The two principal criteria for determining an entity’s liability to Australian tax are residency and source of income.
A resident of Australia must pay tax on their world-wide income whether it is earned in or out of Australia.
A non-resident on the other hand is limited to Australian tax on income derived only from Australian sources.They are not entitled to any tax-free threshold and are taxed at a higher rate.
Those taxpayer’s resident for only part of the year pay tax at resident rates but are only entitled to the tax-free threshold for the months they reside in Australia.
The dictionary definition of reside is to have one’s settled abode, to dwell permanently or for a considerable time or to live in or at a particular place.
Whether a person resides in Australia under this definition is a question of fact in view of the individual’s unique circumstances.
It is suggested that the following factors are useful in determining whether the individual’s behaviour over a considerable period has the degree of continuity, routine or habit that is consistent with Australian residence:
- the intention or purpose of the person’s presence in Australia
- the extent of the person’s family or business / employment ties with Australia
- the location and maintenance of the person’s assets
- social and living arrangements.
THREE STATUTORY TESTS
- The domicile / permanent place of abode test
Under this test a person whose domicile is in Australia is deemed to be a resident, unless the Commissioner is satisfied that the person’s place of abode is outside Australia.
“Permanent” is not used in term of everlasting, but contrasts with temporary or transitory.Key factors the ATO will consider include intention, actual length of stay overseas and where the taxpayer maintains a home.
- The 183-day test
Under this test constructive residence will be attributed to a person who is in Australia either continuously or intermittently for more than half of the year, unless it can be established that the person’s usual place of abode is outside Australia and there is no intention of taking up residency here.
- Commonwealth superannuation test
This applies to public servants and means that if an individual is contributing to a super fund of Commonwealth Government officers they will be an Australian resident.
RESIDENCE OF COMPANY
A company is resident in Australia if:
- It is incorporated in Australia; or
- If not incorporated in Australia it carries on business here and has either its central management or control in Australia, or its voting power controlled by shareholders who are residents of Australia.
SOURCE OF INCOME
The operation of rules that deal with the taxation of foreign source income for residents and the fact that non-residents are usually only assessable on Australian sourced income make the identification of the source of any item of income fundamentally important.
As business transactions become more complex, the following comments are general in nature:
- Income from personal exertion is derived in a country where the services are performed, regardless of how and where you were paid.
- The location of a contract may be relevant where creative knowledge or specialist skills are used to an extent that the place of use is irrelevant.
- The source of business or trading profits is generally the place where services are performed, or trading takes place.
- In cases where income has multiple sources, it will be necessary to determine the dominant factor or factors.On occasion it may be necessary to apportion income among the various sources.
- The source of interest is in the country where the obligation to pay the interest arose e.g. for bank interest it is where the bank account is held.
- Dividend income is sourced in the country in which the company made its profits.
- A pension or annuity is sourced in the country in which the pension fund or annuity fund is located.
- TR 2013/1 states that when determining the source of income, a “substance over form” approach should be adopted, and the actual behaviour of the parties may take precedence over the formal terms of the contract.
DOUBLE TAX AGREEMENTS
The clear intent of double tax agreements (DTA) is that taxpayers are not taxed twice on income earned in countries outside their own.
DTAs usually have a standard format, but it is vital that you refer to a specific agreement should any queries arise.
Income that is usually taxed according to the source of the income includes:
business income derived through a permanent establishment
directors’ income and similar company offices
entertainers and performing artists
income from real property including mining royalties
salary or wages where the employee is present in the other country for more than 183 days
income derived from personal services or derived from a fixed base used by the person concerned.
The following income is generally taxed on a country of residence basis:
- income from independent activities or professional services (excluding public entertainers)
- income earned by an employee present in other countries for less than 183 days in the tax year.This applies where the employer is a resident of the same country where the employee is resident, and the income earned is not an allowable deduction for the employer in that country
- remuneration for services rendered to government officials and bodies
- remuneration for academics or teachers present in other countries for two years or less
- profits from shipping or aircraft
- income derived by a resident from sources outside both countries
- payments made to students for their maintenance
- profits of an enterprise carried on in one country unless a permanent establishment exists in the other country.
