Assessability of bonus payment received by Australian resident from employment performed in the United Kingdom and Australia

Is a bonus received by an Australian resident taxpayer from employment performed in the United Kingdom (UK) and in Australia assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

The proportion of the bonus payment received by an Australian resident taxpayer that relates to service performed by the taxpayer in the UK is not assessable under subsection 6-5(2) of the ITAA 1997 as it is exempt under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936). However, the proportion of the bonus payment that relates to service performed by the taxpayer in Australia is assessable under subsection 6-5(2) of the ITAA 1997.

The taxpayer is a resident of Australia for income tax purposes from August 2001.

Prior to August 2001, the taxpayer worked in the UK and was a resident of the UK. The taxpayer was not a resident of Australia for income tax purposes during that period.

The taxpayer received a bonus from the UK resident employer in June 2002.

The bonus received by the taxpayer was based on the taxpayer's contribution to the business results of the UK employer. The bonus received relates to the period the taxpayer was a resident of the UK as well for the period the taxpayer was a resident of Australia.

The taxpayer was present in the UK for a continuous period of 136 days.

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.

A bonus payment is 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.

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.

Paragraph 4 of Taxation Ruling IT 2534 provides that a bonus is taken to have been derived for income tax purposes at the time it is paid or otherwise made available to the employee. This is so even where the bonus may have been with regard to duties that were performed in a previous year of income.

Therefore, the taxpayer is taken to have derived the bonus when the taxpayer received it.

While it is a requirement for the operation of section 23AG of the ITAA 1936 that the foreign earnings be derived when the individual is a resident for Australian taxation purposes, it is not also a requirement that the relevant foreign service be performed when 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 bonus and was engaged in a continuous period of foreign service of not less than 91 days, the proportion of the bonus that relates to the taxpayer's service in the UK 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.

The proportion of the bonus that relates to service performed by the taxpayer in Australia is not derived from foreign service and is not exempt under section 23AG of the ITAA 1936.

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 because of any of the reasons listed. One of the listed reasons is where the income earned by the resident in the foreign country is made exempt by the operation of a double tax agreement (paragraph 23AG(2)(b) of the ITAA 1936).

Therefore, 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 (Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the ITAA 1997 so that those Acts read as one.

Schedule 1 to the Agreements Act contains the double tax agreement between Australia and the United Kingdom of Great Britain and Northern Ireland (the UK Agreement). Schedule 1A to the Agreements Act contains the protocol amending the UK Agreement (UK Protocol). The UK Agreement and the UK Protocol operate to avoid the double taxation of income received by Australian and UK residents.

Article 12(1) of the UK Agreement provides that salary, wages and other similar remuneration derived by a resident of Australia in respect of an employment shall be subject to tax only in Australia unless the employment is exercised in the UK. If the employment is exercised in the UK, the remuneration may be taxed in the UK.

Article 12(2) of the UK Agreement provides that the income derived from employment exercised in the UK will be exempt from tax in the UK if: • the taxpayer is present in the UK for a period or periods not exceeding in the aggregate 183 days in the UK year of income • the remuneration is paid by or on behalf of an employer who is not a UK resident, and • the remuneration is not deductible in determining the profits of a permanent establishment or a fixed base that the employer has in the UK.

As the bonus is paid by an entity that is a resident of the UK, Article 12(2) of the UK Agreement will not apply. Accordingly, the bonus may be taxed by Australia and the UK.

As none of the circumstances set out in subsection 23AG(2) of the ITAA 1936 apply, the proportion of the bonus payment the taxpayer received in respect of service performed in the UK is exempt from tax under subsection 23AG(1) of the ITAA 1936 and will not form part of the taxpayer's assessable income under subsection 6-5(2) of the ITAA 1997.

However, the proportion of the bonus payment received in respect of service performed in Australia is assessable under subsection 6-5(2) of the ITAA 1997.