Residential Status And Taxation: Analysis Of Two Cases

Question one

Lin is an auditor by profession who is working for a global shipping company. He moved to Australia from Malaysia several years ago with his children and spouse. He has purchased a home to live in Melbourne. However, he has been working with his employer in Singapore from 2015 for a period of two years, which is possible to be extended by further two years and there is probability that Lin is going to take this opportunity due to good working and pay conditions. Lin has leased an apartment in Singapore whereas his family is still residing in Australia and comes on short breaks to live with him in Singapore. He has been getting salary in AUSD 100,000 which he sends home to give his family support. He earns net rental income of AUSD 15,000 from an investment property in Melbourne.

Now given the facts, we are required to determine residential status for Lin for the income year ending 30 of June, 2017. As per Tax laws in Australia, Individuals are Australian residents if they have been residing in Australia (pwc.com 2017). Residency keeps an importance because an Australian resident is subjected to taxation in Australia from all sources of his income in comparison to a person who is not resident and subjected to taxation in Australia only on the Australian sources of income (ajml.com.au 2013). Tax residency’s primary test is the ‘resides test’ which implies that if one lives in Australia, then he/she will be considered as a resident for purpose of taxation and no other residency tests required to be applied in that scenario. In case an individual does not satisfy the resides test then for considering him as resident of Australia certain other statutory tests are required to be performed (oecd.org 2017). We shall elucidate the tests hereunder-

One shall be considered resident of Australia if he passes the domicile test. Now, domicile is the place that is one’s permanent home, unless the tax authorities are satisfied that permanent place for abode is outside of Australia (Australiantax.com.au 2017).

For having a constructive residence in Australia, an individual has to satisfy the criteria of being actually existent in Australia for a period exceeding half of the income year, whether with breaks or continuously, unless it is established that the usual place of abode is outside Australia and there is no intent to take up residence here (Mjcaccountants.com.au 2017). By usual place of abode here we mean that place where person customarily or usually dwells and it includes that place where the person always has intentions to return (Deutsch 2015).

This is a test for the Government employees of Australia which ensures there residence in Australia while they are working overseas at Australian posts (ashfords.com.au 2017).

Further ruling on taxation TR 98/17 talks about individual’s residency status who are entering Australia outlining the circumstances in which they will be considered as Australian resident. It considers people those who enter Australia for pre-arranged contracts of employment. Also the way in which an individual organizes their economic and domestic affairs are influential factor for determining one’s status of residency (health.qld.gov.au 2015). Following shall be taken into account:

• intention or the purpose of presence
• family and employment ties: having a close relationship with a person living in Australia and if the individual is in Australia to live with them or support them
• location and maintenance of asset: the assets included here are dwelling leased or purchased, household effects or motor vehicles
• living and social arrangements: this includes playing of a social sport in local competition, being local community club’s member, redirecting mails to Australia or enrollment of children at local school (Heinemann 2014)

Question two

Some common situations have been listed on website of Australian Taxation Office for guiding in determination of whether one is Australian Resident or Foreign resident for purpose of taxation. In these one of the listed situations are if one leaves Australia on a temporary basis and do not set up a home that is permanent in another country then they will be regarded as Resident of Australia for taxation purposes (Ato.gov.au 2017).

The Commissioner has summarized certain key factors in paragraph 23 of Taxation Ruling IT 2650 those are relevant in determining permanent place of abode:

• intended and actual length of taxpayer’s status in country overseas
• whether taxpayer is intending to stay overseas on temporary basis and then moving on to another country or returning to Australia at some definite time point
• whether the individual has any place of residency or place of abode existing in Australia or one that has been abandoned due to absence overseas
• continuity and duration of taxpayer’s existence in country overseas
• stability of association that a person is having with Australia’s particular place (Handy & Tng 2012)

To determine status of Lin for the Income year the Commissioner will have regard to certain factors as examined in case of Sneddon namely:

Presence in Australia physically

Nationality

History of movements and residence

Mode of life and habits

Regularity, frequency and duration of Australian visits

Purpose of absence from or visit to Australia

Business and family ties with Australia in comparison to concerned foreign country

Maintenance of place of abode

Accordingly, Lin is not physically present in Australia as he is presently working in Singapore from the last two years. His nationality is also not clearly mentioned in the case study but though he initially moved from Malaysia to Australia, we presume that he is not Australian by nationality. Furthermore, if we see his movements he moved primarily from Malaysia then he has been staying in Australia for several years and now for work he did move to Singapore and intends to work there for two more years. His purpose to be absent from Australia is due to work. He has family ties in Australia in the sense that his family is still residing here in Australia and goes to Singapore for short visiting trips. Lastly, he has a permanent place of residence in Australia where his family has been still residing although he has leased a place in Singapore too.

Now, let us determine his residency, the first test is the‘resides test’ that is whether he is living in Australia, Lin is not presently living in Australia and has been shifted to Singapore for work purpose. Second comes the domicile test that is whether the person is having domicile in Australia unless the Commissioner is satisfied about his having permanent abode place in Australia. In case of Lin, he has a domicile in Australia and we should not consider Singapore as his permanent place because he has leased the apartment that shows his intentions of a temporary stay.  Next comes the 183 days test, Lin is in Singapore for the last two years hence he does not satisfy the test. The last test if the superannuation test which is not applicable for Lin. If we talk about intention then Lin is intending stay in Australia, which is evident from his maintaining a permanent place of abode in Australia. Moreover, he has just leased and not bought an apartment in Singapore that again proves his intentions. He is having family ties in Australia as his family has been living there only. To further evidence his social arrangements, his children are going to school in Australia. He is also having a property in Australia as an investment on which he is earning rental income. As per our analysis, Lin will be considered as an Australian resident for the income year. The Income tax liability of Lin is given below:

The resides Test

Winnie is a resident individual in Australia and sold in 2015 her business of horse breeding in Melbourne. However, the purchaser was unwilling to but the land. Cost of this real estate land of 10 hectare to Winnie in 2005 was $1m. He failed to get reserve price of $ 10 m. She sought advices from accountants and agents who advised her to build land’s smaller blocks that would be affordable to home buyers. In that case, the one-hectare ten vacant lands would include minimum subdivision costs and sell for an amount of $2 m each. Another advice given was to spend $100000 as capital expenditure for building 50 townhouses that would be then selling at $1m. Adhering to the given advices Winnie constructed 50 townhouses in July 2016, out of which 25 townhouses were sold at a price of $25m on 30 June 2017.We are required to advise about the income tax consequences of this real estate sale of $25m.

Capital loss or gain is made when we sell a capital asset like shares or real estate (Nab.com.au 2017). As per Haberfield, there is no existence of any actual rate for capital gains tax. This gain or loss is the resultant difference between cost of disposal less expense associated such as agent commission, solicitor’s fee etc. and the original purchase price the costs associated with the purchase like building inspection, stamp duty etc. This gain or losses need to be reported in the income tax return thereby paying capital gains tax on the same (Delahunty 2017). In case an individual makes capital loss then he cannot claim the same against other income but reduce capital gain from the loss (Clark 2014). Personal and depreciable assets are exempted from CGT (Terrano 2017).

Most real estate is subjected to Capital Gains Tax. It includes business premises, vacant land, rental properties, hobby farms and holiday houses. The main residence is exempt from CGT unless it is earned for running a business or renting or its more than two hectares of land. Also in case of real estate, the time at which the individual is making a capital loss or gain is when the contract is entered into by the individual and not when settled (Fiddes 2012). In case of Winnie, the CGT event is when he sold the townhouses as the time of entering into contract has not been stated in the question clearly.

For calculating capital gain, the method available with Winnie is the discounting method. The discount method is applicable if the CGT event has happened after 21.09.1999, the asset has been acquired at least before 12 months before the CGT event, or indexation method has not been chosen (Hrblock.com.au 2016). The property should be held for a period of 12 months then 50% discount is available that means the gain is actually halved. This gain that is discounted is then included in the tax return of the person as his assessable income along with income from employment and other taxable income. Then on them applies the normal marginal tax rates (Zuchetti 2017).

