Assessability of income earned overseas aboard a ship

Is the income earned by an Australian resident taxpayer, while working as an engineer on a ship which operates in Malaysian territorial waters, exempt under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The income earned by an Australian resident taxpayer aboard a ship operating in Malaysian territorial waters will be exempt under section 23AG of the ITAA 1936.

The taxpayer is an Australian resident.

The taxpayer is employed as Chief Engineer on board a ship which is on charter in Malaysia.

The taxpayer is contracted to work on the foreign ship on 12 month contracts. Under the contract, the taxpayer spends time employed on board the ship with temporary breaks from this engagement.

The taxpayer was engaged in 'foreign service' for a period of not less than 91 days.

The taxpayer was in Malaysia for a period in excess of 183 days.

The ship on which the taxpayer is employed is always in Malaysian waters, it does not move out of Malaysian territorial waters.

The taxpayer's employer company is resident in Malaysia.

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources 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 earnings 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 and wages (subsection 23AG(7) of the ITAA 1936).

Paragraph 9 of Taxation Ruling TR 96/15 'Income tax: foreign tax credit system: issues relating to the practical application of section 23AG', states that subsection 23AG(6) of the ITAA 1936 identifies certain temporary absences from a period of foreign service that are related to the foreign service and will not be taken to constitute a break in a period of foreign service. These absences are recreation leave wholly attributable to the period of 'foreign service' (other than, for example, long service leave, leave without pay, furlough and extended leave) and sick leave.

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 tax in the foreign country only because of any of the reasons listed.

One of the reasons listed is where the income is exempt in the foreign country as a result of the operation of a double tax agreement (paragraph 23AG(2)(b) of the ITAA 1936).

Schedule 16 to the International Tax Agreements Act 1953 (The Agreements Act) contains the double tax agreement between Australia and Malaysia (the Malaysian Agreement).

Paragraph 1 of Article 14 of the Malaysian Agreement provides that remuneration derived by an Australian resident from employment exercised in Malaysia may be taxed by Malaysia.

Paragraph 2 of Article 14 of the Malaysian Agreement provides that remuneration derived from employment exercised in Malaysia will be exempt from tax in Malaysia if: • the taxpayer is present in Malaysia for a period or periods not exceeding in the aggregate 183 days in the year of income of Malaysia. • the remuneration is paid by or on behalf of an employer who is not a Malaysian resident; and • the remuneration is not deductible in determining the profits of a permanent establishment which the employer has in Malaysia.

As the taxpayer was employed by a Malaysian resident company and the taxpayer was present in Malaysia for an aggregate of greater than 183 days in the year of income, the taxpayer will not be exempt from tax in Malaysia under paragraph 2 of Article 14 of the Malaysian Agreement. As the taxpayer was not exempt from tax in Malaysia as a result of a double tax agreement, paragraph 23AG(2)(b) of the ITAA 1936 will not be invoked. None of the other reasons in subsection 23AG(2) of the ITAA 1936 apply to the taxpayer's situation.

The taxpayer has been engaged in 'foreign service' for a continuous period of not less than 91 days during the year ended 30 June 2003. As none of the provisions in subsection 23AG(2) of the ITAA 1936 apply, the income the taxpayer received is exempt from Australian tax from 1 July 2002 to 30 June 2003.