Determining Tax Residency For Amity And Assessable Income For Lincoln

Criteria for Tax Residency under ss. 6-1 ITAA 1936 and TR 98/17

Amity has been employed as a tax advisor by the mid-tier private accounting firm YoungPWC and Associates in their Adelaide branch for 7 years.  In January 2015 she was selected to be sent to Kiribati for two years to advise the Kiribati government on the design and implementation of a new VAT.  The placement was for a 2 year period with an option exercisable by Amity to extend the period for a further 3 years.  

Amity jumped at the opportunity and left Australia in January 2015 with her husband Martin. Amity intended to stay in Kiribati for at least the initial 2 years and then make a decision about staying longer if the lifestyle was enjoyable, the work enjoyable and financially rewarding.

On first arriving in Kiribati, Amity and Martin took out a small mortgage on a house on the beach and planned to furnish it with furniture bought from the local furniture stores.  However, they underwent extreme culture shock when they discovered there were no local furniture shops selling anything they wanted and the cost of shipping their furniture over was prohibitive. They decided to sell the house after 4 months and take up a serviced apartment in the capital.  

This was acceptable accommodation and it worked well enough as there were no children. They were able to take out 12 month rent agreements as there were many expats on one year placements. They made the apartment relatively homely with their few belongings.  However, Martin found getting any sort of reasonable employment was essentially impossible and started to get dispirited.

Amity’s salary was paid into an account she opened with the Asia-Pacific Bank. Amity and Martin kept their home in Adelaide and rented it out through agents for 12 month periods.

They discontinued their health insurance membership, however Amity maintained her Chartered Tax Advisor membership.  Their only relatives are their elderly parents who resided in Australia.

Martin contracted a form of food poisoning from eating a toxic fish and after only 18 months away the disenchanted couple returned to Adelaide at the beginning of July 2016.

You are required to advise Amity on whether or not she was an Australian resident during the income year ended 30 June 2016 by reference to the relevant legislation and case law.

With reference to the characteristics of ordinary income and the concept of ordinary income discuss whether the following amounts are ordinary income:

1. An employee dentist swapping dental work valued at $600 for a computer game with a client who sells computer games.  The market value of the game is $550, however it cost the client $300 to place in trading stock.
2. A car valued at $15000 given as a prize to the 500 000^thcustomer of a bank.  

In your discussion you must reference AT LEAST two cases for each scenario.With reference to the relevant legislation and case law discuss whether the following would be deductible under s8-1 ITAA 97.

1. Betty and Barney are a married couple and sell the family home for $450 000.  They purchase a two story building for $700 000 and use the ground floor as a business while they live in the top floor.  Are they entitled to any interest deduction is relation to the $250 000 they borrowed?
2. Robert borrowed $100 000 to purchase plant and equipment for use in his business.  After a period of time the plant and equipment were sold, however the loans were not paid out.  Will the interest on the loan continue to be deductible if:
3. The business continues
4. The business has ceased

Lincoln is an Australian resident for the full year aged 30. He conducts a business as a sole trader as a video game designer and retailer.    During the 2016/17 year he had the following receipts, payments and other information.

Receipts

Sales $527 000

Proceeds from loan $500 000

Lottery win $50 000

Payments

Trading stock purchases $275 000

Gross wages paid to employees $42 000

Total Loan repayment interest $21 890

PAYG instalments paid $57 500

Rent on premises $145 000

Other expenses  -  all deductible   $75 000

Other relevant information

Lincoln received $10 000 from a supplier as an incentive to display their game consoles in his window. He also received a fully franked dividend of $5400.

The value of the opening stock on 1/7/16 was $72 200, and the closing stock on 30/6/17 was $92 300

The $500 000 loan was taken out of 1/8/16 for 7 years.  $400 000 was utilized in the business and the remainder was used to renovate Lincoln’s house.  No income producing activities take place at Lincoln’s house.

Required

Calculate Lincoln’s assessable income and allowable deductions.  Support your analysis with relevant sections from the Income Tax Assessment Acts and/or case law references.

Calculate Lincoln’s taxable income and the balance of his assessment for the 2016/17 income year from the information provided.

Disregard the low income tax offset and Medicare Levy Surcharge.  Calculate the Medicare Levy.

