23AG: The End of the Foreign Income Exemption
Editor’s note: This article was written in 2009, when the changes to the section 23AG foreign employment income exemption were first proposed in the federal Budget. Those changes did proceed, and the exemption now applies only in limited circumstances. The tax rates, figures and examples below reflect the law and rates as they stood in 2009 and are retained for historical reference. For advice on how foreign employment income is taxed today, please book a consultation or see our current services.
Expatriate Australians employed around the world are reeling with the news that from 1 July 2009, their foreign employment income may no longer be exempt from Australian tax.
Under the current (pre-2009 federal budget) rules, foreign-sourced employment income earned by an Australian resident is exempt from tax (s.23AG). To be eligible for the exemption, the taxpayer must be an Australian resident and must work for at least 91 continuous days in a location that generally imposes income tax on such earnings.
Under the rules proposed by the recent Budget, the government intends to remove this exemption, thus causing the income to be fully taxable in Australia.
Fortunately, the government will allow the taxpayer to claim a credit for any foreign tax paid. Most taxpayers, however, will have to pay significantly more tax caused by the difference in tax rates between the foreign country and Australia (see below).
| Singapore | Australia |
|---|---|
| 20% | 46.5% |
Example: Ben, an Australian resident taxpayer (for tax purposes), has been employed in Singapore earning a salary of AUD $250,000 (approximately SGD $290,000). He has $10,000 of rental income earned from an investment property in Australia. Ben lodges a return in Singapore and pays SGD $35,600 tax (approximately $30,746). He is also required to lodge a return in Australia as follows:
Under the new rules, Ben will be required to pay additional tax totalling $59,814 — a 169% increase in tax payable. As this tax will not be withheld by Ben’s employer, Ben will be required to pay it from his own savings.
As you can see, expatriate employees lodging returns as Australian residents may be severely penalised by these changes, and for taxpayers in lower-taxing countries than Singapore (e.g. the Middle East), the effect is even worse.
It is important to note that these budget changes ONLY apply to expatriate employees lodging Australian returns as a resident. If you are a non-resident of Australia for tax purposes, these changes have no effect.
Under the 23AG regime, the distinction between non-resident and resident for Australian tax purposes was often ignored by expats, as the exemption ensured that no Australian tax was payable on those foreign earnings. That distinction now becomes absolutely critical.
Unfortunately, the rules dealing with residency are complex and cannot be resolved with a simple “yes or no” test. They are made more complex by the operation of double tax agreements between countries, which seek to resolve disputes in which two countries may both claim a person as “tax resident”.
As a non-resident, you should ensure that you are truly a non-resident. Residency is assessed on a year-by-year basis, and the rules are not always black and white — they depend on your circumstances.
If you are a non-resident expatriate, you should seriously consider making an appointment with your taxation advisor to ensure your circumstances meet the requirements for non-residency. Similarly, expatriates lodging as residents should consider meeting with their advisor to determine whether they can make changes to their circumstances and change their residency status.
Australian companies also affected
The budget changes mentioned above are likely to also cause a problem for many Australian companies in the form of an increased Fringe Benefits Tax (FBT) burden. Under pre-budget legislation, employers are not liable for FBT on benefits provided to employees where their employment income is exempt under s.23AG.
In many countries such as Singapore (although there is no fringe benefits tax as such), benefits received are taxed in the hands of the employee, not the employer. The reverse is true in Australia. Thus, the proposed budget changes may cause the employer to be liable for FBT on benefits provided, notwithstanding that the employee has also been taxed in the foreign country on those same benefits.
This causes the benefits to be taxed twice. Furthermore, as Australian FBT legislation does not allow foreign credits to be claimed, the proposed budget changes are likely to significantly increase the costs of employing Australians overseas. In particular, Australian companies employing expatriates in the Asia-Pacific region will be affected.
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