Edited version of your written advice

Authorisation Number: 1012704214271

Ruling

Subject: Assessability of foreign income

Question 1

Are the salary and allowances you earned while employed overseas exempt from income tax in Australia?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You were an Australian resident for the period you were working overseas.

You worked in continuous foreign service for the full period in country X.

You were specifically engaged by AusAID for your role to enhance the visibility of Australia's bilateral engagement and to support the implementation of development assistance in country X.

You did not leave country X at all during the period you were working there. You had very limited time off during the period as you were required to have all leave approved via a complex process by diplomatic security. It was essential that they knew your whereabouts at all times.

You left Australia as soon as you were appointed and any leave was accrued from this point. You returned from overseas with over 20 days of leave owing.

You received an allowance for establishment/set up costs in country X. This was made as you were not provided with an office and for the difficulty in operating in a post conflict zone.

After leaving Australia you were required to report to the nearest diplomatic station prior to entering country X. You were there for only a couple of days before entering country X. Your payments from AusAID did not start until after you were in country X.

Australia does not have a tax treaty with country X.

There is no Memorandum of Understanding (MOU) or an Agreement of Co-operation for development in existence between Australia and country X.

Section 26(a) of the country X Tax Act explains: 

26. The following amounts are exempt from income tax-

a) the official employment income of an individual who is not a citizen of country X, not engaged in country X or who is a diplomatic or consular employee;

 b) the official employment income of an individual who is not a citizen of country X and who is in the public service of the government of a foreign country where the income is subject to income tax in that country;

 c) the official employment income of an individual who is not a citizen of country X and who is an employee of a public international organisation the income of which is exempt from taxation under section 8; and

 d) foreign-source income derived by a person whose official employment income is exempt under paragraph (a),(b) or (c) or by a member of the immediate family of such a person.

You point out the bold areas which you believe are the relevant parts of Section 26.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 23AG

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Source of Income

The three factors to be taken into account when determining the source of salary and wage income are generally held to be:

• place of performance of the work;

• place of making of the employment contract; and

• place of payment.

As a broad statement, the source of income from salary and wages is usually held to be the place of performance of the work (FCT v French (1957) 98 CLR 398; 7 AITR 76; 11 ATD 288). If, however, creative powers or special knowledge is involved to such a degree that the place where those powers or knowledge are utilised is relatively important, the dominant source may be the place where the contract was made (FCT v Mitchum (1965) 113 CLR 401; 9 AITR 559; 13 ATD 497).

Place of performance of work

In French's case, the taxpayer, a resident of Australia, was an engineer employed by CSR without a written contract of employment. For 2 to 3 weeks during each of the years from 1943 until 1951, the taxpayer undertook duties in New Zealand as inspecting engineer for his employer. During 1951, he received 110 for his 17 days of service in New Zealand which was deposited into his bank account in Sydney.

A majority of the High Court in French's case (Williams and Taylor JJ with Dixon CJ agreeing with Williams J) held that the salary referable to New Zealand had its source in New Zealand and the 110 was therefore exempt from income tax in Australia under former s 23(q).

Williams J stated at CLR 414; AITR 85 that:

... The locality of the source of income derived from personal exertion in the capacity of employee or in relation to any services rendered surely must be where such personal exertion took place, and the locality of the source of the proceeds of any business where the activities of the business are carried on.

We consider that the decision in French's case is comparable to your case. You have stated that you were undertaking you employment in Country X, therefore the source of your income is considered to be Country X.

Foreign salary and wages

The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 1) Act 2009 explains that the taxation of income in Australia is principally determined on the basis of whether you are an Australian resident or a foreign resident. Generally, Australian residents are taxed on their worldwide income whereas foreign residents are taxed only on income sourced in Australia under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936) provides an exception to the general rule. The exemption applies to foreign earnings derived by an Australian resident individual engaged in continuous foreign service for not less than 91 days. However, such earnings will only be eligible for exemption from income tax if the foreign service is directly attributable to any of the following:

• the delivery of Australian overseas development assistance (ODA) by the individual's employer;

• the activities of the individual's employer in operating a developing country relief fund or a public disaster relief fund;

• the activities of the individual's employer being a prescribed institution that is exempt from Australian income tax;

• the individual's deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force; or

• an activity of a kind specified in the regulations.

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.

You were specifically engaged by AusAID for role in country X.

However subsection 23AG(2) of the ITAA 1936 applies to deny an exemption if the foreign earnings are exempt from tax in the foreign country only because of one or more of the following reasons:

• a double tax agreement with Australia or a law giving effect to a double tax agreement;

• the foreign country does not impose income tax on employment or personal services income, or similar income; or

• a law of the foreign country or an international agreement to which Australia is a party, which deals with diplomatic or consular privileges and immunities, or privileges and immunities for people connected with international organisations (such as the United Nations).

For example, an exemption may be denied where the foreign earnings are exempt from tax in the foreign country only because of the operation of a double tax agreement.

However, subsection 23AG(2) of the ITAA 1936 does not apply to deny an exemption if the foreign earnings are exempt from tax in the foreign country for a reason other than, or in addition to, those listed above. For example, the income may be exempt in the foreign country because of the application of a double tax agreement and because of an agreement between the government of that country and an international aid organisation.

There is no tax treaty, Memorandum of Understanding or Agreement of Co-operation for development in existence between Australia and country X.

You believe that as you were paid in Australia in AUD, country X does not impose tax on that income. In addition, you state that the reason you were not paid in country X was because the banking system is so primitive that the Australian Government had not way of making payments. You had to personally transfer funds to country Y (incurring fees) and then arrange the conversion into country X currency.

We refer to Taxation Determination TD 2005/14 Income tax: does subsection 23AG(2) of the Income Tax Assessment Act 1936 apply where foreign earnings are exempt from tax in a foreign country for one or more of the reasons listed in that subsection and there is no additional reason for exempting that income? This TD examines subsection 23AG(2) of the ITAA 1936. Paragraph 6 states that where foreign earnings are exempt from foreign tax only because of one or more of those reasons listed in subsection 23AG(2) of the ITAA 1936, the exemption in subsection 23AG(1) of the ITAA 1936 does not apply and those earnings will be subject to Australian tax.

Paragraph 23AG(2)(d) of the ITAA 1936 applies to deny you an exemption from income tax in Australia. As you have pointed out, your foreign earnings are exempt from tax in country X under section 26(a) of the relevant tax act:

26. The following amounts are exempt from income tax-

a) the official employment income of an individual who is not a citizen of country X, not engaged in country X or who is a diplomatic or consular employee;

 b) the official employment income of an individual who is not a citizen of country X and who is in the public service of the government of a foreign country where the income is subject to income tax in that country;

 c) the official employment income of an individual who is not a citizen of country X and who is an employee of a public international organisation the income of which is exempt from taxation under section 8; and

 d) foreign-source income derived by a person whose official employment income is exempt under paragraph (a),(b) or (c) or by a member of the immediate family of such a person.

Accordingly, the foreign employment income you derive from country X is assessable in Australia under subsection 6-5(2) of the Income Tax Assessment Act 1997.