Edited version of your private ruling

Authorisation Number: 1012046229696

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Ruling

Subject: Foreign income

Question

Is the income you earn in Country X exempt from income tax in Australia under subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commences on

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian resident for taxation purposes.

You work under contract on a project in Country X with a government department.

Your contracts were for 12 months and for six months.

The project is funded by the World Bank through the International Development Association and a multi donor trust fund, with contributions from several countries

You have stated you are a contractor.

Your contracts refer to you as a consultant, and state your relationship to the Country X government department is as an independent contractor.

You are contracted to perform a number of tasks to design, lead and manage the reform process in relation to the government in Country X's activities, and to report and advise on the progress or completion of tasks and activities at regular intervals.

You receive a monthly remuneration and allowances or reimbursements on submission of invoices, work plan and or work plan progress report and other deliverables specified in the contract.

You are responsible for your own insurance, although you are reimbursed for 50% of your medical insurance premium.

You accrue annual leave at two and a half days per month, and sick leave at one day per month.

You are required to indemnify the Country X government department against any or all claims or judgments brought against them arising out of any misconduct or negligence on your part while performing services.

Your income is subject to withholding tax in Country X.

There is no tax treaty between Australia and Country X.

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(1AA)

Income Tax Assessment Act 1936 section 23AG

Income Tax Assessment Act 1936 paragraph 23AG(1AA)(a)

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).

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:

· the delivery of Australian official development assistance by the taxpayer's employer (generally provided by AusAID or the Department of Foreign Affairs and Trade);

· the activities of the taxpayer's employer in operating a public fund covered by the deductible gift recipient categories overseas aid fund and developed country disaster relief fund;

· the activities of the taxpayer's employer where they are a charitable institution or religious institution which is income tax exempt because they are a prescribed institution located outside Australia or pursuing objectives principally outside Australia;

· the taxpayer's deployment outside Australia as a member of a disciplined force of Australia (generally considered to be the Australian Defence Force or Australian Federal Police); or

· an activity of a kind specified in the regulations.

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) of the ITAA 1936, 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.

Foreign service - holder of an office or in the capacity of an employee

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 the conditions of your contracts to provide services to a government department in Country X. 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 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 indicative of an employer-employee relationship.

You have stated, and your contracts with government department in Country X overall confirm, that you are an independent contractor.

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 the government department in Country X is not exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936.

Note

If taxpayers do not qualify for the exemption under subsection 23AG(1) of the ITAA 1936, the foreign income will need to be included in the tax return as assessable income. In such cases, taxpayers will be eligible to claim a non-refundable foreign income tax offset (FITO) for foreign income tax paid on that income.

The FITO rules replaced the former foreign tax credit system and apply to income years beginning on or after 1 July 2008.