Recently, the Government announced that it would "modernise" the individual tax residency provisions in the 2021-22 Federal Budget. Whilst we are yet to see any draft legislation in relation to this, the Government did mention that the rules will be based on the recommendations made by the Board of Taxation (BOT) which we have summarised below.
PROBLEMS WITH OUR CURRENT RULES
Our current residency provisions are principle based and generally require a detailed analysis of current case law which often leads to confusion and incorrect application of our residency tests.
Currently, individuals are considered tax residents of Australia if they pass any of the following tests:
- The individual resides in Australia according to ordinary concepts; or
- The individual spends more than 183 days in Australia unless their usual place of abode is elsewhere; or
- The individual's domicile is in Australia unless they have a permanent place of abode elsewhere; or
- The individual is a member of certain government superannuation schemes.
INTRODUCING THE PRIMARY 183-DAY TEST
The BOT recommended the implementation of a "bright line" test as the primary test for residency, and if an individual spends 183 days or more in Australia, they will be considered a tax resident of Australia. There is no need for any further consideration on where the individual's family members are, or where their assets are situated etc.
Under current provisions, an individual may not be considered a tax resident of Australia where they can show their "usual" place of abode is not in Australia even if they spend more than 183 days in Australia.
If an individual spends less than 183 days in Australia, they are then required to consider the secondary tests which looks at the following objective factors:
- Whether the individual has a right to reside permanently in Australia
- Whether the individual has Australian accommodation
- Whether the individual has family in Australia
- Whether the individual has economic interests in Australia.
Depending on whether the individual was a resident in the preceding income year, consideration would need to be given on whether they have commenced residency or ceased residency in the current income year.
If an individual fails the 183-day test and was a foreign resident during the previous income year, they could be considered residents of Australia if they spend more than 45 days in Australia and satisfy two or more of the objective factors listed above.
David in an Australian citizen working overseas and considered himself to be foreign resident in the 20XX income year under the current tax residency rules. In the following year (after the changes to the legislation have been made), he spent 50 days in Australia visiting his wife and children.
Result: David would be considered a resident of Australia as he has spent more than 45 days in the income year and satisfies two of the following objective factors:
If an individual was an Australian resident in a previous income year but fails the 183-day test in the current income year, they would then need to consider some additional days based tests along with the objective factors listed above to check whether they have ceased Australian residency.
This depends on whether an individual is a short term or long term resident but simply put, if an individual spends more than 45 days in Australia during the income year, they may still be considered a tax resident of Australia and it will be much harder to "draw a line in the sand" and treat yourself as a foreign resident from the date of departure – the BOT's recommended model ensures the residency status change is a more gradual process.
The implications of an individual changing their tax residency status are substantial from an income tax and capital gains tax (CGT) point of view.
Becoming tax resident
Individuals who become tax residents of Australia are generally taxable on worldwide income (note, certain exceptions apply for certain temporary visa holders). In addition, for CGT purposes, they are deemed to have acquired their assets which are not considered to be taxable Australian property (TAP) at market value. Non-TAP assets include real property situated overseas, and foreign shares etc.
There could also be some further implications if individuals have ownership in foreign entities and could also impact the residency status of any foreign companies or trusts. For example, discretionary trusts are tax residents of Australia where any trustee is resident in Australia at any time during an income year and therefore, if an individual trustee is considered resident in Australia, this could lead to implications for the residency status on their discretionary trust overseas.
Ceasing to be a tax resident
Individuals who become foreign residents of Australia would generally only be taxable on Australia sourced income. Furthermore, certain types of Australian income are taxed at concessional rates (e.g. interest earned in Australia is subject to a 10% final withholding tax).
CGT event I1 may apply and broadly, individuals are deemed to have disposed non-TAP assets at market value when they cease to be Australian residents. Individuals may elect for CGT event I1 not to apply, but this means that those assets are "stuck" within the Australian net until they dispose them or regain their Australian tax residency status. Tax planning may be critical, and some may wish to dispose their non-TAP assets at their market value on becoming foreign residents by election. In addition, foreign residents are not entitled to the tax-free threshold, 50% CGT discount, and the main residence exemption.
Interaction with Double Tax Agreements
We would imagine that many individuals would fall into the Australian "residency net" with the implementation of the 183-day test and the low thresholds (e.g. 45 days under the secondary tests).
This may lead to situations of dual tax residency - where you are considered a resident of two countries under each of their tax rules. In these instances, you will need to apply the tie breaker provisions in the relevant double tax agreement (DTA) to determine which country has primary taxing rights on the source of income. The DTA essentially treats you as a tax treaty resident of only one country based on the tie breaker test.
Under current tax rules, an individual who is a tax treaty resident of another country with which Australia has a DTA under the tie breaker rule, will continue to be considered an Australian tax resident for domestic income tax purposes and as such, will be entitled to the tax-free threshold, 50% CGT discount and main residence exemption.
However, under the BOTs recommendations, tax treaty residents of another country will be taxed as foreign residents in Australia. This may lead to the individual losing their entitlement to the tax-free threshold, 50% CGT discount, and main residence exemption. Furthermore, CGT event I1 may also apply depending on how the final legislation is drafted.
All the above are recommendations from a BOT report. At this stage, we have yet to see draft legislation. We hope to see some sort of transitional arrangements to ensure taxpayers have time to understand and plan for the upcoming changes.
The model suggested by the BOT may be much easier to follow, but taxpayers who come to Australia for extended holidays may want to think twice if they wish to be treated as foreign residents of Australia in the future.
We will provide an update on tax residence provisions once the legislation is released, but this is certainly an area to keep an eye on.
This article is issued as general commentary - please contact us about your specific circumstances.