Determining Tax Residency And Tax Assessability Of Income For Individuals In Australia

Tax Residency and Assessability of Income

Question:

Discuss about the Residency & Source of Income.

In order to determine the assessability of income when income is derived from both domestic and foreign sources, tax residency tends to become a key determinant. This is primarily because in accordance with Section 6-5(3), ITAA 1997, with regards to foreign tax residents, only that portion of the income that would be derived from  sources located in Australia would be assessable for tax as per the prevailing income tax laws in Australia. This is in stark contrast to the corresponding treatment for Australian tax residents highlighted in Section 6-5(2), ITAA 1997 which includes income generated from both domestic as well as foreign income sources[1]. As a result, tax residency becomes a vital link.

With regards to tax residency ascertaining, Section 6(1), ITAA 1936[2] serves as the primary legislation. However, the matter has been discussed in detail in a number of case laws and tax rulings which have highlighted the relevant tests that could be deployed for the testing of tax residency status. One of the relevant tax rulings in this context is TR 98/17 which details the various tests that are available to perform the test for tax residency. It is noteworthy that satisfying of one of these tests would confer Australian tax residency to the concerned individual. Also, determination of tax residency must be done annually as the surrounding facts tend to keep on altering thus resulting in alternation of the underlying tax residency. The four tests available for determining of residency of individual taxpayers in Australia along with the relevant taxpayer who would apply the same are outlined below[3].

• Domicile Test - Applicable only for Australian Residents
• !83 day Test – Applicable only for Foreign Residents
• Resides Test - Applicable only for Foreign Residents
• Superannuation Test – Applicable only for Federal government officers serving outside Australia

In the given case, domicile test would be the applicable one considering that the relevant taxpayer is a Australian resident. As a result, the discussion of the applicable law would also tend to focus on only the domicile test.

For the Australian tax residency to be granted in line with the domicile test, the concerned taxpayer needs to satisfy the below mentioned two conditions[4].

• Valid domicile in accordance with Domicile Act 1982 must be possessed with the taxpayer during the assessment year
• The permanent adobe as outlined by the arguments in the Levene v. I.R.C.[5] must be located within Australia and not in any foreign place for any time during the assessment year

If either of the conditions above remains unsatisfied or unfulfilled, then the taxpayer would fail the domicile test. The condition dealing with possession of Australian domicile is relatively easy because of the objectivity involved but the same cannot be concluded in relation to the verdict on the location of permanent abode which may or may not be different from the place of current residence or abode.

For determining the permanent abode location, the tax ruling IT 2650[6] lists down the various factors that the tax authorities consider in order to reach a conclusion about the underlying location. The various factors are highlighted below[7].

• Difference between the stay period originally intended when moving to a foreign location and the stay period in actuality along with analyzing the underlying reason for variation
• Intent on taxpayer’s part to return to Australia over a period of time
• Any action whereby the taxpayer set up a dwelling in the foreign location and uses it to dwell with family
• Fate of the residence in Australia i.e. rent, lease or liquidate
• Frequency of visits made to Australia during the period of foreign stay by the taxpayer
• The strength of relationships in the personal and professional domain that the taxpayer tends to keep in Australia during the residence period abroad

Often the word “permanent” in the term permanent residence is confused to imply that unless the taxpayer does not intend to return to Australia ever, he/she would be recognised as an Australian tax resident irrespective of the period abroad. However, this understanding is incorrect as highlighted in the F.C. of T. v. Applegate[8] case. As per the relevant details, it involved a domicile holder or resident of Australia being sent to a foreign location to set up office. Considering the undefined scope of work, the intended duration of foreign stay was unclear even though it was apparent from the outset that it would be rather a long period spanning into years.  But, it is decided at the outset only that after the accomplishment of the task, the taxpayer would again return to Australia on a permanent basis. The taxpayer owing to illness had to cut short his trip and returned to Australia permanently. Despite the fact that the taxpayer did return to Australia, the court opined that the taxpayer for both the years would be a foreign tax resident[9]. Hence, it was indicated that for legal decision making, the word permanent implied a significant length and not indefinite period. This stance of the honourable court has also been reiterated in the decision given in the F.C. of T. v. Jenkins[10].

Tests Available for Determining Tax Residency

With regards to the determination of tax residency of Peter in accordance with the domicile test, the following facts are critical.

• Peter is an Australian resident and associated with a band as a bass guitarist.
• Owing to wider success possibilities in England, the band members decided to migrate to England on January 15, 2016 with Peter determined to return to Australia once the band has gained the requisite popularity.
• Peter had a residence in Australia which he leased out and further sold out his car and shares so as to fund the airfare and other early expenses in England.
• After moving to England, the band members took a house on lease for a period of 12 months.
• Over the next one year, the band did really well and earned a handsome amount from the album sales, associated royalties and also the prize money
• The band members made the decision to return to Australia in August 2017 and finally returned in October 2017. However, Peter’s house in Australia was on lease till the end of 2018 and therefore he had to reside in a rented house in Australia.

