Private ruling: International - salary - bonus – country Y double tax agreement (DTA)
Published: July 2018
Ruling period: Question and answer | 1. Is the entire bonus payment you received for your work at assessable in Australia? | Yes. | 2. Are the whole of the employee share scheme discounts assessable income and therefore required to be declared in your Australian tax return? | Yes. | This ruling applies for the following periods: | Year ended 30 June 2018
Date scheme commenced: 1 July 2017


Relevant facts and circumstances: You have been a resident of Australia for taxation purposes since XX XX 2017. You worked for a company overseas for a number of years. You were entitled to receive a bonus payment for work carried out in the 2017 calendar year. You were paid this bonus in the 2018 income year and you paid tax on this bonus payment in Country Y. You participated in the employer’s Long Term Incentive Plan (“LTIP”). The LTIP scheme consists of a conditional or contingent share award at the beginning of a 3 year period (in this case 2015 – 2017). The LTIP performance period is the three calendar years from 1 January 2015 to 31 December 2017. The LTIP vesting period is the three years from the April 2015 AGM to the April 2018 AGM. Your pro-rata vesting period is the period from the April 2015 AGM to the formal end of your employment contract at the April 2017 AGM (while still a non-resident of Australia). So, depending on the company’s economic performance over the full three calendar-year LTIP review period (i.e. earnings per share and total shareholder return vs. that of its comparative peer Group), the actual share award for any recipient is then adjusted with a minimum of nil% and a maximum of 150% of the initial notional award. The decision on the award coincides with the company’s Annual General Meeting (“AGM”) where the financial results are approved by the shareholders (which, for this award, will be on April 2018). After that date, there is a further two year lock-up period during which the shares cannot be sold. You expect to receive (but prorata reduced for the part-time employment in 2017) XXX shares at X. Based on past performance, a multiplier of 125% will then be applied, bringing the Realisation to XXX shares. This will then be pro-rated for the actual period of employment (2 out of 3 years) down to XXX shares. At a current market value of around Euro XX per share, that equates to a likely award value of around Euro XXX,XXX. The taxation rights over the entire Euro XXX,XXX share award will be allocated 100% between the Country Y (where you worked partially for the first portion of the grant to vesting period and worked entirely from April 2016 until your retirement) and Country Z (where you worked for the initial part of the 3-year grant to vesting period to April 2016).

