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Tests of Residency for Income Tax Purposes in Australia

Discuss about the CCH Australia Limited.

Residential status for income tax purpose implies the country of which the taxpayer would be deemed to be resident for computing the taxable income of a particular financial year. The residential status for tax purposes is a crucial aspect because the determination of the taxable income depends upon the residential status of the taxpayer (Income Tax management, 2016). In other words, it could be said that the incidence of tax is determined according to the residential status of the taxpayer. The government of Australia prescribes the rules and regulations to determine the residential status of the taxpayers (Prince, 2013). The important thing about the residential status that one should keep in mind is that it is determined for each financial year separately. Thus, a person who is resident of Australia for one financial year may not be so for another financial year. Further, it is also to be noted that the residential status as per taxation rules is not linked with the citizenship, which means that a person, who is not a citizen of Australia may be resident of Australia for tax purposes (Prince, 2013).

The Income Tax Assessment Act (ITAA) 1936 of Australia contains the crucial provisions and rules that guide in determining the residential status of a taxpayer. In Australia, the taxation ruling 98/17 describes the procedure to determine the tax residency status of individuals coming to Australia Taxation (Ruling TR 98/17, 2016). Further, section 6 of ITAA 1936 provides the conceptual foundation to the taxation authorities so as to enable them to formulate rules and regulations in regard to determine the residential status (Commonwealth Consolidated Acts, 2016). In addition to this, the judicial pronouncements made by the courts are also referred to resolve the critical issues coming across in determining the residential status.          

As per the Australian taxation regime, an individual is tested for residential purpose basically on two parameters such as domicile and period of stay. These are formally known as domicile test and 183 days test, additionally, there is another test of residency known as superannuation test (Ruling TR 98/17, 2016). As per domicile test, the people ordinarily residing in Australia are automatically declared as resident for tax purpose. Thus, the people ordinarily residing in Australia do not need to satisfy any other condition to be declared as resident. The 183 days test is based on the period of stay of the individuals entering Australia from other countries. Thus, as per this test, if the individuals coming from other country stay in Australia for a period of 183 days or more, he/she may be regarded as resident of Australia. The third test of residency that is the superannuation test prescribes explicitly that the Australian government employees, who have been posted outside Australia, will automatically be deemed as resident (Ruling TR 98/17, 2016).

However, in regard to the above discussed tests of residency, it is essential to bear in mind that none of these tests is decisive in itself. This implies that the residential status of an individual can not be determined based on any one of the tests of residency, rather, all the tests to be considered along with the other conditions such as behavior of the individual. The behavior of individual during the stay in Australia is of immense importance in determining the residential status (Ruling TR 98/17, 2016). There are some crucial facts and circumstances that are to be considered in evaluating the behavior of an individual to adjudge whether that individual is a resident or not. Those facts and circumstances include but are not limited to intention and purpose of stay, family, business and employment. Moreover, the maintenance and location of the assets of the concerned individual are also to be given consideration in deciding the residential status. Further, the authorities can also give regard to the social and living arrangements of the concerned individual for such purposes (Ruling TR 98/17, 2016).       

Behavior of an Individual and Other Considerations

Referring to the context developed above and the other applicable provisions of the ITAA 1936, the residential status of Juliette for the financial year 2014-15 and 2015-16 has been determined as under:

Residential Status of Juliette for the Income Year 2014-15

Juliette, ordinarily residing in the UK, has been approached by an Australian management company for performing a role of choreographer in a dance show. For this purpose, Juliette has entered into a contract of two years with the Australian management company. As Juliette is not ordinarily residing in Australia, thus, the domicile test of residency is not applicable to her. Further, the superannuation test of residency also does not apply in case of Juliette as she is not an employee of the Australian government. In this situation, the residential status of Juliette is to be determined by applying the 183 days test. For this purpose, month wise computation of the days of stay of Juliette for the financial year 2014-15 is given as under:

Financial Year: 2014-15

Month

Feb

Mar

April

May

June

Total

Days

28

0

0

31

30

89

The total period of stay of Juliette for the financial year 2014-15 comes to 89 days, which is lower than the statutory requirement of 183 days. However, from the rigorous reading of the rules and provisions in regard to residential status, it has been observed that an individual coming to Australia may be regarded as resident even if the period of stay is less than 183 days in a particular financial year (Exfin, 2016). For this purpose, it is crucial to consider the behavior and the intention of the person to migrate to Australia to live permanently. However, in income year 2014-15, there has not been observed any of the circumstances that indicate the intention of Juliette to migrate to Australia to live permanently. Therefore, considering the fact that the period of stay of Juliette is less than 183 days and that no intention to live permanently exists, it has been articulated that Juliette is not resident of Australia for income tax purposes for the financial year 2014-15.

