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Chapter 2
Schedule 1: taxation of foreign income
Description of the measure
2.1
Schedule 1 of the bill amends section 23AG of the Income Tax
Assessment Act 1936. Section 23AG currently provides that where an
Australian resident has been engaged in foreign service for a continuous period
of not less than 91 days, any foreign earnings from the foreign service are
exempt from income tax.[1]
The exemption was introduced in 1986 in conjunction with the former foreign tax
credit system.[2]
2.2
Proposed subsection 23AG(1AA) removes the general exemption, but
maintains it for certain aid or charitable workers or government employees, or
for an activity prescribed in the regulations.
2.3
The current exemption applies to persons who are Australian residents
for tax purposes. The bill will not change this, and thus will not affect
citizens who are not residents for tax purposes.
2.4
The change will apply to foreign earnings derived on or after 1 July
2009 from foreign service performed on or after 1 July 2009. Foreign tax paid
will be claimable as a non-refundable foreign income tax offset (FITO).[3]
2.5
If an individual is no longer exempt as a result of proposed subsection
23AG(1AA), the employer will be obliged to comply with the pay-as-you-go (PAYG)
withholding rules in Division 12 of the Income Tax Administration Act 1953.
The employer will also have to comply with Fringe Benefits Tax Assessment
Act 1986 in relation to any fringe benefits provided.[4]
2.6
The Government argued that '[the current] section 23AG provides a
mechanism to relieve double taxation, but does not contain a requirement that
foreign tax has been paid for the exemption to apply. This can produce
non-neutral tax outcome between Australian resident individuals working in
different countries with different tax rates, and between individuals working
overseas and individuals working in Australia... The change will remove
non-neutral tax outcomes that can currently arise and will minimise
opportunities for tax avoidance.'[5]
2.7
Treasury estimates that -
- 15,000 to 20,000 individuals could lose their current exemption;
- Of these, around 3,300 taxpayers earning over $100,000 are
currently paying very little tax on more than a third of their income on
average because of the general exemption;
- A further 8,000 individuals currently pay no or very little tax
at all in Australia because of the exemption, despite having average incomes of
around $85,000;
- After FITOs are claimed for foreign tax paid, the average impact
for affected workers will be an increase in tax of $11,000 per year.[6]
2.8
Treasury exposed a draft of this schedule for comment between 12 and 18
May 2009. In response to submissions -
- a new paragraph 26(1AA)(c) was inserted to ensure that employees
of recognised organisations that undertake aid or charitable activities, that
do not form part of Australian 'official development assistance', are eligible
for exemption;
-
a regulation making power was inserted to allow the continuing
exemption to be extended in future as appropriate;
- the application provisions were amended to ensure that income
received after 1 July 2009 in respect of services before 1 July 2009 is exempt.[7]
Issues raised in submissions
2.9
Submissions argued against the change for various reasons summarised
below.
Effects on competitiveness of
Australian firms
2.10
Submissions argued that the change will reduce the competitiveness of
Australian firms working offshore, as it will increase their costs. This refers
both to the administrative costs of compliance and to the cost of topping up
salaries to leave the employee no worse off (assuming they do this).
2.11
For example, the Association of Consulting Engineers Australia claimed:
The current exemption from income tax makes Australian
consulting engineering firms competitive when bidding for international work.
