as the applicant was concerned the amount was money's worth received by him no matter who paid; whether it was the Australian or the American company. He referred to the case of
F.C. of T. v. Dixon (1952) 86 C.L.R. 540 at p. 556 in support of that proposition. On this point of whether the amount was income derived by the applicant he also argued that the amount, once paid, constituted income derived by the applicant and that the nature of some possible subsequent reconciliation with P(US) could not change the fact that the income had already been derived by the applicant. Mr Buss also pointed out that the terms of the agreement set out in the Tax Equalisation Handbook stated that the reconciliation would occur as at the end of each year. Consequently if there had been a

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reconciliation it should have occurred some three years ago and the applicant had chosen not to put any evidence of that reconciliation and transaction before the Tribunal. He said that the question of a reconciliation was purely hypothetical and should be disregarded by the Tribunal.

On the question of the sec. 23(r) exemption Mr Buss argued that the amount was not exempt income because it derived from employment sources remunerated by P(Australia) which was a source within Australia. He referred to sec. 25(1)(b) of the Act which says that the assessable income of a taxpayer shall include, where the taxpayer is a non-resident, gross income derived directly or indirectly from all sources in Australia which is not exempt income. He said that sec. 25 applies to make the payment assessable as income if it is not exempted under sec. 23(r). He cited
Cliffs International Inc. v. F.C. of T. 85 ATC 4374 at p. 4390; (1985) 80 F.L.R. 12 at p. 32 and
Nathan v. F.C. of T. (1918) 25 C.L.R. 183 at pp. 189-190 for the proposition that ``source'' is not a technical legal concept but is to be decided as a practical matter of fact. In this application he said the payments were directly related to employment duties and those duties were performed in Australia. If there had been no performance of those duties there would have been no liability for tax. Finally, the payment of tax was made in Australia and received in Australia and he pointed to the cheque drawn on the bank account of P(Australia) which was signed in Australia and received by the respondent in Australia.

On the question of the double tax treaty between Australia and the United States of America Mr Buss agreed that Article 15(2) para. (a) and (c) were satisfied but claimed that para. (b) was not satisfied in that the remuneration was not paid ``by or on behalf of'' P(US). Citing several authorities including
R. v. Portus & Anor (1949) 79 C.L.R. 428 at p. 435 and pp. 437-438,
R. v. Toohey & Anor (1979-1980) 145 C.L.R. 374 at p. 386 and
Metropolitan Waste Disposal Authority v. Willoughby Waste Disposals Pty. Ltd. (1987) 9 N.S.W.L.R. 7 at p. 10 he pointed out that the phrase ``on behalf of'' had no specific legal definition. As shown in the cases it can mean something as general as ``a witness for'' (as in ``on behalf of the poor'') or, when considering whether a notice has been signed ``on behalf of a creditor'', it would mean whether a person has been ``specifically authorised by'' the creditor. In this case, where the question of sole taxing responsibility between two independent States is concerned, he argued that the words ``on behalf of P(US)'' requires that there be an agency agreement between P(Australia) and P(US) for P(Australia) to pay the applicant's tax on behalf of P(US). He said that it was clear that such an agency agreement did not exist. P(Australia) was responsible for paying many of the expenses incurred by the applicant including his entertainment and travel expenses and categorised them as expenses of its petroleum exploration activities which it later claimed as deductions from its own assessable income in Australia. It is therefore, he submitted, inconsistent for P(Australia) to select the amount paid by it to cover the applicant's income tax liability and to claim it paid this particular amount on behalf of P(US). Mr Buss pointed out that the applicant has the onus of showing that this payment was a payment paid on behalf of P(US) and that he has failed to satisfy that onus.

Having considered all the materials before it the Tribunal is satisfied that the sum of $86,292 paid by P(Australia) to the respondent in satisfaction of the applicant's 1985-86 tax assessment is properly categorised as income rather than as a mere disbursement paid on the applicant's behalf. The English authority of Hartland v. Diggines (supra) which has been regularly followed and affirmed in Australia, is directly in point. If it is part of an employment agreement that the employee's tax liability will be met by the employer then that constitutes a perquisite of the employee which is assessable income. The applicant in other words was receiving part of his emoluments as salary and part in money's worth. That being so, the income was, per force of sec. 19 of the Act, derived by the applicant in November 1985 when P(Australia) paid the tax assessment and the amount must be considered as income derived by the applicant in the 1985/1986 tax year; refer Case U152,
87 ATC 894 and Case V163,
88 ATC 1081. On the question of whether or not the amount should be treated as income it is irrelevant whether it was paid by P(Australia) on its own behalf, on behalf of P(US) or indeed on behalf of the applicant. It is quite clear that the payment was incidental to

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the applicant's employment (during the previous tax year) and

``it is clear that if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else and are obtained as of right or merely as a recognized incident of the employment or work''

(F.C. of T. v. Dixon (supra) at p. 556).

