Edited version of your written advice

Authorisation Number: 1013130030057

Date of advice: 2 December 2016

Ruling

Subject: Overseas employment income

Questions and Answers

1. Are you entitled to a deduction for employment insurance contributions in connection with your employment as an educator in Country A?

Yes.

2. Are you entitled to a foreign income tax offset in respect of income tax and local tax paid in Country A, subject to the limits imposed in Division 770 of the Income Tax Assessment Act 1997?

Yes.  

3. In translating the amounts on your Country A salary statement into Australian dollars, can you use an average rate of tax?

Yes

This ruling applies for the following period(s)

Year ended 30 June 20YY

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You worked in Country A as an educator for more than 12 months.

You have supplied a few monthly salary statements. The following deductions were made from your salary:

Apartment rent

Income tax

Employment insurance

Health insurance

Pension insurance

Local tax

Local tax withholding savings plan

Tax adjustment

Total deductions

Your employer in Country A sent you the following email when you asked for an explanation of the items on your salary statement:

Income tax is tax charged on your income. Employment insurance is national insurance to help you receive some money while you are unemployed. Pension insurance is a national insurance to help you receive some money after one reaches 65 years old. You can claim refund your payment to the insurance after you leave Country A. Please refer to the paper guidance we gave you. Local tax is national tax charged on your income from the previous year. Local tax withholding savings plan is a foreign educator's money saving program to help educators pay local tax charged required by their local government when they leave their employment or Country A

Your employer was not able to provide you with information specific to you regarding 'Local tax withholding savings plan' and 'Tax adjustment'

With regard to the Local tax withholding savings plan, you advised that you did not pay any taxes when you left Country A.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 770-10.

Income Tax Assessment Act 1997 subsection 770-15

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 960

International Tax Agreements Act 1953

Reasons for decision

Foreign income tax offset

A taxpayer whose assessable income in Australia is also subject to foreign income tax and who has, or is deemed to have, paid the foreign income tax in the income year is entitled to a foreign income tax offset (FITO) in Australia under section 770-10 of the Income Tax assessment Act 1997 (ITAA 1997).

The concept of 'foreign income tax' is intended to cover foreign taxes imposed on a basis that is substantially equivalent to income tax imposed under Australian law.

'Foreign income tax' is defined in section 770-15 of the ITAA 1997 as a tax imposed by a law other than an Australian law that is:

● tax on income; or

● tax on profits or gains, whether of an income or capital nature; or

● any other tax, being a tax that is subject to an agreement having the force of law under the International Tax Agreements Act 1953.

The Country A double tax agreement (Country A Agreement) is a relevant agreement under the International Tax Agreements Act 1953.

Article m of the Country A Agreement provides that salary, wages and other similar remuneration derived by a resident of Australia shall be taxable only in Australia unless the employment is exercised in Country A in which case it may also be taxed in Country A.

Article n of the Country A Agreement states the existing taxes to which the Agreement shall apply, are as follows:

● Country A taxes that are specifically identified in the Country A Agreement are income tax and corporation tax.

● Australian taxes that are specifically identified in the Country A Agreement are income tax and the petroleum resource rent tax.

In interpreting the wording of a tax treaty, the Commissioner in Taxation Ruling TR 2001/13 entitled Income tax: Interpreting Australia's Double Tax Agreements accepts that it is appropriate to have reference to the OECD Model Commentary.

The OECD Commentary on Article m provides that:

● It is immaterial on behalf of which authorities such taxes are imposed; it may be the State itself or its political subdivisions or local authorities (constitutes States, regions, provinces, department, cantons, districts…municipalities or groups of municipalities, etc)

● Social security charges or any other charges paid where there is a direct connection between the levy and the individual benefits to be received' shall be excluded from the list of taxes covered by the Convention.

The Commissioner also published a list of foreign taxes that were eligible for a credit against Australian tax payable under the former foreign tax credit system in Income tax ruling IT 2507. In respect of Country A foreign taxes eligible for a foreign tax credit were listed as:

● Income tax

● Corporations tax

● Enterprise tax, as payable on profits or income

● Local (prefectural or municipal) inhabitant taxes, so far as payable on profits, income or chargeable gains from sources in Country A.

