Exempt foreign service income from accrued leave payment: East Timor

Are payments for operational deployment leave, which accrued while the taxpayer was engaged in foreign service and paid to the taxpayer after returning from foreign service, but while still employed, exempt income under subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Yes. The payment for operational deployment leave, which accrued while the taxpayer was engaged in foreign service and paid to the taxpayer after returning from foreign service, but while still employed, is exempt income under subsection 23AG(1) of the ITAA 1936.

The taxpayer was engaged in foreign service in East Timor for a continuous period of more than 90 days.

While engaged in foreign service in East Timor the taxpayer accrued 75 hours operational deployment leave.

The taxpayer took this leave after returning from foreign service but while still employed by the same employer.

None of the listed reasons in subsection 23AG(2) of the ITAA 1936 apply.

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 by the person from that foreign service will be exempt from tax in Australia. 'Foreign service' includes service in a foreign country in the capacity as an employee and 'foreign earnings' include income consisting of salary and wages (subsection 23AG(7) of the ITAA 1936).

The key words here are 'foreign earnings derived by the person from that foreign service'. The payment of the operational deployment leave qualifies as foreign earnings. However, the relevant payment must be derived by the person from that foreign service. However, that does not mean that the foreign earnings must be derived during the period of foreign service.

As operational deployment leave accrues on a daily basis, the portion attributable to the service performed in East Timor can be separated from any portion attributable to service performed in other locations.

Therefore, any payment in respect of operational deployment leave which accrued during the period of foreign service but paid to the taxpayer after returning from that foreign service, but while still employed by the same employer, qualifies as 'foreign earnings' from that foreign service. As such, the relevant payment is exempt from income tax under section 23AG of the ITAA 1936 where all the other requirements of section 23AG are met. Note: New subsection 23AG(1AA) of the ITAA 1936, which applies to foreign earnings derived from foreign service performed on or after 1 July 2009, now restricts the exemption to certain aid workers, charitable workers and government employees engaged in specific employment activities. The ATO ID should be followed having regard to that additional constraint.