ATO ID 2013/27: Income tax: application of section 23AG of the Income Tax Assessment Act 1936 to sick leave accrued during a period of foreign service and taken after the period of foreign service has ceased
Date of decision: 8 May 2013
Year of income: Year ending 30 June 2013
Business line: Small Business/Individual Taxpayers

Issue
Can sick leave payments be exempt from tax under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936), where the leave accrued during a period of foreign service and the leave is then taken after the period of foreign service has ceased?

Decision
No. Sick leave payments cannot be exempt from tax under section 23AG of the ITAA 1936 where the leave accrued during a period of foreign service and the leave is then taken after the period of foreign service has ceased.

Facts
The taxpayer is an individual who worked overseas for a continuous period of at least 91 days. The taxpayer is an Australian resident for taxation purposes. This period of overseas work constituted 'foreign service' as defined under subsection 23AG(7) of the ITAA 1936. During this period of foreign service, the taxpayer accrued three weeks of fully paid sick leave. Under the terms and conditions of both his Australian and foreign employment, the taxpayer was entitled to be absent from his employment where he was unable to work because of an illness or injury. Where the taxpayer met the required conditions, he was entitled to utilise his paid sick leave. The taxpayer did not take any sick leave during the period of his employment in the foreign country. However, after recommencing employment in Australia with the same employer, the taxpayer used two weeks of his paid sick leave entitlement. The taxpayer used the paid sick leave he had accrued during his period of foreign service.

Reasons for decision
Summary: Subsection 23AG(1) of the ITAA 1936 provides that where a resident taxpayer, being a natural person, has been engaged in certain types of foreign service for a continuous period of not less than 91 days, any foreign earnings derived by the person from that foreign service will be exempt from tax. To qualify for the exemption, it is a requirement that the 'foreign earnings' be derived by a resident of Australia who was 'engaged in foreign service' and whose earnings were 'derived from that foreign service': Chaudhri v. Federal Commissioner of Taxation [2001] FCA 554; 2001 ATC 4214; (2001) 47 ATR 126. 'Foreign earnings' has the meaning given in subsection 23AG(7) of the ITAA 1936 and includes income consisting of salary and wages, bonuses or allowances, while 'foreign service' includes service in a foreign country in the capacity as an employee. Under subsection 23AG(6) of the ITAA 1936, the meaning of 'engaged in foreign services' is extended to include: ...any period during which the person is, in accordance with the terms and conditions of that service: ... (b) absent from work because of accident or illness. Foreign earnings do not need to be received at the time of engaging in a period of foreign service. The important test is that the foreign earnings need to be attributable to that period of service in a foreign country rather than to a period before or after the period of foreign service. The period the taxpayer worked overseas constituted 'foreign service' for the purposes of subsection 23AG(7) of the ITAA 1936. Under the terms and conditions of both the taxpayer's Australian and foreign service, the taxpayer was only entitled to be absent due to illness or injury, or entitled to receive sick leave payments, where the taxpayer was unable to work because of that illness or injury. Following the taxpayer's return to Australia, the taxpayer used two weeks of his sick leave that had accrued during his period of foreign service. Sick leave is a conditional entitlement. Until the taxpayer suffered an illness or injury, the taxpayer had no entitlement either to be absent due to illness or injury, or to receive sick leave payments. When sick leave is taken after resumption of duty in Australia, it no longer meets the terms and conditions of foreign service or forms part of the period of foreign service within the meaning of subsection 23AG(7) of the ITAA 1936. Therefore, sick leave is taken and paid, in accordance with the terms and conditions of the continuing Australian service. Where the sick leave is taken after the period of foreign service has ended, those earnings are not 'from' the period of foreign service. They are instead, from the period of sick leave. As the taxpayer's absence due to illness fails to meet the extended definition of 'foreign service' as defined in subsection 23AG(6) of the ITAA 1936, the sick leave payments are not 'foreign earnings' from 'foreign service'. Rather, the payments are solely attributable to, and derived from, the taxpayer's Australian service. The sick leave payments cannot be exempt from income tax under subsection 23AG(1) of the ITAA 1936 and are assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997 .

Legislative references: Income Tax Assessment Act 1936 subsection 23AG(1) subsection 23AG(6) subsection 23AG(7)
Case references: Chaudhri v. Federal Commissioner of Taxation [2001] FCA 554 2001 ATC 4214 (2001) 47 ATR 126
Related public rulings and determinations: TD 2012/8
Subject references: Exempt income Foreign salary & wages International tax Employee allowances