The list in IT 2507 was not meant to be exhaustive. The ruling has not been withdrawn. Therefore, in considering whether an amount deducted from your salary is a 'foreign income tax', it is necessary to consider the basis on which the amount is deducted and any future benefit you might derive in respect of the amount. Substantial, not exact, equivalence to Australian income tax is required.

Income tax deduction

An amount withheld from your salary may not be foreign income tax but may be incurred by you in gaining or producing the assessable salary income. To determine if a withheld amount is deductible for the purpose of determining Australian taxable income, the ordinary tests of deductibility apply. (section 8-1 of the ITAA 1997).

An amount is allowed as a deduction if it is directly related in earning assessable income. The amount must not be a private, domestic or capital expense.

We shall now consider each of the items on your salary statement and consider whether each item is eligible for a FITO or a tax deduction. We shall refer to the amounts shown on your salary statement.

Items on your salary statement

Income tax

Your salary statement an amount described as 'Income tax'.

As 'Income tax' is specifically identified within the Country A Agreement, you are entitled to a FITO in respect of 'Income tax' paid in Country A subject to the limits imposed by Division 770 of the ITAA 1997.

Local tax

Your statement includes an amount described as 'Local tax'. According to a Specific Taxation booklet, individual income taxes in Country A consist of national income tax and local inhabitant tax.

National income tax is a tax on the income derived by individual taxpayers in Country A. Progressive tax rates are applied on the net of assessable ordinary income minus allowable deductions and personal reliefs. We consider this is the 'Income tax' amount on your salary statement.

Local inhabitant tax (a collective term for prefectural and municipal tax) is assessed by the municipal governments on individuals who reside or have domicile in Country A as of 1 January each year, based on income from the preceding year. We consider this is the 'Local tax' amount on your salary statement.

Local inhabitant tax consists of two levies:

● Per capita levy - a small levy imposed regardless of the amount of income

● Income based levy - a more significant tax based on upon the taxable income of the individual.

Although 'Local tax' is not specifically identified within the Country A Agreement, it is a tax on income by local authorities (ie municipalities) in Country A. In accordance with the OECD Commentary, 'Local tax' is a tax covered by the Country A Agreement as taxes can be imposed on income by the State (ie. National) or Local authorities. 'Local tax' is therefore a 'foreign income tax' as defined in section 770-15 of the ITAA 1997.

In addition, Local (prefectural or municipal) inhabitant taxes were identified as foreign taxes eligible for a foreign tax credit under the former rules in IT 2507. Your are therefore entitled to a FITO in respect of 'Local tax' paid in Country A subject to the limits imposed by Division 770 of the ITAA 1997.

Employment insurance

Your salary statement includes an amount described as 'Employment insurance'.

Generally, all employers in Country A are required to enrol their employees in the Employment Insurance scheme. Employment insurance provides benefits to employees for a limited period of time if they become unemployed because of redundancy, the end of a contract, or being dismissed.

To receive employment insurance, employees must pay insurance premiums which are set at a percentage of their total wage. The premium is shared between the employer and employee.

Employment insurance' contributions appear to be similar to income protection insurance in Australia, though compulsory. Premiums for income protection insurance which provides periodic benefits are deductible under section 8-1 of the ITAA 1997:

It is accepted that, as the 'Employment insurance' contributions are analogous to income protection insurance premiums, they are deductible from assessable income to the extent that they may provide you with future periodic (that is, not lump sum) benefits.

Health insurance

Your salary statement includes an amount described as 'Health insurance'.

Information available on a website states that 'Approximately an amount of x per month (approximately y of which is refundable) is deducted from the educator's salary for membership in the Social Insurance System'.

Companies generally provide annual health check-ups to their employees for free. Municipal public health centres also provide free check-ups for residents or at a minimal cost.

As previously stated, where a person makes a compulsory contribution to a levy (or a social insurance scheme as is the case here) which will be used to provide benefits to that person in the future, that contribution is more akin to a payment for a benefit rather than a tax. However, it is recognised that an element of Australian income tax is Medicare Levy.

Medicare gives Australian residents access to a range of medical services, lower cost prescriptions and free care as a public patient in a public hospital. It is partly funded by taxpayers who pay a Medicare levy of 2% of their taxable income. However, all Australian residents are eligible for Medicare benefits regardless of whether they pay the levy or not. Also, the level of benefits Australian residents are entitled to has no bearing on the amount of Medicare levy they pay.

