Question 1
Introduction and Purposes
Minh was born in Malaysia and had been running a successful business. In June 2016, he came to Australia with his family planning to migrate eventually. He bought a house in Melbourne for his family to reside. His children were also enrolled at a local school. During 2016 to 2017 period, he had to leave Australia due to his partner position in a business operating in Kuala Lumpur and his investments there. He lived in his own apartment in Kuala Lumpur during this period. Minh spent 120 days in Australia during this year and had not started any new business by 30 June 2017. And he was not sure whether to reside in Australia permanently yet.
Residency is an integral component when the issue of tax arises. Under s6(1) ITAA 36, residency allows individuals or companies to qualify as residents for the sole reason of tax purposes. This undoubtedly ensures that the treatment of income tax is fairly justified which can implicate tax benefits depending on the scenario. Through Minh's situation, factors from both the ATO and the taxpayers position will be considered with the aid of previous cases and relevant tax law. This information will help determine whether Minh is a resident and to what degree he must pay taxes.
Legal Issues
To study this question, it is necessary to detect the relevant issues. Clearly, this question discusses the residency status of an ‘individual’. Therefore, the four tests need to be taken into consideration. However in this situation, the superannuation test is not relevant.
ATO’s Position
From the ATO’s point of view, there are many factors indicating that the taxpayer Minh was an Australian resident for tax purposes during this period. To start with, under the ordinary concepts test, according to Joachim v FCT (2002) 50 ATR 1072, when an individual intends to treat Australia as home for his or her family, even if the individual is absent from Australia for most of the time, he or she may still be considered as a resident. Specifically, the reason why Minh came to Australia is that he wanted to migrate and start a new business, which is quite similar to Joachim’s case. His absence from Australia during 2016/17 was not permanent and it does not change his intention to derive in Australia. In addition, the commissioner should also consider the business and employment ties: In this case, although Minh did not withdraw his position as a partner in a business in Malaysia, his first intention was still to work in Australia. Furthermore, the taxpayer’s location of assets and social and living arrangements should also be taken into account: Minh did not sell his apartment in Kuala Lumpur, but he bought a new family home in Melbourne for his family to live including his wife and children who are enrolled in local an Australian school.
Under the domicile test Act 1982 (Cth), the taxpayer should still be considered as a resident. To be more specific, in a similar case FCT v Applegate, the Full Federal Court concluded that the taxpayer’s overseas abode was a permanent one. In this case whether a taxpayer holds an Australian domicile is essential; after the argument offered above, it is clear that the taxpayer had already had an Australian domicile during his absence. Another important factor needs to be considered under this test is that if the taxpayer intends to stay in a country, in this case, Australia. It is true that Minh kept his Malaysian domicile, however, during this period, his family still remained in Australia with his intention to come back. Apart from that, the taxpayer’s durability of association in Australia can also be important. This can be further exemplified by the fact that Minh’s children were still enrolled in an Australian local school while Minh was away from Australia.
Taxpayer’s Position
Ordinary concepts primarily discusses the meaning behind what a residency constitutes of. Minh's absence for an extended period of time strikes a signal that the taxpayer is in no way a resident. It’s irregular that an individual that is absence from Australia will be regarded as a resident. Factors that play a role in this is the physical presence that Minh portrays in Australia which is less than half the year, as well as the frequency which is very low. Minh has stated that his absence is due to business needs and investments. In addition to this, Minh is living in his apartment in Malaysia, a key indicator that this is his usual place abode Australia. This is more likely to represent Minh as being a resident of Malaysia, rather than Australia. The other cause which is likely to help Minh is the uncertainty he maintained. Minh ensured for a possible intention to officially move to Australia and open business, however this was nothing more than a mere thought. Uncertainty should not be the cause to declare an individual a resident, as the intention is unclear and not thoroughly thought out. Include case
Minh’s non-residency can further analysed through the domicile test. A vigorous component is the discussion of daily life habits. Since Minh is an important figure in his business in Malaysia, it’s seen that he revolves around his business which can be considered his daily life habit. This high priority ensures that Minh’s cultural needs are met. Although Minh’s family is in Australia, it’s his work which will support his family, so attending to his work is necessary for the survival of his family. In relation to the assets that Minh holds, it would be obliviously to abandon his investments and his apartment which is bound to have some furniture establishing his assets. Due to the investments and the income earning capacity it entails, Minh’s income is sourced outside Australia (FTC v Jenkins) allowing for the classification of non-residency. The taxpayer’s permanent place of abode can be taken into consideration (FTC Applegate) as permanent does not define as forever. Although Minh would eventually visit Australia to see his family, Malaysia is his permanent residence due to the immense period of time he spent overseas. Minh is in now way a resident of Australia under this particular test.