As the applicant was not a resident of Australia in the 1985/1986 year it is necessary to consider the submission that the income is exempt from income tax as it was derived from sources wholly out of Australia within the meaning of sec. 23(r).

The question of source of income must be decided as ``a practical hard matter of fact'' Nathan v. F.C. of T. (supra) per Isaacs J. at pp. 189-190. There is no rule of law that the source of a payment in respect of services rendered is necessarily where the work was done, F.C. of T. v. Mitchum (supra). In the end, as Bowen C.J. said in
F.C. of T. v. Efstathakis 79 ATC 4256; (1979) 38 F.L.R. 276, ``The answer is not to be found in the cases, but in the weighing of the various factors which the cases have shown to be relevant''.

The facts in this case are that the applicant was employed by a United States resident company when he was both a citizen and resident of the United States. He was seconded by his employer to one of its subsidiaries, a company which was a resident of Australia and carrying on business here. As part of the employment agreement the applicant and his employer entered into an arrangement to ensure that he would neither gain nor lose in relation to world-wide taxes applicable as a result of his foreign secondment. The employer had an arrangement in place called ``Tax Equalisation'' and it was included in the agreement that the applicant's Australian tax liability would be met by the employer. Therefore, the legal liability to make the tax payment to the respondent arose from the agreement between P(US) and the applicant and that agreement was entered into in the United States at a time before the applicant became a resident of Australia.

The fact that the source of the legal liability to make the payment is a contract entered into in the United States does not, however, of itself, determine the question of the source of the payment for the purposes of taxation.

If the applicant's Australian tax was being paid on his behalf by P(Australia) during the years in which he was still resident in Australia and performing his employment services in Australia (as it presumably was) then, on the authorities, the source of those payments would be the employment services he was performing. Those services, prior to the 1985/1986 year of income, were being performed entirely in Australia and so any earlier payments would have been income from a source in Australia despite the fact that the legal obligation to make the payment arose under the applicant's employment contract with P(US).

In 1985/1986, after the applicant had ceased to be a resident of Australia and had ceased to be performing services in Australia, the payment of the applicant's tax liability of $86,292 was not a payment for work or services actually done or performed in Australia in 1985/1986 although, obviously, there remains a connection between the payment and employment services performed in the previous year.

Barwick C.J. said in F.C. of T. v. Mitchum (supra) at p. 408, when refuting the suggestion by counsel that the decision in F.C. of T. v. French (supra) laid down a rule of law that in every instance the place where services are performed is the source of a salary or wage:

``I do not feel compelled or persuaded by the decision of the Court in French's Case to hold that in every case where work forms the consideration for wages or salary paid, the source of the income constituted by wages or salary is in the place where the work is done.''

In this instance, as no relevant employment service was performed in 1985/1986, it is appropriate to attribute more weight to the employment contract whereby the applicant consented to allow his employer, P(US), to withhold instalments from his salary to meet future tax commitments arising in both the United States and Australia and to defray those commitments on his behalf. (These payroll deductions presumably funded, at least in part, the obligation assumed by P(US) to defray the actual tax paid to the respondent.) The fact that the payment of the $86,292 was then actually made by P(Australia) rather than by P(US),

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pursuant to an intercompany arrangement regarding the applicant's secondment, is not sufficient to establish Australia as the source of this income.

The amount of $86,292 was income derived by the applicant at a time when he was a non-resident of Australia and it was ``from sources wholly out of Australia''. It is therefore exempt from assessment pursuant to sec. 23(r) and this application for review must be allowed.

For the sake of completeness however it is desirable to briefly consider the applicant's final argument - that the payment is exempt from taxation under the Double Tax Treaty between Australia and the United States of America.

This treaty has been given the force of law by sec. 4(1) and 6(1) of the Income Tax (International Agreements) Act 1953.

Under the terms of Art. 15(1) of the treaty, as it has been determined that the amount was income earned by way of remuneration derived in respect of employment and services performed in Australia, it may be taxed in Australia unless the criteria set out in Art. 15(2)(a), (b) and (c) are satisfied. It is common ground that the criteria set out in sub-art. (2) para. (a) and (c) are satisfied and so the last remaining issue is whether or not, in the terms of para. (b), the $86,292 (being deemed remuneration of the applicant) was paid by P(Australia) ``on behalf of'' P(US) (an employer or company not a resident of Australia).

P(Australia) is incorporated as a separate legal entity in Australia and it derives all of its operating capital from its American parent company. Whether this is arranged by way of stockholders' equity, as disclosed in its company balance sheet, or by way of an annual non-repayable loan, as claimed in evidence by Mr A.R.T., is probably not relevant to this application.

