This article reprises, the 2021 Federal Budget proposal, to implement the Board of Taxation’s recommendations, to restructure the tax ‘residency’ tests for ‘individuals’, as a precursor for the Law Council’s July 2021 submissions, to Government, about the modifications, to the Board’s recommendations, that are needed (see relevant TT article).

See below for further detail

[Tax Month – July 2021]

 


 

Budget measure — Proposed new individual tax residency rules

As part of the 2021–22 Federal Budget, the Government announced that it will replace the individual tax residency rules with new primary and secondary tests to determine residency, based on the Board of Taxation’s recommendations.

The primary test will be a simple ‘bright line’ test under which a person who is physically present in Australia for 183 days or more in any income year will be an Australian tax resident.

Individuals who do not meet the primary test will be subject to secondary tests that will depend on a combination of physical presence and measurable, objective criteria.

The new tests are proposed to commence from the first income year after Royal Assent of the enabling legislation.

The Budget papers do not contain any further details about the Government’s proposal. But it would assist to follow some of the detail of what the Board recommended and how it got there.

Board of Tax’s Proposed tax ‘residency’ rules for individuals

Australia’s current tax residency rules for individuals are difficult to apply in practice, creating uncertainty and resulting in high compliance costs for individuals and their employers — including the need to seek third-party advice, despite having otherwise simple tax affairs.

In May 2016, the Board of Taxation (the Board) commenced a self-initiated review of the current individual tax residency. In August 2017 the Board presented its findings to Government in its report titled Review of the Income Tax Residency Rules for Individuals (the 2017 Report).

The Board concluded that the current individual tax residency rules are no longer appropriate and require modernisation and simplification. In particular, the current rules do not reflect global work practices, and impose an inappropriate compliance burden on many taxpayers in all but the simplest of cases — this has led to increased uncertainty and disputes. In addition, the Board identified a number of integrity concerns that arise due to the way in which the current rules operate.

Boards observations about existing ‘residency’ rules for individuals

Some of the Board’s key observations were:

  • In the over 80 years since the residency rules were introduced, there has been considerable advancement in the way in which individuals work, travel and live, and much change in the global income tax system.
  • Some aspects of the rules are outdated and require reconsideration. For example, the concept of domicile, based on a fundamental attachment to a single country, reflects the limited access to high speed travel of that time and the limited capacity for individuals to move between countries on short notice at affordable prices. The concept of domicile is no longer appropriate in the modern day context.
  • The complexity of the rules means that a variety of reasonably arguable positions are open to taxpayers.
  • There is no clear overarching policy statement for which individual residency represents — this absence leads to uncertainty as to whether the consequences in any given situation are intended or unintended, and to uncertainty in application of the rules.
  • Advisers find that providing definitive advice is difficult, and requires significant resources at a substantial cost to the taxpayer. This is supported by a significant trend of increased engagement with the ATO since 2009.
  • There is an absence of recent guidance to provide clarity. Key ATO material has not been materially updated since the 1990s for modern work and life patterns. Other ATO website guidance is ambiguous and not binding on the Commissioner.
  • Individuals might seek to manipulate their residency status through a number of known integrity issues.
  • An integrity concern arises where an outbound individual is no longer a resident but not legally qualifying for residency under another country’s tax law — i.e. a ‘resident of nowhere’.
  • The superannuation test no longer meets its objective to treat all Commonwealth officials as residents — the two Commonwealth superannuation schemes are now closed to new members and the Commonwealth no longer obliges officials to join its superannuation funds.
2017 – Board recommends ‘two step’ model

The Board recommended that the Government replace the current rules with an improved and simplified residency test based on a ‘two-step’ model —

  1. a simple bright-line test followed by
  2. a more detailed analysis in more complex cases.
2018 – Board’s further brief and consultations

Before taking a position on the 2017 Report, the Government asked the Board to undertake further consultation on its key recommendations. The Board undertook consultation in late 2018. The Board released its report titled Review of the Income Tax Residency Rules for Individuals: Consultation Guide in September 2018 (2018 Consultation Guide), outlining a series of design principles aimed at developing new residency rules, with a particular focus on the following:

  • options for a two-step model for individual tax residency;
  • integrity risks to circumvent existing residency rules (e.g. ‘residents of nowhere’);
  • options to replace the ‘superannuation test’.
2019 Final Report – ‘refocus’ of rules for individuals

After further consultation, the Board submitted its final report to Government titled Reforming individual tax residency rules — a model for modernisation (the Final Report) in March 2019 in which it set out a model for simplifying and modernising the current individual residency rules.

The Board has developed proposed rules to re-focus tax residency in three critical ways:

  • making physical presence the primary measure of residency — moving Australia to closer alignment with international practice;
  • focusing on Australian connections — providing that two individuals with identical physical presence and other connections to Australia should be treated the same;
  • adopting only objective criteria — removing any requirement to test intention or undertake broad, holistic examinations to promote simplicity, consistency and certainty.

The proposed model is intended to:

  • lead to more certain outcomes;
  • maintain existing outcomes (in a streamlined and simplified way) where appropriate in order to minimise disruption and revenue implications.
The ‘current four tests’ of individual residency and the Board’s proposed changes

Under current law, the definition of ‘resident or resident of Australia’ in s. 6(1) of the ITAA 1936 includes an individual who is a resident under ordinary concepts as well as an individual who is resident under one of three statutory tests.

The Final Report summarises the four residency tests and the Board’s proposals as follows:

Source: Board of Taxation, Reforming individual tax residency rules —
A model for modernisation, Table 1, page 112

Board of Taxation: Proposed residency rules flowchart

Source: Board of Taxation, Reforming individual tax residency rules —
A model for modernisation, page 17-18

ATO guidance on existing residency rules

  • The ATO fact sheet Your tax residency provides general guidance on the residency tests.
  • The ATO fact sheet Residency and source of income sets out the ATO’s guidance in relation to individual residency issues which arise as a result of COVID-19 international travel restrictions.

[Source: Tax Banter – 2020 Budget proposal to change the ‘residency’ tests for ‘individuals’]

 

About the author