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Taxation Law And Practice Residency & Assessable Income

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Question:

Discuss about the Taxation Law and Practice Residency & Assessable Income.
 
 

Answer:

Determining the tax residency

The tax residency status of an individual tax payer provides estimation that what portion of the income is assessable for the taxation that is derived either from domestic sources or from foreign sources. As per the Section 6-5(3) of the Income Tax Assessment Act (ITAA), 1997[1], in case of foreign tax resident only the amount of proceeds that are generated with in Australia are considered for the assessable income. Therefore, it is essential to determine the tax residency status of the taxpayer in order to comment on the accessibility of incomes received from various sources.

In the process of determining the tax residency status in case of an individual taxpayer, subsection 6(1) of ITAA, 1936 would be considered. There are lots of parameters under various tax rulings and case laws that can be applied to determine the tax residency.  TR 98/17[2] is one of the imperative tax rulings that highlight the major tests to find the tax residency[3]. These tests are applied on a taxpayer in order to determine the tax residency for given financial year. These tests are highlighted below:

  1. 183 day Test: This test is applicable only when the concerned taxpayer is a foreign resident.
  2. Superannuation Test: This test is applicable only for the government officers who are residing in foreign land in order to complete their duties.
  3. Resides Test: This test is applicable only when the concerned taxpayer is a foreign resident.
  4. Domicile Test: This test is applicable only when the concerned taxpayer is an Australian resident.

In the present case, Domicile test is applicable because the concerned taxpayer is an Australian resident. A detailed discussion of domicile test is as highlighted below:

 


Domicile Test: There are mainly two conditions of the domicile test that need to be satisfied on behalf of the taxpayer in order to recognised as Australian tax resident for the respective financial year[4].

  • It is essential that the taxpayer must possess Australian Domicile as per Domicile Act 1982.
  • The permanent residence as highlighted in the decision of Levene v. I.R.C.[5] case must be situated within Australia for the respective financial year

It is noteworthy that if the concerned taxpayer does not satisfy both the above highlighted conditions, then the taxpayer would not be termed as Australian tax resident under domicile test. In application of the above tests, domicile determination is rather straightforward but the same cannot be said about the ascertaining of permanent abode location which is usually fraught with high degree of subjectivity and hence requires further assistance.

The imperative tax ruling IT 2650 is used to comment on the aspects related to the ascertaining of the underlying location of the permanent residence[6]. These aspects are essential because the tax commissioner would use the below mentioned aspects while deciding on the permanent abode location[7].

  • Total stay in the foreign land, when the taxpayer is outside from Australia then the difference between the actual duration of stay and intended duration of stay would be considered.
  • The reason/purpose on the part of the taxpayer to stay in the foreign land
  • Rate of visits, which involves how many times the resident is going and staying on the foreign land
  • Location of the asset and residential essential to the taxpayers such as rent or lease and so forth
  • Any particular act on taxpayer’s part that indicates the willingness to reside outside from Australia on a permanent basis.
  • Intensity of the personal and professional bonds of the taxpayer in Australia during the period of abroad stay also plays an imperative role in this regards,
 


A critical aspect with regards to application of the test is to understand the contours of the word permanent which gives the perception that a permanent shift of the taxpayer from Australia would cause relocation of the permanent abode. However, this is not true.  The F.C. of T. v. Applegate[8] case is the testimony in this context. According to this case, the concerned taxpayer who was having an Australian domicile was sent overseas for some professional work, then the long term duration of the stay in the overseas would be a significant parameter to decide the permanent abode of the taxpayer. In such cases, if the intended time of stay in the foreign land is not defined but the taxpayer has a strong will to go back to Australia in future after the work is finished, then the taxpayer would be considered as foreign tax resident. But, due to critical reason such as diseases, health issues he/she came back to Australia on permanent basis then also he/she would be recognised as foreign tax resident for the years which he /she has spent in the foreign land irrespective of the significant difference between  the actual stay and intended stay in overseas.

It is apparent that the concerned taxpayer Peter is an Australian resident and engaged in the profession of a guitarist in a well-known band in Australia. It has been found by the taxpayers that the band can get huge success in England and thus, the band members along with Peter decide to go to England. Taxpayer Peter has a strong willingness to return to Australia after getting significant popularity in England. In order to collect the requisite fund, Peter had a house which he rented and also sold his car and shares. When the band members and Peter had arrived in England, they had leased a house for 1 year. As estimated by the band member, a significant popularity was obtained by the band and derived subsequent proceeds, prices and royalties on the album sold along with live shows. In August 2017, it had been decided by members to return back to Australia and in October 2017, they came back to Australia. Additionally, Peter had leased the house with a validation till end of the year 2018 and thus, Peter had to make a stay in a rented house located in Australia.

