Relevant Rule

Discuss About The Australian Taxation Oxford University Press?

The determination of tax residency for a taxpayer is very critical on account of the differential treatment that is extended to a particular taxpayer based on the underlying tax residency. This essentially is not limited to the sources of income that are taken into consideration but also the tax rate that are applied. The ATO offers differential tax rates and concessions for resident and non-resident taxpayers. In the wake of this differential treatment, it becomes pivotal to outline the tax residency and then apply the same based on the given facts of the taxpayer.

The nodal statute for tax residency status determination is subsection 6(1), ITAA 1936. This section tends to highlight the various conditions which in turn determine the tax residency of an individual for the financial year under consideration. Further, a tax ruling TR 98/17 is also found to be useful as it lists down the various tests that are available to individual taxpayers. For any individual, in order to get the tax residency, the only criterion is that one of those tests needs to be satisfied (ATO, 1998). As per TR 98/17 along with the subsection 6(1), ITAA 1936, the following tests for ascertaining individual residency status are available (Barkoczy, 2017).

In order to oblige with this test, there are two main conditions that need to be fulfilled. The first condition pertains to the respective taxpayer being an Australian domicile holder in accordance with the applicable statute i.e. Domicile Act 1982. Another condition that needs to be fulfilled is that the permanent abode of the individual taxpayer must be situated in Australia for the year under consideration. Failure to comply with either of the conditions would lead to non-fulfilment of this test and non-confirming of the Australian tax residency. Based on the underlying conditions, it becomes apparent that this is useful in determining tax residency of Australian domicile holders who tend to stay abroad for extended length of period on account of myriad reasons (Sadiq et.al., 2016).

The word “reside” finds no mention in the statute law and hence reliance on various court cases and tax rulings commentary is the only source to determine the underlying parameters considered for this test. The key factors in this regards are outlined as follows (Nethercott, Richardson and Devos, 2016).

• The first factor takes into account the reason for which the taxpayer enters into Australia. In this regard, the higher the significance, the higher the chances of the taxpayer being termed as Australian resident. The significant reasons could be employment (more than six months preferably a year) along with education.
• In accordance with the IRC v Lysaght [1928] AC 234 case, another key parameter to be considered is the visit frequency to country or origin along with the underlying reason and the duration of such visits.
• The strength of personal and professional ties that the individual taxpayer has in Australia and country of origin needs to be compared as it is indicative of the commitment of an individual towards Australia.
• Also, the nature of social life that the taxpayer tends to reside in Australia and the similarity of the same to the life in the country of origin is also a significant factor.

Along with the above factors, if required then the nationality of the taxpayer is also taken into consideration for tax residency determination.

Domicile test

This above test is very specific and applied only for those taxpayers who are government employees and have to serve abroad due to foreign consignments or deputation on duty for these employees. The tax residency of these employees is dependent on their participation in the specific superannuation funds by way of regular contributions. If the obligation in relation to the dedicated superannuation fund is complied with, then irrespective of other conditions such as the duration of stay, visit of Australia, presence of family would not be considered and the underlying taxpayer would be classified as Australian tax resident (Woellner, 2014).

• 183 day test

This given test is applied for determining the tax residency of foreign residents. In order to comply with the given test, the respective taxpayer needs to fulfil the conditions that have been outlined below (CCH, 2013).

• The respective taxpayer should have spent 183 days at a minimum in Australia being physically present in the financial year for which the tax residency is under consideration. It is not essential that this stay should be at one go or continuous and hence can be done on intermittent basis.
• Also, it is essential that there must be intention on the part of the taxpayer to settle on a permanent basis in Australia in the long term. This intention may be expressed through actions in this regard or an explicit statement regarding the future intent.

Failure on the part of the taxpayer to comply with either of the two conditions outlined above would imply that the concerned taxpayer would not be categorised as a tax resident of Australia (Deutsch et. al., 2016).

• The country of origin for Minh is Malaysia.
• A work visa was granted to Minh in June 2016 and he migrated to Australia with family with the intention of starting a business.
• A family home is purchased in Melbourne where he starts living with his wife and children.
• However, Minh continues to have strong business interests in Malaysia and hence needs to stay there for quite some time.
• Meanwhile his family continue to stay in Australia and the children are enrolled in local school.

