Exempt income - Australian resident taxpayer teacher working in China

Is the salary and wages earned by a taxpayer while working as a teacher in China assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The salary and wages earned by a taxpayer while working as a teacher in China will not be assessable under subsection 6-5(2) of the ITAA as the income will be exempt under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936).

The taxpayer is an Australian resident for taxation purposes.

The taxpayer is employed by a Chinese resident as a teacher in China.

The taxpayer will be in China for a period in excess of 24 months.

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.

Salary and wages are ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997.

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 earning derived will be exempt from tax in Australia. 'Foreign service' includes service in a foreign country in the capacity as an employee (subsection 23AG(7) of the ITAA 1936). 'Foreign earnings' includes income consisting of salary or wages (subsection 23AG(7) 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 therein.

Under paragraph 23AG(2)(b) of the ITAA 1936 where income is exempt in the foreign country as a result of the operation of a double tax agreement that income is not exempt under subsection 23AG(1) of the ITAA 1936.

In determining liability to Australian tax on foreign sourced income it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Schedule 28 to the Agreements Act contains the double tax agreement between Australia and China (the Chinese Agreement). The Chinese Agreement operates to avoid the double taxation of income received by Australian and Chinese residents.

Paragraph (1) of Article 15 of the Chinese Agreement provides that the salary and wages income of an Australian resident will be taxable only in Australia unless the employment is exercised in China. If the employment is exercised in China then China may tax the income.

However under paragraph (2) of Article 15 of the Chinese Agreement where the employment is exercised in China the income will not be taxable in China if one of the following conditions applies; • The taxpayer is present in China for a period or periods not exceeding 183 days in any consecutive period of 12 months • The remuneration is paid by an employer who is not a Chinese resident; and the remuneration is not borne by a permanent establishment or fixed base that the employer has in China.

Paragraph (1) of Article 15 of the Chinese Agreement is also subject to Article 20 of the Chinese Agreement. This Article provides that where an Australian resident teacher who is a resident of Australia visits China for a period not exceeding 2 years for the purpose of teaching any income earned will be exempt from tax in China to the extent that it is taxable in Australia.

As the taxpayer will be in China for a period in excess of 2 years Article 20 of the Chinese Agreement will not apply.

The taxpayer's salary and wages will be paid by a Chinese resident employer and as they will be present in China for a period in excess of 183 days therefore paragraph (2) of Article 15 of the Chinese Agreement will also not apply.

Under paragraph (1) of Article 15 of the Chinese Agreement, although the taxpayer's income is subject to tax in Australia it may also be subject to tax in China. Therefore the taxpayer's income is not exempt from tax in China and accordingly subsection 23AG(2) of the ITAA 1936 does not apply.

As subsection 23AG(2) of the ITAA 1936 does not apply, the taxpayer's income earned in China will be exempt from tax under subsection 23AG(1) of the ITAA 1936 and is not included in their assessable income under subsection 6-5(2) of the ITAA 1997.