Edited version of your written advice

Authorisation Number: 1051332624739

Date of advice: 30 January 2018

Ruling

Subject: National insurance payments

Question 1

Are you entitled to a deduction for the National Insurance Contributions (NICs) that you have paid as a result of earning in excess of the specified amount per week?

Answer:

No.

Question 2

Are payments of the Country X’s NICs a ‘substantially similar tax’ imposed under the law of Country X for the purposes of article Y of the Convention between the Government of Australia and the Government of Country X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains (Country X Convention)?

Answer:

No

Question 3

Are payments of Country X NICs foreign income tax for the purposes of subsection 770-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 4

Can you claim a foreign income tax offset under subsection 770-15(1) of the ITAA 1997 for the NICs deducted from your Country X employment income?

Answer:

No

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commenced on:

DDMMYY

Relevant facts and circumstances

In Country X the relevant authorities determine that tax and National Insurance are separate, although both are deducted as a percentage of your gross pay depending on the amount of income earned.

The tax you would pay in Australia would contribute to unemployment and maternity allowances etc – this is called tax in Australia.

In Country X this happens to be called a National Insurance.

In Australia the portion of your tax that goes towards unemployment benefits, for example, is not deducted from the total amount of tax you pay in the financial year which would therefore understate the amount of tax, as a portion of your salary, you have paid.

This is in fact what happens in Country X. The amount of National Insurance (and therefore the amount that you contribute towards unemployment schemes, maternity schemes etc) is not included in your total tax paid for the income year. Therefore this understates the amount of actual tax you pay.

You are unable to provide a payslip showing a breakdown of the National Insurance you have paid into the separate categories.

Your arguments and references

You provided some observations regarding the examples of rulings that have previously issued on this matter:

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 770-10(1)

Income Tax Assessment Act 1997 subsection 770-15(1)

International Tax Agreements Act 1953 section 4

International Tax Agreements Act 1953 section 5

Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 article 2(2)

Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 article 22

Social Security Contributions and Benefits Act 1992 (UK) paragraph 1(1)(a).

Reasons for Decision

Question 1

The general deduction provision in section 8-1 of the Income Tax Assessment Act 1997 (ITAA97) allows a deduction for a loss or outgoing to the extent it is:

1. incurred in gaining or producing the taxpayer's assessable income (the ‘first limb’), or

2. necessarily incurred in carrying on a business for the purpose of gaining or producing the taxpayer's assessable income (the ‘second limb’).

The first limb of is available to all taxpayers, whether in business or not. The second limb applies only where the taxpayer is carrying on a business.

Various tests have been developed by case law to explain the connection (the ‘nexus’) between a loss or outgoing and the production of assessable income that is required to justify deductibility.

To claim a deduction under section 8-1 it is necessary to establish some link or nexus between the loss or outgoing and the production of assessable income (in the case of the first positive limb) or the carrying on of a business for the purpose of producing assessable income (in the case of the second positive limb). The necessary link or nexus is sometimes referred to as a ‘sufficient connection’. This requires that the loss or outgoing:

1. be ‘incidental and relevant’ to the taxpayer ' s income producing/business operations (Ronpibon Tin NL v FC of T (1949) 8 ATD);

2. have the ‘essential character’ of an income producing/business expense (Lunney v FC of T; Hayley v FC of T (1958) 11 ATD 404); or

3. have a ‘perceived connection’ with the gaining or producing of income (FC of T v Hatchett 71 ATC 4184).

In general terms, a deduction is allowed where the expenditure is necessary and has been incurred to enable or assist a taxpayer in their current income producing activities. The National Insurance contributions (NIC) are not incurred as an expense that facilitates your ability to carry out your employment. The expense is too general in that the nature of your income producing activities would not affect your liability to the NIC.

The connection between the NIC and your income-earning activities does not exist and you are therefore not entitled to claim a deduction.

Question 2

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The Country X Convention is listed in the Agreements Act. The Country X agreement prescribes methods of elimination of double taxation:

1. Subject to the provisions of the laws of Australia from time to time in force which relate to the allowance of a credit against Australian tax of tax paid in a country outside Australia (which shall not affect the general principle of this Article):

(a) Country X tax paid under the laws of Country X and in accordance with this Convention, whether directly or by deduction, in respect of income or gains derived by a person who is a resident of Australia from sources in Country X shall be allowed as a credit against Australian tax payable in respect of that income.

The term Country X tax is defined to mean tax imposed by Country X being tax to which the Country X Convention applies by virtue of Article Y. The existing taxes are specified to be income tax, the corporation tax and the capital gains tax.

National Insurance Contributions

National Insurance is a scheme introduced in Country X where people working there make contributions towards certain benefits including state pensions, jobseeker’s allowance, maternity allowance and bereavement benefits NICs must be made in order to qualify for the benefits of National Insurance. There are certain requirements to pay NICs if you are a certain age or older, an employee earning above a specified amount, or self-employed and making a profit of a specified amount or more a year.

The amount of potential state pension one receives is based on their NIC record over their working life until they reach pension age and not everyone gets the same amount. If one does not have enough contributions or credits for enough years to get a full state pension, they may be eligible for a reduced rate pension. Furthermore, taxpayers are able to pay voluntary contributions to fill in any gaps in their National Insurance record so as to increase their state pension amount due to reasons such as being employed with low earnings or living abroad.

The Country X Convention states:

This Convention shall also apply to any identical or substantially similar taxes which are imposed under the federal law of Australia or the law of Country X after the date of signature of this Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any substantial changes that have been made in the law of their respective States relating to the taxes to which this Convention applies within a reasonable period of time after those changes.

