The two principal criteria for determining an entity’s liability to Australian tax are residency and source of income.
A resident of Australia has to pay tax on their worldwide 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 taxpayers that are 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, dwell permanently or for a considerable time, or 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 a resident unless the Commissioner is satisfied that the person’s place of abode is outside Australia.
“Permanent” is not used in terms of everlasting but contrasts with temporary or transitory. The ATO will consider these key factors: intention, the actual length of stay overseas, and where the taxpayer maintains a home.
- The 183-day test
Under this test, if you are present in Australia for more than half the income year, whether continuously or intermittently, you may be said to have a constructive residence in Australia unless it can be established that:
- your usual place of abode is outside Australia
- you have no intention to take up residence here.
In this test, the ATO must be satisfied that your usual place of abode is outside Australia. This is different from the first test (domicile) that requires the ATO to be satisfied that your permanent place of abode is outside Australia.
- 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. It 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 the 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 where 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 you must 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 accessibility to income and capital gains widen when they become residents for tax purposes. Australian residents are assessed on domestic and worldwide 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 determine future capital gains or losses accurately.
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 for assets with a necessary connection with Australia.
This provision applies as non-residents are only subject to CGT on Australian assets. In such cases, a taxpayer can elect to defer any CGT arising from the change in residency until the 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 are able to 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 payslips, assuming they identify amounts withheld. Under the self-assessment regime, these payslips 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, concerning the facts and circumstances of particular cases under review, that flights to and from home and domestic remote mining worksites are generally considered “otherwise deductible” (see chapter 15) for employers when determining FBT liabilities. This extends to similar arrangements overseas.
Iyengar and Commissioner of Taxation (2011) AATA 856
In a global labour 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. 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. After moving to Australia from India in 1998, he and his family took the step of becoming Australian citizens in 2003 and acquired a home in about 2003. At the same time as 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 as the ‘family home’). 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 favoured 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 leave Australia permanently. He had to make arrangements concerning 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, intending 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 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, the shortfall is often substantial for expatriates living and working in countries with low effective tax rates. The ATO targets 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 the settings to provide evidence that your genuine intention is to cease being an Australian resident.
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 ex-pat in the Middle East. The Federal Court found that although the taxpayer was not a resident of Australia according to ordinary concepts. He was found to be an Australian resident because 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 that Mr Harding did not establish a permanent place of abode in Bahrain in the relevant income year. 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 acknowledgements in his affidavit, his presence in that accommodation in those years was temporary and only intended to continue until his wife, and youngest son joined him. At that time, they would have acquired permanent accommodation.
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.
While these comments are still valid, the taxpayer won on appeal to the full Federal Court in 2019. The High Court of Australia then confirmed this decision. It was considered the key issue was whether Mr Harding had abandoned his residence in Australia. This conclusion may help Australian ex-pats living in serviced hotels or apartments on long term arrangements, where it can be demonstrated they have abandoned their residence in Australia.
This case compares with Handsley v Commissioner of Taxation. An aircraft mechanic Mr Handsley provided services throughout Asia. He spent the relevant income year in multiple locations for short periods. Significantly he had not applied for a long-term visa or residency status outside of Australia. Although he had sold his home and had severed ties with Australia, he had not taken up residence anywhere else. Thus, for the purposes of the Assessment Acts, he was still deemed to be an Australian resident.
FOREIGN CITIZEN ON WORKING HOLIDAY VISA NOT A TAX RESIDENT
MacKinnon v Commissioner of Taxation  AATA 1647. in this AAT case, it has held that a taxpayer, a British citizen on a working holiday visa, was not an Australian resident for income tax purposes. The finding was that even though the British citizen’s presence in Australia was more than 183 days, the residency test was not satisfied. The taxpayer did not intend to settle in Australia, and their usual place of abode was outside of Australia. The AAT did not accept that the taxpayer had intended to take up residence in Australia since her plans were always fluid and conditional.
Many taxpayers and some advisers simplify the 183-day test when determining residency, and this case serves as a warning.
TAX RESIDENCY – PROPOSED CHANGES
In the May 2021 Federal Budget, proposals were announced to replace the current individual tax residency rules with a ‘new, modernised framework’.
The proposed new rules are based on ‘bright lines’ and ‘objective factors’.
The first proposed test is a 183-day test. A taxpayer will be a tax resident of Australia if they spend 183 days or more in Australia in an income year.
The second proposed test is for government officials deployed overseas on foreign service. They will continue to be tax residents of Australia.
The first two tests; remain similar to the current 183-day test and the Commonwealth superannuation test.
However, the proposed new rules are divided into:
- becoming a tax resident of Australia – here, a taxpayer will need to check if they spend 45 days or more in Australia in an income year
- ceasing Australian tax residency.
Commencing Australian Tax Residency
An individual would start Australian tax residency under the proposed new rules if they:
- spend 45 days or more in Australia in an income year: and
- tick the box for two of the four factors in the ‘Factor Test’.