Residential Status of Juliette for the Income Year 2015-16

The computation of the number of days for the Income year 2015-16 in respect of Juliette is shown below:

Income Year: 2015-16

Month

July

August

Sep

Oct

April

May

June

Total

Days

31

31

30

16

16

31

30

185

It can be observed that Juliette stayed for a period of 185 days in Australia in the income year 2015-16, which is greater than the statutory limit of 183 days. Further, she came back in Australia in April with the intention to live permanently with her husband. Therefore, considering these facts, Juliette should be deemed as resident of Australia for the income year 2015-16 (PWC, 2016).

Rental Property Statement

Amount ($)

A. Rental Income

13,900.00

B. Less: Rental Deductions

Agent Commission

695.00

Replacing the damaged fibro roof with longer lasting colorbond

Nil

General repairs and maintenance

6,000.00

Repainting the front fence which consists of painted wooden pickets

2,500.00

Fixing the broken front door which was damaged by vandals

1,000.00

Total

10,195.00

C. Less: Deduction for Decline in the Value of Assets

Stove ($900/12)

75.00

Hot water service ($2000/12)

166.67

Carpets (3500/10)

350.00

Furniture and fittings (5000/13.33)+(1200/13.33*.5)

420.23

Total

1,011.90

D. Capital works deduction

 

Replacing the damaged fibro roof with longer lasting colorbond

($15000*2.5%*0.50)

187.50

Net Rental Income or Loss (A-B-C-D)

2,505.60


The rental property statement shown in the requirement Q2 (a) above depicts that the net rental income of the tax payer is $2,505.60, which implies that the taxpayer would have to pay the taxes on this income (Australian Taxation Office, 2016). Rental property statement is basically divided into three parts such as rental income, rental expenses, and deduction for the decline in the value of assets and capital works deductions. Rental income is the amount of rent received by the owner from the tenants in compensation of the use of such property. Further, the rental income also includes the other indirect incomes that accrue to the owner in connection with letting out the property such as advertisement income. In the present case, the rental income only comprises the rent received by the owner from the tenants, which amounts to $13,900.00 for the entire financial year 2015-16.         

Example of Determining Residential Status for a Taxpayer

The next part of the rental property statement is the rental expense. The rental expenses are further sub-divided into three parts such as expenses allowable in the same year, expenses allowable in the form of deduction for decline in the value of assets over the number of years, and the expenses not allowable at all. The expenses that are allowable in the year of incurrence includes the expenses of revenue natures related directly to the property, for example, repair and maintenance, advertisement, agent’s commission, cleaning, insurance, and property taxes (Australian Taxation Office, 2016). In order to claim these expenses, it is to be ensured that these expenses are borne by the owner and related directly to the letting business.

Further, in respect of repair and maintenance expense, it should be ensured that these are not of capital nature. In case the repairs are of capital nature, these are to be capitalized and allowed over the number of years in the form of capital works deductions (Australian Taxation Office, 2016). In the present case, expense on general repairs, repainting the front fence, and fixing the broken door have been claimed immediately. However, the expense on replacing the damaged fibro roof has been considered to be of capital nature because this expense is expected to benefit for many years. As per the rental property guidelines issued by the Australian Taxation Office, the expenses incurred on building constructions and major repairs to the buildings are allowed as deduction for capital works at the rate of 2.5% or 4%. The rate of 4% is applied to the specified rental properties such industrial units and commercial complexes, while, for others the deduction can be claimed at the rate of 2.5% (Australian Taxation Office, 2016). Thus, an amount of $15,000 incurred on replacing the damaged fibro roof has been capitalized and claimed as capital works deductions at the rate of 2.5% considering that the property does not fall under the specified categories eligible for higher deduction of 4%. Further, this deduction is allowable proportionately if the constructed or repaired property was used not for full year. In the current case, the replacement of roof was made in December 2015, thus, only 50% of the deduction has been claimed.

Further, apart from the cost of acquisition, there some other expenses, which are also not allowed to be deducted from the rental income. These expenses include expenses not actually incurred by the owner of the property, for example, tenants may bear the expenses of water and electricity use. In addition to this, the expenses of personal nature, which have no nexus with the rental income, are also not allowed as deduction. The expenses incurred by the owner before buying the property such as inspection of the property and travelling costs are also not allowed (Australian Taxation Office, 2016). Therefore, while computing the rental income changeable to tax, it should be kept in mind by the taxpayer that the above discussed expenses are not deducted.

