House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 1 Exemption of income earned in overseas employment

Outline of chapter

1.1 Schedule 1 to this Bill inserts subsection 23AG(1AA) into the Income Tax Assessment Act 1936 (ITAA 1936). All legislative references are to the ITAA 1936 unless otherwise stated.

Context of amendments

1.2 The taxation of income in Australia is principally determined on the basis of whether the entity is an Australian resident or a foreign resident. Generally, Australian residents are taxed on their worldwide income whereas foreign residents are taxed only on income sourced in Australia.

1.3 The definition of 'resident of Australia' for taxation purposes is contained in subsection 6(1). In the case of an individual, a person's nationality or citizenship is not necessarily a determinative factor when considering whether or not the person is a resident of Australia for tax purposes.

1.4 Section 23AG provides an exception to the general rule that Australian residents are taxed on their worldwide income. It provides an exemption from Australian income tax for income earned in overseas employment by an Australian resident individual engaged in continuous foreign service for a period of not less than 91 days. The provision has broad application, in that it is not restricted to foreign employment income derived from specific activities.

1.5 Section 23AG provides a mechanism for the relief of double taxation but it does not contain a requirement that foreign tax is paid in order for the exemption to apply. This can produce non-neutral tax outcomes between individuals working in different countries, with different tax rates, and between individuals working overseas and individuals working in Australia.

1.6 This Schedule will improve the targeting of this exemption while avoiding double taxation.

1.7 Existing rules that can operate to deny the exemption will continue to apply under the new rules.

Summary of new law

1.8 This Schedule amends section 23AG, to limit its scope to foreign employment income derived by Australian resident individuals only in specific circumstances.

1.9 Foreign earnings derived by an Australian resident individual engaged in continuous foreign service for not less than 91 days will only be eligible for exemption from income tax if the 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 income tax;

•

the individual's deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force; or

•

an activity of a kind specified in the regulations.

1.10 However, the existing conditions for exemption will continue to apply. In particular, the foreign earnings of individuals engaged in foreign service that are directly attributable to one of the activities referred to in subsection 23AG(1AA) will not be exempt if one of the conditions for non-exemption contained in subsection 23AG(2) applies.

1.11 Subsection 23AG(2) applies, to deny an exemption, if the foreign earnings are exempt from tax in the foreign country only because of one or more of the following reasons:

•

a double tax agreement with Australia or a law giving effect to a double tax agreement;

•

the foreign country does not impose income tax on employment or personal services income, or similar income; or

•

a law of the foreign country or an international agreement to which Australia is a party, which deals with diplomatic or consular privileges and immunities, or privileges and immunities for people connected with international organisations (such as the United Nations).

For example, an exemption may be denied where the foreign earnings are exempt from tax in the foreign country only because of the operation of a double tax agreement.

1.12 However, subsection 23AG(2) does not apply to deny an exemption if the foreign earnings are exempt from tax in the foreign country for a reason other than, or in addition to, those listed above. For example, the income may be exempt in the foreign country because of the application of a double tax agreement and because of an agreement between the government of that country and an international aid organisation. These rules will continue to apply.

1.13 Foreign employment income that is not exempt under the new rules may be subject to Australian income tax. In such cases, taxpayers will be eligible to claim a non-refundable foreign income tax offset (FITO) for foreign income tax paid on that income. This will relieve double taxation for those individuals.

1.14 The FITO rules apply to income years beginning on or after 1 July 2008 and are contained in Division 770 of the Income Tax Assessment Act 1997 (ITAA 1997). The FITO rules replaced the former foreign tax credit system and were designed to provide taxpayers with a simplified way of claiming relief for foreign income taxes paid on amounts included in their assessable income in Australia.

1.15 The new rules do not change the definitions of 'foreign earnings' and 'foreign service' contained in subsection 23AG(7).

Other obligations

1.16 From 1 July 2009, employers of individuals who derive non-exempt foreign employment income will be required to withhold amounts from salaries, wages, allowances, bonuses and commissions paid to their foreign-based employees under the pay as you go (PAYG) withholding rules. Where the income is currently exempt this would not occur because no amount is required to be withheld from payments of exempt income. The PAYG withholding rules are contained in Division 12 of the Taxation Administration Act 1953 .

