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Ruling

Subject: Foreign employment income

Question

Are the salary and allowances you receive from employment in Country X exempt from income tax in Australia under section 23AG of the Income Assessment Act 1936 (ITAA 1936)?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on

1 July 2007

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

You are an employee of an Australian aid agency.

You have been working in Country X on a development cooperation program since the 2007-08 income year.

The program is part of Australian official development assistance.

In addition to your salary, you receive allowances. The allowances are paid to compensate for costs arising from the foreign service and for the hardship attributable to the foreign service.

You have not taken any breaks other than your recreation leave that accrued during your deployment to Country X.

You did not perform any work-related duties if you returned to Australia during your leave.

Australia has a tax treaty with Country X.

Country X taxes employment income under its domestic law.

Your foreign employment income is exempt from income tax in Country X under the terms of a general agreement on development cooperation between the government of Australia and the government of 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 Section 23AG

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

Income Tax Assessment Act 1936 Subsection 23AG(6)

Income Tax Assessment Act 1936 Subsection 23AG(2)

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

International Tax Agreements Act 1953 Section 3AAA

International Tax Agreements Act 1953 Section 5

Reasons for decision

Subsection 23AG(1) of the (ITAA 1936) provides that foreign earnings of an Australian resident derived during a continuous period of foreign service of not less than 91 days employment in a foreign country are exempt from tax in Australia.

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

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.

Section 23AG of the ITAA 1936 has been amended so that foreign employment income derived by Australian residents will only be exempt in certain circumstances. These amendments are effective from 1 July 2009.

Subsection 23AG(1AA) of the ITAA 1936 provides that foreign earnings are not exempt from tax 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.

In your case, you have been working in Country X on a development cooperation program.

As your deployment is directly attributable to the delivery of an Australian overseas aid program by your employer, you satisfy one of the conditions for exemption under subsection 23AG(1AA) of the ITAA 1936.

In addition to your salary, you receive allowances.

Salary and allowances

As you receive a salary from your employment in Country X, this salary is considered to be derived from your foreign service.

The allowances are designed to cover various costs and hardship of the foreign service. As they are paid to compensate for costs arising from the foreign service and for the hardship attributable to the foreign service, they are considered to be derived from your foreign service.

Therefore, your salary and allowances are foreign earnings from foreign service for the purposes of subsection 23AG(1) of the ITAA 1936.

The exemption does not apply if the income is exempt from tax in the foreign country only because of any of the reasons listed in subsection 23AG(2) of the ITAA 1936. One of these reasons is a tax treaty (paragraph 23AG(2)(b) of the ITAA 1936).

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

An article of the Country X Agreement provides that remuneration paid by Australia to any individual in respect of services rendered in the discharge of governmental functions shall be taxable only in Australia. However, such remuneration will be taxable only in Country X if the services are rendered in Country X and the individual is a citizen of Country X, or did not become a resident of Country X solely for the purpose of performing the services.

The employment income you receive in relation to your deployment to Country X is taxable only in Australia under this article of the Country X Agreement as you are an Australian resident and the income is paid by Australia in respect of services rendered in the discharge of governmental functions.

As the employment income you receive while posted to Country X is exempt from tax in Country X because of the operation of a tax treaty, paragraph 23AG(2)(b) of the ITAA 1936 would normally apply and the income would therefore 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 general agreement on development cooperation between the government of Australia and the government of Country X.

The exemption provided by the agreement does not fall under any of the other exemption categories under subsection 23AG(2) of the ITAA 1936.

You satisfy the conditions for exemption under section 23AG of the ITAA 1936.

Accordingly, the salary and allowances you receive from employment in Country X are exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936.

Note

It is important to note that 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.