Eagle-eyed observers may have seen the Government's budget night promise to replace the current individual tax residency rules with a ‘new, modernised framework'.
The changes are overdue. But expats and their advisers need to watch out for some harsh outcomes.
What are the proposed new rules?
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.
There is nothing controversial in these first two tests; they mirror, relatively closely, the current 183 day test (although the exception would be removed) and the Commonwealth superannuation test.
It then gets interesting. The proposed new rules are divided into:
- becoming a tax resident of Australia – which 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 might be determined, not by the Australian domestic income tax laws, but by the tie-breaker tests in a relevant double tax agreement.
For example, a taxpayer who is a tax resident of Singapore under the income tax laws in Singapore, and who has their permanent home in Singapore and has no permanent home available to them in Australia, would be deemed to be a tax resident of Singapore – and not Australia. This is because the double tax agreement, in broad terms, overrides the domestic law to the extent of any inconsistency. A taxpayer in comparable circumstances in Hong Kong, or the Middle East, where there are no relevant double tax agreements, will not get the protection of any tie-breaker tests. Day-counting will take on critical importance.
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:
a. they have been residing in Australia for the three prior income years
b. they are employed overseas with an employment period of over two years from commencement
c. they have accommodation available in the place of employment for the entire employment period
d. 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:
a. spend less than 45 days in Australia in the income year; and
b. 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:
a. the income year; and
b. each of the two previous income years.
The effect of the last test is that residency ‘clings' to a taxpayer who has been a long-term tax resident of Australia – even after they have started residing elsewhere.
There is no credible policy basis for this approach. The core of the residency concept is that a person resides where they live. The proposed test for long-term residents ceasing Australian tax residency will also exacerbate the different treatment for comparable taxpayers who start living and working in countries with which Australia has a double tax agreement, compared to countries with which Australia has no double tax agreement.
Some harsh outcomes?
We commonly see taxpayers move permanently overseas with their families to countries where Australia has no double tax agreement.
Let's assume Haibo accepts a new role to live and work in Saudi Arabia on a project to build a new city on the Red Sea. The position is a promotion, and Haibo moves to Saudi Arabia with his spouse and two children. The family moves into a four bedroom villa and the children are enrolled in primary school at an international school in Saudi Arabia. The former family home in Australia is rented out to arm's length tenants. Haibo is an Australian citizen and has never lived and worked overseas before. His package is US$200,000. He will spend less than 45 days in Australia in any income year. Consistent with industry practice in the Middle East, his employment contract is specified as a 12 month contract, but the project he will work on runs for 10 years, and his employer has told him that his contract will be renewed as a matter of course.
The overseas employment exception does not apply because of the standard employment contract practice in the Middle East.
Applying the long-term residency test, Haibo will continue to be a tax resident of Australia for the income year that he relocates to the Middle East. Haibo will also remain a tax resident of Australia for at least three income years – until the first income year that he can say he has not been in Australia for 45 days or more in the current and past two income years. This would significantly affect the after-tax position of the package he has agreed.
Let's assume the same facts, but Haibo and his family permanently relocate to Thailand. Haibo becomes a tax resident of Thailand under the domestic income tax laws in Thailand.
Haibo would be a tax resident of Australia, but the double tax agreement would prevail over the proposed new domestic income tax laws in Australia. Both Thailand and Australia would claim Haibo as a tax resident, and his tax residency status would be determined by the tie-breaker tests. In this case, the first tie-breaker test would deem Haibo to be a tax resident of Thailand, and not Australia, because Haibo would only have a permanent home available to him in Thailand.
Observations on the proposed new rules
Some of the ‘bright lines' will be helpful to taxpayers and their advisers. These tests should help remove the risk of the uncertainty for when someone ‘resides' in Australia or whether they have their ‘permanent place of abode outside Australia'.
However, the proposed new rules will have some harsh outcomes, particularly in relation to a person's residency ‘clinging' to them after they have started residing in another country.
There will also be inequitable treatment between taxpayers who start living in countries with which Australia has a double tax agreement, compared to those that do not.
Also, in some cases, the ‘bright lines' under the proposed new rules will be overridden by the double tax agreements. Those tie-breaker tests are beleaguered with just as much uncertainty as the current ‘resides' and ‘permanent place of abode outside Australia' tests.
What do I need to do now?
The proposed rules are recommendations made by the Board of Taxation. However, the Government has said that the new framework will be based on these recommendations.
It is unlikely that any changes will take effect from 1 July 2021. However, as the ceasing Australian tax residency test looks back to previous income years, a taxpayer's number of days in Australia may be relevant even before the legislation comes into effect. We will know more once draft legislation is released.
In the meantime, taxpayers and their advisers need to be mindful that:
- for individuals contemplating a move overseas – their future tax residency status may now be affected by their past residency status, and they will need to factor in that risk when negotiating packages or accepting offers
- for current expats – their risk may be significantly higher if they spend 45 days or more in Australia in any income year, although that ‘bright line' may be overridden by tie-breaker tests if a double tax agreement applies.
Cooper Grace Ward is a leading Australian law firm based in Brisbane.
This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please contact Cooper Grace Ward Lawyers.