1.17 In addition, fringe benefits tax (FBT) obligations may arise in respect of benefits provided by employers to their foreign-based employees, pursuant to the Fringe Benefits Tax Assessment Act 1986 . For FBT purposes, a person is regarded as an employee if the person receives salary and wages, which is in turn defined to include a payment from which an amount is withheld under the PAYG withholding rules. Thus, fringe benefits provided to employees whose foreign employment income is exempt under section 23AG are not subject to FBT, but fringe benefits provided to employees whose foreign employment income is not exempt under section 23AG may be subject to FBT.

Comparison of key features of new law and current law

Detailed explanation of new law

Eligibility for exemption

1.18 Foreign earnings derived by an Australian resident individual from continuous foreign service of not less than 91 days will only be exempt from income tax if the foreign service is directly attributable to any of the following:

•

the delivery of Australian official development assistance by the person's employer;

•

the activities of the person's 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 country that has experienced a disaster;

•

the activities of the person's employer, being a prescribed institution that is exempt from Australian income tax;

•

the person's deployment outside Australia as a member of a disciplined force by the Commonwealth, a State or Territory (or an authority of the Commonwealth, a State or a Territory); or

•

an activity of a kind specified in the regulations.

[ Schedule 1, item 1, subsection 23(1AA )]

Australian official development assistance

1.19 Australian official development assistance (ODA) is assistance delivered through the Australian Government's overseas aid program, as administered by the Department of Foreign Affairs and Trade and/or the Australian Agency for International Development (AusAID). Australian ODA aims to reduce poverty and achieve sustainable development in developing countries, in line with Australia's national interest.

1.20 In addition to providing Australian ODA directly, AusAID also competitively contracts aid work to Australian and international entities. Thus, in practice, individuals involved in the delivery of Australian ODA can include both Australian Public Service (APS) employees and non-APS employees.

1.21 For the purposes of subsection 23AG(1AA) the delivery of Australian ODA must be undertaken by the person's employer, which includes AusAID and an entity contracted by AusAID to assist in the delivery of Australian ODA.

Example 1.1

Colin is an APS employee employed by AusAID. He is posted to the Cook Islands, for 120 continuous days, as a project advisor on an Australian ODA project aimed at improving the quality of early childhood education.

Colin's foreign service is directly attributable to the delivery of Australian ODA by his employer and his foreign earnings are therefore eligible for exemption pursuant to section 23AG, subject to the conditions contained in subsection 23AG(2).

Example 1.2

Robert is an APS employee employed by the Commonwealth Department of Climate Change. He is posted to Tokelau for 150 continuous days, to work on a project aimed at minimising the impacts of rising sea levels in Tokelau.

Robert is not an AusAID employee but the project is classified as Australian ODA by AusAID. Robert's foreign service is directly attributable to the delivery of Australian ODA by his employer and his foreign earnings are therefore eligible for exemption pursuant to section 23AG, subject to the conditions contained in subsection 23AG(2).

Example 1.3

Eli is a motor mechanic employed by Emu Engineering Pty Ltd, a private company contracted by AusAID to provide vocational training in Vanuatu. He is posted to Vanuatu for 180 continuous days.

Eli's foreign service is directly attributable to the delivery of Australian ODA by his employer and his foreign earnings are therefore eligible for exemption pursuant to section 23AG, subject to the conditions contained in subsection 23AG(2).

1.22 Foreign service directly attributable to the delivery of Australian ODA does not include diplomatic or consular duties carried out by Australian residents.

Employer operating a public fund

1.23 A person's foreign earnings will be eligible for exemption if they are directly attributable to their employer's activities in operating a public fund covered by item 9.1.1 or 9.1.2 of the table in subsection 30-80(1) of the ITAA 1997. [ Schedule 1, item 1, paragraph 23AG(1AA)(b )]

1.24 Item 9.1.1 of subsection 30-80(1) of the ITAA 1997 applies to a public fund declared by the Treasurer to be a developing country relief fund. Item 9.1.2 of subsection 30-80(1) applies to a public fund operated by a public benevolent institution solely to provide relief to people of a developing country who are in distress as a result of a disaster (a public disaster relief fund). Gifts or donations made to these public funds are tax deductible for income tax purposes to the donor.

