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Ruling

Subject: Foreign income

Questions and answers:

Question:

1. Was the salary earned by you while you were employed in Country X assessable in Australia?

Answer:

No

Question:

2. Was the housing and utilities allowance paid during your employment in Country X assessable in Australia?

Answer:

No

Question:

3. Was your Language allowance which was paid to you during your employment in Country X assessable in Australia?

Answer:

No

Question:

4. Was your Leave allowance paid to you during your employment in Country X assessable in Australia?

Answer:

No

Question:

5. Were your lump sum relocation costs to relocate prior to the commencement of foreign service and after the completion of foreign service paid to you for your employment in Country X assessable in Australia?

Answer:

Yes

This ruling applies for the following period:

Year ended 30 June 2008

The scheme commenced on:

1 July 2007

Relevant facts and circumstances

You are a resident of Australia for tax purposes.

You were engaged in an employment contract with an Australian company in Country X. This was an Ausaid Project.

Your original period of employment was for several years. Your contract was extended.

You received the following allowances:

· housing and utilities

· language lessons

· leave

· relocation costs on completion

You did not perform any work duties while in Australia.

You did not take any breaks in your employment other than annual leave.

You took your leave in Australia or Country X.

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

A Memorandum of understanding (MOU) exists between Australia and Country X which exempted you from tax on employment income earned in Country X.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 6-15.

Income Tax Assessment Act 1997 Section 11-15.

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(6).

Income Tax Assessment Act 1936 Subsection 23AG(7).

International Tax Agreements Act 1953 Section 4.

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 and wages are ordinary income for the purpose 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 it is not included in 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 overseas employment income.

Subsection 23AG(1) of the ITAA 1936 provides that, where a resident taxpayer is engaged in foreign service for a continuous period of not less than 91 days, any foreign earnings derived will be exempt from tax in Australia. 'Foreign service' includes service in a foreign country in the capacity as an employee and 'foreign earnings' includes income consisting of salary, wages, bonuses or allowances (subsection 23AG(7) of the ITAA 1936).

Subsection 23AG(6) of the ITAA 1936 provides that 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.

However, 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 income tax in the foreign country only because of any of the reasons listed.

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

Therefore, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA of 1997 and the ITAA 1936 so that those Acts are read as one. In the event of inconsistent provisions, the Agreements Act overrides the ITAA 1936 and ITAA 1997 (except in some limited situations).

The Agreements Act contains the double tax agreement between Australia and (the Country X Agreement). The Country X Agreement operates to avoid double taxation of income received by Australian and Country X residents.

The Country X Agreement provides that salary and wages derived by an individual who is a resident of Australia in respect of employment shall be taxable in Australia unless the employment is exercised in Country X. If the employment is exercised in Country X, the salary and wages may be taxed in Country X.

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 will also not apply.

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

Accordingly, the salary received by you from services performed in Country X is exempt from tax under subsection 23AG(1) of the ITAA 1936 and is therefore not assessable income in Australia under subsection 6-5(2) of the ITAA 1997.

Allowances

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.

You received a monthly housing and utilities allowance to cover living and utilities costs incurred while you were working in Country X. As this allowance was paid to cover costs incurred while you were performing the foreign service, it is considered to be derived from your foreign service.

You also received a language allowance. As this allowance was paid to cover costs incurred to perform the foreign service, it is considered to be derived from your foreign service.

A monthly leave allowance was paid to cover costs arising from leave that accrued from your foreign service and costs attributable to your foreign service. Therefore, it is considered that this part of the allowance was derived from your foreign service.

Accordingly, the housing and utilities allowance, language allowance and the monthly leave allowance paid to you formed part of your foreign service were exempt from Australian income tax under subsection 23AG(1) of the ITAA 1936 and were therefore, not assessable under subsection 6-5(2) of the ITAA 1997.

The lump sum relocation costs on commencement and relocation costs on completion of the foreign service received by you is for pre and post service airfares, visa applications, departure taxes and travel to and from the airport. It was paid to cover costs arising prior to and after the end of the foreign service, therefore, the relocation costs are not considered to be derived from your foreign service.

Accordingly the relocations costs on commencement and completion of foreign service are not exempt from tax under subsection 23AG(1) of the ITAA 1936.

Therefore, the allowances paid to cover these expenses are assessable under subsection 6-5(2) of the ITAA 1997.

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.