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Tax Residency & Assessable Income

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Question:

Discuss about the Tax Residency & Assessable Income.
 
 

Answer:

Issue

The main objective is to ascertain assessable income for Peter for the given tax years in accordance with the relevant provisions of ITAA 1936 and ITAA 1997.

Rule

The key aspect determining the assessability of the given income source is the tax residency status of the individual taxpayer which particularly becomes prominent when the income also has been derived from foreign sources besides domestic sources. Section 6-5(2), ITAA 1997 categorically state that if the underlying taxpayer is an Australian tax resident, then income from all parts of the world would be subject to tax in Australia and the location of the source becomes immaterial (CCH, 2013). This is not the case for foreign tax residents as has been highlighted in s. 6-5(3), ITAA 1997 which makes it abundantly clear that only domestic income i.e. income arising from sources located within the Australian territorial boundaries would be subject to tax (Barkoczy, 2015).

For opining on the tax residency status the primary stature applicable is s. 6(1), ITAA 1936 along with the relevant tax ruling i..e TR 98/17. Together, these highlight the applicable residency tests that the individual taxpayer can apply to ascertain the residency status for tax purpose in a given assessment year (Nethercott, Richardson and Devos, 2016). In total, there are four tests whose application and key clauses are as enumerated below (Gilders et. al., 2016).

  • Resides Test

The application of this test is limited only to foreign residents who tend to arrive in Australia for a variety of reasons and hence based on the given circumstances, the tax residency may be determined.

  • 183 Test

The application of this test is limited only to foreign residents who tend to arrive in Australia to visit or other purpose and hence based on the given circumstances, the tax residency may be determined

  • Superannuation Test

The application of this test for tax residency determination is limited to Federal government employees who on behalf of the government are serving in foreign locations and thus have to stay out of Australia for significant periods of time.

  • Domicile Test

The application of this test is confined only to Australian residents who are residing at a foreign location for the fulfilment of obligations which may be of personal or professional nature. For the given situation, as the concerned taxpayer is an Australian resident, hence only the detailed discussion of the domicile test is being carried out.

For passing the domicile test for gaining the status of Australian tax resident, the following two conditions are required to be fulfilled (Sadiq et. al., 2016).

  • Possession of Australian domicile in line with the applicable clauses of the relevant statute i.e. Domicile Act 1982.
  • Location of taxpayer’s permanent abode within the geographical boundaries in Australia during the period when taxpayer is away.

The concept of permanent abode has been explored in the discussions carried out during the Levene v. I.R.C. (1928) A.C.217 case. With regards to the application of the above test for determination of the taxpayer’s tax residency, the issue is not with the determination of whether the concerned individual has domicile of Australia or not but with ascertaining with objectivity the underlying location where the permanent abode is located for the period under assessment (Deutsch et. al., 2015). Typically with regards to the determination of permanent abode location, a host of factors are considered to reach a final decision in this regard which has also been highlighted in IT 2650. This particular ruling tends to signify certain factors which are taken into cognizance by the relevant tax authorities when framing a opinion about the permanent abode location (ATO, 1991).

Another key issue pertains to the meaning of the word “permanent” and whether the shift in abode permanently by default implies that the taxpayer would never return to Australian in the future for residence purpose. A leading case which highlights the key arguments in this debate and facilitate the correct interpretation of the word “permanent” here  is the F.C. of T. v. Applegate (1979) ATC 4307 (Barkoczy, 2015).

This case revolved around an Australian domicile holder who was sent abroad with the intention of setting up an office for the Australian employer in the foreign location. As the work scope was quite wide and flexible, the period of stay abroad could not be determined at the onset and would become clear over the period of time as things would start falling in place. This was indicative of the fact that typically the time commitments would be large in the given case. However, it was agreed beforehand between the taxpayer and the Australian employer that post the task accomplishment, the taxpayer would come back to Australia permanently. The taxpayer during the course of discharging his professional commitments fell seriously sick and thereby had to come back to Australia on a permanent basis at the end of the second year even though the work still remained unfinished. Even though the taxpayer was back in Australia on a permanent basis but the honourable court still ruled that for the whole period. An important clarification offered by the court was that the meaning of the word “permanent” in this context was essentially a substantial length of time which necessarily did not imply indefinite period. This stance has been reiterated by the court during the verdict offered for a similar case i.e. F.C. of T. v. Jenkins 82 ATC 4098 (ATO, 1991).

With regards to computation of assessable income, two key components are ordinary income and statutory income that are respectively governed by s. 6-5 and s. 6-10, ITAA 1997 respectively (Sadiq et. al., 2016).