Removing the exemption will substantially increase the cost of working abroad,
making it less attractive for engineering businesses to export their services.[8]
2.12
In their submission, they gave the example of a firm with revenue of $99
million and pretax profit of $10 million, which estimates that the measure will
increase its costs, or its employees' costs, by $5 million.[9]
Pricewaterhouse Coopers gave an example in which the cost of an employee in
China was estimated to increase from $332,000 to $565,000.[10]
2.13
Submissions argued that implementing this bill will reduce Australia's
income from exporting services; encourage firms to employ foreign nationals in
preference to Australian residents; and encourage workers to become
non-resident to avoid tax, or to return to Australia. [11]
A number of submissions argued that the returning expatriates would add to
unemployment in Australia.[12]
2.14
Many submissions from individuals argued that the changes will lead them
to either become non-resident or return to Australia.[13]
2.15
Treasury commented generally on these arguments:
- some organisations have been using the exemption as a wage
subsidy by paying employees less than they would otherwise receive;
- this results in inequity between employers with Australian
resident workers offshore and those who employ Australians to work in
Australia. [14]
Short notice of the change
2.16
Some submitters were concerned by the short notice of the change. For
example:
At any given time a large number of Australian residents will
be working offshore...changes to section 23AG from 1 July 2009 will directly
impact their remuneration arrangements without any regard for, or recourse to,
the terms of the agreement under which they moved offshore.[15]
2.17
The Institute of Chartered Accountants suggested that only new
employment agreements made after 1 July 2009 should be caught.[16]
Pricewaterhouse Coopers (PWC) noted a problem for companies carrying out long
fixed price contracts that do not allow a change in contract price because of
tax changes in Australia. PWC suggested that if the government insists on the
change, it should at least be deferred for 12 months to allow companies time to
adjust. KPMG suggested that projects already in train before the measure was
announced should be protected from the change by giving them approved status
under section 23AF.[17]
2.18
Treasury argued that inserting a grandfathering provision to protect
existing contracts could create inequity and opportunities for tax avoidance.
It would create inequity between parties to long term contracts (who would
benefit more) and parties to short term contracts.[18]
Issues to do with PAYG withholding
2.19
Employees who are no longer exempt will be subject to PAYG withholding rules.
Several concerns were raised about this:
- Employers may have to withhold PAYG tax twice - once for
Australia and once for the other country. This could create cashflow problems
for employees in the period before the foreign income tax offset could be
claimed. If an employer advances salary to cover the employee's cash flow
problem this in itself would be a taxable fringe benefit.
- There will be particular cashflow problems where the tax year in
the country of work is different from Australia's.
- Seeking a PAYG variation to avoid this problem is impractical for
many employers and employees given the difficulty of estimating the likely
foreign income tax offset. It would be liable to penalty payments if a
variation based on estimating the year end liability is mistaken.
- Foreign employers might have to withhold tax for the Australian Tax
Office, which would arguably be impractical.[19]
- The administrative difficulties will create a culture of
non-compliance (for example, among backpackers working casually or short term),
which is undesirable.[20]
2.20
The Taxation Institute elaborated on the 'backpacker problem':
...I go and stay in a hotel, work, and get paid my £250 each week. However,
after three or four months overseas I return to Australia. In that circumstance
I will have to disclose my £250
which tax has been withheld. I will also have a problem that my tax year in
Australia is different to the tax year in the UK...Since I have paid no tax in
Australia on that income, that income will be fully taxed at whatever my
marginal rate is. The tax that I have had withheld in the UK is not available
as an offset because the offset rules require that tax to actually have been
paid...I have to wait through until at least April before the UK tax year ends...I
then have a problem because the UK does not require lodgement of tax returns. I
have to ...pay a UK tax person to lodge my return for £3,000 or £4,000
...which in turn I submit to the government and seek an amendment of my tax
return to provide that credit so that reduces the tax that I have already paid.
This is just a very simple scenario.[21]
2.21
Pricewaterhouse Coopers and KPMG suggested that these problems could be
alleviated by exempting employers from the PAYG rules in respect of their
offshore employees - employees would simply pay their tax liability (net of
foreign income tax credits) in arrears. PWC suggested that alternatively
taxpayers could be allowed to self assess PAYG variations.[22]
2.22
Treasury responded or commented:
- The Commissioner for Taxation may approve a PAYG variation on
application. The ATO would use that provision to avoid the scenario of double withholding
- Australian PAYG withholding amounts could be varied to match the likely end
of year liability net of foreign income tax offsets. In this case there is no
penalty if the withheld amounts fall short of the eventual tax liability.[23]
- Employees who have foreign tax withheld regularly will be
unaffected by non-aligned financial years, since foreign tax is regarded as
