Determining Residency for Taxation Purposes
1. Lin is an auditor who works for the Australian subsidiary of a global shipping company. Lin moved from Malaysia to Australia with his spouse and children several years ago and purchased a home in Melbourne for the family to live. His job occasionally requires an extended overseas assignment, but ultimately he intends to settle in Australia.
In July 2015 he was posted to the Singapore subsidiary of his company for a definite period of two years with a possibility it might extend a further two years. Lin was keen to take this option if it arose because the pay and working conditions were good. Lin took a two year lease on an apartment in Singapore for himself to live in, while his family remained in Melbourne where his children go to school.
During his short holiday breaks his family would travel to stay with him in Singapore. Lin did not return to Australia during the income year.
The Singapore subsidiary paid Lin an annual salary in Singapore dollars equivalent to AU$200,000. Most of his savings were sent home to support his family and to make accelerated payments on the family home loan. During the year he purchased some Commonwealth Bank shares for AU$50,000 and sold them for AU$100,000.
Lin has asked for your advice on whether:
(i) he is a resident of Australia for income tax purposes in the period during the income year to 30 June 2017; and
(ii) the effect this decision might have on his income tax liabilities in Australia
Explain the alternative residency arguments using quality legal references, and form an opinion as to which is the better view from the facts.
Explain how he would be assessed on his salary and capital gains if he was a resident and alternatively if he was a non-resident.
2. In 2015 Winnie, an Australian resident individual, sold her horse breeding business based in the south eastern suburbs of Melbourne.
The purchaser of the business did not want to buy the land. The real estate comprises 10 hectares which cost her $1m in 2005.
Winnie put the entire real estate up for auction but it failed to reach her reserve price of $10m and was passed in. Her real estate agent had suggested the reserve was a fair market value but at the moment no buyers were interested in such a large parcel of land.
She sought advice from agents and accountants who suggested that smaller blocks of land would be more affordable for home buyers. Potentially, 10 vacant one hectare blocks would sell for $2m each and would require minimal costs to subdivide.
However, Winnie was also advised that 50 townhouses could be built at a cost of $100,000 each and they could sell for $1m each.
In July 2016, Winnie installed office cabins on the site and personally managed the entire construction, sales and marketing activities. 50 townhouses on equal size and value blocks were constructed and by 30 June 2017 half of these had been sold for a total of $25m.
Advise Winnie of the possible income tax consequences of the $25m real estate sales this year.
You should discuss any alternative views based on the facts, using quality legal references.
Determine the assessable income resulting from each alternative view.
Finally, provide your opinion on which you think is the better or correct outcome.
1. (i) Whereas s.6–5 of ITAA, 97 states that all ‘Non-Resident Australian Taxpayers’ shall be taxed in Australia on all the incomes derived from sources inside Australia, s.6 (1) of Income Tax Assessment Act, 1936 (ITAA, 36) states that all ‘Resident Australian Taxpayers’ shall be taxed for all incomes which are earned from sources outside Australia, as per Barkoczy, (2013). Surprisingly, both the Acts do not provide any specific rules or definition of the source.
If Common Law statutes are considered, source is stated to arise from the type of income and hence, it becomes difficult to identify it precisely. In a broader sense, it can be said that source can be answered by asking ‘where’, meaning where did the income arise and for this, Common Law has three explanations:
- where work is performed;
- where payment is made; and
- where contract is signed.
Income can be considered as generating from a combination of all these three factors. In the case of Lin this seems to be applicable and although he has three sources of income, they all merge into the single source which is Australia. But prior to settling the source of income, it is necessary to settle the Resident Status of Lin. Only then his income source can be justified for the purpose of taxation and in determining Lin’s tax liability, says Barkoczy, (2013).
The resident status of a taxpayer is decided by the Australian Taxation Office (ATO) on the basis of s.6 (1) of The Income Tax Assessment Act, 1936 (ITAA, 36) which provides an explanation to distinguish between the ‘Resident Australian Taxpayers’ and ‘Non-Resident Australian Taxpayers’. The following test in the case of Lin is sufficient to prove whether he is an Australian resident for taxation purposes. These results are acknowledged by Australian courts, assert Reynolds, Williams & Savage, (2000).
This test, on basis of the following factors decides whether the taxpayer is resident of Australia for taxation purposes:
- Taxpayer’s actual presence in Australia.
- Taxpayer maintains a home for self and/or family in Australia.
- Taxpayer is employed by Australian resident company during period of residence in Australia.
- Taxpayer maintains ‘Social Relationships’in Australia.
Lin satisfies factors 1 (b), (c) and (d) and this establishes that he is a ‘Resident Australian’ for taxation purposes.
For discussion purposes, another alternate test of proving resident status is the ‘Domicile Test’. Domicile depends on the following two elements:
- the first relates to ‘permanent place of abode’ of the individual and/or his family.
- the second relates to the intention of the individual of staying at the selected place of residence.
The Common Law cited in this regard by the Australian courts states that the individual is required to fulfil both the elements. The courts have cited in their judgments the meaning of ‘permanent place of abode’ through the following cases, as per Reynolds, Williams & Savage, (2000).
