Theory Base

An idea evolves from previous conceptions of that idea the ultimate idea may not be perfect but it is a reflection of the stages it has gone through in the past (Bebchuck & Roe)

The taxation system of Australia is complex not because it was designed badly but because it reflects a number of stages Australian tax law has gone through; each new stage merely does its best given its history In a solicitor client context, it is important to understand your clients past and how they got to where they are today before you advise them

When you get someone else to service as agent for you, then there is a risk of them having incongruent interests and thus not performing as optimally as you would have hoped (Jensen & Meckling)

You buy stocks in a company and the companys board of directors should have the aim of making as much wealth for you as possible; however, they are plagued by human concerns and so will be more focused on their own well-being, meaning that your interests are incongruent; to address this, you, the stockholder, will incur agency costs in an attempt to maintain congruency Such is the state of the Australian Tax system; incongruence between FCT and the public

Income tax = Basic Tax Payable Tax offsets (s 4-10) Basic Tax Payable = Taxable income x Rate Taxable income = Assessable income allowable deductions (s 4-15) Assessable income = ordinary income + capital gains + trading stock Allowable deductions = general deductions + specific deductions + trading stock

RESIDENT TAX RATES

Taxable IncomeBase RateMarginal Rate

Nil - $18,200 Nil$0.19

$18,200 - $37,000$0.19 for each dollar over $18,200$0.325

$37,000 - $80,000$3572 AND $0.325 for each dollar over $37,000$0.37

$80,000 - $180,000$17,547 AND $0.37 for each dollar over $80,000$0.45

$180,000 over $54,547 AND $0.45 for every dollar over $180,000Nil

NON-RESIDENT TAX RATES

Taxable IncomeBase RateMarginal Rate

Nil - $80,000 $0.325 for each dollar$0.37

$80,000 - $180,000$26,000 AND $0.37 for each dollar over $80,000$0.45

$180,000 over$63,000 AND $0.45 for each dollar over $180,000Nil

Medicare Levy = 2.5% of taxable income (or 1.5%) Principal of mutuality: one cannot derive income from themselves nor can they count their own expenditure as deductions (Bohemians Club v FCT)

RESIDENCY TESTS:

Overview

ATO has residency requirements if you are a resident, then ATO will attempt to tax all gross income regardless of source; if you arent a resident, then ATO will only tax gross income sourced in Australia (at a different rate where there is no concessional tax rate prior $80,000) Australian Resident defined in 995-1 with reference to resident as defined in s 6 (1) of the ITAA36: a person who resides in Australia within the ordinary meaning of the word, otherwise referred to as the ordinary concepts test but also an individual who falls within the definition of being a resident under one of the three statutory tests (resident within s. 6-5 of ITAA97 is one that satisfies s 6 of ITAA36) Four main residency tests, three of which are alternatives The main residency test is for ordinary residence (common law) The statutory tests (alternatives) are the domicile test, the 183 day test and the superannuation test (apply where common law not satisfied) Must satisfy at least one in order to be a resident depending on whether individual was a previous resident or not, some tests may be more suitable than others Where the taxpayer becomes/ceases to be resident during an income year, foreign sourced income will not be taxable (see Jenkins) Incentive to be non-resident when earning substantial amounts of foreign sourced income

Common Law Residency

According to TR 98/17, generally, individual residency is determined by ordinary meaning of word reside: FCT v Miller there was no doubt that a man resided where he lived However, the following factors must be considered when considering the character and quality of previously non-resident individuals behavior:

Intention or purpose of presence in Australia (Gregory) Frequency or duration of visits (if less than 6 months) Continuity of association (Re Sneddon and FCT) Family location/ties or business ties Maintenance and location of assets Social and living arrangements Nationality or citizenship

Intention must be more than mere presence as traveller i.e. enough to satisfy residence by showing that stay in Australia is consistent (if not essential) to an employment or education opportunity (Miesegaes v IR) Maintenance and location of assets include matters like owning or purchasing housing, establishment of bank accounts Social living arrangements look to place of abode (hotels or house), enrollment of children in schools or joining community organizations i.e. are they behaving as they would in their home country? Note also that an individual can be resident to more than one country at a time (double residency) Levene v Inland Revenue

Miesegaes v Inland Revenue (Residency: Ordinary Test)

A student was in the UK for educational purposes but it was concluded that her stay in UK was not only a part of, but central and essential to her during that phase of her life

