Assessability of arrears of salary and wages received from employment with the Italian Government

Is a lump sum payment in arrears of unpaid salary and wages received by a resident taxpayer in respect of the taxpayer's employment with the Italian Government assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. A lump sum payment in arrears of unpaid salary and wages received by a resident taxpayer in respect of the taxpayer's employment with the Italian Government is not assessable under subsection 6-5(2) of the ITAA 1997.

The taxpayer was an employee of the Italian Government.

At the time the taxpayer exercised their employment, the taxpayer was a resident of Italy for tax purposes and was not a resident of Australia.

The taxpayer ceased employment with the Italian Government and subsequently became a resident of Australia for income tax purposes.

The taxpayer received a lump sum payment in arrears of unpaid salary and wages from the Italian Government after becoming a resident of Australia.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes all the 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 Income Tax Assessment Act 1936 (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.

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

While it is a requirement for the operation of section 23AG of the ITAA 1936 that the foreign earnings be derived whilst the individual is a resident for Australian taxation purposes, it is not also a requirement that the relevant foreign service be performed whilst the individual is a resident for those purposes (paragraph 5 of Taxation Ruling TR 96/15).

As the taxpayer was a resident of Australia at the time of receiving the lump sum payment of unpaid salary and wages which wholly related to a continuous period of foreign service of not less than 91 days, the payment qualifies as foreign earnings from foreign service and may be exempt under subsection 23AG(1) of the ITAA 1936, subject to the application of subsection 23AG(2) of the ITAA 1936.

Subsection 23AG(2) of the ITAA 1936 provides that no exemption is available under subsection 23AG(1) of the ITAA 1936 in circumstances where an amount of foreign earnings is exempt from tax in the foreign country solely because of: • a double tax agreement or a law of a country that gives effect to such an agreement (paragraphs 23AG(2)(a) and 23AG(2)(b) of the ITAA 1936) • a law of that foreign country which generally exempts from, or does not provide for, the imposition of income tax on income derived in the capacity of an employee, income from personal services or any other similar income (paragraphs 23AG(2)(c) and 23AG(2)(d) of the ITAA 1936), and • a law or international agreement dealing with privileges and immunities of diplomats or consuls or of persons connected with international organisations (paragraphs 23AG(2)(e), 23AG(2)(f) and 23AG(2)(g) of the ITAA 1936).

In determining liability to Australian tax on foreign sourced income received by a resident, 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 the ITAA 1997 so that those Acts are read as one.

Schedule 21 to the Agreements Act contains the double tax convention between Australia and the Republic of Italy (the Italian Convention). The Italian Convention operates to avoid double taxation of income received by Australian and Italian residents.

Article 19(1) of the Italian Convention provides that salary and wages paid by the Italian Government or by a political or administrative subdivision or a local authority thereof to any individual in respect of services rendered to the Italian Government, subdivision or authority shall be assessable only in Italy. However, the remuneration shall be taxable only in Australia if the services are rendered in Australia and the recipient is a resident of Australia who: (a) is a citizen or national of Australia, or (b) did not become a resident of Australia solely for the purpose of performing the services.

As the taxpayer exercised the duties of their employment with the Italian Government wholly in Italy, the lump sum payment in arrears of unpaid salary and wages received by the taxpayer from the Italian Government is taxable only in Italy.

Accordingly, the salary and wages received by the taxpayer from their employment with the Italian Government are not assessable under subsection 6-5(2) of the ITAA 1997.

Note: In accordance with Taxation Determination TD 94/58, while the foreign employment income received by the taxpayer may also be exempt under section 23AG of the ITAA 1936 as none of the exceptions in subsection 23AG(2) apply, it is not an exempt amount for the purposes of the 'exemption with progression' calculation in subsection 23AG(3) as Australia is not permitted to tax the income under the Italian Convention. Subsection 23AG(3) refers to 'an amount that is exempt from tax under this section' and thus only applies in respect of income that qualifies for exemption from tax in Australia because of section 23AG, and not for any other reason.