In this case, the court ruled that ‘permanent’ does not mean to say ‘everlasting’ and even if the taxpayer is maintaining a place of abode outside Australia for some period, the individual would still be considered as having passed the test.
Residency Tests in Australia
In this case, the court’s ruling was that although the taxpayer had left Australia for definite period of time, he maintained a ‘place of abode’ outside Australia.
In Lin’s case study, the ‘Resides Test’ and the ‘Domicile Test’ are applicable for determining his resident status. Under such circumstances, even courts in Australia have recommended that in case of the individuals, if the Residency Tests become applicable, then the individual shall be considered as an Australian resident for taxation purposes.
ii) Whether the income under consideration is taxable in Australia has been explained in Section 995(1) of ITAA, 97 by stating that it would be taxable if it was derived from a source located inside Australia. Although the source of income, which needs to be included in an individual’s assessable income, is connected to the type of income which needs to be taxed, it is not easy, says Barkoczy, (2012), to identify those source clearly, as was noted by honourable Jordan CJ in the case of CT (NSW) vs Cam & Sons Ltd (1936) 4 ATD 32. The honourable Jordan CJ stated, and I Quote ‘that the source itself and it commonly does, consist of many different factors and the characteristic of the source may depend on that factor which is found to be the most dominant.’ Unquote
It has been ruled by Australian court in the Case of FCT vs French, that it is a general rule which concerns employment income, and that is that the source is considered to be there where the individual has performed the work, as per Barkoczy, (2012). Even Section 6 (1) of ITAA, 1936 defines that income earned from personal exertion is considered to be the income earned by the employee. The Australian courts also ruled that all the employment incomes shall also include the ex-gratia payments which the taxpayer received and these shall be assessable under Section 15–2 of ITAA, 1997, asserts Barkoczy, (2012). Section 15-2 of ITAA, 1997 is also used for specifying that if a benefit is provided to the taxpayer, then that benefit shall have a direct link with the employment of the taxpayer and with the services which the individual rendered to the employer in lieu of the benefit that he received and this fact has upheld by the Australian courts in the Case of FCT vs Cooke & Sherden 80 ATC 4140.
Based on these discussions, the salary being received by Lin, while he was posted outside Australia, shall be considered as assessable income in his hands and shall be subjected to taxation rules of Australia, by considering Lin to be a Resident Taxpayer of Australia, and this has also been proved by the tests above, asserts Marsden, (2010). This is also irrespective of the fact that these payments were deposited in a bank outside the territory of Australia.
Alternative Residency Arguments
The 2017 Financial Year is from 1 July 2016 to 30 June 2017. The tax rates for Resident taxpayers for the year 2017 are listed below –
Taxable Income Tax on This Income (New Rates)
0 to $18,200 Nil
$18,201 to $37,000 19c for each $1 over $18,200
$37,001 to $87,000 $3,572 plus 32.5c for each $1 over $37,000
$87,001 to $180,000 $19,822 plus 37c for each $1 over $87,000
$180,001 and over $54,232 plus 47c for each $1 over $180,000
In the Federal Budget of 2014-15, a Temporary Budget Repair Levy of 2% was applicable on taxable incomes in excess of $180,000. This, in effect increased the highest marginal tax rate in the above table from 45% to 47%, before taking the effect of Medicare and this was made effective for 3 years, from 1 July 2014 until 30 June 2017.
The tax rates for Non-Resident taxpayers for the year 2017 are listed below –
Taxable income Tax on this income (new scale)
$0 – $87,000 32.5c for each $1
$87,001 – $180,000 $28,275 + 37c for each $1 over $87,000
$180,001 and over $62,685 + 47c for each $1 over $180,000
From the above two tables showing tax rates for Resident Taxpayers and Non-Resident Taxpayers, it can be easily deduced that Residents have NIL tax up to threshold of $18,200, whereas Non-Resident Taxpayers are charged for tax from $0, meaning they do not have any threshold, asserts Renton, (2012).
Assuming Lin reports Net Income of $200,000 for the year 2017 ($150,000 from salary, after deducting the Super contribution and accelerated home loan payments) and $50,000 from Capital Gains of shares. Lin will not be eligible for any incentive on Capital Gains amount as the shares were retained for less than 12 months.
In case Lin is designated as a Resident, his tax liability will be $63,632 + 2% Levy.
In case Lin is designated as a Non-resident, then his tax liability will be $72,085+ 2% Levy.
2. Capital Gain Amounts are the net difference amount between the Capital Proceeds and the Cost Base, of the asset which is being disposed by the seller, as explained under Section 104-10 of Income Tax Assessment Act of 1997 (ITAA, 97). Section 104-10(4) of ITTA, 97 explains about Capital Loss as the difference between the Reduced Cost Base and the Net Capital Proceeds, as per Renton, (2012). Capital Proceeds, as explained under Section 116-20(1) of the ITAA, 97 is the money which is either received or is entitled to be received by the taxpayer with regard to the CGT Event which has taken place. It has been explained in the Act that the taxpayer can claim the deduction of the expenses which the taxpayer has incurred with regard to repairs of the asset under consideration or certain specific parts of the asset or of a depreciating asset, which have been used by the taxpayer, primarily for an income generating purpose and this is explained in Section 25-10(1) of the ITAA, 97, asserts Renton, (2012).
