Foreign Employment Income: It May No Longer Be Tax Exempt
The existing rules will apply to non-exempt foreign employment income derived on or before 30 June 2009.
According to the Government, these changes which were announced in the 2009-10 Budget, are expected to have a low compliance cost impact, as it is expected to only impact 15,000 to 20,000 taxpayers.
We disagree with this and raise some concern as to whether the Treasury’s assertion of low compliance costs has much merit. We contend that these measures have had an immediate impact upon employers of Australian resident taxpayers working overseas from 1 July 2009 and will impact the affected employees when they lodge their tax returns for year ended 30 June 2010.
We provide below an analysis of how precisely the changes will affect both the employers and Australian resident taxpayers working overseas.
Impact for employers
The amendments are likely to impact the competitiveness of employers employing Australian resident taxpayers to work overseas. The effect will be that Australian resident workers will ultimately be subject to Australian tax rates on their foreign income, rather than being taxed at the (generally) lower foreign tax rates.
As a consequence, the cost of Australian employees may increase, as they are likely to insist upon extra compensation in order to receive at least the same after-tax income as before the amendments.
PAYG withholding
As well as these additional employment costs, employers employing Australian residents to work overseas will face increased compliance costs, as employers will now have to comply with obligations arising under the pay-as-you-go (“PAYG”) withholding provisions.
This could have a significant negative impact on the cash flow of Australian resident employees working overseas where amounts are withheld from their income under both the Australian PAYG withholding regime and any equivalent regime in the country where their employment is exercised.
Since 1 July 2009, employers are now required to withhold PAYG from salaries, allowances, bonuses and commissions paid to their employees deriving non-exempt foreign employment income. Further complexity arises here, as employers will be required to withhold only that amount calculated under the relevant PAYG withholding tax table, less any amount of tax to be withheld and paid to the respective foreign country.
FBT issues
Employers employing Australian residents to work overseas will face increased compliance costs, as the fringe benefits tax (“FBT”) provisions may now apply, which is in stark contrast to those pre-1 July 2009 times, where they most likely were not applicable.
This will significantly increase the complexity of reporting and payment obligations for employers in respect of fringe benefits paid to Australian resident employees working overseas and there will be additional compliance costs.
Another FBT issue that may make the use of Australian employees overseas less competitive is the possibility of double taxation of fringe benefits. This may arise, for example, where fringe benefits are provided to an individual taxpayer working overseas who is personally subject to FBT in the overseas jurisdiction and whose Australian employer is also subject to FBT under Australian tax law.
In this regard, the ATO has acknowledged that this is an issue that needs to be addressed, however, as the law stands today, the possibility of double taxation of fringe benefits remains.
Residency review
It may now be necessary for employers to review employees’ residency status for taxation purposes, to determine whether Australian employees working overseas are still Australian residents for tax purposes, as employers will need to satisfy the PAYG withholding obligations for tax resident employees.
Impact for employees
It is important to note that these changes do not only affect employers, but they also directly concern obligations of Australian resident employees working overseas.
PAYG instalment provisions
Australian resident employees working overseas, who are not subject to the PAYG withholding regime, will need to ensure they are complying with the PAYG instalments provisions.
Basically, income which was once exempt may now be assessable and could therefore be subject to the PAYG instalment provisions and a liability may arise to pay PAYG instalment amounts in relation to income earned as a result of working overseas.
Although the amendments will apply from 1 July 2009, unless an employee received an instalment rate from the Australian Taxation Office (“ATO”), the employee will not be required to pay instalments under the PAYG instalment provisions. Consequently, some employees will not be affected by these changes until after they have lodged their 2009-10 income tax return and been given an instalment rate by the ATO.
However, if an employee receives an instalment rate, they will be required to pay the PAYG instalments (generally on a quarterly basis). This will impose an additional compliance burden and potential cash flow problem where an employee may need to fund PAYG instalments on a quarterly basis, in addition to funding any foreign tax instalments offshore.
Foreign tax offset
Employees will also need to apply the foreign tax offset (“FTO”) provisions to ensure they do not suffer double taxation.
The application of the FTO provisions will impose a hefty compliance burden on individual taxpayers, as the FTO rules in Div 770 of the Income Tax Assessment Act 1997 were not drafted in the simplest of terms because they were not drafted to apply to a large number of ordinary working Australians.
A practical difficultly that may arise is satisfying the “tax paid” requirement of the FTO rules, where foreign tax must actually have been paid to claim a FTO. This will be difficult in jurisdictions where there is no requirement to lodge an income tax return, such as in the United Kingdom and New Zealand.
Furthermore, this issue could also arise in practice whenever a taxpayer is working in a country which has a different year end for tax purposes than Australia, such as the United States and the United Kingdom. This timing difference will adversely affect the cash flows of these employees, as they may have to satisfy a tax liability levied (without regard to potential FTOs) some months before the FTO can be claimed.
Where to now?
The section 23AG amendments will make the tax affairs of hundreds of thousands of Australians working overseas even more complicated.
In particular, the amendments will require them each to undertake, now and on a continuing basis, a complicated legal review of their residency status in order to determine their Australian tax obligations.
Therefore, the amendments will increase the costs and compliance obligations for employers employing Australians to work overseas which will hamper their international competitiveness.
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Note:
If your business entity has Australian resident employees currently working overseas or you have plans to send such employees overseas, we recommend you contact your knp representative to discuss these issues and determine the potential impact and cost for your business entity.
Alternatively, if you are an employee and are currently, or plan to, work overseas for an employer, we recommend you also contact your knp representative to discuss the potential impact and cost to you.
Email your knp representative, knp@knp.com.au or call to make an appointment on +61 3 9824 8111.