Minh's complex residency affairs can be scrutinised through the 183-day test. During the 2016-17 financial year, Minh only spent 120 days in Australia, with the remainder of the year in Malaysia where he was originally residing. This critical test ensures that an individual is considered a resident of Australia if only they have lived in the country more 183 days or longer. However, seeing as Minh only lived in Australia for 120 days, and had to return back to Malaysia on business, it’s evident that he is not a resident. His permanent place of abode became Malaysia as the weight of time spent to Malaysia compared to Australia is higher. The significance of this test gives Minh a legal benefit to be excluded from paying taxes as he is not considered a resident for tax purposes. As Minh’s income is directly from overseas it is impossible to classify it under the Australian Tax System, as the business has no direct relationship with the contents of Australia. Income is assessable when services performed is in the same country that the tax is being recognised in (FCT V French). Minh fulfilled services overseas and has no obligation to pay taxes. Minh may need to pay taxes in Malaysia according to their tax system. Although Minh is not certain about having Australian life in his future, it is unlikely that he will have to pay any taxes to the Australian Taxation Office in the future.
Impact of the decision
Before making our final decision, it is necessary to identify how would the tax on Minh’s income sourced from Malaysia be influenced by different decisions. If a taxpayer is an Australian resident for tax purposes within a period of time, then the worldwide income earned in this period is taxed, on the other hand, if the taxpayer is not an Australian resident for tax purposes, then only the income earned within Australia is taxed (Div 6 of ITAA 1997). Since all Minh’s income during the income period was from Malaysia, the impact of the final decision is significant. It is possible that a taxpayer is considered as a resident for more than one country (ITAA 1936 s 6[1]). What is meant by this is that no matter what the final decision is, if Minh is a resident in Malaysia would not be affected.
Conclusion
The extent of Minh’s residency has been considered by both the ATO and the taxpayer and the decision is vitally clear. Through various examining of past cases and specific tax laws, the facts support that for tax purposes Minh is considered a resident. The taxpayer needed only one successful test to pass residency, however Minh passed both the ordinary and domicile test. Although there are many factors which support the opposing view, in essence Minh needs to report his income in the 2016-17 tax return.
Question 2
Introduction and Purposes
Penny wanted to buy a home for her family in the suburbs of Melbourne Eastern. So, she wants that she could do the whole funding within $1m which she will get from the sales of her old house so that she be debt-free. Instead, she bought a large piece of land for $1m. She consequently borrowed $1m to make four new similar houses on the land because the land she bought was much larger than her needs. She called up the builders, however she was engaged in management and planning of the project to save costs.Penny secured one home for her family to live in and the rest of the houses were for sale and consequently, she sold the rest for $1m each.
The following report has been developed to discuss the legal issues in regards to whether the income generated from the sale of Penny’s new-built houses should be considered as ordinary income or capital receipts. Once again, both ATO’s and the taxpayer’s perspective will be analysed in order to identify it is a ordinary income and to what degree she must pay taxes.
Legal Issues:
The relevant issues arising in this question clearly discuss if the income from the sale of the properties should be considered as CGT or ordinary income. The three tests for ordinary income need to be taken into consideration.
ATO’s Position:
The ATO may disagree with the view which is set out in TR 92/3 at [55-58] and argue that Penny had bought the piece of land for making her own house initially but eventually she decided to make some profit through that piece of land afterwards which clearly states that she already knew that it was a large land and and it was totally a money making scheme for Penny.
