A compulsory subscription payable from foreign earnings in a foreign country under a legislative decree is not income tax

Is the subscription payable by a taxpayer in a foreign country to an account set up to provide for 'insurance against unemployment' an 'income tax' for the purposes of subsection 23AG(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

No. The subscription payable by a taxpayer in a foreign country to an account set up to provide for 'insurance against unemployment' is not an 'income tax' for the purposes of subsection 23AG(2) of the ITAA 1936.

The taxpayer is an Australian resident for tax purposes.

The taxpayer is employed under the terms of a contract by an Australian employer. The taxpayer agrees to provide their services in a foreign country for a period of 12 months. The taxpayer's employer pays them the remuneration under the terms of the contract.

Under the terms of a legislative decree (decree) issued in the foreign country where the taxpayer is employed, all the workers employed in that foreign country are required to pay a certain percentage of their wages as a 'subscription' each month to an authority.

The taxpayer is obligated to pay a certain percentage of their salary under the terms of the decree. The taxpayer's employer is also obligated to pay as subscription a certain percentage of the wages paid to their employees.

The subscription collected under the decree is deposited in a special fund (account) set up by the government. The account funds cannot be used for any other purpose other than to meet claims for compensation and against unemployment and to meet its overheads.

Persons who are not 'nationals' of the foreign country are entitled to make a claim upon the account as long as they do not become an 'illegal resident' within the meaning of the decree.

A government authority is responsible for the collection of the subscription, payment of the benefits to unemployed persons and management of the account.

The government authority must have the account examined and audited by independent actuaries and auditors respectively, and publish their reports.

Any 'surplus' in the account identified by the actuary 'must be transferred' to a general reserve fund which shall not be disposed of except for increasing the minimum and maximum amounts of the compensation and aid.

The relevant foreign country has no broad based tax system in place and there is no tax treaty between Australia and the foreign country.

Section 23AG of the ITAA 1936 exempts salary or wages earned overseas by an Australian resident from Australian tax if that person had worked continuously overseas for a period of at least 91 days.

However subsection 23AG(2) of the ITAA 1936 provides that the provision 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 listed reasons is where they are exempt in the overseas country solely because the foreign country does not tax employment income, personal services income or similar income (paragraph 23AG(2)(d) of the ITAA 1936).

In interpreting the term 'exempt from income tax' dealing with taxation of income from the United Kingdom under the former paragraph 23(q) of the ITAA 1936, Fullgar J said in Mutual Life & Citizens' Assurance Co Ltd v. Federal Commissioner of Taxation (1959) 100 CLR 537; (1959) 12 ATD 9 that the meaning of the provision needs to be interpreted based on the Australian Act though one has to inquire into the law of the United Kingdom relating to income tax, and to examine the statutes of the United Kingdom which impose that tax. It follows that the relevant laws of the foreign country are not necessarily decisive of the question whether that payment made to the foreign country authority is an income tax within the meaning of subsection 23AG(2) of the ITAA 1936. The meaning of the term 'income tax' under the Australian law needs to be considered.

Subsection 23AG(7) of the ITAA 1936 defines the term 'income tax' in relation to a foreign country as not to include, in all cases municipal income tax, and state income tax in the case of a federal foreign country. In this case, the subscription payable is not a municipal income tax or a state tax.

In Case R68 84 ATC 482; (1984) 27 CTBR (NS) Case 122 ( Case R68 ), one of the issues the Board of Review had to consider was whether the taxpayer has paid 'income tax' in Saudi Arabia to the effect that the taxpayer would be entitled to the benefits under the former paragraph 23(q) of the ITAA 1936. The Board of Review reached its conclusion having regard to the Latham CJ's dictum on the definition of tax in Matthews v. Chicory Marketing Board (1938) 60 CLR 263, Myers C.J 's views on 'income tax' in the New Zealand case Re Paterson (Deceased) (1942-1943) 3 AITR 1 and the views of the Supreme Court in De Romero v. Read and Anor (1932) 32 SR (NSW) 607 and Evatt J of the High Court in De Romero v. Read and Anor (1932) 48 CLR 649 on 'income tax'.

