Taxation of compensation paid to non-residents

Which Article of a double tax agreement (DTA) governs the taxation of the 'loss of earnings' (LOE) benefit paid to the claimant under section 44 or section 45 of the Transport Accident Act 1986 (Vic) (TAA 1986), or under similar legislation in other Australian States and Territories, where the claimant is a resident of a country with which Australia has entered into a DTA?

Australia has the right to tax LOE benefits that are sourced in Australia and received by a non-resident in accordance with the Other Income Article, which in some DTAs is called the Income Not Expressly Mentioned Article. In the absence of an Other Income Article, or its equivalent, the domestic law will apply without limit or modification.

A non-resident receives LOE benefits if he or she is injured in a transport accident in the State of Victoria. The benefits are statutory compensation payments made under section 44 or section 45 (TAA 1986) for loss of income due to the injury. The benefits are calculated by reference to the recipient's pre-accident earnings. Similar statutory compensation payments are made in other Australian States and Territories under statutory provisions similar to the TAA 1986.

Australia's DTAs are international agreements that have been negotiated between Australia and another country. The primary role of a DTA is to avoid double taxation and one mechanism for doing this is to distribute or allocate taxing rights between those countries that are parties to the DTA. It does this, for some categories of income, by limiting or completely eliminating taxation in the country where the income arises or is derived (the 'source country') and in other cases it allows the source country to tax, but requires the country of residence of the recipient to effectively reduce or eliminate its taxes so that there is no double taxation. LOE benefits fall under the second category of cases.

Articles relevant to the taxation of LOE benefits that require consideration are the Dependent Personal Services (DPS) Article and the Other Income Article, which in some DTAs is called the Income Not Expressly Mentioned Article.

Dependent Personal Services (DPS) Article

This Article generally governs the taxing rights over 'salary, wages and other similar remuneration derived... in respect of an employment'. The general rule is that the country of residence has sole taxing rights over the remuneration derived by its residents, although shared taxing rights will arise where remuneration is derived by a resident of one of the Contracting States from employment performed in the other Contracting State.

The words 'salary, wages and other similar remuneration' are not defined within the DTAs. In the circumstances, the General Definitions Article of the various DTAs provides that any term not defined in the DTA shall, unless the context otherwise requires, have the meaning which it has under the law of the country applying the DTA relating to the taxes to which the treaty applies.

There is no general definition of the term 'salary, wages and other similar remuneration' under Australia's income tax laws. Accordingly, the key terms 'salary' and 'wages' must be given their ordinary meaning, which in the main are left to the general law for determination (see : Mutual Acceptance Co. Ltd v. FC of T (1944) 69 CLR 389; Commissioner of Superannuation v. Carpenter (1983) 77 FLR 224; FC of T v. J Walter Thompson (Aust.) Pty Ltd (1944) 69 CLR 227).

The Macquarie Dictionary (1997, 3rd ed.) defines the term 'salary' as 'a fixed periodical payment, usually monthly, paid to a person for regular work or services...' and the term 'wage' as 'that which is paid for work or services'. Judicial authorities also confirm that the terms apply to payments made for work or services provided by an employee under an employer-employee relationship traditionally described as a master/servant relationship.

In establishing the meaning of the words 'salary, wages and other similar remuneration' as used in the context of the DPS Article, regard may also be had to the Commentary on Article 15 concerning the taxation of Dependent Personal Services by the Organisation for Economic Co-operation and Development (OECD) in its 1997 update of the Model Tax Convention on Income and on Capital. The OECD Commentary recognises that the payments that constitute 'salary, wages and other similar remuneration' arise in the context of an employment relationship, which ordinarily is understood to exist where one person uses the services of another person in return for payment. Thus the meaning attributed to the words 'salaries, wages and other similar remuneration' by the OECD Commentary confirms the meaning given to those words under the general law.

The LOE benefit payments made under the TAA 1986 are not made for work or services provided by an employee in respect of an employment relationship between the payer and the claimant. The compensation is simply for loss of earnings as a result of a transport accident injury and is calculated by reference to pre-accident earnings of the claimant. The source of the LOE benefits is a statutory entitlement to compensation arising from a transport accident injury occurring in Australia. Therefore, the DPS Article cannot apply to LOE benefits because the payment cannot be characterised as 'salary, wages or other similar remuneration' for the purpose of applying the Article.

Other Income and Income Not Expressly Mentioned Articles

As the DPS Article does not apply to LOE benefits, the applicability of the Other Income and Income Not Expressly Mentioned Articles must be considered. These Articles apply to items of income that are not dealt with in any of the other Articles of the DTA.

The Articles in most of Australia's DTAs generally provide that the country of residence has the right to tax but to the extent that the income is derived from sources in the other country, they may also be taxed in that other country. Therefore, if the LOE benefits paid to non-residents are 'sourced' in Australia, then Australia is able to tax those benefits.

The question of the source of income in the form of compensation payments was considered by the High Court in James Fenwick & Co. Ltd v. FC of T (1921) 29 CLR 164. On the facts of the case, the High Court held that the 'real practical source' of a payment of compensation was the requisitioning of two vessels in Australian waters. Consequently, the compensation payment constituted income derived from Australian sources and was taxable.

The LOE benefits arise under an Australian statutory entitlement to compensation for a transport accident injury occurring in Australia. The entitlement accrues when a transport accident causing injury occurs. Both the entitlement and the event given rise to the entitlement occur in Australia. These facts are sufficient to conclude that the LOE benefits are sourced in Australia.

Since LOE benefits are sourced in Australia, the Other Income Article, or its equivalent, will apply to LOE benefits and give Australia, as the source country, a taxing right over the LOE benefits.