your assessable income includes December 17, 2018 postadmin Post in Uncategorized Assignment question: Section 6.5(2) of the Income Tax Assessment Act 1997 (Cth) states “If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether or not in our out of Australia, during the income year.” Analyse the legal issues stated within that sub-section and argue whether the subsection is effective of not. Assignment 1 Criteria A note regarding the word count: Please note that this assignment is designed so that you can demonstrate your ability to filter material and communicate it succinctly. Do not confuse quantity with quality. The following criteria will be used to grade your assignments: Ability to clearly and succinctly outline the key issue(s) (for example, the ability to identify the relevant facts in each case) The ability to integrate the identified facts into a logical argument. Hint: link the reasons the Courts decided each of the cases in the way that they did. Don’t forget any relevant dissenting judgement. The ability to demonstrate a clear understanding of each of the cases Did each of the case clarify or change the law? Or did the case itself result in a law change? Or did the case have little impact on the development of the law? Demonstration of research beyond the course materials and text book Demonstration of critical thinking, weeding out irrelevant facts, and adding value above and beyond the textbook etc. Clarity of communication; development of a clear and orderly structure, spelling, grammar and so on Correct referencing and bibliographic style. The lecturer provided a tutorial on the assignment. He wanted the 5 elements addressed (Australian resident; assessable income; ordinary income; derived directly or indirectly; and sources). He called this part A and broke it down into 5 subsections of approx 400 words but understands that some e.g. ‘resident’ will use more words than ‘assessable income’. He encourages it to be broken down into headings and subheadings, and emphasised footnotes and explanations within will not be taken into consideration for the word count. Part B – (500 words). The lecturer spoke about 2 parts: Inter-relationship b/n assessable income and allowable deductions. For certain residents paying tax they want ordinary income as they are chasing allowable deductions – otherwise they would not be able to claim and reduce taxable income. E.g. Commission of Taxation v Stone (2005) – Police Officer and professional athlete. Is section 6.5 effective or not? Division 35 ITAA (1997) – Non-commercial business activity. Challenge of residency – more and more movement b/n countries. Is this provision effective or not in capturing income for larger companies? Residency test? Seeking tax havens and avoiding tax in Australia. Recommended Text – Principles of Taxation Law 2017 – Sadiq, Coleman, Hanegbi, Jogarajan, Krever, Obst, Teoh, Ting. PART A: Australian resident: An ‘Australian resident’ means a person who is a resident of Australia for the purposes of the Income Tax Assessment Act 1936.1 An Australian resident is taxed on their worldwide income. Section 6(1)2 provides four tests of residency for individuals: the ‘residence according to ordinary concepts’ test; the domicile test; the 183-day test and the Superannuation test. A taxpayer only needs to satisfy one of these tests3 to be considered an Australian resident. ‘Residence according to ordinary concepts’ Test: This is the primary test used in determining whether a person is an Australian resident and requires consideration of where a person ‘resides’. The term ‘resides’ is not defined in legislation and subsequently the ordinary meaning is applied.4 Guidance is also provided from Ruling TR 98/175, paragraph 14 that provides a definition of ‘reside’ as: ‘to dwell permanently or for a considerable time, to have one’s settled or usual abode, to live, in or at a particular place’. The courts considered certain factors in determining ordinary residence and include: physical appearance in Australia6; if the person is a visitor, the frequency, regularity and duration of visits7; the purpose of the visits to Australia and abroad; the maintenance of a place of abode in Australia for the taxpayer’s use8; the person’s family business and social ties9; and the person’s nationality. TR 98/17 considers the residency status of persons entering Australia and discusses many of the factors considered by the courts and are taken into consideration by the Commissioner when determining whether or not a person is an Australian