paid as soon as it is withheld, and thus may count towards a FITO in the
corresponding Australian financial year - there is no need to wait for the
foreign end of year tax statement which may come later.[24]
- Where foreign tax is not withheld regularly, claiming a FITO is
not possible until the foreign tax has actually been paid. Then the taxpayer
could amend their latest Australian tax return to include a FITO matching the
part of the foreign tax payment which relates to the latest Australian tax
year.[25]
- The scenario that a foreign employer of an offshore Australian
resident must withhold PAYG amounts 'does not arise in practice', since the
employer would not normally know the employee's residency status.[26]
[27]
Possible double taxation of fringe
benefits
2.23
Where employees are no longer exempt, their employers will have to
comply with the Fringe Benefits Tax Assessment Act 1986. Submissions
argued:
- There is no facility to claim an offset for foreign fringe
benefits tax paid;
- There will be significant compliance costs for employers; and
- It would not be practical for employers to cash out fringe benefits
as many employers will want to control the benefits provided such as home leave
flights, and many have global policies for medical and travel insurance.[28]
2.24
A particular concern is that fringe benefits may be taxed twice. The
Taxation Institute's example was:
If you are living in Kazakhstan, normally your employer would
supply you with a set of Western-style accommodation...Normally in most countries
around the world, the benefit is taxable to the employee. An estimation of the
non-cash benefit is taken into account in determining what is the value of your
package and what that value is in terms of being taxed in that particular
country. At the same time, the Australian employer who is providing that
benefit is providing a non-cash benefit to an employee who is an Australian
resident and therefore is required under the FBT rules to pay fringe benefits tax
on behalf of that accommodation,... The problem is that there is a mismatch
between the individual rules within the particular country where they are actually
working and what the Australian system does.[29]
2.25
Deloitte suggested amending the Fringe Benefits Tax Assessment Act
1986 so that fringe benefits provided offshore remain exempt. KPMG noted
that exempting offshore workers from PAYG provisions, as it suggested already
for other reasons, would also solve this problem, since individuals exempt from
PAYG withholding by definition are not employees for FBT purposes.[30]
2.26
Treasury responded or commented:
- Bringing offshore employees into the fringe benefits net treats
them consistently with Australian-based employees;
- It is acknowledged that double taxation could arise where
Australia taxes the employer and the foreign country taxes the employee;
- Some of our tax treaties (United Kingdom and New Zealand) contain
rules to resolve this problem; and
- 'Treasury is currently working on that issue to see how it could
be resolved with the aim of providing advice to the government.'[31]
Other administrative and compliance
issues
2.27
Submissions raised a number of other concerns:
- possible difficulty of deciding the employee's residency status,
which should not be the employer's responsibility;[32]
- need to have payroll teams in both countries able to understand
the laws;[33]
- possible difficulty for employees claiming FITOs in documenting foreign
tax paid, particularly in jurisdictions where there is no requirement to lodge
a tax return;[34]
- possible inequities at the boundary of those who will still enjoy
the exemption (for example, comparing AFP and ADF personnel who will enjoy the
continuing 'disciplined force' exemption, with civilian contractors giving them
logistical support).[35]
2.28
Some submissions suggested extending the use of the section 23AF
exemption to mitigate these problems.[36]
2.29
Treasury commented on concerns about compliance costs:
- Some increase in compliance costs is acknowledged;
- However the calculation of a taxpayer's liability using the FITO
system may in some cases be less complex than the calculations required by the
current 'exemption with progression' rules, which already require keeping track
of a taxpayer's onshore and offshore income separately.[37]
Committee comment
2.30
The Committee accepts Treasury's responses on most of the matters
mentioned above. On some points the Committee is sympathetic to the concerns
raised in submissions and comments as follows.
Administrative burden of PAYG
withholding
2.31
The ATO will need to clarify acceptable documentation to prove a foreign
tax payment to claim a FITO. It should acknowledge the possible difficulty of
obtaining documentation for some taxpayers (eg backpackers in casual work). The
government should consider means of reducing the compliance burden where it
would be disproportionate to the revenue gain. For example, this could be done
by exempting the first $X,000 of offshore income (X set at a level which would
aim to distinguish backpackers from salaried employees); or by limiting the
measure to large employers; or by exempting offshore salaries from PAYG withholding
rules, as some submissions suggested.
Recommendation 1
2.32
The government should consider options for limiting the new measure to
reduce the compliance burden where it would be disproportionate to the revenue
gain.
Possible double taxation of fringe
benefits
2.33
The Committee accepts the concerns about this and notes that the government
is considering how to deal with this problem.
Recommendation 2
2.34
The Government should make the necessary consequential changes to ensure
there is no double taxation of fringe benefits.
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