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5

Reasons for decision: Detailed Reasoning - Bonus Payment: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) advises that where you are an Australian resident for taxation purposes, your assessable income includes income gained from all sources, whether in or out of Australia. However, where you are a non-resident of Australia for taxation purposes, your assessable income includes only income from an Australian source. 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. The receipts (bonus payments) were derived from employment and constituted income under ordinary concepts. They were incidental to your continuing income-earning activity as an employee with SBM Offshore. Therefore the bonus payment is ordinary income and is assessable at the time it is received by you on DDMMYY. Income such as director's fees and bonuses are derived for tax purposes at the time such income is paid notwithstanding that the services giving rise to the income may have been performed in a previous income year ( Taxation Ruling IT 2534 Income tax: taxation of directors fees, bonuses etc .). In Federal Commissioner of Taxation v Thorogood (1927) 40 CLR 454 it was stated that "derived is not necessarily actually received, but ordinarily that is the mode of derivation". From that statement there has emerged over the years a principle, applied by Boards of Review on a number of occasions, that an employee is properly assessable upon any amount that is actually received by him in a particular year of income even though some part of it could be said to relate to an earlier year or to a later year of income. The bonus payment you received while working in the Country Y for the overseas company was received by you after you had come to Australia and became a resident for taxation purposes. As a resident of Australia for taxation purposes you are required to declare all your income both in and outside Australia in your Australian tax return. The bonus payment is required to be declared in your Australian tax return in the year you received it. In determining your 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. The Country Y Agreement is listed in section 5 of the Agreements Act. The Country Y agreement operates to avoid the double taxation of income received by residents of Australia and the Country Y. Article X of the DTA with Country Y deals with definitions. Article 3 (3) states: As regards the application of this Agreement by either of the States, any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that State relating to the taxes to which this Agreement applies. The term derive will take on its domestic meaning under Australian law in Article 3. This means the bonus payment will have been derived by you on XX XXX 2018 when you were a resident of Australia for taxation purposes. Article XX considers dependant personal services income. It states: (1) Subject to the provisions of Articles 16, 18, 19 and 20, salaries, wages and other similar remuneration derived by a resident of one of the States in respect of an employment shall be taxable only in that State unless the employment is exercised in the other State. If the employment is so exercised, such remuneration as is derived from that exercise may be taxed in that other State. (2) Notwithstanding the provisions of paragraph (1), remuneration derived by a resident of one of the States in respect of an employment exercised in the other State shall be taxable only in the first-mentioned State if: (a) the recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in the year of income or the fiscal year, as the case may be, of that other State; and (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of that other State; and (c) the remuneration is not deductible in determining the taxable profits of a permanent establishment or a fixed base which the employer has in that other State. Taxation Ruling TR 2001/13 provides the following guidance in relation to the interpretation of Double Tax Agreements: | Detailed Reasoning - Overview: characteristics of DTAs that may affect their interpretation: 85. Some of the specific features of DTAs that in practice impact on their interpretation include: ● DTAs are written in very much more general terms than domestic law so that there is perhaps more room for courts to give an interpretation based on purpose, the consideration of 'substance over form', etc.; ● DTAs use an international tax terminology which may not exist in domestic law (or if it does was usually drawn from treaties so that the international treaty meaning applies; for example, see the consideration of the domestic tax law definition of 'royalties' (which was influenced by treaty meanings) in TR 98/21 on cross border leasing); ● there are internationally accepted OECD Commentaries on the meaning of tax treaties which need to be taken account of to fully understand the DTA and its international usages and context where the DTA reflects the OECD Model Commentaries. As noted below, the same can apply for some UN Model materials; ● because of the common terms used internationally and the Commentaries, treaties are the subject of a much broader and internationally focused jurisprudence in cases, texts and administrative rulings than domestic tax law, and foreign case law may be particularly relevant; and ● tax treaties often have a life of 20 to 30 years and so have to be flexible enough to cope with many changes in domestic law, while remaining true to the negotiated bargain and the agreed balance of obligations and concessions between the two countries. 86. These characteristics necessitate a different conceptual approach to interpretation than is required in construing a statute. In an important article on the interpretation of tax treaties, a group of international DTA experts noted that '[a] point to be made at the outset is that treaty interpretation is a subject in itself and not merely an extension of statutory interpretation, as has sometimes been thought in common law countries where treaties normally take their effect by virtue of a statute.' The authors' approach on this point is in accord with the approach taken by Australian courts in DTA and other treaty cases and represents ATO practice. | Detailed Reasoning - The approach of Australian courts: 87. In Shipping Corporation of India Limited v . Gamlen Chemical Company Australasia , the High Court of Australia considered that, despite the fact that a treaty had been enacted as domestic law, it should be interpreted broadly in a way conducive to producing a uniform international interpretation. The Court said: It has been recognised that a national court, in the interests of uniformity should construe rules formulated by an international convention... 'in a normal manner appropriate for the interpretation of an international convention, unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation', to repeat the words of Lord Wilberforce in James Buchanan and Co Ltd v. Babco Forwarding and Shipping (UK) Ltd [1978] AC 141, at p. 152. 88. The legislature, when legislating the DTA into domestic law, is therefore taken to expect that it be interpreted in the light of the normal rules for interpreting treaties. As noted above, Brennan CJ in Applicant A recognised the prima facie legislative intention that the text of a treaty transposed into an Act is to be read in accordance with normal treaty interpretation principles. | Detailed Reasoning - The requirement to interpret treaties 'liberally': 93. Some debate surrounds the requirement just noted that DTAs be interpreted 'liberally'. Some have interpreted this to mean that this requires the terms of DTAs to be read as broadly as possible. The ATO considers, however, that the requirement for a 'liberal' interpretation of a DTA is directed to the rules of construction to be adopted, rather than being directed at the width and ambit of the content of particular DTA provisions. 94. In other words, when the courts speak of DTAs being given a more 'liberal' interpretation than domestic legislation, in the ATO's view they mean that the rules of construction will not be as detailed and rigid as they might be if the courts were to interpret domestic legislation or domestic instruments, and gaps, imprecision and ambiguities should be accepted as sometimes inevitable in such a text, and to some extent accommodated or 'smoothed over' in a way that addresses the context and meets the object and purpose of the DTA. The term ‘derived’ is defined in subsection 995-1(1) of the ITAA 1997 but only for the purposes of ordinary income where it is used as a timing mechanism. For example, subsection 6-5(2) of the ITAA 1997 states in part: ‘… your assessable income includes the ordinary income you derived … during the income year’ 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.’ When considered as an element within the whole clause, the term ‘derived’ in the context that it is used in paragraph 1 of Article XX of the Country Y Double Tax Agreement merely links remuneration to particular services. This then forms the basis of determining whether there is a limitation on the taxing rights of the other Contracting State (not the country of residence). This also provides a basis for enforcing an obligation on the country of residence to allow a credit for tax paid in the other Contracting State on income that has a source within that other Contracting State. The bonus payment can be taxed in Country Y in accordance with Article XX (1) of the DTA between Australia and Country Y and as it was derived when you were a resident of Australia for tax purposes, it can be taxed in Australia according to this article. Accordingly the bonus payment you received will be taxed in Australia and is required to be declared in your Australian tax return. | Detailed Reasoning - Employee share scheme discount: 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 and 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). You were an Australian resident as at the deferred taxing points identified for this private ruling for the Post July 200X share rights. 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. As per Article XX (1) of the DTA between Australia and Country Y the entire share award is assessable in Australia as you will be a resident when the shares are awarded to you. Article XX (1) also gives Australia the right to tax the rights along with Country Y. The rights are assessable in Australia and should be declared in your Australian tax return.