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Ruling

Subject: Foreign income

Question 1

Is the income you derived in Country X as an employee with a company under secondment to another company on a project exempt from tax in Australia under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer 1

Yes.

Question 2

Is the income you derived in Country X as an independent subcontractor a company on a project exempt from tax in Australia under section 23AG of the ITAA 1936?

Answer 2

No.

Question 3

Is the income you derive in Country X as an independent subcontractor with another company on another program exempt from tax in Australia under section 23AG of the ITAA 1936?

Answer 3

No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

You were employed by a company.

You were seconded to work with another company on a project in Country X into the 2009-10 income year.

The project was implemented to improve quality and access to education in Country X, and is funded and managed by AusAID.

During your employment in Country X , you accrued recreation leave which you utilised throughout your period of employment in this role. On the occasions that you returned to Australia while on recreation leave, you did not perform any work-related duties.

Due to restructuring of the organisation, your employment with the company ceased, and you commenced with the other company under a subcontractor agreement on the project.

Your subcontractor agreement was extended.

You commenced with another company under an independent subcontractor agreement on an education program in Country X.

Your income is exempt from tax in Country X in accordance with the General Agreement between the Government of the Country X and the Australian Government (MOU).

There is a tax treaty between Australia and Country X.

Country X has a tax system in place that taxes employment income.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 23AG(1)

Income Tax Assessment Act 1936 subsection 23AG(7)

Income Tax Assessment Act 1936 subsection 23AG(6)

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

Income Tax Assessment Act 1936 section 23AG

Income Tax Assessment Act 1936 subsection 23AG(2)

Income Tax Assessment Act 1936 paragraph 23AG(2)(b)

International Tax Agreements Act 1953 section 5

International Tax Agreements Act 1953 section 3AAA

Reasons for decision

Subsection 23AG(1) of the ITAA 1936 provides that where Australian resident individuals are engaged in foreign service for a continuous period of not less than 91 days, foreign earnings derived from that foreign service are exempt from income tax in Australia.

Subsection 23AG(7) of the ITAA 1936 defines foreign service to mean service in a foreign country as the holder of an office or in the capacity of an employee.

Foreign earnings include income consisting of salary, wages, bonuses or allowances (subsection 23AG(7) of the ITAA 1936).

Subsection 23AG(6) of the ITAA 1936 provides that the period of a person's foreign service will include recreation leave (which is accrued as a result of the foreign service), other than long service leave or leave without pay or reduced pay, and will not constitute a break in a period of foreign service.

Therefore, the recreation leave that accrued during your employment with the company as an employee, including the period of your secondment another company, will form part of your period of foreign service in Country X.

From 1 July 2009, subsection 23AG(1AA) of the ITAA 1936 came into effect and provides that foreign earnings will not be exempt under section 23AG of the ITAA 1936 unless the continuous period of foreign service is directly attributable to any of the following:

§ delivery of Australian official development assistance by your employer

§ activities of your employer in operating a public fund declared by the Treasurer to be a developing country relief fund, or a public fund established and maintained to provide monetary relief to people in a developing foreign country that has experienced a disaster (a public disaster relief fund)

§ activities of your employer as a prescribed charitable or religious institution exempt from Australian income tax because it is located outside Australia or the institution is pursuing objectives outside Australia

§ deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force.

The term 'Australian official development assistance' is not defined for the purposes of section 23AG of the ITAA 1936. However, the Explanatory Memorandum (EM) which accompanied Tax Laws Amendment (2009 Budget Measures No. 1) Bill 2009) introducing paragraph 23AG(1AA)(a) of the ITAA 1936 provides guidance on the meaning of the phrase.

Australian official development assistance (ODA) is assistance delivered through the Australian Government's overseas aid program, as administered by the Department of Foreign Affairs and Trade and/or the Australian Agency for International Development (AusAID). Australian ODA aims to reduce poverty and achieve sustainable development in developing countries, in line with Australia's national interest.

For the purposes of subsection 23AG(1AA) the delivery of Australian ODA must be undertaken by the person's employer, which includes AusAID and an entity contracted by AusAID to assist in the delivery of Australian ODA.

In your case, the foreign service in Country X as an employee, including your period secondment another company, under a project is directly attributable to the delivery of Australian ODA by your employer.

Subsection 23AG(2) of the ITAA 1936 provides that the exemption under subsection 23AG(1) of the ITAA 1936 will not apply where a person's income is exempt from tax in the foreign country only because of any one of the reasons listed in that subsection.

One of the listed reasons is where the income earned by a person in the foreign country is made exempt by the operation of a tax treaty (paragraph 23AG(2)(b) of the ITAA 1936).

Australia has a tax treaty with Country X (the Country X Agreement). The Country X Agreement operates to avoid the double taxation of income received by residents of Australia and Country X.

An article of Country X Agreement provides that salary and wages income of an Australian resident will be taxable only in Australia unless the employment is exercised in Country X. If the employment is exercised in Country X then Country X may tax the income.