It could also argue that the profit is assessable under Whitfords Beach – ie, Penny is engaged in the business of rebuilding houses. In the Whitfords Beach case, the simple subdivision of the piece of land and the sale of land would not be considered as ordinary income as suggested by the judges. However, an extensive development of land would constitute a business and so it will be an ordinary income. According to principle to Penny requires a determination of whether whatever she did was enough to depict a business or commercial intent.
According to section 6-5 of ITAA 1997, Penny’s gains satisfies both the essential prerequisites of an ordinary income. It is evident that Penny received the income in cash and a real gain has been made by her with the proceeds of sale. It further satisfies the three tests for Ordinary Income. It has the characteristics of the ordinary income, the possible source of income was expected from the taxpayer’s owned property and it has been received as compensation for what clearly would have been an income amount.
Taxpayer’s Position
From taxpayer’s point of view, a lot of factors constitute that a CGT event has occurred.The original intention that Penny pursued promotes the ingenious idea she was forced to take. A major characteristic which will enhance the decision of whether a CGT event occurred is the profit-making intent. It’s clear that from Penny’s view, she was clearly carrying on an investment which will add value, however this event cannot be regarded as a business activity as it is a once-off transaction (Westfield Ltd v FCT). Evidently an extraordinary transaction occurred as this event is an irregular activity. Penny’s original intention did not anticipate that she would have extra land to maintain through the structuring and selling of three houses which resulted due to unused space. These facts demonstrate that ordinary income can be disregarded in this instance. Through the large sum of money Penny used and the work the houses entailed, the scale of activities was very large, however the the genuine intention that Penny had from the beginning was to just build a family home. Therefore it would be unjust for this transaction to be considered ordinary income as there is no business defining activities involved, rather a unique extraordinary transaction.
As Penny had bought a piece of land worth $1m and she also borrowed $1m from bank as a loan to construct her own house but later she decided to build 4 identical houses on that land as it was too large for her. The gain Penny had on selling the houses would be considered for Capital Gains Tax as according to s6-5 of ITAA 1997, if the gains fulfil the two characteristics of income then they are considered as ordinary income (Eisner v Macomber 252 US 189 1920). Although, profit from the sale of the houses is fulfilling the prerequisites of cash (FCT v Cooke and Sherden [1980] 10 ATR 696) and a genuine gain but income by Penny is not an ordinary income as it does not flow from an underlying source. According to s112-25 of ITAA 1997, Penny subdivided a block of land into four pieces out of which she is exempted for one block which is treated as her main residence. However, profit earned on the sale proceeds of the other parts would be regarded as capital gain subject to capital gains tax as Penny did not keep the ownership of the subdivided land after building the houses on it. The cost base of the original land owned by Penny would further be divided between the subdivided blocks on a reasonable basis (TD 97/3).
Assessable Income under both alternatives
Ordinary Income:
If this income was considered as ordinary income, the assessable income for the three houses sold would be: sale price-cost of making the three houses=$3M-$1.5M=$1.5M. $1.5M is subject to ordinary income tax.
Capital Gain:
Proceeds from the selling of house resulted in $3M whereas cost base for building the three houses is $1.5M. The gain of $1.5M is subject to Capital Gains Tax.
Although the assessable income remains the same dollar amount in both alternatives, different tax rates should apply accordingly.
Conclusion
According to ATO’s position, this will be considered as ordinary income as Penny was already having the intention of making profit through this land and she also borrowed $1m dollar from bank to build four houses instead of one and by looking from the taxpayers position, it was merely a subdivision of land to get rid of the excess space she owned. So, according to TD 97/3 ruling , the subdivision of land is subject to capital gains tax. However, after considering both the positions, a conclusion can be made keeping various factors in mind as she had not only divided the land but also did further development to the land which clearly proves her intention of earning a huge amount of profit prior to the initial purchase of land. Her further borrowing from bank contributes to her intention of keeping up with the idea of earning. It also depicts that although she was not engaged in the real estate business earlier but it might have been the commencement of the real estate business. Penny didn’t need to develop the land further to get rid of the excess land.