• The domicile test would not be applicable for Minh as he does not possess a domicile of Australia since he has just migrated to Australia on a work visa.
• Also, the superannuation test is not applicable in case of Minh as he is not a government employee who is serving abroad.
• Further, 183 day test would be applicable for Minh considering that that he is not an Australia resident. However, based on the information provided, it is apparent that Minh has spent only 120 days in Australia in the year FY2017 and thus fails to satisfy the minimum stay period condition of 183 days. Further, the intention to settle in Australia is also lacking on part of Minh. Hence, this test is failed.
• The last test that is applicable is resides test. However, even though his reason for migration is significant in terms of employment and subsequent business but he has not established any business in Australia. Further, for more than half the year, he continues to be in his country of origin maintaining very strong professional ties (stronger than Australia). Also, he maintains a flat in Kuala Lumpur and has cultural and social ties as well. Thus, considering the above, it would be fair to infer that this test is also failed.

The main concern is to determine the impact of residency of Minh on the tax treatment extended to the investment income and assessibility of business income that is being earned from Malaysia.

The tax residency is vital primarily because the assessable income determination is driven by the same. In accordance to s. 6-5(2) ITAA 1997, in case the given taxpayer is not a tax resident of Australia, then only the income arising from Australia would be taxable in Australia (Barkoczy, 2017). The foreign income if any for such a taxpayer would not be assessable in Australia. On the other hand, as per s. 6-5(3) ITAA 1997, in case the given taxpayer in an Australian tax resident, then the income from all the sources (i.e. domestic and foreign) would be taken into consideration for computation of assessable income and determining of the tax liability (Nethercott, Richardson and Devos, 2016).

As has been highlighted above, Minh for the year 2016-17 is a foreign tax resident. Thus, in accordance with the relevant statute, no foreign income would contribute to assessable income. As a result, the business income along with investment income that is procured from Malaysia would be considered as foreign income and hence would not be subject to any taxation in Australia.

No tax would be levied on the income that Minh derives from Malaysia in the form of investment and business income as these are categorised as foreign income and the same is not assessable for foreign tax residents such as Minh.

Resides test

For deriving assessable income, there are various means that have been prescribed in the tax law prevalent in Australia. In wake of the same, it is imperative that the various provisions regarding the same are outlined and then applied to the given case. Further, the amount of tax liability amounting from the application of different rules would also tend to vary which has also been outlined. Besides, the most likely scenario in relation to application of statute would be identified taking into consideration the available facts along with relevant case law and tax rulings.

The key concern in this given case is to ascertain the three alternative ways in which the sales proceeds arising from the three townhouse sales can be recognised with regards to tax purpose.

One of the key sections pertaining to assessable income is s. 6(5) ITAA 1997. It highlights that the income derived from ordinary concepts are referred to as ordinary income. Based on case laws and tax rulings, a plethora of sources have been identified in this regards. One of these is business income which along with employment income contributes to assessable income. However, it is essential to segregate business activity and hobby by considering the various measures identified in the commentary of the Evans v. F.C. of T(1989) 20 ATR 922case (Gilders et. al., 2016).

While any regular business or employment activities for earning money is assessed under s. 6(5), any isolated transactions which has been enacted by the taxpayer in order to earn money is assessed under s. 15(15) ITAA 1997. The only main criterion for this section is that from the outset, there must be an intention to earn profit which has been the key driver prompting the taxpayer to undertake the activity (Sadiq et. al., 2016).

Another contributor to assessable income is in the form of statutory income. As the name suggests, for this particular income, there are dedicated statute which need to be referred to. One of the key contributors to statutory income is in the form of capital gains. These typically would realise when there is sale of any capital asset. Assuming that this sale does not constitute the business of the underlying taxpayer, the proceeds would be capital in nature and hence tax free (CCH, 2013). However, considering the asset cost base and the sale price of the asset, it is possible that the capital gains may have been derived by the taxpayer under s. 104-8 ITAA 1997. In case of these capital gains, these would contribute to the income of the taxpayer which would be subjected to capital gains tax (Barkoczy, 2017).

Superannuation test

In the light of the given facts where Penny’s profession is not stated, it could be assumed that she is a contractor who deals in real estate properties. As a result, she borrowed money and conducted business operations by constructing four identical homes and selling three of these identical houses while retaining the fourth for her private use. Thus, the proceeds that would be derived from sale of three houses would be termed as assessable income under s 6(5) and taxable income would be derived post adjustment for deductible expenses.

In this case, it is assumed that Penny is not in the profession of contracting or dealing with real estate properties. As a result, the profits that the taxpayer Penny derives on account of an isolated transaction would be termed as assessable income under s.15(15). The presence of profit motive behind sub-dividing is apparent. Also, the using of marketing services for deriving the optimum selling price further indicates the intent to maximise profit which is what prompted the construction of four houses at the first place.