As the employment income you receive while on posting in Country X is exempt from tax in Country X because of the operation of a tax treaty, subsection 23AG(2) of the ITAA 1936 would normally apply and the income would not be exempt from tax under subsection 23AG(1) of the ITAA 1936.

However, the income you earn while on posting is also exempt from tax in Country X because of the terms of the MOU entered into between Australia and Country X.

The exemption provided by the MOU does not fall under any of the other exemption categories under subsection 23AG(2) of the ITAA 1936, and you therefore satisfy the conditions for exemption.

Accordingly, the income including overseas allowances that you receive from your employment in Country X as an employee of a company, including the period of your secondment another company, is exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936.

Subcontractor

Subsection 23AG(7) of the ITAA 1936 defines foreign service as service in a foreign country as the holder of an office or in the capacity of an employee.

Taxation Ruling TR 96/15 provides at paragraph 20 that foreign earnings derived from independent personal services fail to qualify for exemption under section 23AG of the ITAA 1936 because they are not rendered during the course of a period of foreign service as the holder of an office or in the capacity of an employee.

Holder of an office

The meaning of this term has been often considered by the courts. Those cases are of assistance in defining the nature of the holder of an office for the purposes of section 23AG of the ITAA 1936 as they both deal with payments made to individuals which arise out of employment like relationships.

In Federal Commissioner of Taxation v. Sealy (1987) 19 ATR 582 at 286; 87 ATC 5076, which concerned a managing partner of a grazing partnership, Pincus J said:

The word office has a range of meanings. In some contexts, it refers to a position of authority in a governmental or other public organisation. It is difficult to think of any reason why the legislature should have intended to confine the concession to instances in which the terminated position is one of a public character or of any high degree of permanency. Presumably, no one would dispute that the position of managing director of a public company could be regarded as an office.

In Grealy v. Federal Commissioner of Taxation (1989) 20 ATR 403 at 408; 89 ATC 4192 at 4197, which concerned a university lecturer, the Full Federal Court held:

It has to be conceded that the word is capable of a variety of meanings, and its definition greatly troubled the Court of Appeal in Great Western Railway Company v. Bater [1921] 2 KB 128, especially at pp 138 and 142. The word office usually connotes a position of defined authority in an organisation, such as director of a company or tertiary educational body, president of a club or holder of a position with statutory powers…The applicant, like holders of professional employments, is not made an office holder merely because his position has a name.

The question in this case is whether you are considered to be a holder of an office. As explained by the courts, the word office usually connotes a position of defined authority in an organisation, such as a director of a company or the president of a club. The holder of a professional employment is not an office holder merely because the position has a name. An office holder's position is more than something which is important or substantial within a company.

In your case, you were engaged to carry out work as per conditions of your contracts to provide services. In the circumstances of your engagement, we do not consider you to be an office holder as you did not have defined authority with distinct responsibilities within the organisation that engaged your services, but instead you were engaged to provide services as an independent contractor.

Accordingly, you are not an office holder for the purposes of subsection 23AG(7) of the ITAA 1936.

In the capacity of an employee

What constitutes an employee is not defined in tax legislation, so the word takes its ordinary meaning as handed down by the courts. The Commissioner has released Taxation Ruling TR 2005/16 which discusses the meaning of an employee that has been developed by the courts.

The ruling provides that the relationship between an employer and employee is a contractual one, and is often referred to as a contract of service. Such a relationship is typically contrasted with the independent contractor/principal relationship that, at law, is referred to as a contract for services.

Indicators of contractor/principal relationship include the following.

An independent contractor generally contracts to achieve a result whereas an employee contracts to provide their labour (typically to enable the employer to achieve a result). In a result based contract, often the payment is made from a negotiated contract price as opposed to an hourly rate.

Although the existence of an Australian business number (ABN) does not prevent an individual from being engaged as an employee, the quotation of an ABN would indicate that the activities done by an individual is not as an employee.

The ruling provides that the power to delegate the work to others (with or without the approval or consent of the principal) is a strong indication that the person is engaged as an independent contractor.

An independent contractor often bears their own insurance and indemnity policies.

On the other hand, the provision of benefits such as annual, sick and long service leave, remuneration on hourly rates, etc, are indicators of an employer-employee relationship.

You have stated, and your contracts confirm, that you are a subcontractor.

As you are not providing services in a foreign country as the holder of an office or in the capacity of an employee, you are not considered to be performing foreign service as defined in subsection 23AG(7) of the ITAA 1936.

Consequently, your income from providing services to GRM and MDI in Country X is not exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936.

Note

Foreign earnings exempt under section 23AG of the ITAA 1936 are taken into account in calculating the tax payable on other income derived by a taxpayer. This method of calculation referred to as exemption with progression prevents the exempt income from reducing the Australian tax payable on the other income.

This income needs to be included as exempt foreign salary and wage income in your Australian tax return.