Tax Residency And Capital Gain Taxation: Analysis Of An Australian Company

Three Tests for Determining Tax Residency in Australia

All the director’s meetings are held in Singapore and the annual general meeting is held in Monaco. The company’s main business is shipping containers between Sydney and Africa, via Singapore. The contracts are signed in Sydney on behalf of the company by Elwood.

The company has a rotating Managing Director with the role changing every three months between the directors. The shares are held only by the directors and are held in equal proportion.

Elwood has started a business outside Australia. The business primarily deals with international shipping and has 4 directors out of which three reside outside Australia and one in Australia i.e Mr. Elwood himself. Further, the board meeting of the company take place outside Australia and AGM in Monaco. The company is facing issue regarding recognition of residency for tax purpose in Australia.

In this regard, reference may be had to section 6-5(2) of Australian Income Tax Assessment Act, 1997 where in it has been stated that for a company resident in Australia in terms of section

Section 6(1) para b shall pay tax on their pan world income in Australia. Further, in terms of Section 6(1) para (b) three tests have been defined for determining tax residency. (Commonwealth Consolidated Acts, n.d.) The three tests are:

• Incorporation Test;
• Central Management and Control Test;
• Controlling Shareholder Test.

If any of the aforesaid test are satisfied than the company shall be considered tax resident of Australia.

Incorporation Test

For a company to satisfy incorporation test, the company must be incorporated in Australia.

For a company to satisfy this test, the company must carry on business in Australia and has its management and control situated in Australia i.e. situs of all major decision undertaken for the company by its directors shall be in Australia or the major decision are resident of Australia. Further, the place of registered offices and area where real business management activities are undertaken shall lay a decisive role in determining residency. Further, it shall be pertinent to note that both the conditions shall be satisfied simultaneously to be classified as resident in Australia (Common wealth of Australia, n.d.).

For a company to satisfy this test, the company must carry on its operations in Australia and the principal shareholders of the company carrying major voting rights are resident in Australia. It shall be pertinent to note that both conditions must satisfy simultaneously for a company to be declared resident in Australia. (Common wealth of Australia, n.d.)

In the present circumstance, the company is incorporated in Singapore, hence the said test is failed. Further, the company consist of 4 directors out of which three are non –resident directors and majority of board meeting of the company takes place in Monaco which is outside Australia. However, majority of the operations of the company are carried overseas between Sydney and Africa. Since the majority of the meeting and the director of the companies are outside Australia, the company fails Central Management Test. (Common wealth of Australia, n.d.)

Analysis of the Company’s Tax Residency Status

Further, w.r.t the third test Mr. Elwood has started the business and is assumed that he is the major shareholder of the company and he is tax resident of Australia. Further, it shall be pertinent to note that the business of the company is in Australia as majority of the contracts of the company are signed in Australia and in substance taken in Australia.

The company is tax resident of Australia in terms of third test i.e. Shareholding Test and accordingly pan income of the company shall be taxable in terms of Section 6 of Income Tax Assessment Act, 1997.

A car he bought 3 years ago for $65 000 and was used solely for his personal use was sold for $25 000. The book value of the car is $27500

In the said case, Elwood has sold his car used for personal use. The said car has not been used for official purpose. Further, the same shall not be chargeable to tax as the asset quality for personal asset and personal asset are not chargeable to Capital Gain Tax in Australia, if the acquisition cost of the same is less than AUD 10,000/- or less in terms of Section 118-10(3) of Australian Income Tax Assessment Act,1997.

Thus, the gained earned on disposition shall be chargeable to tax interms of Section 102-20 of Australian Income Tax Assessment Act, 1997. And the tax amount shall be computed by discounting method in terms of Section 115-A of ITAA, 1997. Thus, the taxable income  of the Elwood shall be:

Vacant land sold in June 2018 for $200,000 that had been bought by him on 21/3/1984 for $20,000. This is being paid in 10 instalments of $20 000, however the purchaser has declared bankruptcy and the last two instalments due next financial year will not be paid.

