Edited version of private advice

Authorisation Number: 1052114000885

Date of advice: 25 May 2023

Ruling

Subject: International - assessable income

Question 1

Is the bonus payment received assessable in Australia?

Answer

Yes.

Question 2

Are the salary payments received assessable in Australia?

Answer

Yes.

Question 3

Is the ESS discount on deferral schemes relating the ESS interests that vested assessable in Australia?

Answer

Yes.

Question 4

Is the leave payout received assessable in Australia?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The taxpayer country of origin is Country Z

The taxpayer is a citizen of Country Z and Australia.

In XX/XX/20XX, the taxpayer commenced employment with an Australian employer.

The taxpayer was an Australian resident for tax purposes until the taxpayer permanently departed Australia on XX/XX/20XX to Country Z. The taxpayer ceased to be a tax resident of Australia at this time.

The taxpayer's last working day in Australia with the Australian employer was XX/XX/20XX.

From XX/XX/20XX to XX/XX/20XX the taxpayer had a Leave Without Pay (LWOP) arrangement with the Australian employer. Employment with the Australian employer was officially terminated on XX/XX/20XX.

A month after departing Australia, the taxpayer commenced employment with an employer in Country Z.

The Country Z employer is unrelated to the Australian employer.

Employment with the Country Z employer initially commenced as a 12 month contract but then became permanent. The taxpayer is taxed as a resident of Country Z under the domestic tax law of Country Z.

The taxpayer will reside overseas in Country Z permanently.

A letter from the Australian employer outlines approval of the LWOP arrangement. Key clauses include Period of Leave, Return to Work, Service and Duration, Obligations and Equity Awards.

The taxpayer received a bonus payment from the Australian employer after becoming a foreign resident. The bonus relates to work carried out with the Australian employer.

The taxpayer received salary payments from the Australian employer after becoming a foreign resident. Tax was withheld by the Australian employer for these items.

While the taxpayer was working in Australia for the Australian employer, the taxpayer participated in an ESS and was granted ESS interests in the form of Restricted Share Units (RSUs).

The ESS Vesting Report shows various ESS interests were granted each year from 20XX to 20XX.

The ESS Annual Tax Statement for the 20XX-XX income year shows Discount from deferral schemes F $XX,XXX. The statement shows RSU's fully vested in XX/XX/20XX.

A copy of the ESS plan was provided.

The Statement of Account indicates the taxpayer disposed the ESS interests on XX/XX/20XX.

The taxpayer received a final employment payment from the Australian employer after the taxpayer became a foreign resident. The final payment paid out unused holiday and/or unused long service leave.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 Subsection 83-10

Income Tax Assessment Act 1997 Subsection 83-70

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Division 83A-C

International Tax Agreements Act 1953 section 4

Reasons for decision

Question1, 2 and 4

Subsection 6-5(3) of the ITAA 1997 provides that the assessable income of a foreign resident taxpayer includes ordinary income that is sourced directly or indirectly from all Australian sources during the income year.

Subsection 6-10(5) of the ITAA 1997 provides that assessable income of a foreign resident taxpayer includes statutory income from all Australian sources.

Employment income is ordinary income for the purposes of subsection 6-5(3) of the ITAA 1997.

Generally, Australian courts have held that the source of employment income is where the employee performs their duties (C of T (NSW) v. Cam and Sons Ltd (1936) 36 SR (NSW) 544; 4 ATD 32 and FC of T v. French (1957) 98 CLR 398; (1957) 7 AITR 76; 11 ATD 288). The courts also confirmed that it is appropriate to apportion income earned to reflect the source of income. Thus, any employment income earned while carrying out duties while physically present in Australia is sourced in Australia. Employment income earned while being carried out overseas is considered to be sourced in that overseas country.

An entity derives an amount of ordinary income as soon as it is applied or dealt with in any way on the entity's behalf or as directed by it (subsection 6-5(4) of the ITAA 1997).

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1) sets out the Commissioner's view on when income is derived and explains that income can be derived either on the basis of the 'receipts' method or the 'earnings' method.

Under the 'receipts' method, income is derived when it is received, either actually or constructively, and is taken to be derived by a person although it may not actually be paid over but is dealt with on his/her behalf or as he/she directs.

Paragraph 18 of TR 98/1 states that the receipts method is likely to be appropriate to determine: income derived by an employee; non-business income derived from the provision of knowledge or the exercise of skill possessed by the taxpayer; and business income where the income is derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services (subject to certain qualifications).

