Tax Residency Status Determination And Taxable Income Calculation

Horizontal Equity and Vertical Equity

1. The Australian taxation system has the following two key objectives.

• To appropriate the requisite monetary resources required for the government to function.
• To act as a medium enabling wealth distribution from rich to poor

1. The concept of equity means that various taxpayers should bear a reasonable tax burden only. Two types of equity

Horizontal Equity – Similar tax burden for individuals having comparable fiscal position.

Vertical Equity – Higher tax burden on the rich and lower on the poor

1. The section 4-15 states the following.

Taxable income = Total assessable income – Total Deductions.

1. It is defined as a tax system where the rich and economically well off taxpayers have a higher contribution of their income to tax in comparison with poor people. This facilitated the wealth redistribution.
2. Value of allowances is dealt with in s.15-2 ITAA 1997.
3. The tax residency specifically of companies having foreign incorporation is the subject matter of TR 2004/15.
4. The useful divisions in this regards are Division 40 & 43.
5. Considering the taxable income of the taxpayer, as per ATO, 32,5% would be the marginal tax rate.
6. Subdivision 11-B is relevant in this case.
7. As per TD2017/4, the applicable rate is 63 cents per km

Question 2

Based on the given information, Martelle’s residency status for tax purposes needs to be determined. A crucial role is played by subsection 6(1) ITAA 1936 in highlighting the various statutory tests that are available for checking the tax residency of an individual taxpayer. These tests along with the basic residency tests have been explained in detail in tax ruling TR98/17. The statutory tax residency tests are briefly explained below.

• Domicile Test – This test has two basic conditions namely that the taxpayer should be Australian domicile holder and also permanent abode should be on Australian soil. Martelle has domicile of France and hence fails to pass this test.
• Superannuation Test-  This applies to a specific set of employees those who are based outside Australia on behalf of the Federal government. Martelle does not satisfy the description and this test does not apply.
• 183 day test – This is a common residency test which applies to foreigners currently residing on Australian soil. Two conditions are required for this test as outlined below.
• Minimum physical presence for 183 days in Australia during the tax year.
• Intention of taxpayer to settle in Australia or make Australia home even though it may not happen in future

While Martelle on account of her 6.5 month stay may have been in Australia for 183 days but clearly on finishing her design project, she intends to return to France with no intention to be in Australia. Thus, this test is not passed.

Residency Test – The only available test remaining is basic residency test which essentially considers a host of factors and then derives the tax residency status, These factors that are considered have been highlighted by courts in relevant cases in the past.

• Purpose to visit Australia – In order to be given tax residency, it makes sense that the reason for visiting Australia is significant. A significant reason such as job or study would ensure more commitment towards staying in Australia for a longer period. In job related cases,  a visit lasting only a few weeks does not result in Australian tax residency as per the verdict of FC of T v. Pechey Thus, the stay period should be little longer and preferably should exceed 6 months.
• Family and Business Ties – The chances of residing in Australia for a longer time duration would enhance if the underlying taxpayer has professional and personal ties. These ties are often compared with corresponding ties in country of origin to make a decision.
• Asset location and maintenance- If the taxpayer has fixed assets in Australia, it implies commitment on part of taxpayer to reside for a longer duration. Also, having an Australian bank account also hints at significant time commitment and is imperative factor not to be ignored.
• Social arrangement –  In accordance with TR 98/17, a taxpayer who tends to engage in several social activities is likely to stay longer as it is indicative of the taxpayer leading a healthy and normal life which can be compared with that existing in country of origin.

Residency Status– Martelle has come to Australia on a design project and the expected duration of stay is expected to exceed six months which seems significant enough.  Additionally, a boat has been bought by her, which amounts to fixed asset purchase. Besides, she also has an Australian bank account in which her employee credits the salary. Further, it is also known that Martelle tends to enjoy a healthy social life where she mingles with friends on regular basis. Collectively, the above evidence clearly reflects that Martelle would be treated as an Australian resident for tax purposes in the year under consideration.

Tax consequences – The key difference in tax consequences with regards to Australian residents and foreign residents pertains to the geographical spread of income sources. For Australian tax residents, s. 6-5(2) ITAA 1997 advocates that both domestic and foreign source income ought to be considered. However, s.6-5(3) ITAA 1997 advocates that in case of foreign tax residents, only domestic income sources ought to be included.  Further, the underlying tax rate applicable coupled with tax concessions tend to be more generous for Australian tax residents in comparison with foreign tax residents. Marlette being a tax resident of Australia would need to pay tax in Australia on all the income she derives irrespective of the source location.

Statutory Tax Residency Tests and Basic Residency Test

Question 3

The respective taxation treatment of the given set of items is highlighted below.

