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Ruling

Subject: Exempt foreign employment income - allowance

Question

Is the capability allowance you received in relation to your deployment to Country X exempt from income tax in Australia under subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are an Australian resident for taxation purposes.

You are a member of the Australian Defence Force (ADF).

You were deployed to Country X in for a period of not less than 91 days

While deployed in Country X, you were paid salary. You stated that your salary income is exempt from tax in Australia under section 23AG of the ITAA 1936.

In addition to your salary, you received a capability allowance, derived during your deployment in Country X.

This allowance is paid to an ADF member in a specific employment category.

During your deployment, you took recreation leave that accrued during your foreign service.

You did not perform any duties during the recreation leave period.

The laws of Country X provide for the imposition of income tax and do not generally exempt employment income from income tax

Australia does not have a tax treaty with 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 Subsection 23AG(2)(a)

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

Income Tax Assessment Act 1936 Subsection 23AG(2)(c)

Income Tax Assessment Act 1936 Subsection 23AG(2)(d)

Reasons for decision

Subsection 23AG(1) of the Income Tax Assessment Act 1936 (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 income tax in Australia.

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

The foreign earnings must be derived from the foreign service, though not necessarily derived during the period of 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.

As you were deployed to Country X as a member of the ADF, you satisfy one of the conditions for exemption under subsection 23AG(1AA) of the ITAA 1936.

Under subsection 23AG(6) of the ITAA 1936 certain temporary absences form part of a period of foreign service, such as recreation leave which is accrued as a result of the foreign service, other than long service leave and leave without pay.

In your case, you did not take any breaks in your employment other than leave which accrued during your service in Country X. This leave will form part of your foreign service, and accordingly the payments for the leave will qualify as foreign earnings.

Capability allowance

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 result of the undertaking of that foreign service.

In addition to your salary, you also received capability allowance. This allowance was derived as result of your undertaking from your foreign service in Country X. As such, it is considered to be derived from your foreign service.

Therefore, your capability allowance is foreign earnings from foreign service for the purposes of subsection 23AG(1) of the ITAA 1936.

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

One of the reasons listed is where the income is exempt from tax in the foreign country because of a tax treaty (paragraphs 23AG(2)(a) and 23AG(2)(b) of the ITAA 1936).

There is no tax treaty between Australia and Country X. Therefore, paragraphs 23AG(2)(a) and 23AG(2)(b) of the ITAA 1936 do not apply.

As the laws of Country X provide for the imposition of income tax and do not generally exempt employment income from income tax, paragraphs 23AG(2)(c) and (d) of the ITAA 1936 also do not apply.

None of the other reasons in subsection 23AG(2) of the ITAA 1936 apply to your situation.

In your case, you are an Australian resident for taxation purposes and were engaged in foreign service for a continuous period of not less than 91 days.

Accordingly, the capability allowance you received in relation to your deployment to Country X is 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 wages income in your Australian tax return.