In a recent case heard by the Administrative Appeals Tribunal (AAT), the timing of employment income plays a significant role in determining an individual’s tax obligations, especially in the context of changing tax residency.

The individual in question was a non-resident taxpayer working in Kuwait and was entitled to a ‘milestone bonus’ as part of their employment. However, the employer was unable to pay this bonus while the taxpayer was working abroad. As the taxpayer later relocated to Australia and became a tax resident here, the bonus was eventually paid in instalments. This situation led to a dispute between the taxpayer and the Australian Taxation Office (ATO) when the Commissioner issued amended assessments to tax the bonus payments received.

The main focus of the dispute was the critical question of when the bonus should be deemed as “derived” for taxation purposes. If the bonus had been derived while the taxpayer was still a non-resident, it would not have been subject to taxation in Australia. Typically, non-residents are only taxed in Australia on income sourced within the country, and employment income is generally sourced where the work is performed, with some exceptions.

The outcome of this determination had significant impacts on the taxpayer’s tax liability. It relies on a fundamental tax principle – tax residency.

The Significance of Tax Residency

In the realm of international taxation, a person’s tax residency status can significantly affect their tax obligations, encompassing not only income earned within the country but also worldwide income. In Australia, tax residency is determined by a complex set of rules, including the primary “resides” test, the “183-day” test, and various secondary tests. The ATO provides guidance and guidelines to assist taxpayers in understanding these residency tests and how they apply in different scenarios. Accurate determination of tax residency is essential for individuals and businesses engaged in cross-border activities, as it can influence the allocation of taxing rights between Australia and other countries.

In the case discussed, the taxpayer transitioned from being a non-resident to becoming a tax resident in Australia. This shift in tax residency was a critical moment, as it changed the jurisdiction that had the right to tax his global income.

In most countries, including Australia, tax residents are generally subject to taxation on their worldwide income. Non-residents, on the other hand, are typically only taxed on income that is sourced within the country’s borders. This concept is known as the “source rule” and is a fundamental principle of international taxation.

Timing Matters: Employment Income and the Source Rule

Australian tax law, like that of many other countries, considers employment income to be “derived” when it is received by the taxpayer. In simpler terms, income is typically recognized for tax purposes when it is physically received, not when it is earned or entitled. This principle has been reinforced by Australian tax case law.

In the case under consideration, the taxpayer received the bonus payments from his former employer after becoming a tax resident of Australia. This seemingly minor detail triggered a significant tax consequence. Since the bonus was received while he was a tax resident in Australia, it fell under the purview of Australian taxation.

The Impact of Timing on Tax Liabilities

The outcome of this case serves as a reminder of how the timing of income recognition can significantly impact an individual’s or business’s tax liabilities, especially in the context of changing tax residency. Had the taxpayer received his bonus when it was originally due in Kuwait, he would have been entirely exempted from Australian taxation. Kuwait does not impose income tax on its residents.

This case underscores the need for individuals and businesses engaged in international activities to carefully consider the timing of income recognition in different jurisdictions. It emphasises the importance of understanding tax residency rules and their implications, as well as the specific rules governing the taxation of various types of income, such as employment income, dividends, and capital gains.

In conclusion, the interplay between timing, tax residency, and the source rule in international taxation is a complex puzzle. The case before the AAT serves as a compelling illustration of how seemingly minor details can lead to significant tax consequences. It highlights the necessity of seeking professional advice and conducting thorough tax planning when navigating the complex landscape of international taxation to optimise tax outcomes and remain compliant with the tax laws of multiple jurisdictions.

Should you please have any question in regards to above, please feel free to contact our friendly team in Pitt Martin Tax at 0292213345 or info@pittmartingroup.com.au.

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.

By Zoe Ma @ Pitt Martin Tax