It is considered that Health insurance is more akin to private health insurance in Australia. 'Health Insurance' on your salary statement is not substantially equivalent to a tax on income such as the Medicare levy.

Therefore, 'Health Insurance' is not considered to be a 'foreign income tax' paid when working out your entitlement to a FITO.

As private health insurance premiums are not deductible in Australia, these amounts are likewise not deductible.

Pension insurance

Your salary statement includes an amount described as 'Pension insurance'.

As per information available on a website, if an individual has Employee's Health Insurance they are also required by law to join the Employee's Pension Insurance Scheme. The website provides the following information:

● As with the Health Insurance, the premiums for Pension Insurance are deducted monthly from the employee's salary.

● Generally, after 25 years of contributions, an individual can claim a regular retirement pension once they retire, even if they spend their retirement outside of Country A.

● Non-Country A citizens who have made more than 6 months' worth of contributions can apply for a lump-sum withdrawal payment of their pension contributions within two years of leaving Country A.

The amount of the retirement pension is calculated according to the amount of insurance premiums paid and the length of the period over which they were paid. The amount of the premiums refunded to a non-Country A citizen who leaves Country A is calculated in a similar manner.

Your entitlement to a retirement pension (or refund of her pension contributions) is determined according to your contribution period and quantum of those contributions. 'Pension insurance' contributions are therefore not substantially equivalent to Australian income tax but are analogous to the superannuation contributions required to be withheld from the salary or wages of Australian employees. As such, they are not a 'foreign income tax' or deductible from assessable income.

Local tax withholding savings plan and Tax adjustment

Your salary statement includes amounts described as 'Local tax withholding savings plan' and a 'Tax adjustment'. With regard to the local tax withholding savings plan, your employer in Country A has advised:

Local tax withholding savings plan is a foreign educator's money saving program to help educators pay local tax charged required by their local government when they leave their employment or Country A.

The payslips you have provided do not provide any further details of the local taxes paid when leaving Country A and/or if there were any adjustments made on your final salary statement (for example, whether any amounts previously deducted as local tax withholding savings plan were refunded to you).

You requested your employer for more information on the Local tax withholding savings plan and Tax adjustment, but were not provided with a response.

In the absence of any further information, our position is that the amounts deducted as Local tax withholding savings plan do not appear to be a tax paid to the local government at the time it was deducted from your salary. However, if you were required to pay local tax on leaving Country A, a tax offset would be allowable in respect of the local tax actually paid. You have advised that you did not pay any taxes on leaving Country A. On this basis no tax offset is allowable. Also, as there no indication that the compulsory contribution is a deductible expense in gaining or producing your assessable salary income, no deduction is allowable.

We are not able to comment on the 'Tax adjustment' shown on your salary statement as we do not have sufficient information.

Converting amounts from Country A currency to Australian dollars

Division 960 of the ITAA 1997 deals with the foreign currency conversion rules. Basically the foreign exchange regulations have been made which may allow for the translation of foreign currency into Australian currency using:

● average rate

● daily rates, or

● rates consistent with the rates used in the preparation of an audited financial report.

Summary

FITO

You are entitled to a FITO in respect of 'Income tax' and 'Local tax' paid in Country A subject to the limits imposed by Division 770 of the ITAA 1997. The FITO is a non-refundable tax offset which reduces your income tax payable.

Under the tax offset ordering rules, the FITO is applied after all other non-refundable tax and non-transferable offsets. Once your tax payable has been reduced to nil, any unused foreign income tax offset is not refunded to you, nor can it be carried forward to later income years.

If claiming a foreign income tax offset of more than $1,000, you will first need to work out your foreign income tax offset limit. Details of how to calculate the FITO are contained in the Guide to foreign income tax offset rules 2015-16 which is available on our website (QC48121).

Tax deduction

You are entitled to a deduction under section 8-1 of the ITAA 1997 for 'Employment insurance' contributions paid to the extent that they may provide the taxpayer with future periodic (that is, not lump sum) benefits.

Other items listed on your salary statement

For the reasons discussed above and based on the current information available, contributions towards 'Health insurance', 'Pension insurance' and 'Local tax withholding saving plan' are not considered to be a 'foreign income tax' when working out your entitlement to a FITO. They are also not allowable deductions under section 8-1 of the ITAA 1997.

Foreign currency exchange rate

In converting amounts into Australian dollars, you may use the average exchange rate.