Criteria for Tax Residency under ss. 6-1 ITAA 1936 and TR 98/17

The individual tax residency is dealt with as per ss. 6-1 ITAA 1936. This subsection highlights the various statutory tests available to ascertain the tax residency status besides the general residency test. These tests have been discussed in detail in the tax ruling TR98/17. The tax residency becomes pivotal owing to the differential tax treatment that is applicable for Australian tax residents and foreign tax residents (Barkoczy, 2017). In accordance with TR 98/17, the following tests may be applicable with regards to determine tax residency of individual taxpayers (Coleman, 2016).

• The Residency Test – This is applicable for foreign residents who come to Australia for various reasons
• The 183 Day Test - This is applicable for foreign residents who come to Australia for various reasons
• Domicile Test – This is applicable to determine the tax residency of Australian domicile holders or Australian residents
• Superannuation Test – This is applicable for government employees of Australia who are serving abroad

Considering the given scenario, it would be fair to assume that Amity is an Australian resident since she has been working with a company in their Adelaide office for 7 years. Further, it is known that Amity is not employed by the government and works for a private firm. As a result, the only test which would be relevant for the taxpayer in the given scenario would be Domicile Test (Krever, 2017).

Domicile Test – In order to pass this test, it is imperative that two conditions ought to be satisfied by the underlying taxpayer. These conditions are outlined below (Reuters, 2017).

• The taxpayer would to be a domicile holder of Australia in accordance with Domicile Act 1982.
• Another requirement for the taxpayer is that the permanent abode must still be in Australia even though the taxpayers may be physically in foreign territory.

For the taxpayer to be recognised as an Australian tax resident, it is pivotal that both the above conditions ought to be fulfilled.  While domicile holding can be determined objectively, the determination of permanent abode location is little more complex and multiple factors need to be considered (Sadiq et. al., 2015).

A relevant case that needs to be cited is  F.C. of T. v. Applegate (1979) 9 ATR 899. In this case, an Australian resident was sent abroad to establish the office of an Australian company and was expected to return back to Australia after the branch is set which would require substantial time. The taxpayer finally returned home after two years owing to an illness. In this case, the court held the taxpayer as a foreign tax resident as shifting of permanent abode does not imply permanent intention to stay abroad. A similar case which led to the same verdict is F.C. of T. v. Jenkins (1982) 12 ATR 745 in which a bank officer was sent abroad for three years but had to return to Australia within 18 months (Deutsch, Freizer, Fullerton,  Hanley & Snape, 2015).

Considering the verdict in above case laws, the given situation seems quite similar since Amity was sent abroad for a substantial period of time with an option to extend the stay by further period of three years. Also, her husband also shifted with her and thereby her personal ties to Australia were limited to parents also. Besides, the health insurance was discontinued in Australia. Additionally, they purchased a house initially in Kiribati which was later sold. Clearly, it would be appropriate to conclude in the wake of given case facts that the permanent abode has shifted from Australia to Karabati and hence Amity would not be considered as an Australian tax resident for the year ending on June 30, 2016.

4140. a) In the given situation it is apparent that a barter transaction is being executed between the dentist and client. A relevant case with regards to these transactions is C. of T. v. Cooke & Sherden80 ATC 4140. This case highlights that if the consideration arising from the barter would fall in the definition of income as per s. 25-1 ITAA 1936, then the consideration received on account of this transaction would also have income character and would be taxable (Reuters, 2017). Besides, it is apparent from Henderson v FCT70 ATC 4016 that when a professional tends to offer services to a client, then the revenue becomes receivable which may be received in cash or kind (Krever, 2017). Considering the above cases, it would be fair to conclude despite the barter, on the part of the dentist $ 550 would be recorded as ordinary income as toy of market value $ 550 is accepted for the service rendered.
4141. b) Any prize would lead to ordinary income under s. 6-5 ITAA 1997 if it is linked to the employment where it might be a common practice or related to skills as an employee. This has been highlighted in the verdict of the Scott v. Federal Commissioner of Taxation(1966) 117 CLR 514 case (Sadiq et. al., 2015).Another relevant case to consider in the given situation is Squatting Investment Co Ltd v. Federal Commissioner of Taxation (1953) 86 CLR 570. As per this case, the assessability of prize would depend on the underlying motives and circumstances in which the prize has been extended to the taxpayer (Coleman, 2016). If it is for any service offered or linked to the employment skills, then the prize would lead to assessable income.  

