Week 1 - Australian Taxation Law and the Administrative Framework

Tax Law Fundamentals

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Tax law originates from three primary sources in Australia:

1. Legislation: This involves formal acts passed by Parliament.

   • Income Tax Assessment Act 1936 (ITAA 1936): Largely deals with income tax and general income concepts.

   • Income Tax Assessment Act 1997 (ITAA 1997): Addresses newer developments and specific tax issues. A Tax Law Improvement Project (TLIP) aimed at consolidating these acts was stalled, so both ITAA 1936 and ITAA 1997 are still used in tandem.

   • Referencing: Accurate referencing of these acts is crucial for tax questions.

     • For Income: Refer to Section 6-1 of the ITAA 1936 (e.g., s 6-1 ITAA 1936).

     • For Expenses: Refer to Section 8-1 of the ITAA 1997 (e.g., s 8-1 ITAA 1997).

   • Access: Acts can be accessed easily online, for example, via the AustLII website, which allows for clickable navigation to specific sections.

2. Case Law (Judicial Precedent): Decisions made by courts (including the High Court) establish legal principles. The doctrine of precedent means that similar cases should be decided similarly. Case names are typically structured as [Taxpayer Name] v FCT (Federal Commissioner of Taxation, another name for the ATO).

3. ATO Rulings: The Australian Taxation Office (ATO) issues rulings to provide guidance and clarity on tax law.

   • Public Rulings: Applicable to the general public, often published on the ATO website.

   • Private Rulings: Specific to a particular company or individual's unique circumstances. Taxpayers can apply to the ATO for a private ruling, and the ATO's response outlines the exact tax treatment they should follow.

   • Other: Oral rulings and interpretive decisions exist but are less significant.

Self-Assessment and ATO Processes

Australia operates on a self-assessment tax system, meaning taxpayers are responsible for calculating and declaring their own tax liabilities. The ATO does not initially calculate tax for individuals or entities; instead, it accepts self-assessed returns.

Implications of Self-Assessment:

• Job Creation: This system inherently creates demand for accountants and tax agents, as many taxpayers require professional assistance to navigate complex tax laws. The accounting bodies (CA and CPA) lobby the government to influence tax laws, which often creates new consulting work for accountants.

• Penalties: To prevent false declarations, the ATO imposes significant penalties (interest at rates above 10\% and fines) for incorrect or fraudulent self-assessments.

• Audits: While the ATO initially accepts returns (and may issue refunds based on self-assessment), it reserves the right to audit taxpayers afterward. The ATO uses big data and benchmarking to identify anomalies or high-risk taxpayers (e.g., high deductions relative to industry averages, extravagant lifestyle with low income). A warning message on a tax return indicates higher risk. Audits can be simultaneous across multiple tax types (income tax, GST, royalties). The ATO has a statute of limitations for auditing, typically around five years.

• Tax Agent Concessions: Tax agents receive extended deadlines (e.g., six months past the October 31 deadline for individuals), providing an incentive for taxpayers to use their services, further boosting the industry.

• Notice of Assessment: Upon lodgment, the ATO issues a Notice of Assessment, often signed by the Commissioner of Taxation.

• Objection and Appeals: If the ATO objects to a self-assessment, taxpayers can object to the ATO's decision, potentially leading to appeals at a tribunal and ultimately court decisions.

Business Activity Statements (BAS):

• BAS are reports submitted to the ATO, usually monthly or quarterly (depending on business size), for various taxes including:

  • PAYG (Pay As You Go) withholding for employees and installable income tax for the company itself.

  • GST.

  • FBT.

  • Wine Equalization Tax.

  • Luxury Car Tax.

  • Fuel Tax Credits.

• These statements facilitate periodic tax payments, comparable to PAYG deductions from individual salaries. Outliers in BAS reports can trigger ATO scrutiny.

Residency for Tax Purposes

Establishing tax residency is critical due to significant differences in tax obligations between Australian residents and foreign residents. Citizenship or government residency is irrelevant for tax residency determination.

Key Distinctions and Consequences:

• Australian Residents (Section 6-5(2) ITAA 1997): Taxed on worldwide income (all sources, inside or outside Australia).

• Foreign Residents (Section 6-5(3) ITAA 1997): Taxed only on Australian-sourced income.

This distinction has substantial financial consequences, impacting income from overseas shares, bank accounts, or contracts.

Tax Rate and Threshold Differences (Illustrative only, rates vary by year, consistency within an answer is key):

• Tax Offsets: Foreign residents generally do not receive tax offsets.

• Medicare Levy: Australian residents pay a 2\% Medicare levy (and potentially a surcharge for higher incomes); foreign residents do not.

• Withholding Tax: Different application for interest and dividends.

• Capital Gains Tax (CGT): Significant differences in how CGT applies.

Four Tests of Residency (Applied Sequentially):

1. Ordinary Concepts Test (Resides Test): This is the most important test. If satisfied, no further tests are needed.

   • Definition: To "reside" means to dwell permanently, have a settlement, or usual abode in a particular place. Cases like Lysaght v IRC, Miller, and Pike illustrate factors.

