Private ruling: Exempt foreign income
Date of advice: 29 November 2017
Published: April 2018
Ruling period: Year ending June 30 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the amount of foreign earnings derived in Country Z during the 2016-17 financial year exempt foreign income under section 23AG of the Income Tax Assessment Act 1936? | A1: Yes

Relevant facts and circumstances: You are an Australian resident for tax purposes. You are a member of an Australian overseas force. You have been deployed to Country Z in the 2016-17 financial year. You were deployed under a treaty between Australia and Country Z. Under the treaty, you are given the status equivalent to that accorded to the administrative and technical staff of a diplomatic mission of a state that is a party to the Vienna Convention on Diplomatic Relations (VCDR). Whilst you were deployed offshore, the only recreational leave you were permitted to take was that of the kind allowed to overseas staff, and started accruing the day you went to work overseas. You travelled across different countries for work and private purposes using your overseas staff leave. You are travelling on a diplomatic passport.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 23AG | Income Tax Assessment Act 1936 section 23AG(1) | Income Tax Assessment Act 1936 section 23AG(1AA) | Income Tax Assessment Act 1936 section 23AG(2) | Income Tax Assessment Act 1936 section 23AG(6) | Income Tax Assessment Act 1936 section 23AG(7)

Reasons for decision: Summary: Under subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936), your foreign earnings are exempt from income tax in Australia where all of the following requirements are satisfied: ● You are a resident of Australia and a natural person. ● You are engaged in foreign service. ● The foreign service is for a continuous period of at least 91 days. ● You derive foreign earnings from that foreign service. ● The foreign service is directly attributable to an activity that is listed in subsection 23AG(1AA) of the ITAA 1936. ● The foreign earnings must not be exempt in the foreign country only for one or more of the reasons covered by subsection 23AG(2) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: As a general rule, and under the provisions of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), the assessable income of an Australian resident taxpayer includes all the ordinary income they earn from all sources, in or out of Australia in an income year. Income in the form of salary, wages and allowances are all types of ordinary income. Although a payment may be considered ordinary income and will generally be assessable under the provisions of section 6-5 of the ITAA 1997, there are some instances where ordinary income may be excluded from an individual’s assessable income in Australia. This will be the case for example if a specific provision of the tax law makes the income exempt from taxation in Australia. Subsection 23AG(1) of the ITAA 1936 provides that where Australian resident individuals are engaged in foreign service for a continuous period of not less than 91 days, foreign earnings derived from that foreign service are exempt from tax in Australia. Subsection 23AG(1AA) of the ITAA 1936, provides that those foreign earnings will not be exempt under section 23AG of the ITAA 1936 unless the continuous period of foreign service is directly attributable to any of the following: ● delivery of Australian official development assistance by your employer; ● activities of your employer in operating a public fund declared by the Treasurer to be a developing country relief fund, or a public fund established and maintained to provide monetary relief to people in a developing foreign country that has experienced a disaster (a public disaster relief fund); ● activities of your employer as a prescribed charitable or religious institution exempt from Australian income tax because it is located outside Australia or the institution is pursuing objectives outside Australia; or ● deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force. You are a member of an Australian overseas force who was deployed to work in Country Z under a treaty between Australia and Country Z. Paragraph 9 of Taxation Ruling TR 2013/7 Income tax: foreign employment income: interpretation of subsection 23AG(1AA) of the Income Tax Assessment Act 1936 defines the phrase ‘disciplined force’ as: The phrase 'disciplined force' in paragraph 23AG(1AA)(d) refers to the Australian Defence Force (ADF), Australian Federal Police (AFP) and the State and Territory police forces. Therefore you are a member of a disciplined force for the purposes of subsection 23AG(1AA). Foreign service is defined in subsection 23AG(7) as: “service in a foreign country as the holder of an office or in the capacity of an employee” The implication in this definition is that foreign service is carried out in one country only. However Graham J in Overseas Aircrew Basing Limited v Commissioner of Taxation FCA 7; (2009) 175 FCR 449 ( Overseas Aircrew ) appeared to suggest in his reasoning that this may not always be the case. The following paragraph is relevant: 93. Section 23AG exempts salaries from tax in Australia where they are derived by persons engaged in service in a particular foreign country and the particular foreign country is the base from which they derive those salaries. In Graham J’s view, when a particular foreign country is considered the person’s “base country”, then service based in that country does not preclude parts of that service being carried out in other countries. In your circumstances, you are based in Country Z. Although you do travel to other countries for work purposes, you spend the majority of your time in Country Z. Based on the time you spent in Country Z, we conclude that the Country Z is the base country of your foreign service. As Country Z is considered your base country, we consider that the reasoning the