BECOMING A RESIDENT
People immigrating to Australia find their assessability to income and capital gains widens when they become residents for tax purposes.Australian residents are assessed on domestic and world-wide income.
New Australians will find that income from foreign investments including interest, dividends, pensions and capital gains or disposal of foreign assets will become subject to Australian tax.
Under the CGT regime, those commencing residency are deemed to have acquired their assets at market value on the given date.It is prudent to obtain valuations in such cases to accurately determine any future capital gains or losses.
CEASING TO BE A RESIDENT
The main issue here is CGT.On becoming a non-resident, you are deemed to have disposed of all assets at market value, except those assets with a necessary connection with Australia.
This provision applies as non-residents are only subject to CGT on Australian assets.In such cases it is possible for a taxpayer to elect to defer any CGT arising from the change in residency until ultimate disposal of the asset.
A tax planning issue arises here, and careful decisions will need to be made when changing residency.
EMPLOYMENT INCOME EARNED OVERSEAS
Australians working overseas can claim a Foreign Income Tax Offset for the foreign income tax paid on those amounts now included in their assessable income.
These taxpayers are not required to lodge a foreign tax return to demonstrate and claim amounts of foreign tax paid.
All they are required to do is keep their normal pay slips, assuming they identify amounts withheld, and under the self-assessment regime these pay slips will only need to be provided if the Tax Office undertakes an audit.
The general application of FBT to overseas based Australian employees is appropriate as it ensures there is consistent treatment of employee remuneration regardless of whether it is received as cash or as a non-cash benefit.
Current judicial and Tax Office interpretative decisions have found having regard to the facts and circumstances of cases under review, that flights to and from home and domestic remote mining worksites are generally considered “otherwise deductible” (see chapter 14) for employers when determining FBT liabilities. This extends to similar arrangements overseas.
Iyengar and Commissioner of Taxation (2011) AATA 856
In a global labor market this case deserves close scrutiny.Do not assume that you are a non-resident for tax purposes because you have met the 183-day test.
In May 2007, the taxpayer, Mr Iyengar, left his family and his family home in Perth to move to Dubai, and later Doha, Qatar, to work as a site engineering manager for the company Maersk, pursuant to a two-year contract which contained an option to extend the contract for two further periods of six months each.
Mr Iyengar’s Australian income tax returns for the years ended 30 June 2008 and 2009 stated that he was a non-resident for Australian income tax purposes and did not include any assessable income. The Commissioner subsequently issued Mr Iyengar with notices of assessment for those years in accordance with his returns.
In November 2010, the Commissioner issued Mr Iyengar with notices of amended assessment for the relevant years, which included in his assessable income foreign source income (following a data-matching process). The taxpayer objected to those amended assessments and the Commissioner disallowed that objection. It was thus for the Tribunal to review the Commissioner’s objection decision. Mr Iyengar’s position is that he was not a ‘resident’ of Australia during the relevant income years such that none of the foreign source income he derived in the United Arab Emirates is subject to Australian tax. He also contended that one of the amended assessments was issued out of time and was therefore unauthorised.
The Tribunal said (at paragraph 80):
Despite the fact that Mr Iyengar spent almost 2 years and 7 months working in Dubai and later Doha for Maersk, his family ties with Australia were such that he remained a ‘resident of Australia’ in the relevant years of income. That is, after moving to Australia from India in 1998 he and his family took the step of becoming Australian citizens 2003 and acquired a home in about 2003. While he was overseas working on the contract for Maersk, his wife, daughter and son remained in Australia (except for three short visits to Dubai by his wife), his most substantial asset (the Winthrop home) was located in Australia, he used almost all of the money he earned abroad to make accelerated payments on his Australian mortgage on the Winthrop home (which he acknowledged he considered to be the ‘family home’) and he took his holidays (albeit short) in Australia at the Winthrop home with his family: Shand and Crockett.
