Edited version of your written advice

Authorisation Number: 1051214677738

Date of advice: 20 April 2017

Ruling

Subject: Employee share scheme - International - Returning to Australia after Grant

Question 1:

Is the discount on rights you acquired under an employee share scheme while you were a foreign resident of Australia for taxation purposes included in your assessable income to the extent that the amount relates to your employment outside Australia?

Answer:

Yes.

This ruling applies for the following periods:

2014-15 income year

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian citizen.

You left Australia and ceased to be an Australian resident for income tax purposes some X years ago.

About X years ago, whilst residing overseas, you commenced employment with company A.

Whilst continuing to reside overseas, you were granted rights from company A. These rights were awarded under the respective 2012 and 2013 Performance Share Plans.

Each right issued under either the 2012 or 2013 Performance Share Plan is an Employee Share Scheme (ESS) interest under section 83A-10 of the Income Tax Assessment Act 1997 (ITAA 1997) being a right to acquire a beneficial interest in an ordinary share.

The ESS interests granted under the 2012 and 2013 Performance Share Plans qualify for deferral under Subdivision 83A-C of the ITAA 1997. Based on the facts of the Plans, taxation was deferred until the date they vested.

Before the vesting date, you re-commenced Australian residency when you relocated back to Australia and commenced employment with an Australian subsidiary of company A.

The rights that you were granted in 2012 and 2013 vested on [dates specified] after you had commenced residing back in Australia.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6,

Income Tax Assessment Act 1997 Division 83A,

Taxation Administration Act 1953 Section 4 and

Foreign Country/Australia Double Tax Agreement Article 11.

Reasons for decision

Summary

The discount on rights you acquired under an employee share scheme while you were a foreign resident of Australia for taxation purposes is included in your assessable included in your assessable income to the extent that the amount relates to your employment outside Australia.

Detailed reasoning

The provisions of Australia's domestic tax laws are relevant to this case as are the provisions of the Agreement to avoid double taxation between the Foreign Country and Australia (the Double Tax Agreement).

While both sets of provisions technically apply at the same time to a particular situation, it is often easier to apply them in practice if Australia's domestic tax law is considered first. (See paragraph 43 to 45 of Taxation Ruling TR 2001/13.)

The employee share scheme provisions - general operation

The employee share scheme provisions that apply for the 2014-15 income year are contained in Division 83A of the ITAA 1997.

The basic operation of the employee share scheme provisions for an individual who has always been an Australian resident are not in doubt.

In your case, the 2012 and 2013 Performance Share Plans are deferral schemes and the deferred taxing points have occurred when the rights vested.

The employee share scheme provisions - foreign service

The actual liability to tax on employee share scheme discounts is determined by Division 83A of the ITAA 1997 in concert with Division 6 of the ITAA 1997.

Both subsections 83A-25(2) and 83A-110(2) of the ITAA 1997 merely define the component of an employee share scheme discount that relates to foreign employment as having a foreign source.

As statutory income, the actual amount to be included in assessable income is determined by either subsection 6-10(4) of the ITAA 1997 for Australian residents or subsection 6-10(5) of the ITAA 1997 for foreign residents.

Paragraphs 1.347 to 1.357 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 confirm this intention and state:

1.347 Consistent with the treatment of most other types of income, whether an amount is included in a taxpayer's assessable income under the new employee share scheme rules will depend on the taxpayer's residency status and the source of the income.

1.348 Under the core rules of the Australian income tax system, an Australian resident taxpayer is subject to income tax on their worldwide income. A foreign resident taxpayer is only subject to Australian income tax on their Australian sourced income.

1.349 Under the existing law, this outcome is achieved by excluding discounts from interests acquired under employee share schemes from tax under the employee share scheme tax rules, to the extent that they relate to foreign service of a taxpayer.

1.350 This mechanism operates in a manner inconsistent with core rules. The new rules use the core rules to achieve the desired outcome. The new rules instead include source rules and rely on the core rules to the exclude foreign sourced income of foreign residents from Australian income tax. That is, the employee share scheme rules attribute a source to discounts received on securities acquired under employee share schemes.

1.351 To the extent that a discount on an ESS interest relates to employment outside Australia, the discount is taken to be from a foreign source. In the case of an ESS interest that is subject to a deferred taxing point, it is the amount included in your assessable income that is attributed a source (that is, both the discount and subsequent gains are attributed with a source). The attribution is done in manner consistent with the rule applying to discounts. [Schedule 1, item 1, subsections 83A-25(2) and 83A-110(2)]

1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005.

1.353 Source is attributed to amounts 'included' in assessable income either upfront or under the deferral method at the ESS deferred taxing point. The inclusion in assessable income is merely notional as all amounts included in assessable income must pass through the core rules before being taken into account in the calculation of taxable income. At this time foreign sourced income of foreign residents will be removed from the calculation of taxable income.

1.354 Whether the discount on the ESS interest acquired under an employee share scheme relates to employment in Australia or outside Australia is a question of fact that needs to be determined on a case-by-case basis.