   • Factors Considered (TR2023/1): The ATO considers a holistic view, with weighting given to factors:

     1. Intention / Purpose: Where the person intends to live permanently (most important).

     2. Family / Employment: Location of family members and primary place of employment.

     3. Assets: Location of significant assets (e.g., home, car).

     4. Social and Living Arrangements: Social ties, club memberships, schooling, etc.

   • Key Reference: TR2023/1 (Tax Ruling, overrides ITAA for this specific test).

   • Application Example (Bjorn - Soccer Player):

     • Scenario: Bjorn offered an eighteen-month contract in Australia, lets out Swedish house (doesn't sell), sells car, redirects mail, family moves to Australia, children attend school, involved in sports. Contract terminated after four months due to poor performance; family returns to Sweden. Bjorn argues residency.

     • Structured Analysis (as per TR2023/1):

       • Arguments for Residency: Sold car, redirected mail, intended to stay for 18 months (high weighting), family in Australia, children attending school, involved in sporting activities (social ties).

       • Arguments against Residency: Only let out his house (kept major asset in Sweden), contract terminated early, returned after only four months (falls short of 183 days for Test 3).

       • Conclusion: The Commissioner ruled Bjorn as a resident because his intention to live for 18 months, supported by family relocation and consistent behavior, outweighed the early departure and retention of his primary dwelling overseas. Emphasis on intention.

   • Application Example (Boden - Accountant):

     • Scenario: Boden, single, living with parents in Waratah, left Australia on June 1 for a nine-month accounting contract in Singapore. Left most belongings in Australia, hopes to return to Australia to continue studies at UoN. Contract requires work in Singapore, paid in SGD.

     • Structured Analysis (as per TR2023/1):

       • Arguments for Residency: Intends to return after nine months (high weighting), intends to continue studies in Australia, family (parents) in Australia, most belongings (assets) in Australia.

       • Arguments against Residency: Work arrangements overseas (Singapore), must do all work in Singapore, paid in Singaporean dollars (likely has Singaporean bank account/assets).

       • Conclusion: On the balance of facts, Boden would likely be assessed as an Australian tax resident, primarily due to his explicit intention to return, continue studies, and his strong ties to family and assets in Australia, which outweigh his temporary work arrangements overseas. For tax advice, it's crucial to argue both sides and provide a reasoned conclusion, even if the final call is subjective. Tax advice typically avoids definitive guarantees.

2. Domicile Test: Applies if Test 1 is not met. It considers where a person's “domicile of origin/choice” is, essentially where they intend to make their permanent home. This test is generally used when someone moves overseas but doesn't change their original domicile. "Permanent" does not mean "everlasting." Factors include length of stay, accommodation (e.g., rented vs. owned), and durability of living arrangements. Example: Applegate v FCT where a taxpayer working overseas with a villa in Sydney was considered an Australian resident as they hadn't established a permanent abode outside Australia.

3. 183-Day Test: A straightforward test. If a person is physically present in Australia for more than 183 days (half the year) in an income year, they are generally considered a resident. Special exemptions exist for working holidaymakers and overseas students.

4. Superannuation Test: Applies automatically if an individual is a member of the Commonwealth Government Superannuation Scheme (i.e., a public servant). This test is rarely encountered in general tax scenarios.

Temporary Residents:

• Individuals granted temporary residency under Division 768 are not assessed on foreign-sourced income but benefit from Australian tax thresholds and deductions.

• Specific concessions apply to holiday workers and overseas students staying for more than six months (e.g., two semesters) to promote their stay and study.

Double Taxation Agreements (DTAs)

• DTAs exist between Australia and many other countries to prevent taxpayers from being taxed twice on the same income. If a resident of Australia earns income in a foreign country, they will pay tax in that foreign country and be liable for tax on that worldwide income in Australia.

• The DTA allows for a tax offset in Australia for taxes paid to the foreign government. This offset reduces the Australian tax liability on that foreign income, but will not result in a refund for overseas taxes paid (i.e., it can only reduce Australian tax to 0).

• Tax Havens & Transfer Pricing: DTAs and residency rules are complex, leading to practices like using tax havens (countries with very low tax rates, e.g., Singapore) and transfer pricing (companies structuring inter-company transactions to shift profits from high-tax to low-tax jurisdictions) to minimize tax. This is a highly lucrative and specialized area for tax accountants.

Sources of Income

Determining the source of income is crucial for foreign residents (taxable only on Australian-sourced income) and residents (taxable on worldwide sources).

• Provision of Services: Generally sourced where the work is physically performed. Complexities arise for mobile workers (e.g., pilots, shipping crew) where the head office location or contract signing place might be considered.

• Business Income: Considers where contracts are signed, where work is performed, and where payments are made.

• Dividends and Interest: The source is often determined by where the trading contract is signed or through which platform the investment is made.

• Statutory Rules: Specific rules apply to various other types of income (e.g., royalties, which are unavoidable even in non-traditional accounting roles).

Company Residency

For companies, residency rules are simpler:

• Place of Incorporation: Where the company is legally registered.

• Management and Control: Where the core business activities and decisions are carried out.

• Shareholding Base: The residency of substantial controlling shareholders.

Conclusion

This first week introduces the vague and subjective nature of tax residency, which contrasts with the black-and-white calculations of future weeks. Mastering the structured approach to residency questions (reference, arguments for/against, conclusion) is vital for assignments and exams.