That is, Mr Iyengar was, and remained, an Australian ‘resident’ according to ordinary concepts: Joachim; Shand and Crockett. It followed, therefore, that Mr Iyengar was also an ‘Australian resident’ for the purposes of the definition of that term in section 995-1 of the ITAA 1997 and as used in section 6-5(2) of the ITAA 1997.
Mayhew and Commissioner of Taxation (2013) AATA 130
By contrast this case went in favour of the taxpayer with the AAT concluding that the taxpayer handled his departure from Australia and his relocation to the Middle East in a manner consistent with a person who had resolved to permanently leave Australia.He had to make arrangements in relation to his children and the assets he was leaving behind and he did this in his own way and in his own time, according to the priorities confronting him.He established a home in Dubai as soon as practicable and furnished the home in a manner with an intention to remain in the location indefinitely.
Returning expatriates – residency issues
The ATO continues to target expatriates returning to Australia, sometimes after an extended time living and working overseas.
In a number of cases the ATO has suggested an expatriate was an Australian tax resident, and that the expatriate’s income earned from overseas employment should be reported as taxable in their Australian income tax returns.
The case of Pillay v Commissioner of Taxation (2013) AATA 447 is a typical example.Dr Pillay was held to be a resident of Australia in the 2010, 2011 and 2012 income years, despite living and working in East Timor since 2006.The AAT accepted the ATO’s submission that Dr Pillay had had a ‘continuity of association’ with Australia and was therefore a resident for tax purposes.Crucially Dr Pillay maintained a house and had bank accounts in Australia.
For expatriates living and working in countries with similar effective tax rates to Australia, any tax shortfall may not be significant, as taxpayers are generally entitled to foreign tax credits for tax paid overseas.However, for expatriates living and working in countries with low effective tax rates, the shortfall is often substantial.The ATO appears to be targeting expatriates from countries with low effective tax rates, often by tracking funds transferred from overseas into Australian bank accounts.
For those returning expatriates contacted by the ATO, it is essential to get professional advice.The same applies to those departing overseas – make sure you have settings in place.
We also refer you to the following cases:
- AAT Case (2012) AATA 799. Re Bezuidenhout and FCT, AAT, Ref Nos 2011/5525-28, McCabe SM, 15 November 2012
- Boer v Commissioner of Taxation 2012 AATA 574
- Sully v Commissioner of Taxation 2012 AATA 582
- Sneddon v Commissioner of Taxation 2012 AATA 516
Decision Impact Statement
We also refer you to Dempsey and Commissioner of Taxation published by the ATO on 1 August 2014, as it has excellent coverage on the above issues.
Harding v Commissioner of Taxation  FCA 837 – Expat resident of Australia
This case deals with a taxpayer who was an expat in the Middle East. The Federal Court found that although the taxpayer was not a resident of Australian according to ordinary concepts, he was found to be an Australian resident as the taxpayer conceded he had retained his Australian domicile in the relevant year and had no permanent place of abode. He had stayed in the same apartment tower in Bahrain but did not stay in the same fully furnished apartment.
The Court found in the relevant income year Mr. Harding did not establish a permanent place of abode in Bahrain. By its character it was a type of premises used for temporary or transitory accommodation and Mr Harding used it as such. By Mr Harding’s own acknowledgements in his affidavit, his presence in that accommodation in that years was temporary and only intended to continue until he was joined by his wife and youngest son at which time they would have acquired permanent accommodation.
So, what is the takeout here?
If possible, make the characteristics of any tenancy permanent – one set dwelling as soon as you leave Australia. It is acknowledged that this will not always be possible due to contractual constraints.
These provisions deal with arrangements under which there are profits through the mechanism of inter company or intra company transfer pricing.
In recent years, significant resources have been put into transfer pricing enforcement by the ATO.The aim is to stop profits being arbitrarily shifted between tax jurisdictions in order to minimise tax.It is recommended that taxpayers adopt a pricing methodology prescribed by the ATO.
