There is one fundamental principle that guides what income you are assessed on when you lodge your Australian tax return:
Tax residents of Australia are taxed on their worldwide income, while non-tax residents of Australia are only taxed on Australian sourced income.
If you live and work in Australia, it is likely that a majority of your income will have an Australian source. But what happens when you reside in Australia while working for a foreign based employer?
For the most part, your residency is usually determined by the place where you live. If you are an Australian who permanently lives in Australia, then, even while working for a foreign based employer, you will remain an Australian tax resident.
Technology has made it possible for many Australians to continue to live in Australia while working for a foreign employer. The ongoing pandemic has quickly pushed even more taxpayers into situations where they can reside in one country while working for an employer who has no physical presence in the country where they live.
If you have found yourself back in Australia, but still working for a foreign employer, then there are a number of matters that require consideration.
Double Tax Agreements
Since both the source country and the country of residence typically have jurisdiction to assess taxes, Double Tax Agreements (DTA) operate to ensure that you are not taxed twice on the same income.
Typically, a double tax agreement will contain a clause providing the basis as to who has the taxing rights with regards to employment or independent contracting income. One country will typically enable the other country to exclusively tax the income if that person has lived in that country for more than 183 days in a twelve month period.
If there is no tax treaty, then the country from which the employer is located may subject the income to their tax system, whether through withholding taxes on each payment, or through the annual assessment system.
While agreements can vary between countries, they typically ensure that foreign tax paid on foreign sourced income by a tax resident of the other country to the agreement can be claimed as a tax credit in the taxpayer’s tax return. A DTA typically also limits the amount of taxation that the foreign source country can impose on certain types of income.
How Foreign Tax Offset Limit the Total Tax Paid
The foreign income tax offset is designed to ensure that an Australian resident taxpayer avoids double taxation where they pay foreign tax on foreign income that is also taxable in Australia. The offset is based on the total foreign income tax paid, but is limited to the amount of the Australian income tax that would be payable on the income. Any excess foreign tax that remains is non-refundable.
Example where Australia has the Higher Tax Assessment:
Peter is an Australian who works remotely from Australia for a Hong Kong based company.
For the 2020 financial year Peter is paid AUD $150,000 from his Hong Kong employer. The Hong Kong tax he paid on this income is AUD $26,000.
The paid Hong Kong tax can be applied as a foreign income tax offset in Peter’s tax Australian return.
Peter has other income to declare in his tax return, resulting in a tax liability of $67,500, assessed on the taxable income.
If he was required to pay the Australian tax on top of the Hong Kong tax then he would be paying a total of $93,500 in taxes between the two countries. However, he can apply the $26,000 already paid in Hong Kong as a credit against the $67,500 Australian assessment. This means he will only need to pay the additional difference of $41,500 to the ATO, bringing his net total tax paid to the Australian assessment of $67,500.
Example where the Foreign Country has the Higher Tax Assessment:
Julie is an Australian working remotely for a company based in Portugal .
In the 2020 financial year she is paid the equivalent of AUD $50,000. She pays AUD $15,000 in Portuguese taxes for this income.
Julie has no other taxable income to include in her Australian tax return. This means she is only assessed for $8,797 in her Australian tax return. She can only apply the $15,000 in foreign tax paid as foreign tax credits up to the point where it reduces the Australian assessed tax on her foreign income to nil. She is not entitled to a refund for the excess foreign tax she has paid. This means that her total tax liability is the amount paid to the Portuguese tax authorities and she is not required to pay any tax in Australia.
Medicare levy is generally paid by Australian tax residents. Excess foreign tax credits can be used to offset the medicare levy and the medicare levy surcharge.
The Tax Impact of Relying on Foreign Sourced Income
As you can see from the above examples, while a double tax agreement will limit the impact of being taxed from both the source country and the country of residence, you, as the taxpayer, are liable for the higher amount of tax that is assessed.
Many countries tax their foreign residents at a flat tax rate, denying them any tax free or lower tax threshold concessions. The underlying assumption behind this method is that if you are a foreign resident then you are not earning your primary income from a foreign country. However, as indicated earlier, for some taxpayers this is not necessarily the case.
If you are an Australian who lives in Australia but works permanently for an overseas based company, your primary, or even sole, source of income may be this foreign sourced income. If you’re one of the many taxpayers who came home for the pandemic but retained your overseas employment, then this is your potentially unenviable position.
Given that Australia has one of the highest rates of income tax in the world, high income earners are more likely to find themselves subject to paying some additional tax on top of the foreign tax payments. This is particularly true if the foreign country caps their foreign resident tax at a lower rate than Australia’s higher tax margins.
Things can get more complicated, and result in higher amounts of tax being paid, if you are compensated for your employment in benefits that are in addition to regular wages.
The Impact of Tax Payable Assessments
One other thing to note is that where you are assessed on foreign income, the ATO may implement PAYG Instalment obligations. This means that you would be required to lodge and pay PAYG Instalments through Instalment Activity Statements over the year. This helps ensure that expected tax obligations are covered when it comes time to lodging the income tax return.
Tax Consequences of Working for an Overseas Employer
In summary, if you are an Australian earning employment income from an overseas employer, then you may be subject to taxes in both the country of employment, and your country of residence. A DTA can help limit the potential for such income to be double taxed.
Since Australia has one of the highest tax rates in the world, most individuals in this situation are likely to find that if they pay taxes in the country that employs them, they may need to pay additional taxes on lodgement of their Australian tax return.
The actual overall impact of working for an overseas employer will depend on which country your employer is situated in and whether Australian has a DTA with the country where your employer is located.