resident. Domicile Test (s 6(1) ITAA 1936): This test generally applies to taxpayers who move overseas (usually as a work posting) but do not change their domicile. A person is a resident of Australia, unless the Commissioner is satisfied that the person has a permanent place of abode outside Australia. This test contains two elements: Element 1: ‘Domicile’ A person’s domicile is the jurisdiction where a person has permanent legal ties.10 Domicile of origin is acquired at birth and is maintained unless a ‘domicile of choice’ is acquired by an individual demonstrating an intention to reside permanently in a different jurisdiction.11 Element 2: ‘Permanent place of abode outside Australia’ In FCT v Applegate12 it was held that permanent meant something less than everlasting but should be contrasted with temporary. This decision was applied in FCT v Jenkins13 where it was held that an employee repatriated back to Australia after 18 months had a permanent place of residence outside Australia during this time. IT 2650 was issued in response to FCT v Applegate14 and FCT v Jenkins.15 It outlined a general rule that a period of two years or longer will be considered a permanent place of residency in another country. However this time period should not be relied upon without considering the other relevant factors outlined in the Ruling.16 183-day Test (s 6(1)(ii) ITAA 1936): This test is usually for people who come to Australia. Individuals will be deemed a resident of Australia if they are in Australia for 183 days or more17 (continuously or intermittently) within a single financial year18. The Commissioner can overrule this test if they are satisfied the persons usual place of abode is outside Australia19 and does not have an intention20 to take up residency within Australia. Superannuation Test (s 6(1)(iii) ITAA 1936): This test applies to relevant individuals who generally reside in Australia but leave temporarily and are not in Australia during the income year. In this test a resident includes: a member of a superannuation scheme21; an eligible employee22 and their families. In Baker v FCT23 it was held that an inactive taxpaying member who is on leave without pay is a ‘member of a superannuation scheme’. Temporary Resident: Individuals who qualify as temporary residents24 will only be taxed on Australian sourced income at resident’s rates. Foreign income in non-assessable non-exempt income and capital gains and losses are disregarded. Company Residency Test (s 6(1) ITAA 1936): The relevant company tests include: the place of incorporation test; the place of central management and controlling shareholders test.25 Only one of these tests need to be satisfied. The place of incorporation test: A company incorporated in Australia is automatically a resident of Australia. Incorporation is a question of fact and determined by legislation.26 The place of central management test: If a company conducts business27 in Australia and has its ‘central management and control’28 held within Australia, the company is deemed a resident of Australia. The test is a question of fact.29 The two limbs of this test are clearly recognised in TR 2004/15. Controlling shareholders test: Company residency is also determined by a two-limb test. The first limb requires a company to have its voting power controlled by Australian residents (> 50% of voting power at general meetings),30 and the second limb of ‘carrying on a business’ is determined by applying the same test utilised in the central management test. Dual residency: It is possible for a company and and individual to be dual residents.31 Double tax agreements contain definitions of ‘residency’ and provide tiebreaker rules32 where the taxpayer has dual residency. Assessable income: Section 6-5(1)33 provides that assessable income includes income according to ordinary concepts, which is ordinary income.34 Assessable income35 includes ordinary income36 and statutory income37 but not any non-assessable income38 (exempt income;39 and non-assessable non-exempt income.40 Ordinary Income: Ordinary income is defined as income according to ordinary concepts.41 It is ‘determined in accordance with the ordinary concepts and usages of mankind’.42 Australian residents are assessed on the ordinary income from all sources.43 Some ordinary income is exempt and subsequently non-assessable,44 and some ordinary income is neither exempt nor assessable.45 Features of Ordinary Income: The receipt must have a sufficient nexus with an income-earning activity and must not be