It is evident from the above information that Peter possesses an Australian domicile and hence fulfils one of the conditions of the domicile test of tax residency. With regards to permanent abode, it is apparent that there is desire on Peter’s part of return to Australia once the band has become enough famous. But it is apparent that typically this would require a sizable time extending into years and hence there is no specific return date or year in mind when Peter migrated to England for professional purposes. Thus, it is evident that Peter shifted to England for a substantial period.  Further, the Australian residence was leased. The fact that on return the lease on house was to continue will the end of 2018 is indicative that Peter did not expect to return to Australia by that time and certainty not as early as late 2017. All these factors coupled with understanding developed in F.C. of T. v. Applegate (1979) ATC 4307 indicate that there was a shift of permanent residence to England for the period Peter was in England. Since a portion of this time was present in FY2016, FY2017 and also FY2018, thus for all the three years under assessment, Peter would be regarded as a foreign tax resident.

For a foreign tax resident, only income obtained from Australian sources would be tax assessable (s. 6-5(3)). Thus, the relevant income sources for Peter from Australia during the given time period along with the applicable tax assessability is highlighted below.

With regards to assessable income, it is noteworthy that there are primarily two components namely ordinary income (Section 6-5) and statutory income (Section 6-10)[11]. In accordance with s.6-5, ordinary income is defined as proceeds derived from ordinary concepts. While the relevant statute does not detail on the income sources contributing to ordinary income, but based on the various case laws and tax rulings, it would essentially compose of the following element[12].

• Income from business, profession or employment
• Income from personal exertion
• Income from investment which would include rent (real estate), dividends (shares) and interest (bank, bonds)
• Income from prize that is obtained by means of profession as is apparent from the verdict of Scott v. Federal Commissioner of Taxation[13].

Also, any royalty payments which are derived on account of profession or business would also fall within the ambit or ordinary income a highlighted in the applicable tax ruling TR 98/1[14].

Further, with regards to statutory income, one of the key components is capital gains on which capital gains tax or CGT may be levied. As per s. 108-20(2), ITAA 1997[15], a car which is used to for recreation and personal enjoyment would be termed as a personal use asset and would be outside the ambit of CGT. Besides, on the sale of various capital assets, if the capital gain realised is long term, then 50% discount may be applicable for individual taxpayer (Australian tax residents only) as per Division 115 ITAA 1997[16]. The long term capital gains would be realised when the underlying capital asset is held for more than one year.

FY2016

• Sale of car – Exempt from CGT as per s. 108-20(2) [Capital receipts from sale non-assessable)
• Sale of shares – Long term capital gains of ($11000-$5000 = $ 6,000) would be contributed to assessable income for application of CGT. No 50% discount since Peter is a foreign tax resident.
• ARIA Award – Assessable income under s.6-5 amounting to $ 20,000
• Income for performances - Assessable income under s.6-5 amounting to $ 140,000
• Lease income on house in Australia would be assessable income under s.6-5

FY2017

• Royalties received from Australia to the tune of $ 30,000 would be assessable income under s.6-5
• ARIA Award – Assessable income under s.6-5 amounting to $ 10,000
• Lease income on house in Australia would be assessable income under s.6-5

FY2018

• Lease income on house in Australia would be assessable income under s.6-5
• Royalty income of $ 4,000 received after coming back to Australia would be assessable income under s.6-5

Further, the other sources of income derived during the stay in Britain will not be assessable as it would be income from foreign sources. In the above evaluation, only income sources located in Australia have been considered for the purposes of tax.

Reference

Australian Taxation Office: Taxation Rulings:  TR 98/17, (25 November 1998), < https://www3.austlii.edu.au/au/other/rulings/ato/ATOTR/1998/tr1998-017/>

Australian Taxation Office, Taxation Ruling No. IT 2650, (1991) <https://www.ato.gov.au/Individuals/Income-and-deductions/Income-you-must-declare/ >

Commonwealth Consolidated Acts: Income Tax Assessment Act 1936–SECT 6.<https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html>

Barkoczy, Stephen,  Foundation of Taxation Law 2015, (North Ryde, CCH, 2015)

Deutsch, Robert, et. al., Australian tax handbook.  (Pymont, Thomson Reuters, 2015)

Gilders, Frank, et. al., Understanding taxation law 2015. (LexisNexis, Butterworths 2015)

Sadiq, Kerrie, et. al., Principles of Taxation Law 2015, (Pymont,Thomson Reuters, 2015)

Case Law

F.C. of T. v. Applegate (1979) ATC 4307

F.C. of T. v. Jenkins 82 ATC 4098

Levene v. I.R.C. (1928) A.C.217

Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514

Barkoczy, Stephen,  Foundation of Taxation Law 2015, (North Ryde, CCH, 2015), p. 39

Commonwealth Consolidated Acts: Income Tax Assessment Act 1936–SECT 6.< <https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html>