Tax Residency Determination And Assessing Ordinary Income And Deductions - Case Analysis

Tax Residency Determination for Australians Working Abroad

1. Amity has been employed as a tax advisor by the mid-tier private accounting firm YoungPWC and Associates in their Adelaide branch for 7 years.  In January 2015 she was selected to be sent to Kiribati for two years to advise the Kiribati government on the design and implementation of a new VAT.  The placement was for a 2 year period with an option exercisable by Amity to extend the period for a further 3 years.  

Amity jumped at the opportunity and left Australia in January 2015 with her husband Martin. Amity intended to stay in Kiribati for at least the initial 2 years and then make a decision about staying longer if the lifestyle was enjoyable, the work enjoyable and financially rewarding.

On first arriving in Kiribati, Amity and Martin took out a small mortgage on a house on the beach and planned to furnish it with furniture bought from the local furniture stores.  However, they underwent extreme culture shock when they discovered there were no local furniture shops selling anything they wanted and the cost of shipping their furniture over was prohibitive. They decided to sell the house after 4 months and take up a serviced apartment in the capital.  

This was acceptable accommodation and it worked well enough as there were no children. They were able to take out 12 month rent agreements as there were many expats on one year placements. They made the apartment relatively homely with their few belongings.  However, Martin found getting any sort of reasonable employment was essentially impossible and started to get dispirited.

Amity’s salary was paid into an account she opened with the Asia-Pacific Bank. Amity and Martin kept their home in Adelaide and rented it out through agents for 12 month periods.

They discontinued their health insurance membership, however Amity maintained her Chartered Tax Advisor membership.  Their only relatives are their elderly parents who resided in Australia.

Martin contracted a form of food poisoning from eating a toxic fish and after only 18 months away the disenchanted couple returned to Adelaide at the beginning of July 2016.

You are required to advise Amity on whether or not she was an Australian resident during the income year ended 30 June 2016 by reference to the relevant legislation and case law.

2. To the characteristics of ordinary income and the concept of ordinary income discuss whether the following amounts are ordinary income:

a. An employee dentist swapping dental work valued at $600 for a computer game with a client who sells computer games.  The market value of the game is $550, however it cost the client $300 to place in trading stock.

b. A car valued at $15000 given as a prize to the 500 000^thcustomer of a bank.  

In your discussion you must reference AT LEAST two cases for each scenario.

3. To the relevant legislation and case law discuss whether the following would be deductible under s8-1 ITAA 97.

a. Betty and Barney are a married couple and sell the family home for $450 000.  They purchase a two story building for $700 000 and use the ground floor as a business while they live in the top floor.  Are they entitled to any interest deduction is relation to the $250 000 they borrowed?

b. Robert borrowed $100 000 to purchase plant and equipment for use in his business.  After a period of time the plant and equipment were sold, however the loans were not paid out.  Will the interest on the loan continue to be deductible if:

1. The business continues
2. The business has ceased

4. Lincoln is an Australian resident for the full year aged 30. He conducts a business as a sole trader as a video game designer and retailer.    During the 2016/17 year he had the following receipts, payments and other information.

Sales $527 000

Proceeds from loan $500 000

Lottery win $50 000

Trading stock purchases $275 000

Gross wages paid to employees $42 000

Total Loan repayment interest $21 890

PAYG instalments paid $57 500

Rent on premises $145 000

Other expenses  -  all deductible   $75 000

Lincoln received $10 000 from a supplier as an incentive to display their game consoles in his window. He also received a fully franked dividend of $5400.

The value of the opening stock on 1/7/16 was $72 200, and the closing stock on 30/6/17 was $92 300

The $500 000 loan was taken out of 1/8/16 for 7 years.  $400 000 was utilized in the business and the remainder was used to renovate Lincoln’s house.  No income producing activities take place at Lincoln’s house.

a. Calculate Lincoln’s assessable income and allowable deductions.  Support your analysis with relevant sections from the Income Tax Assessment Acts and/or case law references.

b. Calculate Lincoln’s taxable income and the balance of his assessment for the 2016/17 income year from the information provided.

Disregard the low income tax offset and Medicare Levy Surcharge.  Calculate the Medicare Levy.

The key aim in this task is to ascertain Amity’s tax residence for the tax year ending on June 30, 2016. The relevant tax law dealing with individual tax residency is ss. 6-1 ITAA 1936 which outlines the requisite tests for residency. Besides, a tax ruling which is relevant for the given task is TR 98/17 which demonstrates the use of the various tests with the aid of particular case laws and examples (Coleman, 2016). Even though there are four key tests that are applicable but based on the whether the taxpayer is an Australian resident or not, some of the tests may not be applicable. In the scenario provided, Amity is an Australian resident who is staying outside Australia and hence the general residency test and 183 day test would not apply. The possible options are domicile test and superannuation test in which also the latter is ruled out owing to Amity having a private job. Thus, the only relevant test for the given situation is domicile test (Barkoczy, 2017).

A particular case which ought to be discussed with regards to location of permanent abode is F.C. of T. v. Applegate (1979) 9 ATR 899. The key aspect that the honourable court highlighted through this verdict was that it is not imperative for the taxpayer to permanently shift to a foreign land for ensuring that the permanent abode is shifted to foreign land and substantial period absence from Australia can also qualify for shifting of permanent abode. As a result, the taxpayer in this case was declared a foreign tax resident even though he intended to return to Australia after completion of professional commitment. However, the fulfilment of this required him to stay for a significant time period which was cut short by an illness which forced him to return to Australia after 2 years (Barkoczy, 2017).  This approach has been supported by another case i.e. F.C. of T. v. Jenkins (1982) 12 ATR 745 where the circumstances were similar and the taxpayer was declared a foreign tax resident (Deutsch, Freizer, Fullerton,  Hanley & Snape, 2015).

