Australian Residency Status And Ordinary Income - Taxation Case Study

Residency Status of Amity

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.

Residency Status of Amity

As per the definition given under “section 995-1 of the ITAA 1997” occupant or Australian dweller denotes individual that has their home in Australia, except for the tax officer is satisfied that the individual has their eternal place of house out of Australia (Woellner et al., 2016). “Section 6(1), ITAA 1936” explains that an individual is said to be an Australian resident if the person has been present in Australia on continuous basis or sporadically for more than six months of the income year except the tax officer is content that he or she has their usual residence out of Australia and hardly has any purpose of taking up the Australian occupancy.

The case study highlights that Amity left Australia in 2015 to live in Kiribati for a period of two years and then take up the decision of whether to stay longer given the lifestyle suits her. The residential status of Amity has been considered in the below listed residency status.

Resides Test: The resides test denotes dwelling enduringly or for a substantial period. The court in “FC of T v Miller (1946)” stated that the residency status of an individual is dependent on the question of “fact and extent” (Pinto, 2013). The intention of the taxpayer or the purpose of presence along with the household or occupation ties forms necessary in establishing the domiciliary position of a person.

Domicile Test: As per the “Domicile Act 1982” a person is regarded as the Australian occupant if he or she has their domicile in Australian except the tax official is satisfied that the person has their everlasting place of abode out of Australia (Robin, 2017). A person obtains the domicile of origin by birth or by the operation of law where the taxpayer intends to take their home indefinitely. As held “FC of T v Applegate (1979)” the high court considered whether the permanent place of abode is out of Australia. The decision held by the court stated that the permanent do not mean eternal and it is judged respectively year. The taxpayer was having the permanent place of dwelling out of Australia and ultimately returned when he was ill.

183-day Test: Under the 183 days test a person is the Australian occupant if they had been present in Australia, uninterruptedly or sporadically for six months or more during the income year in Australian given the person has the normal dwelling out of Australia with no intention of residing in Australia.  

In the current case, Amity went to Kiribati for two years and also had the choices of extending the contract for three years. She maintained her social and living arrangements in Kiribati as her salary was paid into the Asia-Pacific bank. Though she intended to stay long but returned ultimately after her husband fell ill. Referring to “Applegate v FC of T (1979)” the actual intent of Amity was to reside outside Australia for two years’ period and also thought of extending her stay for given the lifestyle suits her. The social and living arrangements made by Amity reflected her intention of residing out of Australian without having any certain intent returning Australia.

Characteristics of Ordinary Income

On a conclusive note, Amity cannot be held as resident of Australian under “section 6(1) of the ITAA 1936” since she did not meet the requirement of Domicile Test and also failed to meet the requirement of 183 days Test.

Mere gift is not considered as income. The court in “Hayes v FCT” stated that the receipts from shares by the company boss was not held as income. Evidently in “Scott v FCT” the solicitor received 10,000 pounds of gift from the wife of client which was not treated as income (Blakelock & King, 2017). The employee dentist here received a computer game of $600 and hence the receipt did not constitute ordinary income under ordinary concepts of “section 6-5 of the ITAA 1997”.

According to ATO a taxpayer winning from any prize or lottery that is run by bank should be treated as ordinary income that attracts tax liability. This includes cash, interest free loans and cars. In “Kelly v FCT” the taxpayer was awarded for being the fairest player. The amount is taxable because it was incidental to his employment (Burton, 2017). Similarly, in “FCT v Stone” the taxpayer was assessed for receiving prize money for carrying on the business of professional athlete. Therefore, receiving car as the prize from bank is an ordinary income under “section 6-5 of the ITAA 1997”.   

“Section 8-1, ITA Act 1997”, allows a person to deduction from their taxable income for any outgoings till the extent they are occurred in generating assessable income. ATO states that a person taking loan to use it for personal and business purpose then the taxpayer can apportion the interest on loan (Miller & Oats, 2016). In such circumstances the interest on loan must be divided under deductible and non-deductible segments. Betty and Barney can claim deduction under “section 8-1, ITA Act 1997” for interest on loan up to the amount of loan that is used for business purpose while the private portion of loan interest is excluded from deduction.

“Section 8-1 of ITAA 1997” allows taxpayer to claim deduction for outgoings given that it is found in business operations which was previously carried on by the taxpayer for generating taxable earnings (Fleurbaey & Maniquet, 2018). In “FCT v Brown 1999 ATC” the taxation commissioner allowed deduction for interest on loan since the loan was entered into by the taxpayer to conduct the business activities and for generating income.

1. A deduction under “section 8-1 of the ITAA 1997”will be permitted to Robert for loan interest when the business was under continuous mode.
2. Robert would also be permitted to claim deduction under “section 8-1 of the ITAA 1997”when the business operation was ceased since the loan was entered into by the taxpayer to conduct the business activities and for generating income.

The court in “FCT v Harris” held that mere windfall gains are not treated as income. The winning from lottery by Lincoln will not be held as income because it is windfall gain (Sikka, 2017). He also received incentive for display of game console in his window. The receipt constitutes ordinary income under “section 6-5 of the ITAA 1997” because it was received during the business course.

References: 

Blakelock, S., & King, P. (2017). Taxation law: The advance of ATO data matching. Proctor, The, 37(6), 18.

Burton, M. (2017). A Review of Judicial References to the Dictum of Jordan CJ, Expressed in Scott v. Commissioner of Taxation, in Elaborating the Meaning of Income for the Purposes of the Australian Income Tax. J. Austl. Tax'n, 19, 50.

Fleurbaey, M., & Maniquet, F. (2018). Optimal income taxation theory and principles of fairness. Journal of Economic Literature, 56(3), 1029-79.

Miller, A., & Oats, L. (2016). Principles of international taxation. Bloomsbury Publishing.

Pinto, D. (2013). State taxes. In Australian Taxation Law (pp. 1763-1762). CCH Australia Limited.

Robin, H. (2017). Australian taxation law 2017. Oxford University Press.

Sikka, P. (2017, December). Accounting and taxation: Conjoined twins or separate siblings?. In Accounting forum(Vol. 41, No. 4, pp. 390-405). Elsevier.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2016). Australian Taxation Law 2016. OUP Catalogue.