In this case, it is assumed that intention to profit was not present for Penny and hence the taxpayer has merely realised a capital asset which was purchased earlier. In such a scenario, the proceeds from the sale of the house would be termed as capital proceeds which would not be taxed. However, capital gains would be computed on the same and CGT would be paid on the net capital gains available after any deduction and concessions that may be applicable.

Hence, the given transaction can be recognised through the use of s. 6(5) (Assessable income), s. 15(15) (Isolated transaction profits) or s. 108(10) (Capital gains).

The assessable income under alternative approaches needs to be determined.

Alternative Approach 1: Assessable income (s. 6(5))

Total proceeds derived from the sale of the three houses = $ 3 million

Cost of construction for four houses = $ 1million

Assuming proportionate division of expenses, construction cost for three houses = (3/4) *1 = $ 0.75 million

Further cost of the vacant land = $ 1 million

Assuming equal land area division for all the four houses, land cost for three houses = (3/4) *1 = $ 0.75 million

Hence, deductions would be available for the above expenses and then taxable income would be computed (Gilders et. al., 2017).

Alternative Approach 2: Assessable income (s. 15(5))

Total proceeds derived from the sale of the three houses = $ 3 million

Foreign residents

Cost of construction for four houses = $ 1million

Assuming proportionate division of expenses, construction cost for three houses = (3/4) *1 = $ 0.75 million

Further cost of the vacant land = $ 1 million

Assuming equal land area division for all the four houses, land cost for three houses = (3/4) *1 = $ 0.75 million

Hence, profits = 3-1.5 = $ 1.5 million

The above amount would be considered as assessable income under this approach (Woellner, 2014).

Alternative Approach 2: Assessable income (s. 108(10)

Cost base of the property = Cost of land + Cost of construction = $1 million + $ 1 million = $2 million

However, the above is for the whole property which consists of four houses, hence the cost base needs to be adjusted accordingly = (3/4)*2 = $ 1.5 million

Proceeds from the sale of the three houses = $ 3 million

Hence, capital gains = 3-1.5 = $ 1.5 million

Assuming that the sale happened within 12 months of purchase of land, hence the discount method is not applicable and hence CGT would be applicable on the complete capital gains of $ 1.5 million derived above (CCH, 2013). It is noteworthy that the marketing cost for sale of house has been considered to be zero for this computation.

It would be inappropriate to assume that Penny is a builder or contractor and therefore the derived proceeds should not be considered as assessable income under s. 6(5). In relation to capital gains, it would have to be assumed that the activity of Penny particularly in relation to sub-division was not related to profit making. Clearly, this is not the case since she borrowed money as she clearly had the hope that she can sell these houses for a higher amount and hence make profits from land subdivision. Thus, while the purchase of land was essentially not driven by profit, it is very apparent that construction of the four identical house and relevant subdivision coupled with marketing are driven by profit motive (Barkocy, 2017). Hence, it would be appropriate to realise the profits from this isolated transaction as assessable income under s 15(15).

Conclusion

On the basis of the above discussion, it is apparent that the given sale of subdivided houses would be regarded under the aegis of s. 15-15 ITAA 1997. This is because the sub-dividing activity seems to be driven from profit motive which is confirmed through the use of marketing services for higher price extraction. Hence, the assessable income would essentially comprise of the profits that the taxpayer tends to derive on the sale of the three houses.

References

ATO (1998), Rulings: TR98/17, ATO Website, [online] available at https://www.ato.gov.au/law/view/document?Docid=TXR/TR9817/NAT/ATO/00001 [Accessed September 25, 2017]

Barkoczy, S. (2017), Foundation of Taxation Law 2017, 9^thed.,North Ryde: CCH Publications

CCH (2013), Australian Master Tax Guide 2013, 51^st ed., Sydney: Wolters Kluwer

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., and Snape, T. (2016), Australian tax handbook 8th ed., Pymont: Thomson Reuters,

Gilders, F., Taylor, J., Walpole, M., Burton, M. and Ciro, T. (2016), Understanding taxation law 2016, 9^th ed., Sydney: LexisNexis/Butterworths.

Nethercott, L., Richardson, G. and Devos, K. (2016), Australian Taxation Study Manual 2016, 4^th ed., Sydney: Oxford University Press

Sadiq, K, Coleman, C, Hanegbi, R, Jogarajan, S, Krever, R, Obst, W, and Ting, A (2016) , Principles of Taxation Law 2016, 8^th ed., Pymont:Thomson Reuters

Woellner, R (2014), Australian taxation law 2014, 7^th ed., North Ryde: CCH Australia