Taxation of Salary and Capital Gains for Residents and Non-Residents in Australia
Capital Proceeds are the sale amount which the seller receives for disposing the asset. From the Gross Amount received by the seller after the disposal of the asset, any expenses, such as legal costs, costs related to preparing the documents and any fees paid to the government agency can be deducted from the amount received and the Net Proceeds shall be treated as the Capital Proceeds, as per Barkoczy, (2013).
Cost Base is calculated on basis of the following Five Elements as explained in Section 110-25 of ITAA, 97.
This is the Initial Cost of Acquisition of the Asset and this is explained under Section 110-25(2) of the Act.
These are the Incidental Costs which are incurred by the taxpayer for acquiring the asset and there are nine categories under which these are specified and this has been explained under Sections 110-25(3) and 110-35 of ITAA, 97, asserts Barkoczy, (2013).
These relate to the Costs of Owning the asset, provided the asset had been acquired after 20 August 1991, when the CGT provision was introduced and this is explained under Section 110-25(4) of the Act.
This includes all the Capital Expenditure which the taxpayer had incurred for the purpose of increasing the asset’s value and this has been explained under Section 110-25(5) of the Act.
This pertains to all those Capital Expenditure which have been incurred by the taxpayer for preserving his right to the asset and has been explained under Section 110-25(6) of the Act, as per Barkoczy, (2013).
All expenses which the taxpayer can avail as deduction under other sections in the ITAA, 97 such as s.110-45 of the Act.
The Capital Gains Tax provisions were introduced with an incentive for the taxpayer. This was applicable on all assets which were acquired by the taxpayer after 21 September 1991 and were held by him for a minimum of 12 months. The incentive was calculated by using the Indexation Method. The indexing factor was based on the Cost Price Index Table, which gave the Indexing Factor for every quarter of the year, as per Barkoczy, (2012).
For arriving at the Net Value of the Capital Gain in this case study, the asset is eligible for the 50% Discount Method. The 50% Discount Scheme is available to the assets as it was acquired and disposed-off after 21 September 1999, as has been explained under Section 115-15 of ITAA, 97. This is subjected to the following conditions, as per Barkoczy, (2013).
- Taxpayer should be a Resident Individual Taxpayer as explained in Section 115-10 of the Act.
- Taxpayer should have owned the Asset at least for 12 months or more, as explained under Section 115-25 of the Act.
According to the provisions of Capital Gains given in the ITAA, 1997, there are three methods which a taxpayer can use for calculating the incentives available to him for arriving at the capital gain or loss. The first method is known as The Indexation Method and can be used for assets acquired before September 21, 1999, provided that the taxpayer owns it for more than 12 months, says Nethercott, Devos & Richardson, (2010). Second method is The Discount Method and this is applicable for assets acquired after 21 September 1999, provided the asset has been owned for at least 12 months and provided this method gives a better result than the indexation method. The taxpayer can calculate his CGT liability by choosing the method which gives him the maximum advantage in reducing the CGT liability, as per Nethercott, Devos & Richardson, (2010). In the current case study, Winnie can use only the Discount Method, as the asset was acquired by her in 2005 and was held by her for more than 12 months.
Cost of acquisition for 10 hectares of land in 2005 $1,000,000
Cost of building 50 townhouses at $100,000 each $5,000,000
Total Cost of the 50 townhouses is $6,000,000
Pro-rata, cost of each townhouse is $120,000
Proposed Sale Price of each townhouse is $1,000,000
Capital proceeds from 25 townhouses sold till 30 June 2107
At $1,000,000 each $25,000,000
Pro-rata, the actual cost of the 25 townhouses which have been
Sold till 30 June 2017 works out to be $3,000,000
The Gross Capital Gain Amount for Winnie from
the sale of 25 townhouses during the year 2017 is $22,000,000
Applying the 50% Discount Method $11,000,000
Hence, the Net Capital Gains Amount is $11,000,000
Barkoczy, S. 2012. Australian Tax Case book, 9th ed. CCH Australia Limited, North Ryde, NSW.
Barkoczy, S. 2013. Foundations of Taxation Law 2012, 5th ed. CCH Australia Limited, North Ryde, NSW.
Marsden, S. J. 2010. Australian Master Bookkeepers Guide, 3rd ed. CCH Australia Limited, Sydney.
Nethercott, L., Devos, K. and Richardson, G. 2010. Australian taxation study manual: questions and suggested solutions, 20th ed. CCH Australia Limited, Sydney.
Renton, N. E. 2012. Family Trusts: A Plain English Guide for Australian Families of Average Means, 4th ed. John Wiley & Sons, Milton, QLD.
Reynolds, W., Williams, A. J. and Savage, W. 2000. Your Own Business: A Practical Guide to Success, 3rd ed. Cengage Learning Australia, Sydney, NSW.
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