Under the earnings (or accruals) method, income is derived when it is earned, and the point of derivation occurs when a recoverable debt is created. In most cases, the earnings method is the appropriate way to determine business income derived from a trading or manufacturing business (paragraph 20 of TR 98/1).

Consequently, income from employment is normally assessable on a 'receipts' basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period (paragraph 42 of TR 98/1) year of income.

Lump sum payments that relate to the termination of a taxpayer's employment are statutory income from personal exertion. Sections 83-10 of the ITAA 1997 and section 83-70 of the ITAA 1997 provide that any amount paid to a taxpayer in lump sum in consequence of termination of employment, being an amount that is paid in respect of accrued unused annual leave (section 83-10 of the ITAA 1997) and accrued long service leave (section 83-70 of the ITAA 1997), are to be included in their assessable income.

Double tax agreement

In determining the taxpayer's liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreements.

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the 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. Country Z agreement is listed in section 5 of the Agreements Act.

Article XX(X) of Country Z Agreement provides that salaries, wages and other similar remuneration derived by a resident of Country Z in respect of an employment shall be taxable only in Country Z unless the employment is exercised in Australia. If the employment is so exercised, such remuneration as is derived from that exercise may be taxed in Australia.

Question 1 - Bonus payment

The taxpayer was an Australian resident for tax purposes until their permanent departure to Country Z. The taxpayer received a bonus payment from their Australian employer after their departure. The bonus was awarded for carrying out employment duties while physically present in Australia. As per FC of T v. French (1957), the source of wages and salaries is usually where the services or duties are performed. Thus, the bonus payment is sourced in Australia.

An amount received as a bonus or incentive payment, in relation to services rendered or to be rendered, is treated as salary and wages for tax purposes under section 6-5 of the ITAA 1997. This is because it is received as a consequence of an employment relationship and is therefore assessable in full in the year of receipt.

Consequently, the bonus payment income is assessable in Australia and is included in the taxpayer's assessable income under subsection 6-5(3) of the ITAA 1997 in the income year the bonus payment was received.

Question 2 - Salary payments

The taxpayer received salary payments from the Australian employer after they became a foreign resident. The employment income was derived from duties exercised for the Australian employer while the taxpayer was in Australia.

Therefore, consistent with the principals established in C of T (NSW) v. Cam and Sons Ltd (1936) and FC of T v. French (1957), the income has an Australian source and is assessable in Australia under subsection 6-5(3) of the ITAA 1997.

Question 4 - Final employment payment

The taxpayer's employment with the Australian employer officially ended when the taxpayer was a foreign resident. The taxpayer received a final employment payment from the Australian employer which paid out unused holiday leave and/or unused long service leave. The payment was received after the taxpayer became a foreign resident.

The payment was made in consequence of termination of employment with the Australian employer and was for work completed in Australia while the taxpayer was a resident of Australia for tax purposes. Therefore, under the relevant article in the tax treaty with Country Z, the unused holiday and/or unused long service leave accrued whilst the taxpayer was in Australia is taxable in Australia.

Therefore, the final employment payment for unused holiday and/or long service leave accrued while the taxpayer was a resident of Australia for tax purposes and working in Australia, is assessable in Australia under section 6-10(5) of the ITAA 1997.

Question3

Detailed reasoning

Division 83A of the ITAA 1997 applies to shares, rights and stapled securities acquired under an ESS on or after 1 July 2009. Under Australian taxation law, the discount on ESS only becomes taxable when the deferred taxing point is reached.

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

An ESS is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees, of the company, or a subsidiary of the company, in relation to the employee's employment.

An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 as a beneficial interest in:

a) a share in the company; or

b) a right to acquire a beneficial interest in a share in the company.

Subdivision 83A-C of the ITAA 1997 allows for the deferral of tax on the amount assessable in respect of an ESS interest if certain conditions are satisfied.

Subsection 83A-110(1) of the ITAA 1997 provides that your assessable income for the year that the deferred taxing point occurs includes the market value of the ESS interest (calculated at the deferred taxing point) reduced by the cost base of the interest.

Subsection 83A-110(2) of the ITAA 1997 prescribes that you treat an amount included in your assessable income under subsection (1) as being from a source other than an Australian source to the extent that it relates to your employment outside Australia.