Adequate documentation should be kept verifying a prescribed methodology has been followed – TR 98/11.
In situations where international related party transactions exceed $2 million, the ATO requires an “International Dealings Schedule” (formerly Schedule 25A) to be completed with the taxpayer’s tax return.
The transfer pricing rules are contained mainly in:
- Subdivision 815-B:applicable to entities in general (22-610)
- Subdivision 815-C:special rules for permanent establishments (22-620), and
- Subdivision 815-D:special rules for trusts and partnerships (22-610; 22-630)
The current thin capitalisation rules have been in operation for seventeen years and apply to both foreign entities investing in Australia and to Australian entities carrying on a business or investment activities overseas.
Effectively these rules set limits on the amount of debt that can be used to finance the Australian operations of an entity and to set a minimum level for the amount of equity capital that is required to finance Australian operations.
The objective is to prevent multinational taxpayers highly gearing their Australian enterprises with a view to paying less tax in Australia.
Note: Significant thin capitalisation changes commenced on 1 July 2014.
Taxpayers subject to thin capitalisation need to forecast their expected debt levels from1 July 2014 and whether any interest expense would be denied under the proposed regime (the forecasts are largely based on accounting projections).
Effectively the changes will:
- Reduce the ‘safe harbour’ debt limit for ‘general’ entities from 75 per cent of adjusted Australian assets (from 3:1 to 1.5:1 on a debt to equity basis);
- Reduce the ‘safe harbour’ debt limit for non-bank financial entities from 20:1 to 15:1 on a debt to equity basis;
- Increase the ‘safe harbour’ minimum capital for banks from four per cent to six per cent of the risk weighted assets of their Australian operations;
- Reduce the ‘worldwide gearing ratio’ from 120 per cent to 100 per cent and make it available to inbound investors; and
- Increase the de minimis threshold from $250,000 to $2 million of debt deductions.
- CHANGES FOR FOREIGN PROPERTY INVESTORS
- The May 2017 Budget introduced numerous measures that impact the taxation of investment properties owned by foreign residents.
- These measures are aimed at improving housing and rental affordability for Australian residents:
- It was announced that foreign and temporary residents will no longer have access to the capital gains tax main residence exemption on properties acquired after 7.30pm (AEST) on 9 May 2017. Properties held prior to this time will be grandfathered until 30 June 2019.
- Updated foreign resident capital gains withholding rates will see an increased tax withheld of 12.5% on properties sold for more than $750,000 (previously 10% and $2 million respectfully). This is to be withheld by the seller and passed on to the ATO. These rates came into effect from 1 July 2017.
- Also proposed is an additional charge for foreign investors who leave rental properties unavailable to rent for more than 6 months of the year. The annual charge will be equal to the investment application fee.
- Foreign residents will also find it harder to purchase properties as restrictions on New Dwelling Exemption Certificates prevent more than 50% foreign ownership in newly developed properties. This restriction only applies to multi-storey developments with more than 50 dwellings.
MULTINATIONAL TAX MEASURES
Diverted profits tax at 40%
In the May 2016 Federal Budget, the Treasurer announced the introduction of a 40% Diverted Profits Tax (DPT).
The new tax is aimed at multinational corporations that artificially divert profits from Australia.The tax applies to income years commencing on or after 1 July 2017.
The new tax targets companies that shift profits offshore through arrangements involving relating parties:
- That result in less than 80% tax being paid overseas than would otherwise have been paid in Australia;
- Where it is reasonable to conclude that the arrangement is designed to secure a tax reduction; and
- That does not have sufficient economic substance.
Where such arrangements are entered into, the ATO will apply a 40% tax on diverted profits to ensure that large multinationals are paying sufficient tax in Australia.
This measure will apply to large companies with global revenue of $1 billion or more.
Companies with Australian revenue of less than $25 million will be exempt, unless they are artificially booking their revenue offshore.