Levene v Inland Revenue (Residency: Ordinary Test)

Appellant was a British subject who lived in London until 1919 when he left England under medical advice with the intention of living abroad He returned to UK for period of 5 months each year until 1925 for purposes of obtaining medical evidence, visiting relatives, taking part in certain religious observances and dealing with income tax affairs He had no fixed residence either in UK or abroad during those years (mostly living in hotels abroad) Held: Was still a resident of UK during the years he was supposedly abroad

Domicile and permanent place of abode test

Three types of domicile an individual can have: origin, choice and dependency Domicile of origin of an individual is the domicile of their father at date of birth Domicile by choice is the act of an individual acquiring a new domicile; there need both be an act and an intention to select a new jurisdiction as the persons permanent home Domicile of dependency will exist in relation to minors or individuals who are of unsound mind Domicile test is two tiered:

1. FCT has to be satisfied that person has established an Australian domicile (by reference to any of the above) and;2. FCT must also be satisfied that the persons permanent place of abode is not outside Australia

Permanent place of abode looks to factors like (Ruling IT 2650):

Intended and actual length of stay overseas (rule of thumb 2 yrs) Continuity of presence overseas Intention to return to Australia at some definite point in time or travel to another country (Applegate) Establishment of a home outside of Australia Abandonment of place of abode within Australia Durability of association with Australia or an overseas country

Permanent does not mean everlasting (Applegate v FCT) In relation to intention to return, that is not to say that just because a person has an intention to return, that they cannot also have a permanent place of abode outside of Australia (and vice versa that even though a person had not intended of extending their stay outside Australia does not disqualify them from making that place their permanent place of abode) Jenkins v FCT In terms of the durability of association the person has with Australia or the other country, one might look to the persons employment relationship, bank account status, emotional ties in terms of family member locations and longtime home establishment, notification to government about permanent relocation etc. The rule of thumb that an absence of 2yrs indicates non-resident status in IT 2650 should not be adopted as a matter of routine (AAT Case 12,551) May need to assess residency based on the individual years spent away from Australia (Applegate) For examples, see: http://law.ato.gov.au/atolaw/view.htm?Docid=ITR/IT2650/NAT/ATO/00001

FCT v Applegate (Residency: Domicile)

Applegate left Australia on November 1971 and remained in Vila Hebrides for the relevant tax year Applegate was a solicitor and went to Vila for purpose of managing a branch office there on behalf of his firm Applegate was married and at time of leaving Australia, was expecting his first child he left with his wife to Vila together He gave up tenancy of the flat and left no assets but retained membership to HCF Upon arrival to Vila, he obtained lease of a house with initial term of 12 months with renewable 12 months extension He returned to Australia after two years due to ill health he would have stayed as long as necessary had it been otherwise Held: During year ended June 1972, taxpayer had acquired permanent place of abode outside of Australia

FCT v Jenkins (Residency: Domicile)

Jenkins, a bank officer, accepted a three-year appointment to Vila in February 1977 and returned to Australia 18 months later (July 1978) for unanticipated health reasons Before leaving, taxpayer tried to sell house, but unsuccessfully; he then leased his house and stored furniture He cancelled his medical benefit fund membership and told SS at Toowoomba to cancel the child endowment payment Bank account was also maintained to cater for property expenses and rent receipts Over in Vila, wife and child entered fully into the social and recreational activities in Vila; children went to school there Held: During period Jenkins was overseas, he had permanent place of abode outside Australia; even though taxpayer had not given consideration to prolonging his staying in Vila beyond his three years, this did not make his stay temporary for tax year ended June 1977, Vila sourced income not taxable since permanent place of abode outside Australia already acquired; for tax year ended June 1978, also not taxable since health issue was unanticipated and no evidence to suggest that Jenkins knew his stay would be curtailed

AAT Case 12,551 (Residency: Domicile)

The taxpayer, a physiotherapist, travelled from mid 1992 to July 1997 In April 1994, she returned to Australia for 6 weeks during which she obtained a working holiday visa for Canada where she eventually worked for 18 months During entire period overseas, taxpayer was single, retained her Australian investments, bank accounts and Medicare registration Her parents had also maintained her chattels and family home Held: Did not have permanent place of abode outside Australia during those 5 yrs