Overseas Aircrew case supports the position that your work trips to other countries outside Country Z were part of your foreign service. | Detailed Reasoning - Temporary Leave Absences: Temporary leave absences from foreign service can be included in the total foreign service if they are in accordance with the terms and conditions of that foreign service and constitute recreational leave on full pay that is attributable to the period of foreign service. You undertook periods of leave during your foreign service. This was taken as the special overseas staff leave and this was the only recreational leave you were permitted to take whilst deployed and commenced to be accrued on the day you were first deployed. As this leave constituted recreation leave attributable to your foreign service within the meaning of subparagraph 23AG(6)(a)(i), it does not count as absences which can break the continuity of your foreign service. The entire period of your posting was continuous foreign service and exceeded 91 days. | Detailed Reasoning - Non-exemption conditions: Subsection 23AG(2) of the ITAA 1936 provides that no exemption is available in circumstances where an amount of foreign earnings derived in a foreign country is exempt from tax in the foreign country solely because of: ● a double tax agreement or a law of a country that gives effect to such an agreement (paragraphs 23AG(2)(a) and (b)); ● a law of that foreign country which generally exempts from, or does not provide for, the imposition of income tax on income derived in the capacity of an employee, income from personal services or any other similar income (paragraphs 23AG(2)(c) and (d)); and ● a law or international agreement dealing with diplomatic or consular privileges and immunities, or privileges and immunities of persons connected with international organisations (paragraphs 23AG(2)(e), (f) and (g)). If your foreign employment income is exempt for a reason other than, or in addition to, the conditions listed above, then it will still be exempt from taxation in Australia. There is a double tax agreement between Australia and Country Z to prevent double taxation and fiscal evasion, and foster cooperation between Australia and other international tax authorities by enforcing their respective tax laws. Paragraph 1 of Article 19 of the double tax agreement provides that remuneration (including a pension) paid to any individual in respect of services rendered in the discharge of governmental functions to one of the states may be taxed in that State. However, any such remuneration, not being a pension, shall be taxably only in the other State if the services are rendered in that other State and the recipient is a resident of that other State who is a citizen or national of that state or did not become a resident of that State solely for the purpose of performing the services. You are an Australian resident for tax purposes and hence the second section of paragraph 1 does not apply to you. Accordingly, subsection 23AG(2) does not apply as the double tax agreement states earnings derived in the source country may be taxed in the source country. Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements provides interpretation of Australia's tax treaties in particular, paragraphs 22 to 26 provide an interpretation on the words used to allocate taxing rights. Paragraph 23 of TR 2001/13 provides the phrase ‘may be taxed’ gives the source country of the income a non-exclusive entitlement to tax the income. However, under normal international tax principles, the other (residence) country may also continue to tax its residents (where its domestic law so provides) on the income, wherever sourced, unless the DTA explicitly prevents it from doing so. Therefore, paragraphs 23AG(2)(a) and 23AG(2)(b) of the ITAA 1936 will not apply. As the laws of Country Z for the imposition of income tax and do not generally exempt employment income from income tax, paragraphs 23AG(2)(c) and (d) of the ITAA 1936 will not apply. You are travelling on an official Australia Diplomatic Passport. The treaty between Australia and Country Z provides Australian personnel shall be accorded the status equivalent to that accorded to the administrative and technical staff of a diplomatic mission of a state that is a party to the Vienna Convention on Diplomatic Relations (VCDR) . Under normal circumstances, paragraphs 23AG(e), (f) and (g) of the ITAA 1936 will apply since the VCDR is an international agreement which provide diplomatic agents to be exempt from all dues and taxes, personal or real, national, regional or municipal except for dues and taxes on private income having its source in the receiving State and capital taxes on investments made in commercial undertakings in the receiving State. However, Class Ruling CR 2008/71 Income Tax: assessable income: Australian Federal Police deployed to Timor-Leste sets precedence in relation to tax implications of subsection 23AG(2). Paragraph 119 of CR 2008/71 provides visiting forces arrangements are not an international agreement that is legally binding at international law. You are under an inter-country agreement that treats Australian personnel as a status equivalent to that of administrative and technical staff of a diplomatic mission in the VCDR. Hence you do not receive diplomatic or consular privileges and immunities under an international agreement. As a result, paragraph 23AG(2)(e), (f) and (g) of the ITAA 1936 will not apply as the foreign earnings are exempt from tax for a reason other than those listed in subsection 23AG(2) of the ITAA 1936. | Detailed Reasoning - Conclusion: Since none of the circumstances listed in subsection 23AG(2) applies, it is not necessary to consider if your foreign earnings were exempt in Country Z for a reason not included in subsection 23AG(2). Your foreign earnings derived during your period of Foreign Service are exempt from income tax in Australia under section 23AG of the ITAA 1936.