Amount	Details	Nature	Explanation
$90,000	Per month paid into the Westpac Bank Account	Taxable	Salary is considered as ordinary income under s. 6(5)
$425	Interest amount in the Westpac Bank Account	Taxable	Rent is considered as ordinary income under s. 6(5)
$6500	Winning amount	Taxable	It is apparent that winning amount has not resulted because of luck of the taxpayer and has been received because of the skill of the taxpayer. Therefore, the winning amount would be termed as ordinary income under s. 6(5). The Kelly v FCT (1985) case is the testimony of this aspect.
$10,000	Amount resulted through signing the restrictive covenant	Not taxable	According to the judgement in Higgs v Olivier (1952) case the amount would be considered as capital receipts. Also, the amount is capital proceeds because Ellen has restricted her rights to start a business and thus, CGT could be taken into consideration for the taxation of capital proceeds.
$500	Amount paid for health insurance	No deduction	It is apparent that nature of expenditure is personal and would not be the part of the assessable income of the taxpayer. Hence, would not be deducted under s. 8-1

Taxable income can be calculated based on the above classification.

Particular	Amount
Winning amount	$6,500
Interest amount	$425
Salary amount	= $9000 * 12 = $108,000
Taxable income	=$114,925

The part of personal income tax for the year 2017/2018 is highlighted below.

 It can be concluded based on the above table that the taxable income for Ellen would be $114,925.

Tax amount payable on the part of taxpayer = 19822 + {0.37 * (114925 -87000)} = $30,154.25

2% on the taxable income would be taken into consideration under Medicare levy. However, in the present case, Medicare levy surcharge would not be applied despite the taxable income  exceeding the threshold income of the taxpayer at $90,000 p.a. since private insurance amount has already been claimed on the part of the taxpayer.

Medicare levy & surcharge = 2% of the total taxable income = 2%* 114925 = $2,298.5

Sum amount of tax payable = Tax amount payable on the part of taxpayer + Medicare levy & surcharge = $30,154.25 + $2,298.5 = $32452.75

Question 4

According to s. 40-60 ITAA 1997, the depreciation in case of assets associated with the business may be deducted to extent of the asset utilized for the business. In accordance with s. 40-65 ITAA 1997, depreciation would be calculated based on the two main methods which are highlighted below. Further, the selection of method would be decided by the taxpayer based on the consumption of the asset in the business.

Prime Cost Method

A steady and uniform depreciation would be taken into consideration in the asset’s value till the life of the respective asset under this method. The formula to determine the decline in the value is shown below.

The decreasing depreciation would be taken into consideration in the asset’s value under this method. Also, significant decline would be observed in the value of the asset in the starting period as compared with the later on period. The formula to determine the decline in the value is shown below.

The base value of the respective asset would be shifted every year after balancing the decline value from the last year value.

Hair Dryer

It is apparent considering the business that taxpayer is running, that hair dryer is a business asset. Further, it is also a depreciating asset and hence the decline in value would be tax deductible.

Hair Dryer Cost = $ 8,000

Useful life = 7 years

For the given year, the hair dryer would be considered for full year considering the purchase on July1 i.e. first day of the tax year.

Computer Software

As per ss. 40-30(1) ITAA 1997, depreciating asset may comprise of intangible asset as mentioned in ss. s. 40-30(2) ITAA 1997. A particular intangible asset which is considered depreciating asset is in-house software. It is not imperative that the business should develop the same and purchasing from outside vendor is also permissible. Hence, the computer software is a depreciating asset for computation of decline in value. Further, software is linked to the business and hence deduction is available for the decline in value that may be computed.

Computer software cost = $ 295

Useful Life = 3 years

Audi Q5

There is no denying the fact that a car is a depreciating asset and hence there would be a decline in value. However, the same would not be deductible since it is not a business asset but rather a personal asset. The given business of hairdressing would not require any Audi car and thus no deductions.

Question 5

It is significant to be able to differentiate between activity pursued as hobby and one pursued as business. This is because the income generated from business activity would attract tax liability while it would not be the case for hobby related income. In order to distinguish between the two, tax ruling TR 97/11 & Evans v. FC of T provides guidance for identifying the relevant factors.

• The profit intention – Any activity undertaken with the primary aim being generation of profit, it is highly likely that this would be categorised as a business activity. However, if the intention behind engaging in activity is more to derive enjoyment and self-satisfaction, then this would be categorised as hobby. Hence, Julie needs to decide as to what is the primary motive with which she wants to engage in her photography.
• Repetition of activity – Isolated spells of engaging in an activity normally is categorised as hobby which is meant for free time or leisure time. On the contrary, business activities are repetitive in nature since they are done on regular basis and not ad-hoc basis. Thus, depending upon how often Julie intends to engage in photography, s decision could be made.
• Investment in terms of resources – A large amount of resources is spent on business activities owing to their ability to generate financial returns. As a result, more time would be spent engaging in this activity and also investment in the form of requisite equipment and training would be done. However, for an activity as hobby, typically the investment would be lesser.  Julie’s conduct with regards to the time given to photography coupled with the capital expenditure on buying the professional equipment would be indicative in this case.
• Scale of operations and professional management – The business activities are well managed and carried at large scale so as to earn maximum profits. Additionally, for computation of profit/loss, suitable record keeping is done. However, in case of hobby, the scale of activities is quite small with little management. Also, no bookkeeping is done since the underlying profit or loss does not matter. Julie also through her scale of photography in terms of clients served, time given and book keeping activities would indicate whether or not the underlying activity is business or hobby.