The case facts with regards to the given scenario are quite comparable to the above cases in the sense that Amity has been sent abroad (Kiribati) for a substantial time of 2 years and has the option of extending for another 3 years. Further, during the period, the personal ties of Amity with Australia are minimal as her husband travels with her to Kiribati. Additionally, they buy a house in Kiribati which was later liquidated due to issues with furniture. Also, a local bank account has been opened for receiving salary. All these factors coupled with the verdict in the above case laws clearly highlight that for the tax year 2015-2016, Amity would not be considered as a tax resident of Australia.

2. a) In the context of a barter based transaction, C. of T. v. Cooke & Sherden80 ATC 4140 is a noteworthy case. It highlights that in the scenario that barter related consideration is labelled as income as per s. 25-1 ITAA 1936, then the consideration related to transaction that the given taxpayer obtains will be taxable income at his/her end (Reuters, 2017).  Besides, another relevant case with regards to recognition of professional services based revenue is Henderson v FCT70 ATC 4016. This indicates that once the services have been provided to the client, then there arises a receivable on the part of the professional providing the service and any consideration (cash or kind) provided by the client would constitute assessable income (Krever, 2017).  In the situation presented, the dentist has already provided service to the client and hence a receivable is created which is discharged by the client by providing the toy with a market value of $ 550 and hence the same amount is booked as ordinary income under s. 6-5 ITAA 1997 which would be assessable (Sadiq et. al., 2015).

Assessing Ordinary Income - Case Study 1

b) The proceeds derived from prize would be categorised as ordinary income (s. 6-5) only when the prize is the result of the skills deployed by the taxpayer which are used for deriving employment or business related income. A relevant case worth highlighting for endorsing the above understanding is Scott v. Federal Commissioner of Taxation(1966) 117 CLR 514 case (Barkoczy, 2017). Further, the assessability of prize proceeds is dependent on a host of factors and not essentially to one factor which has been indicated in the decision of the Squatting Investment Co Ltd v. Federal Commissioner of Taxation(1953) 86 CLR 570 (Coleman, 2016). One of these factors is relation to the skills deployed for deriving employment income while the motive of the prize provider is also imperative.

Based on the provided scenario, it becomes apparent that winning of the prize is not linked to any particular skill which the winner possessed and is essentially linked to luck or chance. As a result, the underlying prize money would not result in generation of any income.

3. a)  General deduction for outgoing and expenses is provided as per s. 8-1 ITAA 1997 if the relation of these with assessable income production can be established. However, there are certain exceptions to the above deduction which are referred to as negative limbs and are outlined below (Barkoczy, 2017).

• Expenditure is capital in nature
• Expenditure is domestic and not related to business
• Expenditure is related to production of non-assessable income

Based on the relevant facts of the situation at hand, it is apparent that the loan assumed is for purchase of property that has both commercial as well as residential elements. A relevant case is Ronpibon Tin v FC of T (1949) 78 CLR 47 at 57 which indicates that general deduction of outgoing is possible when it has been undertaken for assessable income generation. In the situation provided, the assessable income (rent income) production would be enabled only when purchase of property goes through and this this would require the loan amount. The deduction in interest on the loan amount would be available only to that extent which has been diverted for the purchase of the ground floor as it produces assessable income (Sadiq et. al., 2015).

b) General deduction for outgoing and expenses is provided as per s. 8-1 ITAA 1997 if the relation of these with assessable income production can be established. A relevant case is Ronpibon Tin v FC of T(1949) 78 CLR 47 at 57 which indicates that general deduction of outgoing is possible when it has been undertaken for assessable income generation (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015).

i) The given information indicates that given loan was taken to facilitate the purchase of plant and equipment which then could be assumed to enhance generation of assessable income. The scenario highlights that even though plant and equipment have been sold but the debts related to these have not been discharged. It is apparent that the underlying assets for which the loan would be assumed no longer exist and hence the connection with assessable income generation ceases to exist. As a result, no deduction for incremental interest would be granted as per s. 8-1 ITAA 1997 (Krever, 2017).

ii)  In the given case, the winding up of the business has already taken place and no incremental income can thus be generated by the outstanding loans. As a result, no deduction for incremental interest would be granted as per s. 8-1 ITAA 1997 (Reuters, 2017).

4 a) The computation of assessable income and allowable deductions is indicated in the tabular format below (Reuters, 2017).

Explanations

1) Loan proceeds are capital in nature as these need to be repaid and hence non-assessable.

2) Lottery winnings would not contribute to assessable income as it is attributed to chance and not skill.

3) Franking Credits = (5400/0.7) -5400 = $2,314

4) For all the allowable deductions included in the table above, these are related to sale generation (i.e. assessable income production) and hence deductible under s. 8-1 ITAA 1997.

5) The computation of raw materials consumed has been facilitated through the following formula.

b) The taxable income can be derived by using the computation of assessable income and allowable deductions highlighted above.

A key aspect to be noted is that on the above taxable income, the tax actually paid would be lowered by the quantum of franking credits since the dividend paying company has already paid the same to ATO (Coleman,2016). 

References

Barkoczy, S. (2017) Foundation of Taxation Law 2017. 9^th ed. Sydney: Oxford University Press.

Coleman, C. (2016) Australian Tax Analysis. 4^th ed. Sydney: Thomson Reuters (Professional) Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2015) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

Krever, R. (2017) Australian Taxation Law Cases 2017. 2^nd ed. Brisbane: THOMSON LAWBOOK Company.

Reuters, T. (2017) Australian Tax Legislation (2017). 4^th ed. Sydney. THOMSON REUTERS.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., &Ting, A. (2015) Principles of Taxation Law 2015. 7th ed. Pymont: Thomson Reuters.