1. Australian citizen and tech genius, Marty Goodson, set up “Planks Pty Ltd”, a tech business in Silicon Valley USA in 2012 developing new platforms for web designers and companies throughout the world. He incorporated the company in the USA and issued five shares to himself and five shares to five of his friends. His friends now reside in the US, Europe, Asia, Australia, and New Zealand. Each share was worth $100,000. Marty and his team used the $1,000,000 equity capital to develop a successful tech company in only a few years.
During the 2012/2013 financial year, Marty’s income was $100,000, and he did not return to Australia. During the 2013/2014 financial year, Marty’s income was $200,000 and he returned to Australia during the Christmas period for four weeks to spend time with his mother, father, and sister. His sister and her husband live in his residential home rent free. He met with his accountant to discuss the status of his three commercial investment properties in Brisbane, Sydney, and Melbourne. He also attended a friend’s birthday party and fell in love. During the 2014/2015 financial year, Marty’s income was $400,000 and he returned to Australia from the 1st September to the 1st April to spend time with his girlfriend. During the 2015/2016 financial year, Marty earned $100,000 before he returned to Australia permanently to marry the love of his life and start a family.
During the 2012/2013 financial year, Marty was the sole director and made all the management decisions for the company. The company made $1,000,000 profit. During the 2013/2014 financial year, the company expanded and the shareholders appointed a board of directors who all reside in the USA. However, it was widely assumed by the staff that Marty still made all the important decisions. The company made $10,000,000 profit. During the 2014/2015 financial year, Marty was appointed managing director. From 1st September to the 1st April, Marty made all his management decisions from Australia, and carried out all associated business activities such as signing contracts, and trading Platforms from Australia. The company made $25,000,000 profit. During the 2015/2016 financial year, Marty resigned as managing director, sold his shares to another tech company for $50,000,000, and returned to Australia a very rich man. The company made $50,000,000 profit.
1. a) Issue
The issue is to determine whether Marty is considered to be an Australian Tax resident or not.
Tax residency is an essential aspect that must be computed in order to decide the amount of income that would be considered as assessable for taxation in Australia. The tax residency in case of individual taxpayer is highlighted in the subsection 6 (1) of Income Tax Assessment Act 1936 (Barkoczy, 2016). Further, there are four tests known as residency test which are mentioned in the Tax Ruling TR 98/17 that are applied on to the taxpayer in order to check the tax residency status. A taxpayer would be termed as Australian tax resident only if any of the residency tests is successfully satisfied by the taxpayer.A brief discussion about the terms and essential aspects of residency test is listed below (CCH, 2014):
- Domicile Test
- Resides Test
- 183 day Test
- Superannuation Test
1. Domicile Test
It is noteworthy that this tax is applicable to the Australian residents only .The concerned taxpayer would be designated as Australian tax resident if the below mentioned conditions are satisfied by the taxpayer (Sadiq et. al., 2016).
- Taxpayer has domicile of Australia under the relevant clauses of the Australian Domicile Act 1982.
- Permanent residence must be located within Australia only.
There are some of the significant aspects that need to be taken into consideration regarding the permanent residence location determination of the taxpayer. These aspects are highlighted in the Tax Ruling IT 2650 and must be considered by the respective tax authorities while deciding the permanent residence (ATO, 1991).
- Purpose of visits to foreign country and investments
- Frequency of visits, duration of stay in the foreign land and the difference in the intent stay and actual stay
- Level of personal professional or other tie with the foreign country
- Action of the taxpayer which indicates the planning of the taxpayer to migrate from Australia permanently
It is noteworthy that if the taxpayer has permanent residence outside of, Australia then the resident would be recognised as foreign resident. This has been highlighted in the verdict of Federal Commissioner of Taxation v Applegate (1979) ATC 4307 case, According to this case, if the taxpayer has resided in other country in order to establish a business or to run a company and also, the taxpayer does not have any idea regarding specified duration of stay in the other country but eventually due to any reason has returned back to Australia then the act would indicate that the taxpayer has migrated from Australia for the significant time period. Then in such cases, it has been assumed that the permanent residence of the taxpayer has shifted to that country and hence, the taxpayer would be designated as foreign tax resident for that specified time period which he has spent on foreign land (Gilders et. al., 2016).
2. Resides Test
This test is applicable for those taxpayers who are foreign resident. The factors that would be associated with this test are the frequency of visits to Australia and in country of origin, duration of abode, strength of various relations (private, professional, educational),purpose of stay, social arrangements. Further, the citizenship of the taxpayer would also be considered (Deutsch et. al., 2016).
