Key tax law concepts

Whether an individual is a ‘resident’ for Australian income tax purposes is, ultimately, a question of fact based on an individual's connection to Australia. Broadly, an individual will be a ‘resident’ where they satisfy any one of the following four tests:

1. Resides test
2. Domicile test
3. 183-day test, and
4. The Commonwealth superannuation test.

The Board of Taxation in its 2019 report "Individual Tax Residency Rules – a model for modernisation”, recommended the tests for individual tax residency be simplified into a simple “bright line” test to address the inherent uncertainty present in a nuanced multi-factorial test in the context of a modern global workforce. Treasury released a consultation paper in July 2023 inviting industry consultation on the proposed reform of individual tax residency. However, as at the time of writing, Treasury has not released any exposure draft legislation outlining the legislation to implement the proposed reform such that the four individual tax residency tests above remain the current law.

In June 2023, the ATO released updated guidance on the four residency tests for individuals in Taxation Ruling TR 2023/1, which largely summarises the case law developed to date.  

Currently, a company will be an Australian tax resident where:

• It is incorporated in Australia, or
• If it is a foreign incorporated company, carries on a business in Australia and either:
  • has its central management and control (CMC) in Australia, or
  • its voting power is controlled by shareholders who are Australian residents.

In the 2016 decision of Bywater,^[1] the High Court adopted a broader interpretation of the requirement to carry on a business and have central management and control in Australia. Companies with individual directors physically present in Australia participating in the decision-making process of the company, are at greater risk of being considered to be carrying on a business in Australia, and so be an Australian tax resident.

The ATO published PCG 2018/9 to clarify its view on the corporate residency tests after the Bywater decision and has adopted a compliance approach for foreign incorporated companies relying on the old law.

An outgoing on revenue account may be deductible upfront but if treated on capital account may be dealt with under the capital gains tax (CGT) regime, deductible over a period of time or give rise to a capital loss.

Different categories of tax losses can only be applied against particular categories of assessable income. Importantly, capital losses cannot be applied against revenue gains.

The CGT regime provides a number of concessions to gains on capital account (such as the CGT discount) that are not available for revenue gains. As such, a capital gain may result in a lower tax liability for the taxpayer as opposed to a revenue gain via the application of relevant concessions, if available.

Generally, non-resident entities will not be subject to tax on capital gains unless the gain is sourced from a transaction involving Australian real property or an interest in a company or trust which, in turn, holds an interest in Australian real property.

Where a listed public company undertakes an off-market share buy-back or selective share capital reduction on or after 25 October 2022, new laws apply which:

• prevent part of the purchase price for an off-market share buy-back or selective share capital reduction from being taken to be a dividend (effectively making it unfrankable), and
• make the distributions paid as consideration for a selective share capital reduction unfrankable.

The result is that shareholders who participate in such an off-market share buy-back will only realise a gain or loss from the sale of the share.

Though no part of the purchase price is taken to be a dividend, listed public companies that undertake an off-market share buy-back must debit their franking account to the extent the buy-back price is not debited to the company’s share capital account effectively wasting franking credits.

Distributions made by a company on or after 28 November 2023 which are directly or indirectly funded by capital raising activities that result in the issue of new equity securities will be “unfrankable” (i.e. no franking credits can be attached to these distributions). The denial of franking credits applies to a distribution if the capital raising, funds at least a substantial part of the distribution (rather than any part of the distribution). If the provisions apply, only the portion of the distribution that is funded by the capital raising will be unfrankable.

Generally, non-resident taxpayers will only be subject to Australian CGT made on the disposal of ‘Taxable Australian Property’ (TAP), subject to the applicable DTA. TAP includes a direct or indirect real property interest, such as mining, quarrying or prospecting rights. An indirect real property interest is where the non-resident taxpayer holds 10% or more ‘participation interest’ in a company or trust, where the underlying market value of the assets is comprised of 50% or more of Australian real property. If the capital gain is subject to tax, no CGT discount is available. However, in light of the recent Federal Court decision of Greensill caution should be had where non-resident beneficiaries of Australian discretionary trusts receive capital gains in relation to non-TAP assets.

In that case, the Federal Court was required to consider the complex interaction of Australia’s taxation laws as they apply to trusts and individuals, as well as specific deeming provisions. The key question was whether the non-resident taxpayer was entitled to disregard a capital gain arising from non-TAP assets held by the Australian resident discretionary trust. The Federal Court held the paramountcy of the legislative texts above all other policy considerations in deciding that the non-resident beneficiary would be taxable on the capital gain, even though, if they had held the relevant non-TAP asset directly they would have been entitled to disregard the capital gain as it did not result from the disposal of TAP. The case serves as an example of the complexity of Australia’s tax laws.­

As part of the 2024-25 Federal Budget, the Government announced proposed changes to the application of Australia’s CGT regime to non-resident taxpayers including changes to:

• clarify and broaden the types of assets that non-residents are subject to CGT
• amend the point-in-time principal asset test to a 365-day testing period, and
• require non-residents disposing of shares and other membership interests exceeding $20 million in value to notify the ATO, prior to the transaction being executed.

The Government has announced that it will consult on the implementation of this measure, with more details and draft legislation to be expected.

Where the eligibility requirements are satisfied, Australian resident individuals and trusts may reduce their capital gains by 50%, and complying superannuation funds may reduce their capital gains by 33%. Companies cannot access any discount on capital gains, and the CGT discount is not applicable to all CGT events.

There are multiple integrity provisions under the CGT regime. A common integrity provision is the ‘market value substitution rule’, which applies to CGT events when the parties are not dealing with each other on arm’s length terms. The effect is that for the purposes of calculating any CGT liability, the proceeds received by the vendor are replaced by the market value of the asset, and the purchaser receives the market value as the asset’s cost base going forward.

There are several ‘rollover’ provisions under the CGT regime that enables CGT to be deferred or disregarded in particular circumstances. For example, rollover relief may be available when shares in a company are exchanged for shares in another company or units in a unit trust are exchanged for units in another unit trust.