Domicile Test

Winnie doesn’t have the option of choosing the indexation method as this option  for calculating the CGT payable is only available if the asset has been acquired between the period of 20^th September 1995 and 21^st of September 1999. The method takes inflation into account and one is only required to pay tax on that profit which is in excess of the inflation (advisernet.com.au 2017). The real estate has been purchased by Winnie in 2005. Since the asset has been purchased after 1999 hence the indexation method is not available to Winnie, had the asset been purchased in a period between 1985 and 1999 then Winnie would have been able to index his cost base for adjusting the inflation factor with the cost base.

As regards the construction of townhouses, the law is of the view that for purpose of CGT certain exceptions prevail to the rule that what gets attached to land is part of that land. In some of the circumstances a structure or building is considered to be a CGT asset that is separate from land. A structure, building or other capital improvements on land which has been acquired after or on 20^th September 1985 is a CGT asset that is separate and not land’s part if provision of balancing adjustment applies to it (Ato.gov.au 2017). Now since Winnie has constructed the townhouses in 2016 and sold the same in 2017 and there is ambiguity regarding depreciation on the townhouses, we assume that Winnie was not providing depreciation on the same and hence we are not considering it as a separate CGT asset but as a part of land. The construction expenses are hereby considered as capital expenditure and added to the cost base of the real estate land itself (Ato.gov.au 2017).  

Cost of Acquisition or purchase cost for the real estate land in 2005 for Winnie was AUD 1 million. To this we add the Capital expenditure of AUD 0.1 million. Now if he uses the discounting method then total un-indexed cost base works up to AUD 1.1m. We deduct this from the sale proceeds earned by Winnie for the 25 townhouses that is AUD 25 million. The un-indexed cost base results to AUD 23.9 million for 50 townhouses. To get it for 25 townhouses we decide this amount by 2 thereby getting AUD 11.95 million. Now as Winnie has held the asset for a more than 12 months he is eligible to get 50% discount. This implies that his capital gain would be halved i.e. 50% of AUD 11.95 million. His Net Capital Gain results to AUD 5.975. This will be included in his tax return as assessable income and then Winnie would be liable to pay tax at marginal rates thereafter. The working out is given hereunder:

If we take an alternative view and consider the townhouses constructed as depreciating assets then, the legislation provides that if the individual has received a sale amount of several items which also includes a depreciating asset then apportionment needs to be done, of the amount received between depreciating asset’s termination value and other item. Termination value being only that part which one has received and which is reasonably attributed to the asset. Apportionment is done on the basis of market value of the different items for which received amount is acceptable (Ato.gov.au 2017). Now if we apply this to Winnie’s case, he has apparently sold the townhouses (depreciating asset) along with the land (non depreciating asset). The amount received on sale i.e. AUD 25 million needs to be apportioned reasonably between termination value of the townhouses and proceeds for land sale which would be based upon the land and townhouses relative market value. But due to the absence of relative market values we are unable to apportion the same.

The 183-days Test

Winnie was also advised that smaller land blocks would be more attractive to buy from buyer’s point of view. This would then involve the real estate land getting sold at AUD 2m each accumulating to AUD 20m as sale proceeds. This would entail minimal subdivision costs. In that case his net capital gain would work up to:

There were two advices made to Winnie one was to construct townhouses and the other to divide the lands into smaller blocks and then sell. In the first case that is constructing townhouses and then selling Winnie is making net capital gain of AUD 11.95 million if he sells all the 50 townhouses whereas if he is diving the blocks involving negligible sub-division costs then the net capital gain becomes AUD 9.5 million. Hence, we can see that Winnie is better off from a tax point of view by not constructing townhouses but sub-dividing the land into blocks as this would involve less capital gains and less tax.

References

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