a capital gain.46 Capital gains are assessable under the capital Gains Tax regime.47 There are three established categories for ordinary income: income from personal services/exertion (e.g. salary); income from business (e.g. accounting firms selling accounting services); and income from property (e.g. rent or dividends). Where income does not fit within an established category, the following general propositions of income must be examine to determine whether it is ordinary income. Pre-requisites for Ordinary Income: Money or convertible to money Amounts which cannot be converted into money will not be income.48 Section 2149 provides that where the consideration for any transaction is paid or given other than in cash, the money value of that consideration is deemed to have been paid. Section 21A(1)50 provides that a ‘non-cash business benefit’ that is not convertible into cash shall be treated as if it were convertible into cash. Section 15-251 makes the value of allowances, gratuities, compensation, benefits, bonuses and premiums a provided in respect of employment to be income, regardless of whether they are convertible to money. Realised gain: An unrealised gain will not be ordinary income.52 Must be a real gain: If the taxpayer is better off financially then it could be deemed ordinary income. If not, then it is not ordinary income.53 Must be from an external source: Income is what is received by a taxpayer and not what is saved from going out.54 If taxpayer does not receive an item, or it received but is non-cash or cash convertible (even though it saves taxpayer from incurring expenditure), it is not ordinary income. Constructive receipt rule: Income is treated as being derived by a person when that income has been dealt with as that person directs.55 If someone is entitled to receive income but arranges for someone else to receive it then the person originally entitled to income has constructively received it and hence will be assessable on it. Principle of mutuality: This principle provides income must come from ‘outside sources’ and taxpayers cannot derive income from themselves.56 This type of receipt is non-assessable non-exempt income under s 6-23.57 The rule will not apply if receipts are from other sources like interest from investment, fees collected from non-members etc.58 Characteristics of Ordinary Income:59 Periodicity, recurrence and regularity Payments that arise frequently, especially where taxpayers can reasonably rely on them, are more likely to become income in nature.60 One off payments for isolated profit-making schemes may become income.61 Periodic payments for the purchase of a capital asset will be treated as capital.62 Flow concept is satisfied: Income must ‘flow’ from the capital63 and there must be a sufficient nexus with income-earning activity: property; business; or personal exertion. The receipt must also be severable from its earning source and must not be a capital gain. Flow principle not satisfied: Some gains are ordinary income despite having no earning source. If receipts are regular, expected and taxpayer depends on them for support, this is enough to make them ordinary income.64 Do any other principles apply? Illegal Receipts: Receipt from an illegal activity is assessable despite the illegality of the activities.65 Compensation: Compensation payouts will adopt the form of the money they replace and compensation for loss of ordinary income is deemed ordinary income.66 Is it Statutory Income? Section 10.567 provides a list of provisions that include assessable income amounts that are not ordinary income. Amounts that are not ordinary income but are included in assessable income by specific provisions68 are: return to work payments;69 dividends;70 net capital gains;71 royalties;72 and allowances.73 When there is an overlap between ordinary and statutory income, the amount will only be included in the assessable income once74 and usually statutory income prevails.75 Section 6-10(3)76 proscribes constructive receipt for statutory income. Derived indirectly or directly: Assessable income includes ‘ordinary income you derived directly or indirectly from all sources….’77 “Derived” is not defined in either of the Income Tax Assessment Acts. In the absence of a statutory definition, income derivation is to be determined by the application of ‘ordinary business and commercial principles’78 When calculating assessable income it is important to determine when that income has been ‘derived’ in a tax year. This timing will be dependent upon whether