Subsection 83A-110(2) of the ITAA 1997 attributes a source to a gain that is (or would be) assessable income under subsection 83A-110(1) of the ITAA 1997. Whether the gain is ultimately included in the taxpayer's assessable income is then determined by the core residence and source rules relating to statutory income in section 6-10 of the ITAA 1997.

The assessability of statutory income is affected by the residency status of the person who derives it. The assessable income of an Australian resident will include statutory income from all sources, whether in or out of Australia (subsection 6-10(4) of the ITAA 1997). On the other hand, for a foreign resident, the assessable income includes statutory income from all Australian sources (paragraph 6-10(5)(a) of the ITAA 1997).

A gain on an ESS interest that relates to employment in Australia is treated as income from sources in Australia. The gain will be assessable income under the core residence and source rules, whatever the residency status of the taxpayer.

A gain on an ESS interest that relates to employment outside Australia is treated as income from sources outside Australia. This has several important consequences, as set out below, which flow from the core residence and source rules and specific provisions regarding foreign employment income.

Division 83A of the ITAA 1997 does not provide any guidance in determining whether a gain on an ESS interest relates to employment inside or outside Australia this is considered to be a conclusion of fact.

The Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 confirms this intention and states:

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... 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 a manner consistent with the rule applying to discounts.

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

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 resident 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).

Accordingly, consideration of the explanatory memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 is required. Relevantly, the document states at the following paragraphs:

4.32 Individuals will need to examine their circumstances and specific employee share plan to determine whether the period after becoming an Australian employee is relevant to the acquisition of the employee share or right. The period of employment after becoming an Australian employee will generally not be relevant if no forfeiture conditions remain at the time an individual becomes an Australian employee. If the employee share or right may be forfeited unless the individual undertakes further employment or services at the time employment commences in Australia, a portion of the discount will generally be assessable in Australia.

4.34 However, for inbound individuals the portion of the discount that relates to foreign service when a non-resident will not be included in assessable income. This exclusion may also apply in other cases, such as where a taxpayer ceases to be a resident before the end of the relevant period of employment (see paragraph 4.43). [Schedule 4, item 5, subsection 139B(1A)]

4.41 How, for these provisions, the amount of the otherwise assessable discount will be assigned to the relevant foreign or qualifying service will depend on the facts and circumstances of each case. This is essentially the approach adopted by the OECD in respect of rights, and therefore also of relevance in interpreting the relevant articles of Australia's tax treaties.

4.42 The revised OECD commentary does, however, set out a number of principles that offer guidance as to what outcome the facts and circumstances would typically point to. Those principles suggest that a generally reasonable approach would look at the time worked in the relevant foreign or qualifying service as a proportion of the total period of employment to which the right relates.

While these statements are focused on inbound employees, the same principles apply to employees leaving Australia.

Therefore, if the ESS interest may be forfeited unless the individual undertakes further employment or services at the time employment ceases in Australia, then generally only a portion of the discount will relate to Australian service. Consequently, apportionment of amounts that relate to employment both in and out of Australia may be required.

Application to the taxpayer's situation

The taxpayer commenced employment with the Australian employer then terminated their employment with the Australian employer at the conclusion of the LWOP arrangement.

Prior to the end of the LWOP period, the taxpayer departed Australia and commenced employment with an employer in Country Z.

Country Z employer is unrelated to the Australian employer.

While the taxpayer was employed in Australia, they participated in an ESS offered by the Australian employer. They were granted ESS interests in various income years, prior to moving overseas. The taxpayer continued to be an employee with the Australian employer under the LWOP arrangements and the ESS interests were not forfeited when the taxpayer left Australia.

The Australian employer determined that the deferred taxing point (vesting date) for the ESS interests occurred after the taxpayer became a foreign resident but prior to the conclusion of the LWOP period and official termination of employment.

As outlined above, ESS interests are earned over the vesting period and the taxpayer will be assessable on any portion of the ESS discount that is attributable to their Australian employment.

Based on the information provided, we have concluded the ESS discounts arising in relation to the ESS interests granted prior to the date the taxpayer left Australia, relates to the time that is attributable to their Australian employment. Therefore, they are Australian source income.

The full amount of the ESS discount will be assessable in Australia notwithstanding that the taxpayer was a foreign resident at the deferred taxing point. Foreign resident taxpayers need to declare Australian sourced statutory income.

The whole amount disclosed on the ESS statement at Item 12, Label F "Discount from deferral schemes" of their income tax return.