1.355 Australian resident taxpayers are subject to Australian income tax on all discounts they receive under employee share schemes regardless of whether they received it in relation to employment in Australia or outside Australia. However, this may be affected by Australia's double tax treaties and the temporary residents rules.

1.356 Foreign resident taxpayers are only subject to Australian income tax on discounts they receive under employee share schemes to the extent that the discount relates to the employment in Australia. The core rules are contained in sections 6-5 and 6-10 of the ITAA 1997.

1.357 The outcome effectively mirrors the tax treatment of employment income. It has been necessary to modify the treatment of employee share scheme discounts received in respect of employment outside Australia in order to bring the employee share scheme rules into closer alignment with the ordinary treatment of salary and wage income and to prevent taxpayers avoiding the recent changes to section 23AG of the ITAA 1936 (exemption for foreign employment income).

The first argument that you have advanced in your submission about why the foreign source portion of the employee share scheme discount shouldn't be assessable in Australia seeks to continue the exemption that applies to the foreign source portion for grants before 1 July 2009.

That exemption doesn't apply to grants after 30 June 2009.

You were an Australian resident as at both of the deferred taxing points identified for this private ruling for the 2012 and 2013 Performance Share Plans. Therefore, the whole of the employee share scheme discounts that relate to these deferred taxing points is to be included in your assessable income under Divisions 6 and 83A of the ITAA 1997.

The Double Tax Agreement - Income from employment

The Double Tax Agreement provides a mechanism for achieving fairness in respect of income that may be taxable in both the Foreign Country and Australia.

Paragraph 1 of Article 11 of the Double Tax Agreement states:

Subject to this Article and to Articles 12, 13 and 14 remuneration or other income derived by an individual who is a resident of one of the Contracting States in respect of personal (including professional) services shall be subject to tax only in that Contracting State unless the services are performed or exercised in the other Contracting State. If the services are so performed or exercised such remuneration or other income as is derived therefrom shall be deemed to have a source in, and may be taxed in, that other Contracting State.

Article 17 of the Double Tax Agreement states:

Profits, income or gains derived by a resident of one of the Contracting States which, under any one or more of Article 4A, Article 5, Articles 7 to 14 and Article 16A, may be taxed in the other Contracting State shall for the purposes of Article 18 and of the laws of the respective Contracting States relating to tax be deemed to be income from sources in that other State.

Paragraph 4.6 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 states:

4.6 The OECD commentary on the articles of the model tax convention is relevant in interpreting Australia's tax treaties. The revised commentary treats the benefit accruing up to the exercise of a right as an employment benefit to which Article 15 (Income from Employment) of the model tax convention applies. The commentary recognises that the facts and circumstances of the particular case will determine the period of employment to which the right relates. The number of days worked in a treaty country during this employment period then determines the extent of that country's source taxing rights.

Paragraph 2.2 of the OECD Commentary on Article 15 (about employment) states:

'The condition provided by the Article for taxation by the State of source is that salaries, wages or other similar remuneration be derived from the exercise of employment in that State. This applies regardless of when that income may be paid to, credited to or otherwise definitively acquired by the employee.'

The second argument that you have advanced in your submission as to why the foreign sourced portion of the employee share scheme discount shouldn't be taxable in Australia seeks to apply Article 11 of the Double Tax Agreement at a time when you were still a resident of the Foreign Country.

You have placed considerable emphasis on analysis of the OECD Commentary about Double Tax Agreements and the explanatory memoranda supporting the employee share scheme amendments in 2005 and 2009. However, the discussion points you have raised are focussed on determining the earning period as a component of the method used to give a source to the employee share scheme discount.

It has already been accepted that the employee share scheme discount for the 2014-15 income year has both Australian and foreign components and therefore in part has a foreign source which is considered to be foreign source income for the purpose completing your income tax return.

Article 11 of the Double Tax Agreement is applied at the time the discount is assessable under Australian law. At that time, you were an Australian resident in receipt of employee share scheme discounts that had both Australian and the Foreign Country sources.

The Commissioner has considered the application of these matters previously and issued Class Ruling CR 2013/9 which focussed on the extent to which foreign income tax offsets are claimable. It concludes at paragraph 18 that:

18. The ESS interests granted after 30 June 2009 meet the conditions for deferred taxation under Subdivision 83A-C. Consequently, there will be no tax payable on the discount until the earliest deferred taxing point. As the participant is a resident of Australia at the time of the deferred taxing point, his or her assessable income in Australia includes the whole gain on the ESS interests as at the deferred taxing point.

Consequently, the ATO is not prevented by the Double Tax Agreement from taxing the whole of the employee share scheme discount as you are a resident of Australia at our taxing point.

Note: Division 770 of the ITAA 1997 allows you to claim a foreign income tax offset in relation to the portion of the employee share scheme discount that was subject to tax in the Foreign Country. (See Class Ruling CR 2013/9.)