1.25 A developing country relief fund is a fund established by an organisation solely for the purpose of providing relief to people of a developing country. The organisation must be an approved organisation as declared by the Minister for Foreign Affairs and the country must be a developing country as declared by the Minister for Foreign Affairs. These conditions are contained in paragraphs 30-85(2)(a) and (b) of the ITAA 1997 respectively.

1.26 A public disaster relief fund is a fund established and operated by a public benevolent institution in response to an event recognised as a disaster by the Minister for Foreign Affairs. The recognition requirement is contained in section 30-86 of the ITAA 1997.

1.27 Paragraph 23AG(1AA)(b) ensures that employees of recognised organisations that undertake aid or charitable activities, that do not form part of Australian ODA, are eligible for exemption on their relevant foreign employment income.

Example 1.4

Kate is a social worker employed by a charitable organisation that operates a fund approved as a developing country relief fund by the Treasurer.

Kate is posted to Nigeria for 120 days to help provide relief to people in distress.

Kate's foreign earnings are eligible for exemption pursuant to section 23AG, subject to the conditions contained in subsection 23AG(2).

Employer is an exempt institution for income tax purposes

1.28 A person's foreign earnings will be eligible for exemption if the foreign service is directly attributable to their employer's activities as an institution covered by paragraph (c) or (d) of section 50-50 of the ITAA 1997. [ Schedule 1, item 1, paragraph 23AG(1AA)(c )]

1.29 These paragraphs apply to a prescribed charitable or religious institution that is exempt from Australian income tax pursuant to item 1.1 or 1.2 of section 50-5 of the ITAA 1997. Such organisations are either located outside Australia or have a physical presence in Australia but incur their expenditure and pursue their objectives principally outside Australia.

1.30 Paragraph 23AG(1AA)(c) ensures that employees of recognised organisations that undertake aid or charitable activities, that do not form part of Australian ODA, are eligible for exemption on their relevant foreign employment income.

Foreign deployment as a member of a disciplined force

1.31 A person's foreign earnings will be eligible for exemption if the foreign service is directly attributable to that person's deployment outside Australia as a member of a disciplined force by an Australian government, or an authority thereof. A disciplined force is intended to refer to a defence force, including a peacekeeping force, and a police force.

1.32 In a defence force context, the exemption would apply to a person's deployment outside Australia as part of a non-warlike operation. In a police force context, the exemption would apply to Australian Federal Police employees deployed on an International Deployment Group mission who are subject to Commanders Orders to achieve operational policing outcomes. [ Schedule 1, item 1, paragraph 23AG(1AA)(d )]

Other specified activities

1.33 The new rules will permit the making of regulations to include other specified activities within the scope of subsection 23AG(1AA). [ Schedule 1, item 1, paragraph 23AG(1AA)(e )]

1.34 This will enable the scope of the exemption to be broadened, if necessary, beyond the specific categories listed.

Continuous period of foreign service must be directly attributable to certain activities

1.35 Subsection 23AG(1AA) will apply where an individual undertakes a continuous period of foreign service of 91 days or more and the foreign service relates to more than one of the activities listed in paragraphs (a) to (e).

Example 1.5

Lisa is an APS employee employed by AusAID. On 1 July 2009 Lisa is posted to Tonga for 45 days, as a project advisor on an Australian ODA project.

At the end of the 45 day posting, Lisa resigns from AusAID and takes up a position as an aid worker in Tonga, employed by a prescribed charitable institution covered by paragraph 23AG(1AA)(c). Lisa remains in her new position for another 100 days.

Lisa's continuous period of foreign service for the purpose of subsection 23AG(1AA) is 145 days and her foreign earnings are eligible for exemption pursuant to section 23AG, subject to the conditions contained in subsection 23AG(2).

Example 1.6

As in the above example, Lisa resigns from AusAID at the end of her 45 day posting. However, rather than commencing work as an aid worker, Lisa takes up permanent employment with a bank in Tonga.

Lisa's continuous period of foreign service in Tonga exceeds 91 days but none of her foreign earnings are eligible for exemption because she did not attain 91 days of continuous foreign service in relation to an activity covered by subsection 23AG(1AA).

