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Is income earned by an Australian resident taxpayer derived from service in the Joint Petroleum Development Area (JPDA), assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. Income earned by an Australian resident taxpayer derived from service in the JPDA is assessable under subsection 6-5(2) of the ITAA 1997 and is not exempt from tax under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936).

The taxpayer is an Australian resident for tax purposes.

The taxpayer is employed in the JPDA for a continuous period of more than 90 days.

The area that is the JPDA is established and defined in the Timor Sea Treaty signed between the Government of East Timor and the Government of Australia on 20 May 2002. Although the Timor Sea Treaty has not yet been enacted as law in Australia, the Governments of Australia and East Timor have entered an interim arrangement contained in an Exchange of Notes signed on 20 May 2002. These Exchange of Notes were given effect in tax administration by virtue of a Special Gazette Notice on 22 July 2002 that provided the withholding tax schedule for payments made to individuals performing work or services in the JPDA on or after 1 August 2002. This notification of the withholding schedule was made by virtue of section 15-25 of Schedule 1 to the Taxation Administration Act 1953 and the withholding amounts are based on arrangements under the Exchange of Notes signed on 20 May 2002.

The Exchange of Notes provides that petroleum exploration and exploitation in the area that the Timor Sea Treaty defines as the JPDA shall take place in accordance with the arrangements in place on 19 May 2002. This effectively means that the Timor Gap Treaty, which was given the force of law in Australia by section 13 of the Petroleum (Timor Gap Zone of Cooperation) Act 1990 , continues to operate because the arrangements under the Timor Gap Treaty were in place at 19 May 2002.

The purpose of the Timor Gap Treaty was to determine the taxing rights of Australia and Indonesia in relation to the exploitation of petroleum in the Timor Gap Zone of Cooperation. This Zone of Cooperation includes the area that is now defined under the Timor Sea Treaty as the JPDA. However, paragraph (3) of Article 2 of the Timor Gap Treaty makes it clear that there is no territorial delimitation implied by the Treaty. The Article states that although the treaty provides for the taxing rights for both countries in relation to petroleum exploration and exploitation in the Zone of Cooperation, it does not deny maritime claims to the area by the two countries.

Both Australia and East Timor continue to have sovereignty over the area and therefore, for the purposes of Australian law, the area is considered part of Australian territory. Paragraph 7 of the Exchange of Notes further provides that nothing in the Exchange of Notes shall be interpreted as affecting Australia's or East Timor's position or rights relating to a seabed delimitation or their respective seabed entitlements.

Therefore, the JPDA is still treated by Australia as part of Australia's maritime zones under the arrangements.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Subsection 6-15(2) of the ITAA 1997 provides that if an amount is exempt income then it is not assessable income.

Section 11-15 of the ITAA 1997 lists those provisions dealing with income which may be exempt. Included in this list is section 23AG of the ITAA 1936 which deals with overseas employment income.

Subsection 23AG(1) of the ITAA 1936 provides that where a resident taxpayer is engaged in 'foreign service' for a continuous period of not less than 91 days, any 'foreign earnings' derived will be exempt from tax in Australia.

Subsection 23AG(7) of the ITAA 1936 defines 'foreign service' as service in a foreign country as the holder of an office or in the capacity of an employee, and 'foreign earnings' include salary, wages, commission, bonuses or allowances.

Section 23AG of the ITAA 1936 is only available to resident taxpayers who derive foreign earnings from service in a foreign country. The area can only be treated as part of a 'foreign country' where it is clearly deemed to be a 'foreign country' for the purposes of section 23AG of the ITAA 1936.

As the JPDA is not a 'foreign country', exemption under section 23AG of the ITAA 1936 cannot therefore apply to earnings derived from service in the JPDA.

Accordingly, the income earned by the taxpayer from service in the JPDA is assessable under subsection 6-5(2) of the ITAA 1997 and is not exempt from tax under section 23AG of the ITAA 1936.