Edited version of private ruling

Authorisation Number: 1011691211003

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Ruling

Subject: Foreign service

Question

Is the portion of a bonus paid to you in the 2009-10 income year relating to the period of your foreign service during the 2008-09 income year exempt from tax under section 23 AG of the Income Tax Assessment Act 1936 (ITAA 1936) ?

Answer

Yes.

This ruling applies for the following period

Income year ended 30 June 2010

The scheme commenced on

Relevant facts

You are an Australian resident for income tax purposes from July 2009.

Prior to July 2009, you were a foreign resident of Australia and a resident of Country X.

You worked for the same employer both before and after moving to Australia.

In 2010 calendar year, you were awarded a bonus of for the calendar year 2009.

Your employer provided a letter which states that the bonus related to both your employment in Country X from 1 January to 30 June 2009 and your employment in Australia from 1 July to 31 December 2009.

You were in present in Country X for period or periods less than 183 days in total in the Country X year of income or year of assessment.

A portion of the bonus is for services performed or exercised for or on behalf of the Country X resident company.

The Country X related portion of the bonus is taxable in Country X.

This bonus is paid via your employer in Australia and tax was withheld from the payment.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 6-15(2)

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

Income Tax Assessment Act 1936 Section 23AG

Income Tax Assessment Act 1936 Subsection 23AG (1)

Income Tax Assessment Act 1936 Subsection 23AG (2)

Income Tax Assessment Act 1936 Subsection 23AG (7)

Income Tax Assessment Act 1936 Subsection 23AG (1AA)

International Tax Agreements Act 1953

Reasons for decision

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

Salary, wages and bonuses are ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997.

Subsection 6-15(2) of the ITAA 1997 provides that if an amount is exempt income then it is not assessable income.

Section 11-15 of the ITAA 1997 lists those provisions dealing with income which may be exempt. Included in this list is section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936) which deals with exempt foreign employment income.

Section 23AG of the ITAA 1936 provides an exemption from Australian tax on the foreign earnings derived by an Australian resident who has been engaged in foreign service continuously for 91 days or more.

Subsection 23AG(1) of the ITAA 1936 provides that the foreign earnings of a resident engaged in foreign service for a continuous period of not less than 91 days is exempt from tax.

Taxation Ruling 96/15 provides guidance for the practical application of this section. Paragraph 5 of TR 96/15 provides that while it is a requirement for the operation of section 23 AG that the foreign earnings be derived whilst the individual is a resident for Australian taxation purposes, it is not also a requirement that the relevant foreign service be performed while the individual is a resident for those purposes.

Therefore, section 23 AG of the ITAA 1936 can apply where the residential status for Australian tax purposes of an individual taxpayer changes during a year of income from a foreign resident to a resident and on or after the date the taxpayer receives foreign earnings in respect of a continuous period of foreign service performed whilst a foreign resident.

The definition of 'foreign earnings' is contained in subsection 23AG(7) of the ITAA 1936, which provides that:

foreign earnings' means income consisting of earnings, salary, wages, commission, bonuses or allowances, or of amounts included in a person's assessable.

To qualify for the exemption the 'foreign earnings' must be derived from the 'foreign service'. That does not mean that the foreign earnings need to be derived at the time of engaging in foreign service. The important test is that the foreign earnings, when derived, need to be derived as a result of the undertaking of that foreign service.

In your case the bonus was paid after you returned to Australia. Part of the bonus related to the period of your foreign service. Such a bonus relating to foreign service is treated as foreign earnings derived from that foreign service. Where the bonus relates to both a period of foreign service and a period of employment in Australia, an apportionment of the bonus relating to foreign service based on period of service can be considered to be foreign earnings.

In this case the bonus was paid in the 2009-10 income year. Taxation Ruling IT 2534 provides at paragraph 4 that bonuses are considered to be have been derived for income tax purposes at the time the bonus was paid or made available to the employee. Therefore, the bonus is assessable in the 2009-10 income year.