The proposed factors in the ‘Factor Test’ are:
- the right to reside permanently in Australia
- Australian accommodation
- Australian family
- Australian economic interests.
An Australian passport-holder who owns an investment property in Australia would tick the boxes for at least two of the four factors. If they spend 45 days in Australia in an income year, they will be an Australian tax resident under the proposed new rules.
However, as with the current law, a taxpayer’s residency could be determined, not by the Australian domestic income tax laws, but by the tie-breaker tests in a relevant double tax agreement.
Note that double tax agreements could be crucial, and that the breaker test could prove to be a real benefit.
Ceasing Australian Tax Residency
Under the proposed new rules, a taxpayer only stops being a tax resident of Australia if they meet one of three tests.
- The first proposed test is the ‘overseas employment rule’. A taxpayer would cease Australian tax residency under the ‘overseas employment rule’ if they meet all the following factors:
- they have been residing in Australia for the three prior income years
- they are employed overseas with an employment period of over two years from commencement
- they have accommodation available in the place of employment for the entire employment period
- they will spend less than 45 days in Australia in each income year of the employment period.
- The second proposed test applies to ‘short-term residents’. A ‘short-term resident’ is someone who has been a tax resident of Australia for less than three consecutive income years. To stop being a tax resident, a taxpayer would need to:
- spend less than 45 days in Australia in the income year: and
- satisfy fewer than two factors (i.e., satisfy none or only one factor) of the ‘Factor Test’.
- The third proposed test applies to ‘long-term residents’. A ‘long-term resident’ is not a ‘short-term resident’. To stop being a tax resident, a taxpayer would need to spend less than 45 days in Australia in:
the income year; and
b. each of the two previous income years.
This could mean that residency ‘clings’ to a taxpayer who has been a long-term tax resident of Australia – even after they have started residing elsewhere.
We will keep you informed on developments.
These provisions deal with arrangements under which there are profits through inter-company or intracompany transfer pricing mechanisms.
In recent years, significant resources have been put into transfer pricing enforcement by the ATO. The aim is to stop profits from being arbitrarily shifted between tax jurisdictions 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.
When 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
- Subdivision 815-C: special rules for permanent establishments, and
- Subdivision 815-D: special rules for trusts and partnerships
The current thin capitalisation rules have been in operation for eighteen years and apply to foreign entities investing in Australia and Australian entities carrying on business or investment activities overseas.
Effectively, these rules set limits on the amount of debt that can be used to finance an entity’s Australian operations and set a minimum level for the amount of equity capital required to finance Australian operations.
The objective is to prevent multinational taxpayers from 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 would no longer have access to the capital gains tax main residence exemption on properties acquired after 7.30 pm (AEST) on 9 May 2017. Foreign residents for tax purposes who held properties prior to 9 May 2017 were able to claim the main residence exemption if they disposed of the property prior to 9 May 2017.
- 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, respectively). This is to be withheld by the seller and passed on to the ATO. These rates came into effect from 1 July 2017.
- There is also an additional charge for foreign investors who leave rental properties unavailable to rent for more than six months of the year. The annual charge will be equal to the investment application fee.
MULTINATIONAL TAX MEASURES
Diverted profits tax at 40%
In the May 2016 Federal Budget, the Treasurer announced the introduction of the 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, 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 an insufficient economic substance that reduces 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 arrangements to access the diverted profits where a related party transaction is assessed as artificial or contrived.
- Impose a liability when the ATO issues an assessment (i.e., it will not operate on a self-assessable basis).
- Require the 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 would 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, taking into account the recommendations made by the Board of Taxation in its report on the Australian Implementation of the OECD hybrid mismatch rules.
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 issuer’s offshore operations, requiring the franking account of the user to be debited as if the returns were to be franked.
These measures were implemented on 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 HOLIDAYMAKERS
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 flat tax rate of 15% on earnings up to $37,000 for working holidaymakers from 1 January 2017. To withhold the special rate of tax, employers need to register with the ATO. If a worker were employed before and after 1 January 2017, for the 2017 year, they would need to be issued two payment summaries.
Working holidaymakers who earn superannuation will also be subject to a 65% tax rate on taxed and untaxed elements of any Departing Australia Superannuation Payments made after 1 July 2017.
YEAR END EXCHANGE RATES – 30 June 2021
Below are the average exchange rates for the financial year ended 30 June 2021 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 2021|
TAXATION RULING – TR 2018/5
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:
- Does the company carry on business in Australia? (see paragraph 6 of this Ruling).
- What does central management and control mean? (see paragraph 10 of this Ruling).
- Who exercises central management and control? (See paragraph 19 of this Ruling).
- 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.
We also draw your attention to ATO Practical Compliance Guideline 2018/19. This contains 15 practical examples, which along with the commentary, gives valuable guidance on this subject