 

Ordinary Income

Section 6-5 mentions that ordinary income would be income that is derived in accordance with the ordinary concepts but has not provided the details in this regard. Hence, the commentary given in relevant tax rulings along with case laws has been deployed to decipher that the following sources tend to contribute to ordinary income under the aegis of s.6-5  (CCH, 2013).

  • Proceeds derived on account of personal exertion
  • Proceeds in the form of rent or lease payments
  • Proceeds in the form of interest payment from various investments in banks and securities
  • Proceeds from carrying business or engaged in employment
  • Proceeds from dividends resulting from the shares
  • Proceeds derived by professionals on account of their skills which includes relevant prizes that may be regularly awarded.

Statutory income

In accordance with the name, it is apparent that for this form of income, a separate statute would exist which would provide relevant details about the same.  A key constituent of this income is in the form of capital gains which tend to attract CGT or Capital Gains Tax. When a capital asset is liquidated, the capital proceeds are non-taxable, however, the capital gains made in the process may be taxable in accordance with the applicable CGT provisions (Deutsch et.al., 2015). As per s. 108-20(2), ITAA 1997, any asset which is essentially meant for personal use would not be subject to CGT and thus would be exempt from CGT (Barkoczy, 2015). Also, in line with Division 115 ITAA, 1997, individual Australian tax residents can avail a discount of 50% on the taxable capital gains if these are long term capital gains (Gilders et. al., 2016).

Case Facts

The relevant information from the given case is a highlighted below:

  • Peter was a bass guitarist in a popular band in Australia.
  • He was born and raised and Australia (Australian resident)
  • He along with his band member departed to England because they knew that there would be high possibility that the band would do great business in England.
  • Peter has already decided that once the band achieved significant success, he would return back to Australia.
  • In order to collect additional fund for airfare and initial expenses, he leased out his home which is located in Brighton. He did not know about the exact period of stay in England. Hence, he leased the house till the end of 2018.
  • He also sold his car and shares.
  • The band members also received various awards and price money in Australia for their albums.
  • On 20th January 2016, they leased a large house for office work as well as for professional work in London.
  • In a year, band had successfully achieved significant popularity and they received price money, awards for their album in Britain.
  • In October 2017, Peter had returned back to Australia. He had to rent a flat because he leased his own house for end of 2018.
  • After their arrival in Australia, they were continuously receiving royalties form the overseas sale of the album.
 

Application

It is apparent that Peter does possess the domicile of Australia. With regards to location of permanent abode, the arguments made in F.C. of T. v. Applegate (1979) ATC 4307 would apply. Here, at the time of migrating to England, Peter had no idea about the timeframe required but based on the behaviour of other band members and also leasing of house till 2018, it is apparent that the period was expected to be substantial. Hence, it may be conclude that during the period of stay in England, his permanent abode was located in England only and not Australia. Hence, for the all the three years i.e. FY2016, FY2017 and FY2018, the domicile test is not satisfied. As a result, Peter would be classified as a foreign tax resident and only would have income derived from Australia as potentially tax assessable. Foreign income would be outside the scope of Australian tax authorities.

The assessable income for Peter during the three years has been highlighted based on the above mentioned facts.

FY 2016

  1. Capital receipts received from the sale of a car is non assessable. Hence, the income received from sale of car would notcontribute in the assessable income. Moreover, as per section 108-20(20), it would be exempted from the capital gain tax.
  2. It is apparent from the given facts that acquisition period of share is more than one year. Therefore, the long term capital gains obtained from the sale of the shares would also contribute in the assessable income of Peter.
  3. According to the Section 6(5), income obtained in the form of awards would be assessable, because it is ordinary income from professional work.
  4. Price amount received from various shows and events would be assessable income as per the provision of Section 6(5).
  5. Peter has leased his own house located in Australian. Hence, the received rent amount would be considered as assessable income from investment.

FY 2017

  1. Prize amount received from various events would be assessable income as per the provision of Section 6(5).
  2. The amount of award would also be classified as assessable income as per the ruling of Section 6(5).
  3. Peter has leased his own house located in Australian. Hence, the rent amount would be considered as assessable income from ordinary concepts.

FY 2018

Peter has leased his own home for a period that would continue till end of 2018. Therefore, the income derived in the form of lease amount would be classified as assessable income as per Section 6(5).

  1. Peter has also received royalty amount on the best albums which would be from professional course of work and therefore, would be categorised as assessable income as per Section 6(5).
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