Edited version of private advice

Authorisation Number: 1051745281840

Date of advice: 25 August 2020

Ruling

Subject: Foreign service - taxation obligations for locally engaged staff

Question 1

Does the entity have a PAYG Withholding obligation to withhold from salary or wages paid to employees who have been engaged, or are taken to have been engaged, in foreign service for a continuous period of not less than 91 days, who have returned to Australia due to COVID-19 and continue to provide services to the same foreign clients remotely whilst they are located in Australia (Australian services)?

Answer

Yes

Question 2

Does the entity have a PAYG Withholding obligation to withhold from salary or wages paid to employees who have been engaged, or are taken to have been engaged, in foreign service for a continuous period of less than 91 days, who have returned to Australia due to COVID-19 and continue to provide Australian services?

Answer

Yes

Question 3

Does the entity have an FBT liability in relation to any fringe benefits it provides to employees covered by Questions 1 and 2?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 20XX

Income year ended 30 June 20XX

Fringe benefits tax year ended 31 March 20XX

Fringe benefits tax year ended 31 March 20XX

The scheme commences on:

1 April 20XX

Relevant facts and circumstances

The entity runs an approved overseas project. It has employees usually based in delivery locations which are overseas for periods exceeding 91 days. Whilst overseas these employees generally satisfy the requirements for an income tax exemption of their salary and wages under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936).

As a result of the COVID-19 global pandemic, and under advisement of recommendations from the Department of Foreign Affairs and Trade (DFAT), the entity demobilised all Australian project employees.

The demobilised employees include different categories of staff for tax purposes. These include;

·         those who had previously met the 91 days foreign service eligibility requirement for the tax exemption;

·         and, those who have not yet met the 91 days foreign service eligibility requirement.

While demobilised, these employees have continued to undertake their ordinary duties that they would otherwise have been undertaking, delivering the project objectives into the various countries (to the extent they can). They have done so working remotely, ensuring that their work has the desired effect in the foreign country to the extent that is possible to do so while being physically located in Australia. The employees' substantive positions are on the approved project and it is the intention to remobilise staff as soon as it is safe for them to return to the foreign countries and international travel recommences.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 23AG

Income Tax Assessment Act 1936 subsection 23AG(1)

Income Tax Assessment Act 1936 subsection 23AG (1AA)

Income Tax Assessment Act 1936 subsection 23AG(2)

Income Tax Assessment Act 1936 subsection 23AG(6)

Income Tax Assessment Act 1936 subsection 23AG(7)

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 subsection 6-15(2)

Income Tax Assessment Act 1997 subsection 6-20(1)

Income Tax Assessment Act 1997 section 11-15

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 section 66

Taxation Administration Act 1953 section 12-35

Reasons for decision

Question 1

Summary

The entity has a PAYG Withholding obligation to withhold from salary or wages paid to employees who have been engaged, or are taken to have been engaged, in foreign service for a continuous period of not less than 91 days, who have returned to Australia due to COVID-19 and continue to provide Australian services.

Detailed reasoning

Section 12-35 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) provides that an entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee.

For the provision to apply, there must be an employee, a payment of salary, wages et cetera to an employee as a consequence of his/her employment and finally, the payment must be made by an 'entity'.

However, subsection 12-1(1) of Schedule 1 to the TAA 1953 provides that an entity need not withhold an amount under section 12-35 where the whole of the payment is exempt income of the entity receiving the payment.

The amounts received by the entity's employees are not considered to be exempt income of the employees (either under section 23AG of the ITAA 1936 or another provision) as the payments are made after the employees have returned to Australia in respect of their Australian service. The entity must withhold an amount from payments made to the recipients under section 12-35 of Schedule 1 of the TAA 1953.

Section 23AG of the Income Tax Assessment Act 1936

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, wages and allowances are ordinary income for the purposes 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 then it is not assessable income.

Subsection 6-20(1) of the ITAA 1997, relevant to this case, provides that an amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the ITAA 1936 or ITAA 1997.

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 ITAA 1936 which deals with exempt foreign employment income.

Section 23AG of the ITAA 1936 provides an exemption from Australian tax on the foreign earnings derived by an Australian resident. Subsection 23AG(1) states:

Where a resident, being a natural person, has been engaged in foreign service for a continuous period of not less than 91 days, any foreign earnings derived by the person from that foreign service are exempt from tax.

However, subsection 23AG(1AA), which applies to foreign earnings derived on or after 1 July 2009 from foreign service performed on or after 1 July 2009, provides that those foreign earnings will not be exempt under section 23AG unless the continuous period of foreign service is directly attributable to an activity that is listed in subsection 23AG(1AA).

Further, certain foreign earnings that meet the requirements of subsection 23AG(1) and 23AG(1AA) may not be exempt from tax under section 23AG if the amount is exempt from income tax in the foreign country only because of one or more of the reasons listed in subsection 23AG(2).

