Private ruling: Foreign employment income - country X
Published: March 2012
Ruling period: Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the salary and overseas allowances you earn in country X exempt from income tax in Australia under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: Yes. | Q2: Is the transfer allowance you receive in relation to your employment in country X exempt from income tax in Australia under section 23AG of the ITAA 1936? | A2: No.

Relevant facts and circumstances: You are an Australian resident for income tax purposes. You are an employee of an Australian government aid organisation. You have been appointed to undertake deployment to country X. You will be deployed on an Australian aid project to country X for a period of not less than 91 days with an option to extend the contract. In addition to your salary you will receive various allowances including a transfer allowance and overseas allowances. The transfer allowance is paid to cover costs associated with preparing for departure and returning from deployment. The overseas allowances are paid to cover various costs and hardship incurred while working in country X. You will only take recreation leave that is accrued during your service in country X. You will not perform any work-related duties if you undertake any breaks in Australia. There is a double tax agreement between Australia and country X. Country X taxes employment income under its domestic law. There is a current Memorandum of Understanding (MOA) between the government of Australia and the government of country X on development co-operation. Your foreign employment income is exempt from income tax in country X under the terms of the MOA.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 23AG(1) | Income Tax Assessment Act 1936 Subsection 23AG(7) | Income Tax Assessment Act 1936 Section 23AG | Income Tax Assessment Act 1936 Subsection 23AG(1AA) | Income Tax Assessment Act 1936 Subsection 23AG(2) | Income Tax Assessment Act 1936 Paragraph 23AG(2)(b)

Reasons for decision: Summary: Subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that foreign earnings of an Australian resident derived during a continuous period of foreign service of not less than 91 days employment in a foreign country are exempt from income tax in Australia. Foreign earnings includes income consisting of salary, wages, bonuses or allowances (subsection 23AG(7) of the ITAA 1936). To qualify for the exemption the foreign earnings must be derived from the foreign service. That does not mean that the foreign earnings need to be derived at the time of engaging in foreign service. The important test is that the foreign earnings, when derived, need to be derived as result of the undertaking of that foreign service. Section 23AG of the ITAA 1936 has been amended so that foreign employment income derived by Australian residents will only be exempt in certain circumstances. These amendments are effective from 29 June 2009. Subsection 23AG(1AA) of the ITAA 1936 provides that foreign earnings are not exempt from tax unless the continuous period of foreign service is directly attributable to any of the following: · the delivery of Australia's overseas aid program by the individual's employer; · the activities of the individual's employer in operating a developing country relief fund or a public disaster relief fund; · the activities of the individual's employer being a prescribed institution that is exempt from Australian tax; or · the individual's deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force. In your case, you have been appointed to undertake a deployment to country X on an Australian aid project. As your deployment is directly attributable to the delivery of an Australian overseas aid program by your employer, you satisfy one of the conditions for exemption under subsection 23AG(1AA) of the ITAA 1936. In addition to your salary, you will receive a transfer allowance and overseas allowances. | Detailed Reasoning - Transfer allowance: The transfer allowance is paid to cover costs associated with preparing for departure and returning from the deployment. This allowance is not paid to cover costs arising from the performance of your foreign service. It is paid to cover costs arising prior to and after the end of the foreign service. Therefore, this allowance is not considered to be derived from your foreign service. Accordingly, the transfer allowance is not exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936 as it is not derived from your foreign service. | Detailed Reasoning - Salary and overseas allowances: As you receive a salary from your foreign employment, this salary is considered to be derived from your foreign service. The overseas allowances are designed to cover various costs and hardship of the foreign service. As they are paid to compensate for costs arising from the foreign service and for the hardship attributable to the foreign service, they are considered to be derived from your foreign service. Therefore, your salary and overseas allowances are foreign earnings from foreign service for the purposes of subsection 23AG(1) of the ITAA 1936. However, subsection 23AG(2) of the ITAA 1936 provides that the exemption in subsection 23AG(1) of the ITAA 1936 will not apply where the income is exempt from income tax in the foreign country only because of any of the reasons listed in this section. One of the listed conditions is where the income earned by the resident in the foreign country is made exempt by the operation of a double tax agreement (DTA) (paragraph 23AG(2)(b) of the ITAA 1936). Therefore, it is necessary to consider not only the income tax laws but also any applicable DTA. Australia has signed a DTA with country X. The DTA operates to avoid the double taxation of income received by a resident of either Australia or country X. An article of the DTA provides that remuneration paid by Australia to any individual in respect of services rendered in the discharge of governmental functions shall be taxable only in Australia. However, such remuneration will be taxable only in country X if the services are rendered in country X and the individual is a resident and country X, or did not become a resident of country X solely for the purpose of performing the services. The employment income you receive in relation to your deployment to country X is taxable only in Australia under this article of the DTA as you are an Australian resident and the income is paid by Australia in respect of services rendered in the discharge of governmental functions. As the employment income you receive while posted to country X is exempt from tax in country X because of the operation of a DTA, paragraph 23AG(2)(b) of the ITAA 1936 would normally apply and the income would therefore not be exempt from tax under subsection 23AG(1) of the ITAA 1936. However, the income you earn while on posting is also exempt from taxation In country X because of the terms of the MOU entered into between Australia and country X. The exemption provided by the MOU does not fall under any of the other exemption categories under subsection 23AG(2) of the ITAA 1936. Therefore, subsection 23AG(2) of the ITAA 1936 does not apply and as a result, your salary and overseas allowances are exempt from income tax in Australia under subsection 23AG(1) of the ITAA 1936. | Detailed Reasoning - Note: Foreign earnings exempt under section 23AG of the ITAA 1936 are taken into account in calculating the tax payable on other income derived by a taxpayer. This method of calculation referred to as exemption with progression prevents the exempt income from reducing the Australian tax payable on the other income. This income needs to be included as exempt foreign employment income in your Australian tax return.

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