Question 6

The relevant explanation with regards to deduction or non-deduction of the given expenses is offered below.

S.No.	Expenses	Type	Comment
(a)	$ 300,000 cost paid as salary	Deductible	The salary is paid for running the business which produces assessable income. As a result, general deduction under s.8(1) would apply
(b)	$ 4000 cost paid as salary to run	Deductible	The salary is paid for running the business which produces assessable income. As a result, general deduction under s.8(1) would apply. A critical aspect is to consider whether the amount paid is reasonable for the work done. In case of any inflated payment, deduction would be available only to the extent of work done
(c )	$ 900 cost in form of membership fee for entertaining clients	Deductible	There is a sufficient causal relation between entertaining of clients and assessable income generation. This is because the underlying profession is marketing where a key requirement is relationship building with clients. Thus, general deduction as per s.8(1) would apply.
(d)	$ 2000 cost on smart clothing for image	Deductible	The clothes may be conventional only but still it is a vital part of the taxpayer’s job and would have an impact on assessable income generation. Thus, in accordance with TR94/22., FC of T v. Edwards along with s. 8(1), deduction can be availed.
( e)	$ 5,500 cost in form of meal expenses  on clients	Non-deductible	The tax ruling TR 97/17 clearly highlights that tax deduction cannot be availed on expenses on meal for clients. The same is also validated from the Fringe Benefit Tax Assessment Act (FBTAA 1986).
(f)	$ 3,400 cost in form of interest on business loan	Deductible	Deduction available as per s.8(1) since positive limb satisfied. This is because the interest pertains to those funds which are used for business.
(g)	$ 3,000 cost in form of travelling between home and office	Non -deductible	If either the starting point or the final point is home, then travelling expenses on such journey would not be deductible as per s.25-100(3) ITAA 1997.
(h)	$ 2500 cost as telephone bill but 80% business usage	Deductible (80%)	Telephone calls to the extent related to production of assessable income are deductible as per s. 8-1. Therefore, only 80% of the telephone bill can be deducted by the taxpayer.
(i)	$ 6000 cost in relation to accommodation and airfare for conference	Deductible	The airfare and accommodation related to conference having relation with assessable income production would be categorised as self –education expense and full deduction can be availed as highlighted by TR 98/9 and s. 8(1).
(j)	$ 500 cost paid to accountant for completing tax return	Deductible	Section 25-5 ITAA 1997 allows the taxpayer to make deductions for expenses related to tax returns filing

References

ATO, TR 94/22, 1994 < https://www.ato.gov.au/law/view/document?DocID=TXR/TR9422/NAT/ATO/00001>

Austlii, Section 25-100 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s25.100.html>

Austlii, Section 25-5 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s25.5.html>

Austlii, Section 8-1 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s8.1.html>

Austlii, Section 40-30 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s40.30.html>

ATO, TR97/11,1997 < https://www.ato.gov.au/law/view/document?docid=TXR/TR9711/NAT/ATO/00001>

Austlii, Section 40-60 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s40.60.html>

Austlii, Section 40-65 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s40.65.html>

Austlii, Section 6-5 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s6.5.html>

ATO, TR98/17, 1998 < https://www.ato.gov.au/law/view/document?Docid=TXR/TR9817/NAT/ATO/00001>

Barkoczy Stephen, Core Tax Legislation and Study Guide 2017 (Oxford University Press Australia, 2017)

Krever Richard, Australian Taxation Law Cases 2017 (THOMSON LAWBOOK Company, 2017)

Reuters, Thomson, Australian Tax Legislation (THOMSON REUTERS, 2017)

Austlii, Section 15-2 < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s15.2.html>

ATO, TR 2004/15, 2004 < https://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR200415/NAT/ATO/00001&PiT=20041020000001>

ATO, TD2017/4, 2017 < https://www.ato.gov.au/law/view/document?DocID=TXD/TD20174/NAT/ATO/00001&PiT=99991231235958>

FC of T v. Pechey (1975) 5 ATR 322 case

Evans v. FC of T (1989) 20 ATR 922

FC of T v. Edwards (1994) 49 FCR 318; 94 ATC 425