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There will be pitfalls for expats and departing businesspeople if the proposed rules pass unchanged.
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Why a bright-line residency test must focus on certainty, equity
18 August 2023
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12 minute read
Following a Board of Taxation’s 2019 report, the former government’s 2022 budget announcement, and the recent Treasury consultation paper, the process of amending Australia’s decades-old individual tax residency rules is gathering momentum.
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The proposals incorporate four design principles: adhesive residency, certainty, simplicity, and integrity.
Bright-line test
The first change is the introduction of a bright-line primary test under which an individual will be a tax resident if they are physically present in Australia for at least 183 days in an income year. While this is similar to the existing 183-day test, it is simpler and does not allow the exclusions available under the current law.
Where an individual has been here for less than 183 days, several secondary tests would be applied to different scenarios when determining tax residency and these tests are designed to be simpler and less subjective than the existing residency tests that depend to a large extent on case law and ATO interpretation and can be difficult for taxpayers to apply.
Secondary tests
A key element of the secondary tests is a 45-day threshold. This assumes that individuals who have been here for fewer than 45 days will in most cases be non-resident, while those present for more than 45 days but fewer than 183 days are more likely to be resident depending on the application of four specific factors: right to reside permanently, Australian family, Australian accommodation, and Australian economic interests.
This replaces the existing more subjective test requiring an examination of all relevant facts, which it can be argued is still more appropriate.
Some have suggested that a 45-day threshold is too low and that it may catch too many individuals whose presence in Australia during the year would not previously have caused them to be treated as a tax resident. In this respect I agree with a submission previously made by the Taxation Institute that a 60-day threshold may be more appropriate and would still achieve the basic policy objective.
Once the 45-day limit is reached an individual will be a resident if they satisfy any two of the four factors. For Australian citizens (such as returning expatriates) or someone who has permanent resident status, this means only one other factor is needed and in most cases the accommodation factor will be enough to deem them to be a resident, with the family and economic interests tests also likely to be satisfied.
It would seem more reasonable for these individuals if the right to reside was put to one side and they were required to meet two of the remaining three factors. Most people would still be treated as residents, but this seems to provide a more reasonable balance.
Ceasing residency
Ceasing residency is more complex as there are multiple different scenarios. The first involves an “overseas employment rule”, whereby if an individual who has been resident for the previous three years takes up overseas employment (but not with an entity related to the individual) for more than two years, has accommodation in the overseas country for the entire period, and spends less than 45 days in Australia in each year of the employment period they will be a non-resident.
There are several assumptions in this rule, but in principle it appears reasonable and does remove some of the current uncertainty as to when a relocation for employment purposes will change tax residency, subject to the above comments as to whether 45 days is an appropriate threshold to use and whether some flexibility may be possible.
Assuming the foreign employment rule does not apply, the next distinction is between ceasing short-term or long-term residency, with short-term defined as less than three consecutive years.
A short-term resident leaving would need to be physically in Australia for fewer than 45 days and also meet fewer than two of the four factors. That is more likely to be possible for “temporary residents” who will have limited ties to Australia after they leave, while Australian citizens or those with PR (who may still be short-term residents if they are returning expats leaving Australia again) will find that much more difficult.
This is no doubt a deliberate policy outcome, but it also discourages skilled and entrepreneurial Australians who have had success overseas from returning if to do so mean that they would become permanently caught in the Australian tax system to an unreasonable degree.
For departing long-term residents the four factors will not need to be applied. Rather, it will be necessary to spend fewer then 45 days in Australia for this year and the previous two income years. This means that Australians moving overseas would need to be overseas for three years before they could change tax residency, unless they fell within the special foreign employment rule. This will make the process more difficult for some individuals and is likely to produce some inequitable outcomes, for example, business owners who will not be taking up external employment.
Double Tax Agreements
Then there is the question of tax residency under the provisions of the Double Tax Agreements (DTAs) that Australia has with more than 40 countries including covering most of those countries that individuals move to or come from. The “tie-breaker” article in the DTA overrides domestic tax law so that when both countries claim an individual as a resident the DTA will generally apply several tests successively, starting with where they have their “permanent home”, then where they have their “habitual” home, and then where their personal and economic relations are closest (known as the centre of vital interests).
The DTA tests are very similar to the current Australian residency tests and the principles developed through many years of case law, in effect making the proposed amendments redundant in many situations with treaty countries. This also moves away from the stated principles of simplicity and certainty in the sense that individuals may have different outcomes depending on whether or not the other country involved has a DTA with Australia.
Finally, there will need to be transitional provisions to deal with the fact that individuals have already assessed their residency based on the existing law and these have yet to be spelt out.
Challenges and consultation
In summary, while the process of reviewing and updating Australia’s tax residency tests is welcome and long overdue, as is often the case the devil is in the detail. The key challenges will be meeting the stated policy aims while also actually providing a certain and equitable outcome in at least the vast majority of situations and achieving outcomes that are generally consistent with the terms of Australia’s DTA’s to avoid the domestic law being overridden by the DTA.
It will also be critical that the government engages in productive discussions during the consultation process with the professional accounting and tax bodies and other interested parties with the aim of implementing new rules that meet the design principles outlined above that are also practical.
Peter Bembrick is a tax partner at HLB Mann Judd Sydney.
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