There are significant differences between NICs and Country X income tax. NICs and income tax are managed by the department responsible for the collection of taxes in Country X; this does not mean they are both taxes. The ATO similarly collects payments that are not taxes such as HELP repayments; this does not class such payments as taxes.

As stated by Deputy President Alpins in Confidential and Commissioner of Taxation [2014] AATA 961 (23 December 2014) [67] (Case 8/2014), ‘what matters in that regard is not the conduit used, but rather the destination of the funds and the purposes for which they may be used’.

In Country X, NICs are paid into the National Insurance Fund (NIF) to provide unemployment benefits, sickness benefits, retirement pensions and other benefits in cases where individuals meet the contribution and other qualifying conditions, while income tax flows into general revenue. Therefore, the specific use of the NIF is distinct from the general use of the monies in the consolidated fund.

Additionally, in line with paragraph 68 of Case 8/2014, although the imposition of NICs and Country X income tax are both compulsory and imposed by law, this does not assist in determining that NICs are a substantially similar tax to income tax. The fact that both are managed by the relevant authority does not indicate a substantial similarity to an income tax.

While the value of an individual’s contributions in terms of potential benefits is not linked to the NICs paid, whether or not an individual gets the full state pension is affected by any gaps in years of contributions. Case 8/2014 stated that despite the fact that contributors might not receive benefits proportional to their contributions or might not receive benefits at all; there could still be a direct connection between the contributions and the benefits received as long as such an entitlement arises by virtue of making the requisite contributions.

In your case, it is immaterial that there is no individual fund because entitlement to the benefits is limited to those who contribute, such as yourself. A paragraph 1(1)(a) of a legislative Act of Country X states that the funds required for paying the benefits under the Act, or any other Act, are payable out of the National Insurance Fund and not out of other public money. The types of benefits that contributors are entitled to are also dependent on the class of NICs paid.

Lastly, entitlement to a contributory benefit depends on how long a contributor has paid in NICs. For these reasons, it is sufficient to conclude that there is a direct connection between the NICs and the benefits that flow from such contributions.

Just like the applicant in Case 8/2014 who was not entitled to benefits due to being a non-resident of Ireland, you are not entitled to the benefits stemming from NICs because you are not a Country X resident. However, in line with Case 8/2014, the character of NICs cannot be classed differently for you as compared to other contributors merely because your own circumstances are different.

Paragraph 3 of the OECD Model Tax Convention on Income and Capital 2014 (Model Tax Convention) commentary on Article 2 concerning taxes covered in the Convention states:

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 not be regarded as “taxes on the total amount of wages”.

In your case, there is a direct connection because entitlements to benefits such as pension arise if a recipient has made NICs and the benefits are funded by such contributions. The allowance of tax offsets provided in the Country X Convention does not extend to NICs.

NICs are covered by the operation of Country X’s tax avoidance legislation, however it must be noted that NICs are not referred to as a tax in any legislation, and rather are referred to purely as contributions to the National Insurance Fund.

Therefore NICs are not a substantially similar tax to Country X income tax for the purposes of the Country X Agreement.

Question 3

Summary

Payments of the Country X NICs are not foreign income tax for the purposes of subsection 770-15(1) of the ITAA 1997.

Detailed reasoning

According to subsection 770-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997), to count towards a foreign income tax offset, foreign income tax must be imposed under a law other than an Australian law and be:

● a tax on income; or

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

● any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953.

The foreign income tax offset rules are designed to protect you from the double taxation that may arise where you pay foreign tax on income that is also taxable in Australia. This is achieved by allowing you to claim a tax offset where you have paid foreign tax on amounts included in your assessable income.

Paragraph 5 of Taxation Ruling IT 2437 Income tax: foreign tax credit system- foreign taxes eligible for credit against Australian income tax explains that foreign tax must be imposed on a basis substantially equivalent to that on which the Income Tax Assessment Act operates. This means that it must be imposed on the basis of a taxpayer’s net income or gains, whether of an income or capital nature.

NICs in Country X are taken out by the employer before employees get paid. This is not taken out based on a taxpayer’s net income. This means that NICs are not ‘imposed on a basis substantially equivalent to that on which the Income Tax Assessment Act operates’ and thus does not qualify as foreign income tax.

This is further supported by the commentary in the OECD’s Model Taxation Agreement that social security charges such as NICs shall not be regarded as taxes on the total amount of wages.

According to subsection 770-15(1) of the ITAA 1997, to count towards a foreign income tax offset, foreign income tax must be imposed under a law other than an Australian law. As explained in the foreword of the review, it was merely discussing if the alignment of Income Tax and National Insurance was a realistic idea. Its recommendations have not been given legislative force nor implemented into the operation of the collection of NICs. While NICs are imposed under the Country X Act, this is not sufficient to qualify as a foreign income tax imposed under a law other than an Australian law for the reason that NICs are not foreign income tax.

NICs are therefore not a foreign income tax for the purposes of subsection 770-15(1) of the ITAA 1997.

Question 4

Summary

You cannot claim a foreign income tax offset under subsection 770-15(1) of the ITAA 1997.

Detailed reasoning

The payments taken directly from your Country X salary as a contribution to the Country X National Insurance are not a tax on income, or a tax on profits or gains, or a tax that is subject to an agreement covered by the International Tax Agreements Act 1953.

Therefore, you are not entitled to a foreign income tax offset pursuant to subsection 770-15(1) of the ITAA 1997 for the NIC amounts taken directly from your Country X salary. Further the Country X convention only applies to substantially similar taxes imposed after the signing of the convention on DDMMYZ; NICs have been required under Country X legislation since well before 2003.

Therefore NICs are not a substantially similar tax to the Country X income tax for the purposes of the Country X Convention.