Income tax: assessability of service income received by a non-resident of Australia and East Timor from the Joint Petroleum Development Area

Is income earned by a non-resident taxpayer of both Australia and East Timor from services in the Joint Petroleum Development Area (JPDA) assessable under sub section 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. Income earned by a non-resident taxpayer of both Australia and East Timor from services in the JPDA is assessable under subsection 6-5(3) of the ITAA 1997, with a rebate of 90% of the Australian tax payable on that income. The taxpayer may be entitled to a foreign income tax offset in Australia for foreign income tax paid on that income.

The taxpayer is a non-resident of both Australia and East Timor.

The taxpayer works for an Australian company in the JPDA.

Subsection 6-5(3) of ITAA 1997 provides that the assessable income of a non resident taxpayer includes ordinary income derived directly or indirectly from all Australian sources during the income year, as well as other ordinary income included by a provision on a basis other than having an Australian source.

Salary and wages are ordinary income for the purposes of subsection 6-5(3) of the ITAA 1997.

Accordingly, for subsection 6-5(3) of the ITAA 1997 to apply, it is necessary to determine whether the income earned by the taxpayer from service in the JPDA is from Australian sources.

The Timor Sea between northern Australia and East Timor contains proven petroleum resources in the seabed. Australia and East Timor have competing claims to the resources of this seabed. The Timor Sea Treaty (Treaty) enables Australia and East Timor to jointly develop the petroleum resources of a major part of the seabed of the Timor Sea, defined in Article 3 of the Treaty as the JPDA, pending agreement to a seabed boundary with East Timor.

The Treaty was signed between the Government of East Timor and the Government of Australia on 20 May 2002. The Treaty entered into force on 2 April 2003 but is taken to have effect and all of the provisions will apply and be taken to have applied on and from the date of signature, 20 May 2002.

Article 13 of the Treaty provides that the JPDA shall be deemed to be, and treated by Australia as part of Australia (and by East Timor as part of East Timor) for the purposes of taxation law related directly or indirectly to: (a) the exploration for or the exploitation of petroleum in the JPDA, or (b) acts, matters, circumstances and things touching, concerning arising out of or connected with such exploration and exploitation.

It follows that income earned from service in the JPDA will be sourced in Australia and is, in this case, assessable under subsection 6-5(3) of the ITAA 1997.

Article 13(3) of the Taxation Code under the Treaty provides that JDPA income derived by an individual who is not a resident of either Australia or East Timor in respect of employment exercised in the JDPA may be taxed in both Australia and East Timor on 100% of that income. They will then receive a rebate of the reduction percentage of their gross tax. In the case of Australia, the reduction percentage is 90%.

In effect, third country residents are taxed in Australia on their total JPDA income, at non-resident rates of tax, with a rebate allowed equal to 90% of the Australian tax payable on their net assessable JPDA income (net assessable JPDA income is assessable JPDA income less allowable deductions relating to that income).

Division 770 of the ITAA 1997 outlines the operation of the foreign income tax offset rules. These provisions allow taxpayers to claim relief in the form of a tax offset for foreign income tax paid on an amount included in their assessable income.

While the foreign income tax offset mainly applies to Australian resident taxpayers, in limited circumstances where the income of a foreign/non-resident is taxed as assessable income in Australia, they may be able to claim the offset.

The main rules governing entitlement to claim the foreign income tax offset are set out in section 770-10 of the ITAA 1997.

Subsection 770-10(1) of the ITAA 1997 provides that a taxpayer is entitled to a foreign income tax offset for foreign tax paid in respect of an amount that is included in the taxpayer's assessable income in a year of income. The tax offset has the effect of reducing the Australian tax that would otherwise be payable on the double-taxed amount. The amount of the foreign income tax offset is subject to the foreign income tax offset limit calculated in accordance with section 770-75 of the ITAA 1997.

Subsection 770-10(3) of the ITAA 1997 limits the offset so that it does not apply to foreign income tax paid to a foreign country by a taxpayer who is a resident of that country, on amounts sourced outside that country. This means that the taxpayer will not be entitled to a foreign income tax offset in relation to any foreign tax that they pay in their country of residence on the income earned from service in the JPDA.

However, a foreign resident will still be entitled to a tax offset for foreign income tax they pay to their country of residence, or in a third country, where the tax is paid on the basis that the source of the income is that country. That is, where the foreign country levies tax on the income because that country is the source, the foreign resident will be entitled to a tax offset where the taxpayer is also assessed on that income in Australia. This means that the taxpayer is entitled to a foreign income tax offset in Australia in relation to income tax paid in East Timor on the income earned from service in the JPDA.

Accordingly, the income earned by the taxpayer from service in the JPDA is assessable under subsection 6-5(3) of the ITAA 1997, with a rebate of 90% of the Australian tax payable on that income. In addition, if foreign income tax has been paid in East Timor on that income, a foreign income tax offset will be allowed.