Australian Residency And Assessable Income: Key Criteria And Factors For Tax Liabilities

A note regarding the word count: Please note that this assignment is designed so that you can demonstrate your ability to filter material and communicate it succinctly. Do not confuse quantity with quality. 

The following criteria will be used to grade your assignments:
1.Ability to clearly and succinctly outline the key issue(s) (for example, the ability to identify the relevant facts in each case)
2.The ability to integrate the identified facts into a logical argument. Hint: link the reasons the Courts decided each of the cases in the way that they did. Don’t forget any relevant dissenting judgement. 
3.The ability to demonstrate a clear understanding of each of the cases
4.Did each of the case clarify or change the law? Or did the case itself result in a law change? Or did the case have little impact on the development of the law?
5.Demonstration of research beyond the course materials and text book
6.Demonstration of critical thinking, weeding out irrelevant facts, and adding value above and beyond the textbook etc. 
7.Clarity of communication; development of a clear and orderly structure, spelling, grammar and so on
1.Inter-relationship b/n assessable income and allowable deductions.

For certain residents paying tax they want ordinary income as they are chasing allowable deductions – otherwise they would not be able to claim and reduce taxable income. E.g. Commission of Taxation v Stone (2005) - Police Officer and professional athlete.

Test for Individual Residency

Australian resident:

An ‘Australian resident’ means a person who is a resident of Australia for the purposes of the Income Tax Assessment Act 1936. The same section defines that a person includes ‘company.’ Further ‘company´ means:

1. A body corporate, or
2. Any other unincorporated association or body of person,

but does not include a partnership or a non-entity joint venture.

Thus after interpreting the above definitions the following persons can qualify to be an Australian Resident: an individual person; a company and association of persons, provided the tests laid down in section 6(1) are satisfied. There are separate tests of residency for Individuals and for corporate i.e. companies. Both have been detailed out below:

Test for Individual Residency:

In addition to the above, Section 6(1) provides four tests of residency for individuals namely:

1. The ‘residence according to ordinary concepts’ test: It is the primary test. The test decides residency by considering where a person resides. Factors like a person’s maintenance of place of abode, visit, frequency of visit, his social ties, family involvement etc are considered while determining the residency.

2. The domicile test: This test puts stress on the fact where permanent place of residence is lying. This test has two elements – ‘domicile’ and ‘permanent place of residence outside Australia’

3. The 183-day test: Individuals ore considered Australian resident or deemed Australian resident if he/she stays in Australia for more than 183 days. This test generally applies to individuals who are coming from outside Australia.

4. The Superannuation test: This applies to the individuals who are Australian Resident but was not staying in Australia in the current income year. In this test a resident includes: a member of a superannuation scheme; an eligible employee and their families.

If any individual satisfies any of the four tests mentioned above, that individual will be considered as an Australian Resident. This determination is important for the analysis as the subsection applies to Australian residents only.

The relevant company tests include:

a) The place of incorporation test: All companies incorporated in Australia automatically become a resident of Australia. 

1. Place of Central Management and control: Companies having its central management or place of effective control within Australia is deemed to qualify as an Australian Resident.
2. Controlling Shareholders Test⁴: A company whose more than 50% Voting power at general meeting is held with Australian Resident, is considered as an Australian Resident.

It is possible for a company and individual to have dual residency.Double tax agreements contain definitions of ‘residency’ and provide tie breaker rules where the taxpayer has dual residency. Double taxation agreement provides further guidance and clarity on the income that is doubly taxed.

Interpretation of ‘Australian Resident’: Australian Resident includes within its scope individuals, association of persons and companies who qualifies the residency test, but excludes a partnership or non-entity joint venture. The subsection will only apply to an Australian Resident and none other. Thus this subsection stands ineffective for a partnership or a non-entity joint venture.