183-Day and usual place of abode test

Where an individual has been in Australia for more than half the income year, they will be deemed a resident by statute note that this is for the income year i.e. a person who resides in Australia between February and November 2012 would not be treated as resident under the 2011 income year nor the 2012 income year It is not necessary that the 183-day be continuous can be intermittent Where the FCT believes that the persons usual place of abode is outside Australia, and that the person has no intention of taking up residence in Australia, the 183-day test will not apply Unclear distinction as to usual place of abode and permanent place of abode Where a person satisfies the 183-day test, they will only be deemed resident for the days they are present in Australia and not the entire income year (Re Groves and FCT) Could be argued that where ordinary residency test applies, that 183-day test would not; this argument is valid and consistent with TR 97/18 where stated a migrant who comes to Australia intending to reside is resident from arrival

Superannuation test

Application of test depends solely on membership to Commonwealth government superannuation schemes a person is resident if they are a member of such super schemes Where a person is such resident under this test, then their spouse (regardless of sex) and children under 16 will also be considered resident for purposes of tax

SOURCE:

Introduction

In order for ATO to tax, it must know the source of the income For residents, tax rate applies to ordinary income regardless of source; For non-residents, tax rate applies only to ordinary income sourced in Australia; incentive to have income sourced outside Australia if one is a non-resident and earning overseas Source is not a legal concept; it is a practical matter of fact: Nathan v FCT Factors that may inform source (Determination TD 2011/24):

Form of source (AKA three principle factors): jurisdiction in which contract is made (FCT v Mitchum), where the contract is performed (Thorpe v FCT) and where payment is made (Nathan) Substance over form where form of source used to deliberately escape taxes: Thorpe; Tariff Reinsurance v CT; pay close regard to predominant factor which may be the principal factor in any case (Commissioner of Tax v Can & Sons) For real estate derived income (i.e. rent), because real estate is fixed, the source is the location of the property, regardless of whether income is rent or premium etc. (Rhodesia Metals v CT) Australias double tax agreement rules can also determine where economic activity occurs

For different types of income, source may inform them in different ways:

Personal services income: ordinarily source is place which services take place, but also consider place of negotiation for services, conclusion of contract and place of payment Business income: generally determined by looking at place of negotiation, place of execution and place of payment (but note substance over form above) Sales income: depending on type of property sold; if real property, then generally place of property is the source; if shares or other intangible property, will again have to refer to the three principle factors Interest: most important consideration is the place where the contract for loan was made (Spotless Services v FCT) Dividends: source is generally the place from which the funds of profit enabling payment of dividends arose (Esquire Nominees) cf. Nathan v FCT and substance arguments

Nathan v FCT (Source)

Held: dividends received in England by a shareholder from a company incorporated in England and having its registered office and central management and control there, to the extent that they represent a share of the profits of that part of the business of the company which is carried on in Australia, are derived from a source within Australia

FCT v Mitchum (Source)

Famous actor signs contract in Switzerland to produce and direct a movie to be filmed partly in Australia and partly in England Commissioner of Tax submitted that because part of the film was to be filmed in Australia, the income earned by the actor during his time in Australia was to be income sourced in Australia and thus taxable for a non-resident Held: source was not Australia; simply executing (part of) a contract in Australia is not enough to dictate source; not taxable by ATO

Thorpe v FCT (Source)

Business venture almost entirely planned in Australia but final execution of contract was to take place in Switzerland Held: the fact that the contractual execution was in Switzerland does not mean that the source is thus Switzerland As a matter of substance, the source was Australia rather than Switzerland The activities in Switzerland were merely 'part of a pre-arranged plan' to avoid tax in Australia It was relevant that there was no particular reason for choosing Switzerland as opposed to any other country outside Australia other than the attraction of low tax rates

ASSESSABLE INCOME ORDINARY INCOME:

A general overview

AY = ordinary income + statutory income (s 6-1 ITAA97) What is ordinary income? Anything that is considered ordinary income by common law standards (as distinguished from capital gains which is not income for purposes of div. 6-5) for purposes of AY Incentive to reduce AY as much as possible without having an actual decrease in income i.e. make it not ordinary income Ordinary income must be either money or capable of being transferred to money (FCT v Cooke and Sheridan) Character of income (capital vs. ordinary) determined in taxpayers hands Key indicia to appreciate in making the income/capital distinction (each is an indicator but none are decisive: FCT v Montgomery):