3. 183 day test
For the fulfilment of 183 days it is essential that the foreign resident must reside in Australia for a minimum duration of 183 days in the income year under consideration. Further, it is imperative to have intention on taxpayer’s part to settle permanently in Australia in future (Barkoczy, 2016).
4. Superannuation Test
This test is applicable for officers and employees of the Federal Government only who are working in other countries to complete their duties. Further, it is essential on behalf of the taxpayer to contribute some amount to the designated superannuation schemes for obtaining Australian tax residency (Nethercott, Richardson & Devos, 2016).
Marty who is the resident of Australia has formed a company in Silicon Valley (USA) in the year 2012 with his own share being 50%. Also, he has not made any single visit in Australia in income year 2013. Moreover, he made 4 weeks stay in Australia due to Christmas in year 2014. He also has a fixed asset i.e. home in Australia which he has extended rent free to his sister. In year 2014/2015 he has made a stay with his girlfriendof nearly 7 months. Finally, in income year 2016, he returned back to Australia to marry his girl-friend and to reside permanently.
Applicability of the residency test:
- Superannuation test – Not valid because Marty is not an officer of Federal Government.
- Resides Test - Not valid because Marty is an Australian resident and this test is applicable only for foreign resident.
- Domicile Test–Marty is an Australian citizen and holds Australian Domicile. It is apparent that Marty has resided in USA in order to sustain a company. Moreover, he does not have any idea about the exact time of stay in USA but he has the intention to reside there for significant time duration. This leads to the shifting of the permanent abode of Marty to USA. Therefore, it can be decided that Marty for the time till he has resided in USA and not retuned to Australia on a permanent basis would be designated as foreign resident.
- 183 days Test –It is apparent that for the income year 2015 he has stayed in Australia for more than 183. However, he would not be considered Australia tax resident because at that duration he does not have any plan to reside permanently in Australia. Therefore, this test is also not passed by Marty.
It can be concluded that till the time Mary does not return back to Australia permanently, he would be designated as foreign tax resident.
The issue is to determine whether Planks is considered to be an Australian tax resident company.
With regards to determining the tax residency status of a company, it is pivotal that either of the two conditions outlined below must be satisfied by the concerned company to be termed as an Australian resident for the given year (Nethercott, Richardson & Devos, 2016).
- The place of incorporation for the company must be located in Australia.
- In case of company incorporated outside Australia, the key aim is that the satisfaction of either of the following is necessary for gaining tax residency of Australia.
- Australia must act as the home for the control and central management in context of the company under question.
- Australian tax residents must possess controlling or majority voting rights in the given company.
For further clarification regarding the above rule, TR 2017/D2 is critical. It reflects that central management of the company is entrusted with making key strategic decisions and should not be based in mundane and daily affair decisions. Further, the central management and control does not necessarily lie in the person having the authority to take management decisions but in the person who actually takes them and this person concerned would be significant in the context of the given test (KPMG, 2017).
In accordance with the known facts, the place of incorporation for the company happens to be USA and not Australia. Thus, in line with a foreign incorporated company, it needs to oblige with one of the two prerequisites outlined above. It is pivotal to critically analyse the distribution of the voting rights to ascertain if the related condition can be fulfilled or not. At the inception of the company, 50% shareholding existed with Marty while the remaining shareholding was equally divided amongst the five friends having different nationalities. One of these friends happens to be Australian resident. However, considering the fact that the tax residency status of Marty for the whole period during which he has a stake in the company is essentially a foreign resident, hence this condition would never been satisfied by the company. Thus, the only way to gain Australian tax residency is ensuring the central management is located in Australia which could potentially take place when Marty was in Australia. This happens for the first time during FY2014 when Marty comes during the Christmas vacations for a period of four months but during that period he was primarily on holidays and also did not occupy any formal position in the Board. But when he returned back in FY2015 to spend quality time with his girlfriend, he had become the managing director and was actively involved in making key strategic and management decisions.
It may be concluded that the given company would be considered an Australia resident from September 1, 2014 to April 1, 2015 while for the remainder duration, the company is essentially a foreign tax resident.
c) The aim is to comment on the Australian tax liability related to the Marty’s income
According to the section 6-5(2), ITAA 1997 the taxpayer who is considered to be an Australian tax resident is liable to pay taxes on all of the income earned from domestic or foreign sources. Further, as per section 6-5(3), ITAA 1997, if the taxpayer is a foreign tax resident then the income derived from Australian sources would be accountable for taxation (Sadiq et. al., 2016).