Assessable income of a taxpayer is broadly the summation of his ordinary income and statutory income, but excludes the exempted income. This subsection clearly states that “your assessable income includes the ordinary income derived directly or indirectly from all sources” Thus the subsection clearly excludes the statutory income of an Australian resident. To understand what will be included in the assessable income we need to understand the term ‘ordinary income’

Ordinary income is defined as the ‘income according to ordinary concepts’. It is ‘determined in accordance with the ordinary concepts and usages of mankind’. Some ordinary income is non assessable because it is exempt, and some ordinary income are non assessable by qualification. To understand the assess ability of an ordinary income we need to understand the features of ordinary income.

• The receipt must have a direct nexus or link with the income-earning activity.

• There are three established categories for ordinary income: income from salary; income from business; and income from property.

1. Money or convertible to money: Amounts which can be converted into money will be income. Section 21 provides that where the consideration for any transaction is paid or given other than in cash, the money value of that consideration is deemed to have been paid. 

2. Realised gain:An unrealised gain will not be ordinary income.

3. Must be a real gain:If the taxpayer is better off financially then it could be deemed ordinary income.  If not, then it is not ordinary income.

4. Must be from an external source:Income is what is received by a taxpayer and not what is saved from going out.  If taxpayer does not receive an item, or it received but is non-cash or cash convertible (even though it saves taxpayer from incurring expenditure), it is not ordinary income.

5. Constructive receipt rule:When a person directs a particular income to be received by someone else, then such income in deemed to be an income of the person earning it and not receiving it⁵. This concentrates on the earning of income and not receipt of income

6. Principle of mutuality:This principle provides income must come from ‘outside sources’ and taxpayers cannot derive income from themselves. This type of receipt is non-assessable non-exempt income under s 6-23.
   

When calculating assessable income it is important to determine when that income has been ‘derived’ in a tax year.  Sections 6-5 and 6-10 also refer to these as the ‘receipts method’ or ‘earnings method’.

Cash/receipts basis: Under this basis income is derived when cash or its equivalent is received. This also includes constructive receipt as taxpayers are taken to have received an amount as soon as it is applied or dealt with on the taxpayer’s behalf.

Accruals/earnings basis: Under this basis income is accounted when it has been earned, irrespective of its receipt. It is accepted that income has been earned when a debt comes into existence. The relevant method of accounting to be adopted is that which ‘is calculated to give a substantially correct reflex of the taxpayer’s true income’.

Test for residency of a company

The accrual method of accounting is generally appropriate for the income of professional partnerships and for trading businesses. Generally, income from advanced payments is derived at the time of receipt on a cash basis. Where the income is subject to dispute, it is derived once the dispute is concluded.

Source of Income means the place from where the money or income is coming. It can come from multiple sources, and in such a situation it will be appropriate to segregate the income between different sources.

Here are some different sources of income namely:

• Sale of Good:The source of income is where trading activity is taking place.  This derivation is a question of fact.

• Sale of Property (other than sale of goods):Location of the property will be the source in this case and courts also rely on the same rationale.

• Salary, Wages, Fees:The place of performance of the service is taken as the source of service income.  The place of performance must be considered in the context of possibility, other factors being relevant (e.g where the contract was made and where the money is paid).

• Interest:Factors including place of contracting and place where the funds are advanced must be considered.

• Dividends:Dividends are assessable income.  The source of a company’s profits is the question of fact.

• Royalties:Source of royalty is location of industrial or intellectual property from which the royalty flows.  When royalty is outgoing (paid by Australia to foreign entity) section 6C deems royalty to have an Australian source.

• Rental Income:Where real property is leased, the source of income is the location of the property. 

• Sale of property (non-trading stock):Where property is sold, the income will generally be sourced from the place the contract was entered into. Special rules relate to shares and in the case of realty, income will be sourced from the location of the property rather than the place where the contract was made.

• Financial Transactions:  Generally, the source is where services of the company are performed.

Conclusion:

In a nut shell the applicability of the subsection or the extent of effectiveness of the subsection can be summed up into the following below mentioned points.

1. The subsection is not applicable to all. It has certain exclusions. The first step of exclusion is the test of residency, where partnership and non entity joint ventures are excluded. Thus the subsection stands effective only for Australian Residents other than partnership and non entity joint ventures.

1. Only Ordinary income in included in the scope of the subsection. Statutory incomes have been excluded. Accordingly the subsection stands ineffective for statutory incomes.