P(US) was responsible for paying the applicant's salary, for he remained an employee of that company, but any of his business, travel and entertainment expenses which were met by P(US) were then billed to P(Australia) under an intercompany billing system. P(Australia) also paid the Australian income tax levied on the applicant's income. The outgoings incurred by P(Australia) for paying the applicant's various other expenses were later claimed as deductions in that company's tax return under the heading of expenses of petroleum exploration. No documentary evidence was tendered to show whether or not the sum of $86,292 was also later claimed by P(Australia) as a deductible expense of petroleum exploration. It would seem from the evidence of Mr A.R.T. and from the evidence of the tax return of P(Australia) that the various expenses incurred in respect of the applicant's employment in Australia, whether they were actually paid at the time by P(US) or by P(Australia), would eventually be billed to P(Australia) as part of the intercompany financial adjustments. It would seem logical therefore that the net expense incurred by the corporate group in paying his Australian and United States income taxes would be treated in the same way.

Mr A.R.T. was able to give evidence from his own experience as to how the group's tax equalisation scheme worked in general and was able to clarify some matters in the 1989 Tax Equalisation Handbook which he said set out the same procedures and concepts as were being applied in 1985 and 1986 during the period of the applicant's employment in Australia. He was unable to comment however on the details applicable to payment of the applicant's tax. The handbook also provided few details of the general arrangements for payment of an expatriate employee's income tax liability in the foreign country. It said on p. 6 that the matter would be governed by local tax requirements to be discussed between the employee and the foreign subsidiary. In 1985 and 1986 Mr A.R.T. was not a director of P(Australia) and he said he was not aware of what arrangements may have been made for the secondment of the applicant who came out to be a director of P(Australia).

The term ``on behalf of'' is not defined in the Double Tax Treaty but the Tribunal accepts Mr Buss' submission that Art. 31(1) of the Geneva Convention provides the applicable rule of interpretation which is:

``That a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty, in their context and in the light of its object and purpose.''

This treaty is concerned with providing the rules governing taxation rights as between

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States and it would ordinarily be expected that if that question depended on whether or not a payment was made by an Australian company on behalf of a foreign company then the relationship between the two companies involved would require some degree of formality - something like an agency agreement.

The onus is on the applicant to establish the nature of the agreement between P(Australia) and P(US) with regard to the payment of the applicant's income tax. Whether the payment was made on behalf of P(US) is still shrouded in the undisclosed details of the financial arrangements between the two companies. A document of 15 May 1989 signed by one R. L. Balinger as Manager International Compensation and Benefits of P(US) stated:

``In accordance with P(US's) policy P(Australia) was responsible for the payment of [the applicant's] Australian Income Taxes while on this assignment.''

A subsequent letter dated 1 June 1990 signed by the same person, clearly with this litigation in mind, endeavoured to explain the previous document by saying that it ``does not reflect the legal contractual position as between P(US) and [the applicant]''. It went on to argue that P(Australia) was in fact acting on behalf of P(US) when it made the payment.

On reading the two letters it seems that P(US) is trying to assert that P(Australia) was meeting P(US's) obligation to pay the applicant's Australian income tax when it made the payment of that tax to the respondent. It still leaves open the likelihood that because that liability arose as a result of the applicant's secondment to P(Australia) then, as between the two companies, that amount (or some lesser amount) would not only be initially paid by, but also be finally borne by, P(Australia) - as were the other employment-related expenses incurred by the applicant in the course of his Australian employment.

P(Australia) may well have paid the amount in satisfaction of a legal obligation entered into in America by P(US) in favour of the applicant but in paying the amount it seems that P(Australia) was acting in its own right and was committing its own funds pursuant to an intercompany arrangement under which the costs of the payment would be borne by P(Australia) as it was just another expense incurred as a consequence of the applicant being seconded to P(Australia).

One thing which is clear is that the payment was made on behalf of the applicant as it was he who was liable to the respondent to pay the tax. As between P(Australia) and P(US), however, the question is not so clear. In the final result, the Tribunal is not satisfied that the payment of the amount in question by P(Australia) was made on behalf of P(US). Accordingly, if the question remained to be decided, the payment would not be exempt from taxation pursuant to the terms of the Double Tax Treaty between the United States of America and Australia since the requirement of Art. 15(2)(b) is not satisfied.

After considering all the material before it the Tribunal is satisfied that the sum of $86,292 was correctly treated by the respondent as income derived by the applicant in the 1985/1986 year of income, but it was from a source wholly out of Australia. Therefore, as the applicant was a non-resident in that year of income, the amount is exempt income in terms of sec. 23(r) of the Act.


The decision under review is set aside and the matter is remitted to the respondent to issue an amended assessment reducing the applicant's 1985/1986 taxable income by $86,292.


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