Another category of rental expenses is the deduction in the form of decline in the value of depreciable assets (Australian Taxation Office, 2016). These are the expenses such as purchase of furniture and fittings, carpets, water service machine, and other assets that are used by the tenants along with the use of building. The deduction for decline in the value of assets is allowed either on prime cost or diminishing value method (Australian Taxation Office, 2016). In the present case, the owner has applied prime cost method in computing the decline in the value of assets. The total value claimed as decline in the value of assets amounts to $1011.90, which comprises of $75 on stove, $166.67 on hot water service, $350 on carpets, and $420.23 on furniture and fittings. In this regard, it is important to note that the deduction is allowed in proportion to the days that asset is held by the owner in the subjected income year (Australian Taxation Office, 2016). Therefore, the deduction on the additions amounting to $1200 made to the furniture and fittings in the month of December 2015 have been allowed to the extent of 50 percent only.                         

In determining the deduction for decline in the value of assets, it is crucial that the effective life of assets estimated correctly (CCH Australia Limited, 2011). The Australian Taxation Office has framed general guidelines to assist the taxpayers in determination of the effective life of the assets. As per these guidelines, in determination of the effective life of an asset, the considerations are to be given to the wear and tear of the asset. The expected quantum wear and tear of the asset will be a decisive factor in estimating the effective life. In this connection, it is assumed that the asset will be maintained properly and it will be kept in a good condition over the number of years (CCH Australia Limited, 2011).

In regard to the rental income, certain other facts are also crucial to remember, for example, co-ownership of rental property. In case of co-ownership of rental property, the income and expense gets divided having regard to the legal interest of each co-owner (Compton, 2012). The guidelines framed by the Australian Taxation office in regard to apportionment of the income and expense in case of co-ownership overrides any private agreement between the co-owners. Thus, even if the co-owners agree on some other ratio to proportionate the income and expense, the apportionment will be made only on the basis of legal interest in the property (Compton, 2012).

References

Australian Taxation Office. (2016). Deduction for decline in value of depreciating assets. Retrieved August 12, 2016, from https://www.ato.gov.au/individuals/income-and deductions/in-detail/investments,-including-rental-properties/rental-property-expenses/?page=3#Deduction_for_decline_in_value_of_depreciating_assets.

Australian Taxation Office. (2016). Expenses you can claim. Retrieved August 12, 2016, from https://www.ato.gov.au/General/Property/Residential-rental-properties/Expenses-you-can-claim/.

Australian Taxation Office. (2016). Guide for rental property owners. Retrieved August 12, 2016, from https://www.ato.gov.au/uploadedFiles/Content/MEI/downloads/Rental-properties-2016.pdf.

Australian Taxation Office. (2016). Income tax: residency status of individuals entering Australia: Ruling TR 98/17. Retrieved August 11, 2016, from https://law.ato.gov.au/atolaw/view.htm?Docid=TXR/TR9817/NAT/ATO/00001

Australian Taxation Office. (2016). Rental Property Expense. Retrieved August 12, 2016, from https://www.ato.gov.au/individuals/income-and-deductions/in-detail/investments,-including-rental-properties/rental-property-expenses/?page=3.

Australian Taxation Office. (2016). Worksheet. Retrieved August 12, 2016, from https://www.ato.gov.au/Forms/Rental-properties-2014-15/?page=11.

CCH Australia Limited. (2011). Australian master tax guide 2011. CCH Australia Limited.

Commonwealth Consolidated Acts. (2016). Income tax assessment act 1936 - sect 6. Retrieved August 11, 2016, from https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html.

Compton, T. (2012). Rental property and taxation: an Australian investor's guide. John Wiley & Sons.

Exfin. (2016). Australian tax residency – guidelines. Retrieved August 11, 2016, from https://www.exfin.com/australian-tax-residency.

Income Tax management. (2016). Introduction and meaning of residential status under the income tax. Retrieved August 11, 2016, from https://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/Residential-Status/Meaning-of-Residential-Status.html.  

Prince, J.B. (2013). Tax for Australians for dummies. John Wiley & Sons.

PWC. (2016). Taxation of International Assignees Country – Australia. Retrieved August 11, 2016, from https://www.pwc.com/us/en/hr-international-assignment-services/assets/australia-folio.pdf.

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