It is apparent that Peter is having an Australian domicile under the Domicile Act 1982. It means he satisfied one of the essential of domicile test. Moreover, in regards to comment on the permanent abode of Peter, it is apparent that he has leased his permanent house located in Australia and shifted to England for professional course of work for acquiring requisite popularity of band.  It is evident that Peter does not have any clear idea regarding the duration of stay in England but expects it to be of long enough to stretch into years. Hence, he has leased his house for substantial period of time i.e. end of year 2018. This indicates that there is very less possibilities regarding the early return of Peter. Therefore, it can be concluded that for the time period, which he has spent in England, it would be considered that Peter had shifted the permanent abode and thus, he would be recognized as foreign tax resident as per the leading case F.C. of T. v. Applegate (1979) ATC 4307 case.

 

Assessable income

The tax treatment of an Australian tax resident under the provisions of Section 6-5(2) of ITAA, 1997[9] takes into consideration both foreign income as well as domestic income for the purposes of tax accessibility. This is in stark contract with a foreign tax resident for whom only income derived from sources situated in Australia would be taxable. Since, Peter is  not an Australian tax resident, hence only sources located in Australia are eligible to contribute towards assessable income.

According to the Australian tax law, there are two main parts of assessable income as identified below.

  • Ordinary income as per Section 6(5) of ITAA, 1997

As name suggests, any income earned or derived from ordinary source of income such as due to investment, dividend, rental or lease amount, interest amount, professional works or through personal exertion are termed as ordinary income. There is no specific ruling or provision given in the statue for the ordinary income specifying the exact sources and thus, the leading case law and their verdicts are considered for the determination whether the income is assessable under the ordinary income concepts or not[10]. Moreover, any proceeds derived on the account of the royalty for the professional work would also be termed as assessable income under the ordinary income concept of TR 98/1 if the same is derived from skills related to profession. Also, profession related prize money as per the arguments in Scott v. Federal Commissioner of Taxation[11] would also contribute to ordinary income.

  • Statutory income as per Section 6(10) of ITAA, 1997

One of the key components of statutory income is capital gains on which application of capital gains tax or CGT takes place. The income derived on liquidation of a capital asset would result the capital receipts and, if the capital gains is obtain than capital gains, then the same would be taxable as per the provision of CGT[12]. Moreover, capital gains received from a personal use asset that are used by the taxpayer for personal work or for entertainment would not liable for CGT under the Section 108-20(2), ITAA 1997[13]. Moreover, fifty percent discount would be validated for the concerned Australian resident taxpayer on the received long term capital gains as per the Division 115 ITAA, 1997[14].

 

Application

Case facts

Therefore, the income derived in Australia only would be liable for the computation of assessable income as per the provision of Section 6-5(3).

For income tax year 2016

Sale of car

Exempt from the capital gains tax

Section 108-20(2)

No assessable income

Sale of shares

Long term capital gains

 

(Peter is not liable to get 50% discount because he is foreign tax resident in 2016)

assessable income

 

($11000 - $5000) = $6000

 

ARIA award amount

Ordinary income

Section 6(5)

assessable income

($20,000)

Proceeds due to good performance

Ordinary income

Section 6(5)

assessable income

($140,000)

Lease amount results from the leased house located in Australia

Ordinary income

Section 6(5)

assessable income

 

For income tax year 2017

Royalty amount

Ordinary income

Section 6(5)

assessable income

($30,000)

 

ARIA award amount

Ordinary income

Section 6(5)

assessable income

($10,000)

 

Lease amount results from the leased house located in Australia

Ordinary income

Section 6(5)

 

assessable income

 

For income tax year 2018

Lease amount results from the leased house located in Australia

 

Ordinary income

Section 6(5)

assessable income

 

Royalty amount received after returned back to Australia

 

Ordinary income

Section 6(5)

 

assessable income

 ($4,000)

It is noteworthy that the income received from the foreign source (while residing in England) would not be considered as assessable income because in that period of time he is termed as foreign resident.

 

References

Websites

Australian Taxation Office: Taxation Rulings:  TR 98/17-Income tax: residency status of individuals entering Australia (25 November 1998), < https://www3.austlii.edu.au/au/other/rulings/ato/ATOTR/1998/tr1998-017/>

ATO, Guide to capital gains tax, < https://www.ato.gov.au/Tax-professionals/TP/Guide-to-capital-gains-tax-2016/>

Commonwealth Consolidated Acts: Income Tax Assessment Act 1997 –SECT 6.5. <https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s6.5.html>

ATO, INCOME TAX ASSESSMENT ACT 1997, < https://www.ato.gov.au/law/view/document?DocID=PAC/19970038/6-5>

Books

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

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

Relevant Statutes

Income Tax Assessment Act, 1936

Income Tax Assessment Act, 1997

Case laws

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

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

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