Flow: key is for there to be a nexus between the flow and the earning source (must be fruit, not tree) income gained from the source of the flow (tree) would be considered capital Ordinary income is generally regular/recurrent; also a degree of reliance on payment of the ordinary income i.e. social security is included in this group of income (see FCT v Anstis) Isolated transactions can constitute ordinary income where entered into for the purposes of making relevant profit (provided it was not mere realization of capital asset: Westfield v FCT) Character of the right disposed: where right disposed of stops the flow of income, a payment in exchange would be income (Moneymen v FCT); where rights disposed of inhibits means of producing income, payment in exchange would be capital (i.e. restrictive covenant compensations: FCT v Woite) Compensation for lost income or asset will generally be income (income substitution replacement principle): FCT v Dixon Payment made by force of contract or other legal obligation

FCT v Dixon (Ordinary income and replacement principle)

Taxpayer was a clerk who enlisted to fight in 1940 During course of WWII, employer paid him difference between war wages and clerk wages so that hed be no worse off for going to war Held: extra payment was ordinary income; regular and periodic; reliance; replacement principle i.e. extra income intended to make up for lost wage

FCT v Anstis (Social security payments)

Commissioner of Taxation submitted that youth allowance is income according to ordinary concepts Held: youth allowance payments enable recipients to rely upon them for regular expenditure, and recipients can expect to receive those payments but only so long as they satisfy the various requirements of the social security legislation; it follows that such amounts are income according to ordinary concepts

Moneymen v FCT (Character of right disposed)

Taxpayer (dairy farmer and supplier) assigned a 20yr milk supply contract to another In return, he was paid monthly by the other in accordance to the notional amount of milk that could be sold Held: such monthly repayments were ordinary income as the character of the right disposed was of a profit-making nature rather than a profit-yielding nature

FCT v Woite (Character of right disposed)

Prominent footballer was approached by a team to play for them (and them only) Inducement of $10,000 was paid to the footballer but he was under no obligation, having received that amount, to play for that team in fact, he never did Held: inducement payment was not part of ordinary income as it had the hallmarks of a restrictive covenant

Keep in mind when considering indicia that profit does not inform income/capital distinction Three main avenues of generating ordinary income: through personal services; through businesses; and through income from property i.e. interest, rent and dividends (specifically dealt with in s 44 ITAA36)

Ordinary Income from Personal Services and Employment

Amounts earned directly or indirectly by virtue of a taxpayers personal exertion or provision of skills or exercise of services will constitute ordinary income (Brown v FCT) An important factor will be determining flow i.e. a nexus between the income and the activity undertaken for example, a receipt would not be income if it was not as a reward for employment or services (Hayes v FCT); incentive to sever the nexus where possible, like for gifts or prizes or gratuitous payments

Salaries, wages, commissions, tips and bonuses are all generally ordinary income if proportional to the exertion of the employer (Moore v Griffiths) Ruling IT 167: radio or television competition prizes counts as income if the requirement of skill outweighs the element of chance Voluntary/gratuitous payments in return for services can be considered ordinary income if sufficient nexus (Brown v FCT); if not sufficient nexus, may still be income in special circumstances: see FCT v Dixon which considers the replacement principle Personal gifts are presumed not to be ordinary income where the recipient has already been remunerated for their services, where it was a surprise or where it was paid for a personal quality i.e. Scott v FCT, Seymour v Reed (donations); this can be displaced where one can establish a nexus between the gift and the services provided i.e. Hayes v FCT Entry into a restrictive covenant may not be considered ordinary income if the restrictive covenant goes to the tree rather than the fruit (FCT v Woite)

Scott v FCT (Personal Gift)

A solicitor received 10,000 from the widow of a client The solicitor had for years acted for the client and had been remunerated for his services Wishing to distribute some of her wealth before her death, the widow gifted sums to several persons, including the solicitor (who paid gift duty on the sum) Held: payment not to be ordinary income as it was made because of friendship and not in consequence of any services provided by the solicitor

Seymor v Reed (Donations)

Where a benefit match or benefit period is organized to demonstrate affection and regard for the personal qualities of the player, the proceeds are not earnings and are not sourced in employment and not counted as ordinary income

Hayes v FCT (Displacement of gift)

Taxpayer transferred some shares to his associates for no payment Held: did not have the character of a gift because the shares related to the ordinary income of the taxpayer and he appeared to be giving out of legal obligation rather than out of any spirit of generosity