the taxpayer is operating on a cash basis or an accruals basis. Sections 6-5 and 6-1079 also refer to these as the ‘receipts method’ or ‘earnings method’. Cash/receipts basis: Under this basis income is derived when cash or its equivalent is received. This also includes constructive receipt as taxpayers are taken to have received an amount as soon as it is applied or dealt with on the taxpayer’s behalf.80 Accruals/earnings basis: Under this basis income is derived when it has been earned, irrespective of whether payment has yet been received. It is accepted that income has been earned when a debt comes into existence; typically when services have been performed or goods delivered and an invoice sent to the customer. The relevant method of accounting to be adopted is that which ‘is calculated to give a substantially correct reflex of the taxpayer’s true income’.81 Different types of income and their derivation: Salary and wages is derived on a cash basis.82 Rent and royalties are generally assessable on a cash basis.83 If they are derived from a business income, they may be assessable on an accruals basis.84 Interest is generally assessable on a cash basis.85 Dividends are generally assessed on a cash basis.86 Individuals providing personal services are assessed on a cash basis.87 Sole practitioners are generally assessed on a cash basis.88 The accruals basis is usually the appropriate method of accounting for the income of professional partnerships.89 Legislation preventing recovery action from being instituted until a certain period of time has lapsed does not mean that income has not been ‘earned’ until after the end of that period.90 The accruals basis is usually the appropriate method of accounting for trading businesses.91 Generally, income from advanced payments is derived at the time of receipt on a cash basis, however the accruals basis may be appropriate in some circumstances.92 Where the income is subject to dispute, it is derived once the dispute is concluded.93 Sources: The source of income is a question of fact.94 Where income is derived from multiple sources, it may be appropriate to apportion the income between the different sources.95 Different sources of income include: Sale of Goods (Trading Stock): The source of income relates to where trading activities take place. This derivation is a question of fact.96 Sale of Property (other than trading stock): The source of income derived from sale of property will depend on the property being sold.97 Courts generally look at the location of the economic activity-giving rise to the income.98 Salary, Wages, Fees (Service Income): The source of service income is generally taken to be the place of performance of the service.99 The place of performance must be considered in the context of possibility of other factors being relevant100 (e.g where the contract was made and where the money is paid). Interest: Factors including place of contracting and place where the funds are advanced must be considered.101 Dividends: Dividends are assessable income.102 The source of a company’s profits is a question of fact.103 Royalties: Source of royalty is location of industrial or intellectual property from which the royalty flows. When royalty is outgoing (paid by Australia to foreign entity) section 6C104 deems royalty to have an Australian source. Rental Income: Where real property is leased, the source of income is the location of the property.105 Where personality is leased, the source of income will probably be the place where the contract was entered into.106 Sale of property (non-trading stock): Where property is sold, the income will generally be sourced from the place the contract was entered into.107 Special rules relate to shares and in the case of realty, income will be sourced from the location of the property rather than the place where the contract was made.108 Financial Transactions: Generally, the source of financial transactions is where services of the company are performed.109 PART B: 1 Income Tax Assessment Act (ITAA) 1997, s 995.1. 2 ITAA 1936. 3 The first test is a common law test, and the following three are statutory tests. 4 Macquarie Dictionary: ‘to dwell permanently or for a considerable time; have one’s abode for a time’. 5 Residency status of individuals entering Australia. 6 Joachim v FCT (2002) 50 ATR 1072. 7 IRC v Lysaght [1928] AC 234. 8 Joachim v FCT (2002) 50 ATR 1072. 9 Levene v IRC [1928] AC 217. 10 Domicile Act 1982 (Cth) and common law rules. 11 Domicile Act 1982, s 10; IT 2650. 12 (1979) 9 ATR 899. 