1. Though assessable income includes both ordinary income and statutory income but this subsection clearly spells out the exclusion of statutory income for the scope of assessable income. Thus the effectiveness of the subsection is limited to the definition.

1. To conclude the interpretation, if a non exempt ordinary income is earned, irrespective of its source, by an Australian Resident as defined above, this subsection will be in effect.

The term assessable income and allowable deduction are deeply Co related with each other. These are nothing but the steps by which an entity can ascertain it's tax liability. In general terms assessable income means both statutory and ordinary income earned during a previous year.. It includes all incomes whether earned on the same country or not but it excludes exempt income. on the other hand if we want to get taxable amount then we need to make some deductions from the assessable income as those deductions are known as allowable deduction which is both general and specific in nature. Now by going through the definitions it can be generally said that a person wants to have some ordinary income in order to get the deduction as these deductions are available to those expenses which are made for earning the ordinary income. But this is not right in all the cases. The income tax assessment law says that one can not get deduction for all expenses incidental to the assessable income. For example If any person is getting some dividend from shares of a listed company then the dividend can be treated as ordinary income of that person but the price paid for purchasing the same share is not allowable as expenses as this transaction is capital in nature and the person is getting an enduring benefit by earning dividend from those share. Another example for the same is purchasing a home unit for renting it to other. Here the person is purchasing the home for earning long term revenue so it can not be allowable as deduction.  On the other if a company pay lease rent for its factory for another one month then the rent is deductable as it doesn’t give any enduring benefit for the business-it only gets the premises for another one month. As in the case Commission of Taxation v Stone (2005) it is found that even if gift prize which is earned from personal talent should be considered as business income and will comes under assessable income.

So from the above discussion it can be concluded that though some of the people are trying to add ordinary income with their total earnings but if the expenses is meant for giving long lasting benefit then it is not deductable and they will not get the benefit of tax reduction even if they have ordinary income and section 6.5 is effective here as it deals with ordinary income.

Section 35 ITAA (1997) creates a special challenge to large companies. As per the act this provision is applicable to Individual tax payers who are carrying on any business and business includes  large companies. In order to get the benefit of this section one has to pass some test in that country. Now when an entity has more than one place of business then it may pass the residency test on Australia as its having a controlling unit of Australia but at the same time it is not possible to segregate the total non commercial business loss accrued in Australia and other countries. So from this point of view it can be said that this section is to some extent not much effective to those entities that has multiple place of business.

References

Income Tax Assessment Act (ITAA) 1997, S 995.1 2018 

Eisner V Macomber, 252, U.S. 189, (1920). 2018 

Tariff Reinsurance Ltd V CT (Vic) (1938) HCA 21 2018 

Commissioner Of Tax V Kirk [1900] AC 588. 2018

Sadiq, Kerrie et al, Principles Of Taxation Law 2017 

Rhodesia Metals V CT 2018 

Ibid, S 6-10(2). 2018 

Established By Deed Under The Superannuation Act 1990. 2018 

IT 2650: Intention To Take Up Residence Means To Become A Resident Under Immigration Law 2018 

[2012] AATA 168 2018 

Koitaki Para Rubber v FCT (1940) HCA 33 (Unreported, 2018) 

Taxation Laws Handbook (Australian Taxation Office, 1992) 

Guide To New Legislation, Taxation Laws Amendment Act (No. 3) 1991 (Act 216 Of 1991), Income Tax (Deferred Interest Securities)(TFN Withholding Tax) Act 1991 (Act 215 Of 1991), Medicare Levy

Amendment Act 1991 (Act 212 Of 1991) (Australian Taxation Office, 1992)

Home Page (2018) Ato.gov.au https://www.ato.gov.au/

Commission Of Taxation V Stone (2005) 2018 

Joachim V FCT (2002) 50 ATR 1072 2018 

IRC V Lysaght [1928] AC 234 2018 

Domicile Act 1982 (Cth) And Common Law Rules 2018 

Australian Corporations Legislation 2009 (LexisNexis Butterworths, 2009)

Brent’S Case (Brent V FCT (1971) HCA 48) 2018