Application and transitional provisions

1.36 The new rules apply to foreign earnings derived on or after 1 July 2009 from foreign service performed on or after 1 July 2009. Foreign earnings derived on or before 30 June 2009 will remain eligible for exemption under the existing rules and foreign service performed on or after 1 July 2009 will be included in the calculation of the period of continuous foreign service, even where the foreign earnings derived on or after 1 July 2009 are no longer exempt. [ Schedule 1, item 2, paragraphs 2(a) and (b) and subitem 3 ]

Example 1.7

Wallace is an Australian resident employed by a Thai company to work in Bangkok from 1 June 2009 to 30 September 2009. His foreign earnings are not directly attributable to any of the activities covered by new subsection 23AG(1AA).

Wallace's foreign earnings derived after 1 July 2009 will not be eligible for exemption under the new rules. However, Wallace's foreign earnings in respect of foreign service performed before 1 July 2009 will remain eligible for exemption because his total foreign service from 1 June to 30 September exceeded 91 consecutive days.

1.37 Foreign earnings paid to an individual on or after 1 July 2009 in respect of foreign service performed before 1 July 2009 will remain eligible for exemption under the existing rules.

Example 1.8

Jennelle has been engaged in continuous foreign service since 1 February 2009. Her foreign earnings are not directly attributable to any of the activities covered by new subsection 23AG(1AA).

On 1 July 2009 Jennelle is paid in respect of foreign service performed during the month of June 2009. Her foreign earnings for the month of June 2009 remain eligible for exemption notwithstanding the fact that they were paid on 1 July 2009.

However, Jennelle's foreign earnings derived in respect of foreign service performed on or after 1 July 2009 are not eligible for exemption because they are not directly attributable to any of the activities covered by new subsection 23AG(1AA).

Consequential amendments

1.38 There are no consequential amendments arising from Schedule 1.

Regulation impact statement

Policy objective

1.39 The objective of the proposed amendment to section 23AG is to minimise the potential for inequity between individuals working in different countries, with different tax rates, and between individuals working overseas and individuals working in Australia.

1.40 This is consistent with the general principle that individuals who are Australian residents for tax purposes should pay tax on their worldwide income.

Implementation options

1.41 Only one option was examined in detail - to limit the scope of the current tax exemption to only apply to individuals engaged in a narrow range of employment activities, namely 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 tax-exempt institution;

•

the individual's deployment outside Australia by an Australian government (or an authority thereof) as a member of a disciplined force; or

•

an activity of a kind specified in the regulations.

Assessment of impacts

Impact group identification

1.42 The proposed amendments will affect Australian resident individuals who derive foreign employment income, which will no longer be exempt under the new rules. They may also impose withholding and reporting obligations on the Australian employers of those individuals.

Analysis of costs/benefits

Individuals

1.43 Some Australian resident individuals will no longer be entitled to an exemption in respect of their foreign employment income. Such income will be taxable in Australia in accordance with the principle that Australian residents should pay Australian tax on their worldwide income.

Employers

1.44 Employers of those individuals who will no longer be exempt from 1 July 2009 will be required to comply with the PAYG withholding rules. That is, those employers, as payers, will be required to withhold amounts from the payments they make to their employees, in accordance with Division 12 of the Taxation Administration Act 1953 , and remit those amounts to the Commissioner of Taxation. No PAYG withholding obligations exist in relation to payments of exempt income.

1.45 Employers of those individuals who are no longer exempt from 1 July 2009 will be required to comply with the Fringe Benefits Tax Assessment Act 1986 in relation to any fringe benefits provided to those employees. No FBT liability arises in relation to payments of exempt income.

1.46 These obligations would arise as a direct consequence of the loss of the tax exemption for the employees. Australian Taxation Office

1.47 The proposed amendments are expected to lower administrative costs for the Australian Taxation Office in the long term.

1.48 The Australian Taxation Office currently devotes significant resources to providing interpretive advice on the operation of section 23AG. While this is likely to continue upon implementation of the new rules, the number of individuals who will be eligible for an exemption from 1 July 2009 will decrease over time, thereby resulting in fewer requests for interpretive advice.

Consultation

1.49 The proposed amendments were announced by the Treasurer on 12 May 2009, as part of the 2009-10 Budget. Public consultation was undertaken but the consultation period was necessarily short so as to facilitate the introduction of this Bill into Parliament in the 2009 Winter Parliamentary sitting.

Conclusion and recommended option

1.50 Limiting the scope of the tax exemption provided by section 23AG, as proposed, will help maintain the integrity of the tax system by ensuring that most Australian resident individuals face the same tax burden in relation to their worldwide income.