Assessable Income and Ordinary Income

In the given scenario, it is apparent that the prize won by the taxpayer is not on account of any skill but purely on account of chance. This would therefore result in windfall gains which would not be categorised as ordinary income under s. 6-5 ITAA 1997.

1. a) With regards to s. 8-1 ITAA 1997, tax deduction is available if the underlying outgoing or loss is necessary for the generation of assessable income. There are few negative limbs related to general deduction under s. 8-1 which would prohibit any tax deduction under this section. These are listed as follows (Barkoczy, 2017).

• The expenditure is not revenue but capital.
• The expenditure is incurred for production of non-assessable income.
• The expenditure is for domestic purposes and not business purpose.

In the given case, it is apparent that the loan has been assumed for a property which is partly used for residential purpose and partly for earning rent or assessable income under s. 6-5 ITAA 1997. Further, as highlighted in Ronpibon Tin v FC of T (1949) 78 CLR 47 at 57 case, it is essential to develop a causal relationship between the incurring of the expense and the production of assessable income. In the given case, the rent income (which contributes to assessable income) is produced only because of the expenditure undertaken. Thus, interest on loan would be deductible to the proportion that loan amount is diverted to the purchase of the ground floor since the first floor is personal expenditure (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015).

1. b) An essential condition for general deduction under s. 8-1 ITAA 1997 is that the expense or loss has to be produced in the process of assessable income production. The given situation needs to be analysed in the wake of the above statement which has been emphasised in the Ronpibon Tin v FC of T(1949) 78 CLR 47 at 57 case (Krever, 2017).
2. i) In the given scenario the loan was taken for plant and equipment which in turn would have led to production of assessable income. In the present however, these assets have already been liquidated and no longer exist. As a result, the current pending loan cannot be attributed to enhancing the assessable income and hence the interest would not be deductible under s. 8-1 ITAA 1997 (Sadiq et. al., 2015).
3. ii) In the situation presented, the business has bound up and hence the loan proceeds pending cannot potentially produce any higher assessable income and hence interest levied on the same would not be deductible as the same is unrelated to production of any taxable income (Reuters, 2017).
4. a) The related aspects of Lincoln’s assessable income are discussed as follows.

Components of Assessable Income

Sales – It would be considered as ordinary income as per s. 6-5 ITAA 1997

Proceeds from loan – Not considered as assessable income since these proceeds are capital and non-taxable

Lottery Win- It is not considered as taxable income since it is windfall gains

Incentive to Display – Since this incentive does not reduce the cost of purchase for the buyer, thus it would be considered as assessable income as highlighted in tax ruling TR 2009/5

Dividend – It is assessable income as per s. 6-5 ITAA 1997. Additionally, franking credit would also be added to dividend income.

Components of deductible expenses

Gross wages paid – This would be deductible in accordance with s. 8-1 ITAA 1997.

Raw materials - This would be deductible in accordance with s. 8-1 ITAA 1997. Raw materials used = Opening inventory + Purchases – Closing Inventory

Rent on premises - This would be deductible in accordance with s. 8-1 ITAA 1997.

Interest expenses - This would be deductible in accordance with s. 8-1 ITAA 1997 to the extent that it is used for business purposes.

The assessable income and allowable deductions can be computed as shown below.

10. b) Taxable income = Total assessable income – Total deductions = 544,714 – 534,412 = $ 10.302

It is noteworthy that for the tax liability arising on the above, a tax rebate of $ 2,314 would be available on account of franking credit which has already been paid by the company providing the dividend (Coleman,2016).

Medicare Levy = 2% of taxable income = (2/100)*10302 = $ 206.05

References

Barkoczy, S. (2017) Foundation of Taxation Law 2017. 9^th ed. Sydney: Oxford University Press.

Coleman, C. (2016) Australian Tax Analysis. 4^th ed. Sydney: Thomson Reuters (Professional) Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2015) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

Krever, R. (2017) Australian Taxation Law Cases 2017. 2^nd ed. Brisbane: THOMSON LAWBOOK Company.

Reuters, T. (2017) Australian Tax Legislation (2017). 4^th ed. Sydney. THOMSON REUTERS.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., &Ting, A. (2015) Principles of Taxation Law 2015. 7th ed. Pymont: Thomson Reuters.