Harding and tax residency – High Court dismisses residency appeal

The High Court has refused Special Leave for the ATO to appeal the decision of the Full Federal Court in Harding v Commissioner of Tax [2019] FCAFC 29.

This creates legal certainty that a “permanent place of abode” outside of Australia is by reference to the wider location of a country, and is not narrowly limited to a single unit of accommodation.

For the first time, long-term residents in other countries can organise their accommodation within a country without fear that the ATO will consider successive homes to be an indicator of inpermanence when applying the test of a permanent abode.

As this test is only one of four tests of tax residency, living long-term in another country does not guarantee a person has broken tax residency of Australia. However, the decision in Harding provides clarity for this particular test.

Loss of the main residence exemption for foreign-resident owners? Or not?

The 2017 Australian Federal Budget announced that the exemption from tax on capital gains on a person’s main residence would no longer be available for residences sold after the owner had become a foreign resident. This change, as drafted in Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018, would apply to the whole ownership, without pro-rating an exemption for the period of occupancy. Given the large increases in much Australian residential property, large taxable gains are likely for many.

Under the bill, the exemption remains in place if an expat resumes tax residency prior sale of the property and provides transitional provisions to enable existing foreign-resident owners to sell before 30 June 2019 without losing the exemption. However, whether this change will become law is unknown as the bill has remained before the Senate since March 2018.

Progress of this bill would be welcomed to provide certainty for those currently non-resident who may wish to sell their former homes before mid-2019 but would not do so if this bill does not proceed.

Business innovation, operations and tax

Business innovation is essential for generating revenue into the future, for without revenue, a company is not a business. Tax minimisation and cost cutting are irrelevant for obsolete businesses.

Companies are increasingly short-lived. Over the last 50 years, the average lifespan of S&P 500 companies has reduced from 60 years to about 18 years.[1] The nature of business itself is rapidly changing. It is projected that 40% of current jobs in Australia will disappear in the next 15 years due to automation.[2]

Electronic commerce has increased access to foreign markets and brought foreign competition, often with lower cost structures. Many Australian businesses have offshored costs to bring them into line with competitors. There has been increased focus on tax efficiency, with internet-based ordering and delivery enabling many businesses to sell globally while avoiding international tax issues.

Vision and adaptability will lead to your business being commercially relevant into the future. Investment in evolving the business is ideally supported by networks, legal protections and commercialisation assistance.

A base in another country may provide a great platform for later access to other markets. Moving into a lower-taxed country may enable greater reinvestment into developing the future of the business. However, selecting a market on tax-efficiency alone may leave you short changed when the wider context of value creation and support are considered. Consider what else a country offers for your business to thrive:

  • Strategic and trusted networks to mitigate the risks of operating in new territories.
  • A workforce that adds value to the business and the state of industrial relations
  • A marketplace that is an adopter of new ideas and products
  • Legal protections, business ethics and levels of corruption
  • Ability to obtain finance and credit
  • Acceptance of foreign ownership
  • Government support for your industry, including grants, tax concessions and their eligibility criteria.

With new opportunities come new risks. Before you start foreign operations, planning and knowing whether a market exit would be difficult – should risks come to fruition – will help you to decide whether they are risks you are willing to take.

At one level, tax is a cost of doing business. However, it also creates much administration, and absorbs management time and money, especially if a tax dispute arises. International tax compliance can be a disproportionately high cost for smaller business, such as transfer pricing compliance, which is required when there are transactions with related parties in other countries. Evaluate the total cost of tax and its administration, not merely the headline tax rate.

Your type of business and the way you go about it can affect where and how you are taxed. For example:

  • How does setting up an office or shop compare with using agents to make sales?
  • Should you set up a factory overseas or use a contract manufacturer?
  • Should you sell software, sell a license to use it, or offer a service which utilises the software for commercial advantage?
  • What mix of debt and equity should be put into a foreign subsidiary?

The answers to how these factors alter after-tax profits will vary for each business, and will include other commercial and regulatory considerations. Optimal market engagement may require methods that are not highly tax efficient but if a method expands revenue and after-tax profits, strict adherence to purely tax-effective strategies may be questionable.

Many tax questions need answers quick enough for commercial negotiations. The answers are imperative to control tax costs and profit margins. Each country has its own different tax rules. Assumption is highly risky.

Having long-term plans for the business and its exit strategy enables pathways to be developed early on. The pathways put down for developing and selling a business may be different to shaping a business intended to attract larger investors to fund expansion.

Knowledge of what triggers tax helps an enterprise understand how its international operations affect where it pays tax, how and when. However, where tax minimisation draws necessary resources away from optimising the commercial offering or exposes the business to unaffordable risks, it may be the undoing of the value proposition and the ability to thrive.

[1] https://hbr.org/2014/04/the-art-of-corporate-endurance

[2] http://theconversation.com/australia-must-prepare-for-massive-job-losses-due-to-automation-43321 “Australia’s future workforce? June 2015”, Committee for Economic Development of Australia.

 

Copyright © 2015 Tax Scope

Foreign resident CGT withholding tax now law

Buyers of capital gains tax assets must now withhold 10% of the consideration paid to buy the property and pay it to the Australian Taxation Office (ATO) if the seller is, or is ‘reasonably believed’ to be, a foreign resident. This requirement is effective from 26/2/2016.

Which sales are affected?

Withholding tax applies to “Taxable Australian Property” with a market value of more than $2m including:

  • Sales of real property situated in Australia (including residential property); and
  • Sale of indirect interests, such as shares, where at least 50% if the value is attributable to real property or mining interests for resources located in Australia, except where the interests are officially listed on and sold through a stock exchange.

The sale of businesses that are Taxable Australian Property will also be affected, adding further tax complexity to earn out arrangements.

Transactions excluded from this include those:

  • conducted on an approved stock exchange
  • as part of the administration of insolvency and bankruptcy matters

Discretion to vary the amount withheld

The Commissioner issue  may exercise discretion to reduce the amount which must be withheld, such as where secured creditors are entitled to more than 90% of the proceeds. The discretion must be applied for and is not guaranteed. Secured creditors also have the right to request exercise of the Commissioner’s discretion.

The withholding tax would be a non-final tax, which would be refundable on the lodgement of a tax return by the seller for the transaction should it exceed the tax liability.

Who is impacted?

Buyers must withhold the tax where they have not received a declaration of residence from the vendor and do not have reasonable knowledge of the vendor’s Australian residency. Failure to withhold can result in the buyer becoming liable for the amount personally.

Sellers who are Australian residents should provide a declaration of their residency or obtain a clearance certificate from the ATO to facilitate a smooth settlement without withholding tax. Non-residents can expect the amount to be withheld and must lodge an Australian income tax for final assessment of the tax owed, with the balance either payable or refundable. The time lag between the settlement and when you can lodge a tax return may adversely affect cash flow.

Secured creditors can apply to the ATO (as can vendors and purchasers) for a variation to the withholding tax so that their interest can be recovered on sale of the asset.

Unsecured creditors may have no right of recovery. Anyone with a right should register their interest on the Personal Property Security Register.

What to do now

For more information on whether you need to withhold tax on a purchase, if you need assistance with your tax residency status, or to find what you need to do to comply with the rules and eligibility for exemptions and discretions, please contact us for assistance.

Copyright © 2015 Tax Scope