In the said case land has been acquired before 20^th September, 1985 and shall not be eligible for taxation under Capital Gain Taxation regime. Further, the same shall be exempt from taxability.

10,000 shares in ABC Ltd sold in February 2017 for a total sale price of $175,000. Elwood bought all the shares for long term investment purposes during November and December 1994 at a total cost of $80,000.

In the said case, Elwood has purchased certain shares in November and December, 1994 and disposed off the same in the current year leading to rise of a Capital Gain Tax event in terms of Section 102-20  and Section 104-10(1) of ITAA, 1997. Further, the holding period of the shares exceeded 1 year. Thus, the provisions of subdivision 115-A of ITAA, 1997 shall be applicable as the disposition has been made by an individual with holding period greater than 1 year and the purchase of such asset was made after 20^th September,1985. Accordingly, the taxable income has been worked out here-in-below:

Capital Gain Taxation

An antique sold on 1 May 2018 for $15,000. Elwood bought the antique on 31 December 1989 at a cost of $5,000 for personal reasons.

In terms of Section 118.10 of Income Tax Assessment Act, 1997 disposition of collectibles shall not be liable to capital gain or loss if the cost element of such base does not exceed AUD 500 at the time of purchase. Further, it is stated that if the asset is used both for private and official use then appropriate apportionment should be made. (Commonwealth Consolidated Acts, n.d.) 

In the current scenario, antique sold on 1^st May qualifies for collectible. However, exemption shall not be provided as the cost of acquisition of such asset exceed AUD 500 and disposition of the same shall trigger capital gain tax liability in terms of Section 102-20  and Section 104-10(1) of ITAA, 1997. Further, the holding period of the collectible exceeded 1 year. Thus, the provisions of subdivision 115-A of ITAA, 1997 shall be applicable as the disposition has been made by an individual with holding period greater than 1 year and the purchase of such asset was made after 20^th September,1985.Accordingly, the taxable income has been worked out here-in-below:

Jewellery sold in July 2017 for $5,000. The jewellery was purchased for 29/09/09 for $20,000

In terms of Section 118.10 of Income Tax Assessment Act, 1997 disposition of collectibles shall not be liable to capital gain or loss if the market value of such base does not exceed AUD 500 at the time of acquisition. Further, it is stated that if the asset is used both for private and official use then appropriate apportionment should be made. Further, in case the asset was acquired before 16 December, 1995 then the provision of Section 118-10 of Income Tax (Transitional Provisions) Act, 1997 (Commonwealth consolidation, n.d.) shall apply which are similar to above.

In the current scenario, jewellery sold in July qualifies for special collectible. However, exemption shall not be provided as the market value of acquisition of such asset exceed AUD 500 and disposition of the same shall trigger capital gain tax liability in terms of Section 102-20  and Section 104-10(1) of ITAA, 1997. Further, the holding period of the jewellery exceeded 1 year. Thus, the provisions of subdivision 115-A of ITAA, 1997 shall be applicable as the disposition has been made by an individual with holding period greater than 1 year and the purchase of such asset was made after 20^th September,1985.Accordingly, the taxable income has been worked out here-in-below:

Computation of Taxable Income in Different Scenarios

Shares in XYZ Ltd were sold on 1/10/2017 for $45000. These shares were purchased for long term investment purposes on 31/10/1998 for $41500.

In the said case, Elwood has purchased certain shares in 31/10/1998 and disposed off the same in the current year leading to rise of a Capital Gain Tax event in terms of Section 102-20  and Section 104-10(1) of ITAA, 1997. Further, the holding period of the shares exceeded 1 year. Thus, the provisions of subdivision 115-A of ITAA, 1997 shall be applicable as the disposition has been made by an individual with holding period greater than 1 year and the purchase of such asset was made after 20^th September,1985. Accordingly, the taxable income has been worked out here-in-below:

Elwood has interests in many businesses. One particular business is a clothing store. This store imports a lot of clothing from overseas and is entitled to a concessional rate on the customs duty for a quota (a particular quantity) of protective clothing. However, this protective clothing was not selling well so Elwood sold the quota to another business for $50 000. The value of the quota at purchase 5 years ago was $25 000. Elwood also has to pay an annual fee of $5000 to renew the quota.