From 1 July 2009, subsection 23AG(1AA) of the ITAA 1936 restricts the exemption to specific employment activities.

Your foreign earnings are not directly attributable to any of the activities covered by new subsection 23AG(1AA) of the ITAA 1936.

The following paragraphs in the Explanatory Memorandum (EM) on paragraph 23AG(1AA) of the ITAA 1936 provide guidance on the scope and meaning of this new provision.

Application and transitional provisions

1.36 The new rules apply to foreign earnings derived on or after 1 July 2009 from foreign service performed on or after 1 July 2009.

………….

1.37 Foreign earnings paid to an individual on or after 1 July 2009 in respect of foreign service performed before 1 July 2009 will remain eligible for exemption under the existing rules.

Example 1.8

On 1 July 2009 Jennelle is paid in respect of foreign service performed during the month of June 2009. Her foreign earnings are not directly attributable to any of the activities covered by new subsection 23 AG(1AA). Her foreign earnings for the month of June 2009 remain eligible for exemption notwithstanding the fact that they were paid on or 1 July 2009

In this case, a portion of the bonus relates to foreign service prior to 1 July 2009 However, the bonus was received after 1 July 2009 and assessable in the 2009-10 income year.  In view of the explanation provided in the EM, the foreign earnings relating to foreign service performed prior to 1 July 2009 remain eligible for exemption under section 23 AG of the ITAA, notwithstanding that the foreign earnings were paid after 1 July 2009.

However, subsection 23AG(2) of the ITAA 1936 provides that no exemption is available under subsection 23AG(1) of the ITAA 1936 in circumstances where an amount of foreign earnings derived from service in a foreign country is exempt from tax in the foreign country solely because of:

a double tax agreement or a law of a country that gives effect to such an agreement (see paragraphs 23AG(2)(a) and (b)).

Australia has a tax treaty with Country X (the Country X Agreement) which is contained in Schedule X of the International Tax Agreements Act 1953 (the Agreements Act).

The particular Article of the Country X Agreement provides that remuneration or other income derived by an individual who is a resident of Australia in respect of personal (including professional) services shall be taxable in Australia unless the services are performed or exercised in Country X . If the services are performed or exercised in Country X, the income may be taxed in Country X .

Another Article of the Country X Agreement provides that remuneration or other income derived by an individual who is a resident of Australia in respect of personal (including professional) services performed in Country X shall be exempt from tax in Country X if all of the following three conditions are met:

(a)  the recipient is present in Country X for a period not exceeding in the aggregate 183 days in the year of income; and

(b)  the services are performed for on behalf of a person who is a resident of Australia ; and

(c)  the remuneration is not deductible in determining the Country X assessable income of the Australian resident's permanent establishment (PE) located in Country X .

In the 2009-10 income year you were an Australian resident for income tax purposes. You were not in Country X for a period exceeding in aggregate 183 days in their year of income. However, the service for which the bonus was paid was performed for or on behalf of a Country X resident (not for an Australian resident company).

Therefore, Article 12 will not apply to exempt the portion of bonus relating to Country X employment services from tax in Country X. You have also stated that this portion of the bonus relating to your employment in Country X is taxable in Country X.

Since your portion of bonus relating to Country X services is not exempt from tax in Country X, subsection 23AG(2) of the ITAA 1936 will not prevent this income from being exempt under subsection 23AG(1) of the ITAA 1936.

Consequently, the portion of bonus paid to you in 2009-10 income year relating to the Country X service during the 2008-09 income year can be exempt from tax under section 23 AG of the ITAA 1936.

Further issues for you to consider

Exemption with progression

The 'foreign earnings' that are exempt from Australian tax under section 23AG of the ITAA 1936 are nevertheless taken into account in calculating the Australian tax on other assessable income derived by the employee (see subsection 23AG(3) of the ITAA 1936).

Tax on other assessable income will be calculated by applying to the non-exempt income (for example, Australian salary, investment income) the notional average rate of tax payable on the sum of exempt income and non-exempt income.