Australia’s ageing rules are too subjective and difficult to apply.
Home or away, residency test needs reform
With the worst of the pandemic apparently behind us and international borders reopening in line with the general wish to get “back to normal”, the government must prioritise reforms to modernise and simplify the tax residency definition for individuals.
While the May 2021 budget announced a much-needed overhaul of individual residency tests, no draft legislation has yet been released for consultation and the proposed changes seem a fair way off.
Regardless of which party wins the election, if they choose to pursue these measures the earliest any tax residency changes could realistically take effect is 1 July 2023, which would require the legislation to be passed by 30 June 2023.
Why are reforms needed?
First, the existing residency tests are decades old and highly subjective, and therefore difficult to apply in practice.
Second, the removal in 2009 of the general exemption for foreign-sourced employment income earned by Australian tax residents created a much greater incentive for Australians working overseas to ensure they cease to be a resident. This means they are taxed on their salary only in the country in which they are working, and this has led to a dramatic increase in the number of court decisions examining individual tax residency status.
As well as the fact that in most countries individual tax rates are lower than in Australia, there are also practical advantages to not having to declare a salary in both countries.
What is being proposed?
The proposed changes aim to address some of the more subjective elements of determining tax residency.
First, there would be a primary 183-day “bright-line” test. If an individual was physically present in Australia for 183 days or more in a year, they would be automatically treated as a tax resident.
If the person was a resident in the previous year, then they would be resident for the whole of the current year, otherwise they would be resident only from their date of arrival in Australia. This is far simpler and more certain than the existing 183-day test.
The position would be much more complex for someone in Australia for fewer than 183 days in a year, although there is only an overview of the proposed new tests and more detail is needed.
It does, however, appear that such individuals would need to apply either a commencing residency test (if they were a non-resident in the previous year) or a ceasing residency test (if they were a resident in the previous year), each of which has several elements.
Applying the secondary tests may make the proposed changes just as complex as the current rules. It is also likely that, while overall the new definition offers greater certainty, more outbound expats will be treated as residents than is currently the case. That is a great concern to many Aussies living overseas who have qualified as non-residents under the existing tests. This will only become a more pressing issue as international relocations continue to rise.
How might the proposed commencing residency test affect individuals?
Individuals who were non-resident in the previous year and spent less than a certain number of days in Australia during a year (45 days has been suggested, but this will need to be confirmed) will not be treated as commencing residency.
Also, those who were a non-resident in the previous year and exceeded the threshold number of days in Australia (but less than 183 days) during the year may be treated as a resident from the day they arrive if they also satisfy the factor test. This requires they have any two of the following:
- Right to reside permanently in Australia
- Australian accommodation
- Australian family
- Australian economic connections
These four factors represent some – but not all – of the factors that have traditionally been considered by the ATO and the courts in applying the current law. This showed that analysis under the new tests could be just as difficult and potentially subjective, and benefits from this change may not be as great as they appear at first glance.
How does the ceasing residency test affect individuals?
Historically, the ceasing residency test has created a significant number of disputes since the 2009 tax law change, including the 2019 court decision in Harding v FCT, where the taxpayer successfully argued that he was a non-resident while working overseas. All these decisions depended on a subjective analysis of the particular circumstances.
Under the proposed changes, someone who was a resident for the previous year but spent fewer than 183 days in Australia during the year may be treated as ceasing residency if they:
- Satisfy specific date count tests on the length of their overseas employment (for example, a period of more than two years has been suggested)
- Have accommodation available to them in the place of employment for the entire overseas employment period.
- Spend less than a certain threshold number of days (for example, 45 days) in Australia each year while they are away
An extra layer of complexity has been suggested by the Board of Taxation that would add further tests to individuals hoping to cease residency depending on whether they had been a “long-term resident” (a resident for at least three consecutive years) or a “short-term resident”. It is unclear whether these tests will be included in the proposed legislation.
If the outcome of the relevant tests is that an individual is treated as ceasing residency, then they would generally be treated as a non-resident from their date of departure.
A brighter line
The proposal to introduce the more prescriptive primary “bright line” residency definition should add greater certainty for individuals in determining their tax residency status, reducing the current reliance on decades-old case law and subjective analysis of a range of factors with no clear guidance on how much weighting each factor should be given.
It would also bring Australia more in line with the approaches to residency taken in many other countries such as the UK, where there has been significant movement of expats both ways.
There will inevitably still be hoops for expats to jump through in determining their residency status for tax purposes, and the new factor test is still subjective, but the proposals offer a degree of comfort that deciding tax residency will become easier in most cases.
What now for Aussies going overseas or expats returning home?
With international borders reopening, it’s unsurprising that many Australians are once again taking the chance to live and work overseas, while at the same time some expats are returning home for an extended period.
It is strongly recommended that you seek local and foreign tax advice before you decide to move overseas, as the existing residency rules remain highly subjective and you’ll likely be assessed for tax residency on a case-by-case basis.
Peter Bembrick, tax partner, HLB Mann Judd Sydney