Residency, source and derivation

Key concepts Residency Derivation Source

«What can Australia tax? » RESIDENCY AND SOURCE Importance: Determine Australia's jurisdiction to tax a person's income. Who can be taxed? What is taxed? Example: Marie, a French citizen, who lives in Paris, receives: Salary from her accountancy job in Paris; and Rent from an investment property she owns in Melbourne. Ask yourself: «What can Australia tax? »

«When is the payment derived by Acme DERIVATION Why is ‘derivation’ important? It determines in what year a person’s income is to be brought to account for tax purposes. Example: Acme Pty Ltd sells a customer a machine on 1 May for $100,000. Payment is to be made in 30 days but the customer does not pay until 1 July (the start of the next financial year). Ask yourself: «When is the payment derived by Acme for tax purposes? »

RESIDENCY: residents v non-residents Different treatment for residents and non- residents. For example: 1) [KEY DIFFERENCE]: Residents are taxed on income from all sources; non-residents only on income with a source in Australia. Tax rates vary. Non-residents do not pay the Medicare levy. Special withholding tax rates for non- residents.

RESIDENCY: residents v non-residents The key difference: Section 6-5(2): Australian resident’s assessable income includes ordinary income derived directly or indirectly from all sources. Section 6-5(3): Non-resident’s assessable income includes ordinary income derived directly or indirectly from Australian sources.

Residency test: individuals

Residency test: individuals – primary/common law test The person must ‘reside’ in Australia. Will ‘reside’ where the person: dwells permanently or for a considerable time; or has their settled or usual place of abode. In determining this issue the Australian courts take a number of factors into account. None of these is decisive, but collectively build up a ‘picture’ of a person’s residency.

‘RESIDE’ : individuals – common law test - factors to consider Physical presence of the person in Australia for some part of the year The nationality of the person The person’s history of residence and movements The person’s mode of life If the person is a visitor to Australia, the frequency, regularity, duration and purpose of the visit(s) Where a person visits for more than two years they will be seen as a resident: TR 98/17 If a person is outside Australia for part of the year, the length and purpose of the absence. The person’s family and business ties in Australia. Whether the person maintains a place of abode in Australia or elsewhere.

Residency test: individuals – statutory tests If individual is not a resident under the primary/common law test, they may be a resident under the statutory tests. The main statutory tests are: The domicile test The 183 day test

Residency test: individuals – statutory tests (domicile) Statutory ‘domicile test’: Domicile is (prima facie) proof of residence UNLESS Commissioner is satisfied that the person’s permanent place of abode is outside Australia. ‘Domicile’ - the place the person regards as their home (even if they do not live there). Can be domicile of origin or of choice. Under s 10 of the Domicile Act in order to acquire a domicile of choice in a country, the person must have the intention to make their home “indefinitely” in that country.

Residency test: individuals – statutory tests (domicile) ‘Domicile test’ - the exception: UNLESS the person has a “permanent place of abode outside Australia” Permanent does not mean ‘forever’ FCT v Applegate IT 2650

Residency test: individuals –statutory tests (183 day test) Statutory ‘183 day test’: Must be physically in Australia for at least 183 days Will be a resident UNLESS Commissioner is satisfied that the person’s usual place of abode is outside Australia AND (b) they have no intention of taking up residence in Australia

Residency test: companies FIRST QUESTION: <<<Is the company incorporated in Australia?>>> If ‘YES’: it is a resident of Australia for tax purposes. If ‘NO’: go to the second question.

Residency test: companies SECOND QUESTION: [If the company is not incorporated in Australia (that is, the answer to the first question is ‘no’)] ASK: «Does the company carry on business in Australia? » If it does not, it is NOT a resident. If it does it WILL be a resident if EITHER: (a) Its central management and control is in Australia; OR (b) Its voting power is controlled by Australian residents.

Residency test: companies Incorporated in Australia? Yes No A resident Carries on business in Australia? Yes No Control or voting power in Not a resident Australia? A resident Not a resident

Residency – ATO guide The ATO has a site dedicated to explaining the meaning of resident. http://www.ato.gov.au/individuals/content.asp?doc=/c ontent/64131.htm

Residency – other issues Double taxation Dual residency Temporary residence

Residency: double taxation Our system of taxing income from all sources can lead to the possibility of double taxation. Ask yourself: «How can this occur and (importantly) how can it be prevented?»

Residency: double taxation Double taxation can occur where: A resident receives foreign sourced income which is taxed in the country of source A non-resident with Australian sourced income is also taxed on that income in their country of residence

Residency: double taxation What can be done to prevent it? Effect is nullified by: (A) Foreign tax credit system (B) Double tax agreements (DTA) (C) Specific exemptions

Residency: double taxation (A) Foreign tax credit system Where an Australian resident pays foreign tax on non-Australian sourced income, the resident receives in Australia a credit for the foreign tax paid.

Residency: double taxation (B) Double tax agreements Taxing rights over certain classes of income are reserved exclusively for the country of residence. All other income can also be taxed by the country of source; but if also taxed by the country of residence, the latter must give a tax credit for the tax paid in the source country.

Residency: double taxation Example of a DTA: Clause 19: Australia/Germany DTA “Remuneration which a professor or teacher who is resident of a Contracting State and who visits the other Contracting State for a period not exceeding 2 years for the purposes of [study/research/teaching] at a [uni/college/school] receives shall not be taxed in that other State”. Ask yourself: «What is clause 19 doing?»