Based on the given case facts it is apparent that Marty has retuned back to Australia in the year 2016. Also, it can be said that the for the time till Marty has not returned back to Australia on permanent basis, he is designated as foreign tax resident and therefore, the employment income derived in the seven month of stay in Australia would be taxable as the company was a tax resident of Australia during that time and hence constituted an Australian source of income. Besides, it is known that Marty has a house on rent along with three commercial properties located in Australia. While the house has been provided rent free but the commercial properties would be attracting some rental income. Hence, the rental income obtained from commercial properties that are Australia based would also reflect in the taxable income for Marty.
d) The aim is to determine the Australian tax liability related to the Planks company which is a foreign tax resident for a majority of the period barring the time which Marty spends with his girlfriend in Australia in FY2015 which has been already discussed in part (b). Considering that the entity is foreign tax resident, thus only income sources based in Australia could contribute to taxable income in Australia on behalf of the company. As a result, the income that the company would derive from Australia based operations or businesses belonging from Australia would contribute to assessable income in Australia. However for the period of the company being termed as an Australian resident, all the income that the company would make with indifference to the geography that it originates from would contribute to assessable income in Australia.
The key issue is to highlight any assessable income that would be derived by Rommy on account of the various transactions given.
For any taxpayer, assessable income may be derived in two main forms i.e. ordinary income and statutory income. Depending on the regularity of a given event, ordinary income may be derivable under section 6-5 or section 15-15, ITAA 1997. Statutory income mainly refers to non-cash based income and has been outlines in Section 6-10, ITAA1997. Further, there are a host of statutory income types that are covered in particular sections of the enabling legislation i..e ITAA 1997 (Deutsch et. al., 2016).
While conducting any activity that may yield income, it becomes critical to label it as business or hobby. In this regards, it is noteworthy that there are key differences relating to size, intention, regularity of activity, amount of profit generated, capital and time devoted. Typically, a business activity would be conducted at large scale, with regularity, profit motive, would involve record keeping and have high investment of time and capital. In a hobby, things are quite different starting with profit not being the prime motive, scale of operation being small, small profit generation may or may not happen and the capital investment is typically small with regularity being lacking (CCH, 2014). The income which a taxpayer derives from indulging in a particular hobby would not be taxable income till the time such proceeds become common enough to be labelled as ordinary income. It makes sense not to tax income from hobby as it does not fall within the purview of s.6-5.s.6-10 or s15-15 (Gilders et. al., 2016).
In case of land subdivision, it is possible that ordinary income under s. 6-5 or s.15-15 is applicable. In the absence of the above, capital gains would be derived which would be subject to tax in the form of CGT. As per TR 92/3, s.15-15 would be satisfied if the purchasing of land and subsequent subdividing was carried out with the intention of making money (Sadiq et. al., 2016). However, s. 6-5 can also be applicable if the land is a trading stock and the concerned taxpayer is involved in trading business involving land or property (Deutsch et. al., 2016). Besides, capital gains may arise on account of a capital event as outlined in s.108-5, ITAA 1997 and also for the net capital gains determination, individual taxpayers can use the discount method to avail a rebate of 50% to work out the net capital gains subject to CGT (Nethercott, Richardson & Devos, 2016).
The information provided highlights the purchase of the property way back in 2000 with the intent that the same would a retreat place in the weekend. Going forward, it was converted into a hobby farm where small scale grape production was done and the produce used for wine production. Also, the excess production of wine beyond personal consumption was given to friends and once was even sold at a stall. However, it is obvious that Rommy has no formal selling mechanism either directly or indirectly. The above facts such as small scale production and lack of underlying profit intent clearly reflect on the activity being a hobby only. As a result, any of the income derived which is not frequent as it is only once that he had sold it in the market, would be regarded as tax exempt income and would have no contribution to assessable income.
Clearly neither the buying of the property nor subdividing the same seems to be driven by profit motive and thereby it amounts to realisation of capital assets with capital proceeds being free from tax. However, the capital gains would be taxable in the given case and will be add upto the assessable income of the concerned taxpayer.
It is fair to assume that property cost base be assumed as $ 500,000 as no other information on any incremental expenses in the form of taxes or otherwise seem to be incurred.
Property sales proceeds are given as $ 1,500,000.
Thereby gross capital gains = 1500000-500000 = $ 1,000,000
While both discount and indexation method are available to individual taxpayers such as Rommy, it is in the taxpayers’ interest to choose discount method as it would lessen the tax liability by 50%.
Hence, capital gains on which CGT would be applied = 50% * 1,000,000 = $ 500,000
On the basis of the above, it would be fair to conclude that the assessable income for Rommey based on the transactions highlighted would be $ 500,000 in the form of capital gains.
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