Accordingly, the basic tests for the exemption of foreign employment income in subsection 23AG(1) of the ITAA 1936 are:

·         the taxpayer must be a 'resident of Australia'

·         the taxpayer must be 'engaged in foreign service'

·         the foreign service must be for a 'continuous period of not less than 91 days'

·         the taxpayer must derive 'foreign earnings' from that 'foreign service'

·         the foreign service must be directly attributable to an activity that is listed in subsection 23AG(1AA), and

·         the foreign earnings must not be covered by subsection 23AG(2).

An Australian resident deriving foreign earnings from service in a foreign country may be entitled to an income tax exemption on those foreign earnings under section 23AG of the ITAA 1936. This exemption can only apply where the foreign earnings are from a continuous period of service in the foreign country that last for at least 91 days.

Any period of absence from foreign service breaks the continuity of your foreign service, unless the absence:

·         still counts as foreign service

·         does not exceed one-sixth of your total period of foreign service.

Where the employee has already completed 91 days of continuous foreign service and has met all the other requirements in section 23AG of the ITAA 1936, the foreign earnings they earned while undertaking the completed foreign service will remain exempt.

The income the employee earned after their return that is attributable from that period of foreign service will also continue to be exempt even if paid after the employees' return (for example, wages paid in arrears and paid recreation leave that accrued during the period of foreign service).

Temporary absences forming part of a period of foreign service

Subsection 23AG(6) treats certain temporary absences from foreign service as forming part of the period of foreign service. The Commissioner's view of the application of that subsection is contained in Taxation Determination TD 2012/8.

Absences which form part of the period of foreign service include absences taken in accordance with the terms and conditions of that service because of recreation, accident or illness.

'Recreation leave' is leave in the nature of paid holidays to which an employee has accrued an entitlement. Usually it is the employee's accrued annual leave. Leave which fits this description is 'recreation leave', even if it is not called this.

However, 'recreation leave' does not include:

·         leave that is not in the nature of paid holidays, such as weekends, rostered days off, flexidays, and days off in lieu

·         public holidays

·         leave wholly or partly attributable to a period of employment other than that of foreign service

·         long service leave, furlough, extended leave or similar leave, and

·         leave without pay or on reduced pay.

An employee's period of continuous foreign service will be maintained where the employee is absent from work in accordance with the terms and conditions of that foreign service due to:

·         an accident or illness of their own, or

·         an accident, illness or death of another person.

An absence from work due to accident or illness requires:

·         the person to have actually ceased work - someone is not absent from work if they are performing work, but in a different location

·         an accident or illness to have actually occurred - the situation where someone is in danger of suffering an injury or illness and the taking of preventative action is different to a situation where an accident or illness actually occurs.

Furthermore, an absence from foreign service because the employee has returned to Australia as a result of COVID-19 and commenced working in Australia is not a temporary absence from foreign service. The employee is returning without knowing when they will recommence their service in a foreign country. The employee's time in Australia also cannot be characterised as a short work-related trip.

Continuity of the period of foreign service - 1/6^th legislative rule

The 1/6^th legislative rule allows two or more continuous periods of foreign service to be treated as a continuous period of foreign service unless, at any time, the total period of absence (in days) between the period of foreign service exceeds 1/6^th of the total number of days of foreign service.[1]

However, even if two periods of foreign service are 'joined' to form a continuous period of foreign service in this way, the time that constitutes the break itself cannot be counted as foreign service. Take the example of Person A who undertakes 60 days of foreign service, then returns to Australia for 10 days and then undertakes another 40 days of foreign service. Person A will be taken to have a continuous period of foreign service of 100 days. However, this does not mean that the 10 days of the break whilst they were in Australia are foreign service - they are not.

If the period of absence exceeds 1/6^th of the total period of foreign service at any time, continuity of foreign service is broken. The employee will begin a new period of foreign service when he or she next engages in foreign service and must determine whether that period of foreign service lasts for at least 91 continuous days (subsection 23AG(6A)).

Income from Australian service

The income the employee earns from work they do whilst located in Australia will not be exempt income and will therefore be assessable to the employee in Australia. This is because:

·         the income the employee earns from work in Australia is not from service in a foreign country, and

·         the employee's return to Australia does not satisfy the criteria for their absence from foreign service to count as foreign service.

This is the case even if the employee returns to Australia and commences or continues to work in Australia on matters relating to their previous foreign service.

Ordinary meaning of foreign service

Subsection 23AG(7) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that foreign service 'means service in a foreign country as the holder of an office or in the capacity of an employee'.

Section 2 of the Acts Interpretation Act 1901 provides that this Act applies to all Acts unless a contrary intention appears. Section 2B of the Act defines foreign country as follows:

foreign country means any country (whether or not an independent sovereign state) outside Australia and the external Territories.

There is nothing contained in either section 23AG or the ITAA 1936 more generally which would suggest that there is a contrary meaning and that this meaning should not apply.

Australia is not a foreign country for the purposes of the application of section 23AG of the ITAA 1936. Therefore, service undertaken in Australia cannot be regarded as foreign service.