Australia’s DPT is based largely on the second limb of the UK’s DPT which was introduced in 2015, otherwise known as the ‘Google Tax’.It will:
- Impose a penalty tax rate of 40% on profits transferred offshore through related party transactions with insufficient economic substance that reduce the tax paid on the profits generated in Australia by more than 50%;
- Apply where it is reasonable to conclude based on the information available at the time of the ATO that the arrangement is designed to secure a tax reduction;
- Provide the ATO with more options to reconstruct the alternative arrangement on which to access the diverted profits where a related party transaction is assessed to be artificial or contrived;
- Impose a liability when an assessment is issued by the ATO (i.e. it will not operate on a self-assessable basis);
- Require upfront payment of any DPT liability, which can only be adjusted following a successful review of the assessment; and
- Put the onus on taxpayers to provide relevant and timely information on offshore related party transactions to the ATO to prove why the DPT should not apply.
Transfer Pricing Rules to be strengthened to implement 2015 OECD recommendations
The Government announced that it will amend Australia’s transfer pricing law to give effect to the 2015 OECD transfer pricing recommendations.
Tax Integrity Package – Implementing the OECD hybrid mismatch arrangement rules
The Government will implement the Organisation for Economic Co-operation and Development’s (OECD) rules to eliminate hybrid mismatch arrangements, considering the recommendations made by the Board of Taxation in its report on the Australian Implementation of the OECD hybrid mismatch rules.The Government has asked the Board of Taxation these rules in relation to regulatory capital as part of this measure.
This measure is aimed at multinational corporations that exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions.This measure targets instances where tax is either deferred or not paid at all.It will apply broadly to related parties, members of a control group and structured arrangements.
Further announcements in the May 2017 Budget defined targeted rules to eliminate hybrid mismatches on regulatory capital known as Additional Tier 1 (AT1) capital:
- Prevent returns that are tax deductible in foreign jurisdictions from carrying franking credits;
- Where the AT1 capital is not wholly used in the offshore operations of the issuer; requiring the franking account of the user to be debited as if the returns were to be franked.
These measures apply from the latter of 1 January 2018.
Tax Integrity Package – increasing administrative penalties for significant global entities
The Government will increase administrative penalties imposed on companies with global revenue of $1 billion or more who fail to adhere to tax disclosure obligations.
This measure applies from 1 July 2017.
TAX RATES FOR WORKING HOLIDAY MAKERS
A taxpayer is a working holiday maker if they earn income while working under a visa subclass 417 (Working Holiday) or 462 (Work and Holiday).
On 1 December 2016, the Treasurer announced a new flat rate of tax of 15% on earnings up to $37,000 for working holiday makers from 1 January 2017. To withhold the special rate of tax, employers need to register with the ATO. If a worker was employed before and after 1 January 2017, for the 2017 year they will need to be issued two payment summaries.
Working holiday makers who earn superannuation will also be subject to a 65% tax rate on both taxed and untaxed elements of any Departing Australia Superannuation Payments made after 1 July 2017.
YEAR END EXCHANGE RATES – 30 June 2018
Below are the exchange rates for the financial year ended 30 June 2018 for converting foreign income into Australian dollars.
The rates for selected countries and Europe are reproduced below (foreign currency equivalent to $1).
|Country||Average for year ended 30 June 2018|
Income tax: central management and control test of residency
This Ruling sets out the Commissioner’s view on how to apply the central management and control test of company residency following Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation  HCA 45; 2016 ATC 20-589 (Bywater).
A company is a resident or a resident of Australia under the central management and control test of residency if it:
- carries on business in Australia, and
- has its central management and control in Australia.
Four matters are relevant in determining whether a company meets these criteria:
(1) Does the company carry on business in Australia? (see paragraph 6 of this Ruling).
(2) What does central management and control mean? (see paragraph 10 of this Ruling).
(3) Who exercises central management and control? (see paragraph 19 of this Ruling).
(4) Where is central management and control exercised? (see paragraph 30 of this Ruling).
Whether a company is a resident under the central management and control test of residency must be determined by reference to all the facts and relevant case law.