The Board concluded that: Whilst the contributions of employees were based on their incomes, the scheme, whilst compulsory, encompassed a segment only of the total population of Saudi Arabia, namely, wage-earning workmen. Additionally, the funds paid under the scheme were paid into a special bank account, as distinct from the consolidated revenue of the country, and were used for a specific purpose, namely, to pay benefits to a specified and restricted class of persons. It is therefore clear, we consider, that the contributions so made by the taxpayer bear none of the distinguishing features of an income tax.

In Case S52 85 ATC 388; (1985) 28 CTBR (NS) Case 58 ( Case S52 ), the question at issue was whether compulsory contributions made to the Federal Insurance Fund, levied under the United States Federal Insurance Contribution Act (FICA), come within the meaning of 'income tax' for the purpose of former paragraph 23(q) of the ITAA 1936. FICA contributions were deducted from salary and calculated according to a statutory formula provided for by the United States (US) Inland Revenue Code.

Dr Gerber (the board member), with whom the other board members agreed, concluded that the contribution constituted 'income tax' for the purposes of paragraph 23(q) of the ITAA 1936 even though it was deemed not a tax according to the US law. Dr Gerber referred to most of the cases mentioned in Case R68 above and said schemes like FICA were known in Australia. He referred to the Social Services Contribution Assessment Act (No 39 of 1945) and the Social Services Contribution Act (No 40 of 1945) that were administered by the Commissioner of Taxation. The sums collected under this legislation went into consolidated revenue. When this legislation was repealed and was replaced with Income Tax and Social Contribution Assessment Act (No 48 of 1950) and Income Tax and Social Contribution Act (No 49 of 1950), it was put beyond doubt that these contributions were part of the income tax regime, even though the legislation continued to refer to them as a 'social services contribution'.

Dr Gerber gave the following reasons for treating the contribution as 'income tax': The obligation to make the payment is part of the US Internal Revenue Code, it is paid by the employee 'in addition to other taxes' (sec. 3101), is stated to be tax to be struck as a percentage of wages (up to the limit imposed by statute). In practice, a proportion of salary is withheld for FICA out of each and every instalment of salary. It follows that even though the tax is limited to only part of salary, none the less it is deemed to be a tax on the whole of the amount.

Having regard to the above Board of Review decisions, the subscription payable by the taxpayer is considered to be not 'income tax' for the purposes of subsection 23AG(2) of the ITAA 1936 for the following reasons: • subscriptions payable, although compulsory, encompassed only a segment of the total population of the foreign country, namely, certain wage earners • subscriptions are paid into a special account, as distinct from consolidated revenue of the foreign country, and may only be used to pay benefits calculated in accordance with the decree to qualifying unemployed persons, including persons who are not nationals of the foreign country • qualifying persons may directly claim against the account for their entitlements under the decree, and have the rights of appeal • any 'surplus' of the account (over estimated claims on the Account) determined by the reporting actuary must be transferred to a special reserve which can be used to fund any increase in the entitlements of claimants • subscriptions payable by the taxpayer do not bear the requisite features of an income tax as the payments are not part of any comprehensive income tax system as generally understood. It is deducted at the source and not in pursuance of an assessment as such • the obligation to pay the subscription is not part of a taxation code and is not paid by the employee 'in addition to other taxes' as was in the case in Case S52 , and • it was never stated to be a 'tax' to be struck as a percentage of wages but rather as 'unemployment insurance subscriptions' under the terms of the decree.

Therefore, the subscriptions payable by the taxpayer to the account on which the taxpayer may be able to make a future claim can not be legally characterised as an 'income tax' within the meaning of subsection 23AG(2) of the ITAA 1936.