Residency: double taxation (C) Specific exemptions See, for example, s 23AG ITAA 1936 which (subject to certain conditions) exempts from Australian tax the foreign employment income of an Australian resident individual who was engaged in certain foreign service for a period of not less than 91 days.

Residency test: dual residency <<<Can a taxpayer be a resident of more than one country?>>> YES. In such cases relief from double taxation is normally found in a DTA. Most DTA have tie-breaker rules for these situations (eg: for individuals – it is the place where they have their permanent home; if that doesn’t decide, it is where they have closer personal or economic relations) If no DTA applies, the foreign tax credit system may provide relief.

Residency : temporary residency Temporary resident – basically a person who holds a temporary visa and is not a resident under the Social Security Act 1991 and does not have a resident spouse: [s 995-1 ITAA 1997] Generally they are taxed on the same basis as non-residents: [see s 768-900-768-915 ITAA 1997].

SOURCE OF INCOME Importance of source: Basis of government’s right to tax based on residency. 2) Income sourced in Australia can be taxed by government. Remember: (a) s 6-5 ITAA 1997 (b) Double Tax Agreements

Source of income: how is it determined? (1) No general definition of source in the ITAA. (2) Specific direction given for particular types of income. For example: (a) S.6C ITAA 1936: income in the form of royalty payments which are an outgoing of an Australian business– deemed to be sourced in Australia. (b) DTAs have own source rules.

Source of income: how is it determined? Source is a question of fact As was noted by the court in Nathan v FCT : ‘…the ascertainment of the actual source of a given income is a practical, hard matter of fact.’

Source of income: how is it determined? Principles for determining source: (1) Where income is derived solely from the acts of the taxpayer: Source is where the acts are performed. (2) Where income arises from the possession of property : Source is where the property is situated

Source of income: how is it determined? (3) Where the taxpayer’s act involves the performance of a contract: Must consider: (a) Place of performance (b) Place of payment (c) Where the contract was entered into Ask yourself: «What happens if these are all in a different country?» Must balance the factors according to importance.

Source – types of income Wages and salaries income – generally where the services are performed Business income – generally where the goods are sold or where the business is transacted Interest income – usually the place where the loan agreement is entered into and the money is lent Dividend income – generally the place where the profits of the company that pays the dividends are made Property income – usually where the land is located Note: these are a guide only. It very much depends on the facts of the case (see, for example, FCT v French and FCT v Mitchum) and legislation (see, for example, s 6C ITAA 1936).

Derivation of income: why is it important? 1) S.6-5 ITAA 1997 brings to account income ‘derived’ by the taxpayer. 2) It is a timing concept – it determines in which year the taxpayer should bring particular income to account for tax purposes.

Derivation of income: When does it occur? Depends on the tax accounting method adopted by the taxpayer Note: (a) There are two choices. (b) Derivation differs for each choice.

Derivation: which method should be used? Taxpayer must choose the method which: ‘is calculated to give a substantially correct reflex of the taxpayer’s true income’. per: Dixon J in C of T (SA) v The Executor Trustee and Agency Co of South Australia (Carden’s case)

Derivation: tax accounting methods

Derivation: cash receipts method Occurs by the movement of cash or its equivalent to the control of the taxpayer. Cash or equivalent must be received by the taxpayer. The receipt may be ‘actual’ or ‘constructive’.

Derivation: cash receipts method Actual receipt Physical receipt – the payment has been physically received. Constructive receipt Two types: Payment credited to the taxpayer without restriction. Receipt under s. 6-5(4) or s. 6-10(3) ITAA 1997.

Derivation: who uses cash receipts method? Normally used by employees and professionals whose income is derived from the personal provision of skill and knowledge. Applies to investment income.

Derivation: earnings/accruals method Derivation occurs when the income is ‘earned’ (which can occur before payment is received). The income is earned when the taxpayer has the legal right to receive payment. This depends on the contractual. arrangement between the taxpayer and the payer, the common law and any statutory provisions.

Derivation: who uses the earnings/accruals method? 1) Used for business income involving trading or manufacturing. 2) Used by professionals whose activity constitutes the running of a business.

Derivation: changing methods Taxpayer is allowed to change tax accounting method and it may be necessary if the taxpayer’s income earning activities change. Cannot be changed merely to obtain a tax advantage. See: Henderson v FCT

Derivation: pre-payments Pre-payments for goods or services are not normally income until the goods or services (or parts of them) have been supplied. Until then the money has not been ‘earned’. Possibility of need to refund the money also suggests it is not derived income. Books of account should reflect ‘unearned’ nature of the pre-payment. See: Arthur Murray (NSW) Pty Ltd v FCT

Derivation: work-in-progress The value of work-in-progress need not be brought to account unless the contract pursuant to which the work was done allows for progress payments.

Derivation: time-to-pay Under the earnings/accruals method, income is derived when the account is issued (not when the payment is received).

Derivation: deductions for prompt payment If it is a virtual certainty based on past experience that the discount for prompt payment will be received by the customer, the trader need only account for the discounted amount. If, contrary to expectations, the discount is not claimed, the extra amount must be returned as additional income.