In the said case, Elwood has purchased business quota 5 years ago and disposed off the same in the current year leading to rise of a Capital Gain Tax event in terms of Section 102-20  and Section 104-10(1) of ITAA, 1997. Further, the holding period of the shares exceeded 1 year. Thus, the provisions of subdivision 115-A of ITAA, 1997 shall be applicable as the disposition has been made by an individual with holding period greater than 1 year and the purchase of such asset was made after 20^th September,1985. Also, in addition the expenses incurred towards maintain the quota shall also be deducted while computation of capital gain tax or loss. Accordingly, the taxable income has been worked out here-in-below:

Elwood is keenly promoting a car made in Fiji which runs on overproof alcohol. However, the Federal Government has decided this is undesirable and has imposed a new, strict limit on the number of cars which can be imported. Elwood is Fijian and is hopping mad about this. He has launched a media campaign, costing $175 000, attacking this restriction and demanding its removal claiming it is an unfair restriction on his business structure and is undermining freedom of product choice.

Elwood has borrowed a significant amount of money to set up the structure to import the cars, buy and fit out showrooms and provide the after sales support for the cars.

• interest on the loan, amounting to $250 000, will be deductible. He took the loan out after confirmation from both governments the importation could go ahead, however he did not have a showroom at this time. He acquired the showroom before the first cars arrived.
• costs of the media campaign are deductible.

In terms of Division 8 of ITAA, 1997, there are generally two categories of deduction shall be allowed (a) General deduction u/s 8-1 of ITAA, 1997 and (b) Section 8-5  of ITAA ,1997 specific deduction. Further, under section 8-1 there are positive and negative limbs of deduction. In general, ITAA 1997 permits deductions for those expenses that have been incurred for generating assessable income or has been incurred for generating assessable income. Further, a nexus should be established between expenditure and generation of assessable income as laid down in judgement of Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344. (Anon., n.d.)

Further, if the link is remote the same shall not be allowed as deduction. Besides reference may be had to the judgement of Steele v DCT (1999) 197 CLR 459 wherein it was held that interest incurred on loan taken to purchase the property shall be allowed as deduction if the taxpayer could demonstrate that the said expense was incurred to generate assessable income even though the project has been abandoned. (Commonwealth of Australia, 2015) 

In the present case, the expenditure incurred by Elwood was with the intention to generate revenue, hence the said expenditure shall be allowed as deductible expense under ITAA, 1997.

Further, w.r.t the deduction for campaign to protest against the restriction and demanding removal of the same does not have a direct nexus with generation of assessable income and accordingly the same may not be allowed as deduction in terms of above case laws and relevant section and division of ITAA, 1997.

References:

Anon, n.d,Charles Moore and Co (WA) Pty Ltd v Federal Commissioner of Taxation. [Online]
Available at: https://jade.io/j/?a=outline&id=65191
[Accessed 9 September 2018].

Common wealth of Australia, n.d,Residency requirements for companies, corporate limited partnerships and trusts. [Online]
Available at: https://www.ato.gov.au/Business/International-tax-for-business/In-detail/Residency/Residency-requirements-for-companies,-corporate-limited-partnerships-and-trusts/
[Accessed 9 September 2018].

Commonwealth Consolidated Acts, n.d, INCOME TAX ASSESSMENT ACT 1997 – SECT 118.10. [Online]
Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s118.10.html
[Accessed 9 September 2018].

Commonwealth Consolidated Acts, n.d, INCOME TAX ASSESSMENT ACT 1997 – SECT 6.10. [Online]
Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s6.10.html
[Accessed 7 September 2018].

Commonwealth consolidation, n.d, INCOME TAX ASSESSMENT ACT 1997. [Online]
Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s118.10.htmlQuestion
[Accessed 9 September 2018].

Commonwealth of Australia, 2015, Rental Property – timing of deductions. [Online]
Available at: https://law.ato.gov.au/atolaw/view.htm?docid=AID/AID2002364/00001

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