Indeed, in paragraph 9 of Chaudhri v Commissioner of Taxation [2001] FCA 554 (the Chaudhri case) the Full Federal Court made the following comments regarding the terms "country" and "foreign country":

Ultimately, we think that we should return to the ordinary English use of the word "country" in the context of that being a place where personal service such as employment may be engaged in and where income may be derived. In that context, ordinary usage would not suggest that the high seas, or for that matter some parts of them, were in a composite sense to be regarded as a country, or for that matter a series of countries. Rather the ordinary meaning of the expression "foreign country" in modern usage looks to a political entity, be that a tract of land, a district, or a group of islands. It does not extend to an ocean or region of the sea.

Therefore, in line with the Chaudhri case the words "foreign service" are interpreted in the ordinary sense. That is, a foreign service is a service undertaken in a foreign country where that country is not Australia.

Refer also to ATO Interpretive Decision ATO ID 2003/907 as an example where this approach has been applied in practice.

If the term 'foreign service' is replaced with its definition, subsection 23AG(1) of the ITAA 1936 reads:

Where a resident, being a natural person, has been engaged in [service in a foreign country as the holder of an office or in the capacity of an employee] for a continuous period of not less than 91 days, any foreign earnings derived by the person from that [service in a foreign country...] are exempt from tax.

It is therefore not to the point that the entity's employees have not been absent from work or that they are continuing the same service. Once they have returned to Australia, they are not engaged in service in a foreign country.

Question 2

Summary

The entity has a PAYG Withholding obligation to withhold from salary or wages paid to employees who have been engaged, or are taken to have been engaged, in foreign service for a continuous period of less than 91 days, who have returned to Australia due to COVID-19 and continue to provide Australian services.

Detailed reasoning

As discussed above, an Australian resident deriving foreign earnings from service in a foreign country may be entitled to an income tax exemption on those foreign earnings under section 23AG of the ITAA 1936. This exemption can only apply where the foreign earnings are from a continuous period of service in the foreign country that lasts for at least 91 days.

Where an employee had not yet completed 91 days of continuous foreign service, the employee's foreign earnings from that period of foreign service are not exempt and therefore will be assessable to the employee in Australia.

The income the employee earns from work they do whilst located in Australia will also not be exempt income and will therefore be assessable to the employee in Australia. This is because:

·         the income the employee earns from work in Australia is not from service in a foreign country, and

·         the employee's return to Australia does not satisfy the criteria for their absence from foreign service to count as foreign service.

Therefore, the amounts received by the entity's employees as wages, who have been engaged, or are taken to have been engaged, in foreign service for a continuous period of less than 91 days are not considered to be exempt income. As a result, the entity has a PAYG Withholding obligation under section 12-35 of Schedule 1 of the TAA 1953 to withhold from salary or wages paid to these employees both for their period of foreign service and for any service they provide in Australia.

Question 3

Summary

The entity has an FBT liability in relation to any fringe benefits it provides to the employees covered by Questions 1 and 2.

Detailed reasoning

The entity are liable to pay fringe benefits tax (FBT) in respect of staff for whom they have a PAYG withholding obligation.

In general terms, subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) provides that a fringe benefit will arise where in a year of tax there is a benefit to an employee provided by an employer in respect of the employment of the employee that is not an exempt benefit or excluded from the definition under paragraphs (f) to (s). FBT is a tax paid by employers on fringe benefits provided to their employees (or their associates) in respect of their employment.

Of relevance to the definition of fringe benefit is the meaning of employee for FBT purposes. Subsection 136(1) of the FBTAA 1986 bases the definition of employee on the receipt of salary and wages. Broadly, subsection 136(1) defines salary and wages to mean a payment from which an amount must be withheld.

The Taxation Administration Act 1953 (TAA) states at section 12-35 that, 'an entity must withhold an amount from salary, wages, commissions, bonuses or allowances it pays to an individual as an employee'.

Section 66 of the FBTAA 1986 states that fringe benefits tax imposed on any fringe benefits taxable amount is payable by the employer of the employees to whom it relates.

So, the obligations on employers for fringe benefit tax purposes hinge on the application of the PAYG withholding provisions. A fringe benefits tax liability will only arise when PAYG withholding is triggered for an employer in respect of an employee.

In addition, FBT obligations may arise in respect of benefits provided by employers to their foreign-based employees, pursuant to the FBTAA 1986. For FBT purposes, a person is regarded as an employee if the person receives salary and wages, which is in turn defined to include a payment from which an amount is withheld or should have been withheld under the PAYG withholding rules. Thus, fringe benefits provided to employees whose foreign employment income is exempt under section 23AG are not subject to FBT, but fringe benefits provided to employees whose foreign employment income is not exempt under section 23AG may be subject to FBT.

Therefore, the entity is liable for any fringe benefits tax that arises in respect of fringe benefits they provide to their employees:

·         all employees covered by question 1 - the time they perform Australian service

·         all employees covered by question 2 - both the time they performed foreign service and the time they performed Australian service.

[1]See Example 13 of TD 2012/8