Assessability of salary and allowances received by a resident taxpayer from Timor-Leste

Are the salary, overseas and transfer allowances received by an Australian resident taxpayer from employment in Timor-Leste assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

The salary and the overseas allowance received by an Australian resident taxpayer from employment in Timor-Leste are not assessable income under subsection 6-5(2) of the ITAA 1997 as they are exempt income under subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936). However, the transfer allowance received by the taxpayer that covers activities undertaken prior to the commencement or after the completion of foreign service, is not derived from that foreign service and is not exempt from tax under subsection 23AG(1) of the ITAA 1936.

The taxpayer is an Australian resident for income tax purposes.

The taxpayer is employed in Timor-Leste for a continuous period of not less than 91 days.

The taxpayer receives salary and two types of allowances.

The taxpayer receives a 'transfer allowance' to cover the costs associated with the preparing for departure to Timor-Leste and costs on returning from Timor-Leste.

The taxpayer receives an 'overseas allowance' to cover the cost of living, posting, hardship, special hardship and household maintenance in Timor-Leste.

The laws of Timor-Leste provide for the imposition of income tax and do not generally exempt employment income from income tax.

A Memorandum of Understanding (MOU) exists between the governments of Australia and the Democratic Republic of Timor-Leste (Timor-Leste), which exempts the taxpayer's employment income from income tax in Timor-Leste.

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 allowances 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 it is not included in 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 and 'foreign earnings' includes income consisting of salary, wages, bonuses or allowances (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.

One of the reasons listed is where the income is exempt in the foreign country because of a double tax agreement (paragraphs 23AG(2)(a) and (b) of the ITAA 1936).

There is no double tax agreement between Australia and Timor-Leste. Therefore, paragraphs 23AG(2)(a) and 23AG(2)(b) of the ITAA 1936 will not apply.

As the laws of Timor-Leste provide for the imposition of income tax and do not generally exempt employment income from income tax, paragraphs 23AG(2)(c) and (d) of the ITAA 1936 will not apply.

None of the other reasons in subsection 23AG(2) of the ITAA 1936 apply to the taxpayer's situation.

The taxpayer's salary and wages are exempt from tax in Timor-Leste under the terms of a MOU signed by the governments of Australia and Timor-Leste. This is not one of the reasons listed in subsection 23AG(2) of the ITAA 1936.

However, to qualify for the exemption the 'foreign earnings' must be derived from 'that foreign service'. That does not mean that the foreign earnings need to be derived at the time of engaging in foreign service. The important test is that the foreign earnings need to be derived as a result of the undertaking of that foreign service.

As the taxpayer has been engaged in foreign service for a continuous period of not less than 91days, the salary received by the taxpayer from service in Timor-Leste is exempt from tax under subsection 23AG(1) of the ITAA 1936 and is not assessable income under subsection 6-5(2) of the ITAA 1997.

The 'overseas allowance' received by the taxpayer is exempt from tax under subsection 23AG(1) of the ITAA 1936 as the allowance is derived as a result of the undertaking of that foreign service.

The 'transfer allowance' received by the taxpayer is for activities undertaken prior to the commencement or after completion of the foreign service. The allowance is not exempt from tax under subsection 23AG(1) of the ITAA 1936 as it is not derived from that foreign service. Therefore, the taxpayer's assessable income will include the transfer allowance under subsection 6-5(2) of the ITAA 1997.