13 (1982) 12 ATR 745. 14 (1979) 9 ATR 899. 15 (1982) 12 ATR 745. 16 At [23]: intended and actual length of the taxpayer’s stay in the overseas country; acquisition of place of abode outside Australia and intention to make that place a ‘home’; abandonment of place of abode in Australia; duration and continuity of presence in the overseas country; and durability of association with a place. 17 If satisfied, taxpayer treated as resident for whole of income year: Executors of the Estate of Subrahmanyam (2002). 18 ITAA 1936, s 6(1). 19 Means something less than permanent residence and should be given its ordinary and natural meaning; Koustrup [2015]. 20 IT 2650: Intention to take up residence means to become a resident under immigration law. 21 Established by deed under the Superannuation Act 1990. 22 For the purposes of the Superannuation Act 1976. 23 [2012] AATA 168. 24 Subdiv 768-R ITAA 1997; ITAA 1997, s 995-1 Definition of temporary resident; (a) a person who holds temporary visa under Migration Act 1958; (b) not an Australian Resident within Social Security Act 1991; (c) not an Australian resident’s spouse under Social Security Act 1991. 25 ITAA 1997, s 6(1)(b). 26 Corporations Act 2001 (Cth). 27 If company has its central management and control in Australia, and caries on business it will carry on business in Australia within the meaning of central management and control residency test. 28 Will be the location of the actual decision making, rather than the formal execution of the director’s resolutions: Malayan Shipping Co Ltd v FCT (1946) 71 CLR 156. 29 TR 2018/5; Bywater Investment Limited & Ors [2016]. 30 Kolotex (1975). 31 Koitaki Para Rubber v FCT (1940) HCA 33. 32 Tie-breaker rules differ. For individuals, it is permanent house location and for company it is the place of effective management. 33 ITAA 1997. 34 Ibid, s 6-5. 35 Ibid, s 6-1. 36 Ibid, s 6-5. 37 Ibid, s 6-10(2); Examples Return to work payments (s15-3); Net Capital gains (s102-5). 38 Ibid, s 6-15. 39 Ibid, s 6-20. 40 Ibid, s 6-23. 41 Ibid, s 6-5(1). 42 Scott v FCT (1935) 35 SR NSW 215. 43 ITAA 1997,s 6-5(2). 44 Ibid, s6-1(2); 6-1 (3). 45 Ibid, 6-1(4). 46 Eisner v Macomber, 252, U.S. 189, (1920). 47 Brent’s Case (Brent v FCT (1971) HCA 48). 48 FCT v Cooke & Sherden (1978) 9 ATR 310. 49 ITAA 1936. 50 Ibid. 51 ITAA 1997. 52 Eisner v Macomber, 252, U.S. 189, (1920). 53 Hochstrasser v Mayes (1960) AC 376. 54 Tennant v Smith (1892) AC 150. 55 ITAA 1997, s 6.5(4) 56 The Bohemians Club v Acting FCT 24 CLR 334. 57 ITAA 1997. 58 Carlisle & Silloth Golf Club v Smith [1912] 2 KB 177. 59 The following characteristics must be sufficiently met (provided the pre-requisites are satisfied). 60 FCT v Dixon (1952) 86 CLR 540. 61 FCT v Myer Emporium Ltd (1987) 163 CLR 199. 62 Foley v Fletcher. 63 Eisner v Macomber, 252, U.S. 189, (1920). 64 Keily v FCT (1983). 65 Partridge v Mallandaine (1896); Lindsay (1932); TR 93/25. 66 FCT v Dixon (1952) 86 CLR 540. 67 ITAA 1997. 68 Ibid, s 6-10(2). 69 Ibid, s 15-3. 70 Ibid, s 44(1). 71 Ibid,s 102-5. 72 Ibid, s 15-20. 73 Ibid, s 15-2. 74 Ibid, Subsection 6-25(1). 75 Ibid, Subsection 6-25(2). 76 ITAA 1997. 77 Ibid, s 6-5(2). 78 Gibbs J at p 570 Brent v FCT (1971) 125 CLR 418. 79 ITAA 1997. 80 Ibid 6-5(4). 81 Dixon J at p 154 Commissioner of Taxes (South Australia) v Executor, Trustee and Agency Company of South Australia Limited (Carden’s Case) (1938) 63 CLR 108. 82 TR 98/1 at [42]; Firstenberg’s Case. 83 TR 98/1 at [48]. 84 Ibid. 85 TR 98/1 at [47]; Leigh v IRC. 86 Brookton Co-operative Society v FCT (1981) 147 CLR 441. 87 Brent v FCT (1971) HCA 48. 88 Carden’s Case; FCT v Firstenberg; FCT v Dunn. 89 Henderson v FCT (1970) 119 CLR 612. 90 Barratt v FCT (1992) 23 ATR 339. 91 J Rowe & Sons Pty Ltd v FCT. 92 Arthur Murray (NSW) v FCT (1965) 114 CLR 314. 93 BHP Billiton Petroleum (Bass Strait) v FCT (2002) 51 ATR 520. 94 Nathan v FCT (1918) 25 CLR 183. 95 CT (NSW) v Cam & Sons (1936) 36 SR (NSW) 544. 96 Commissioner of Tax v Kirk [1900] AC 588. 97 Rhodesia Metal Ltd (Liquidator) [1940]. 98 Cliffs International Inc (1985) 16 ATR 601. 99 French (1957); FCT v Efstathakis [1979] HCA 73. 100 FCT v Mitchum (1965) 113 CLR 401. 101 FCT v Spotless Services Ltd (1996) HCA 34. 102 ITAA 1936 s 44(1). 103 Esquire Nominees Ltd v FCT [1972] 129 CLR 177. 104 ITAA 1936. 105 Rhodesia Metals v CT. 106 James Fenwick v FCT [1921] HCA 12. 107 Subject to specific rules relating to certain property such as realty and shares. 108 Thorpe Nominees v FCT (1988) ATC 4886. 109 Tariff Reinsurance Ltd v CT (Vic) (1938) HCA 21.