Tax White Paper Task Force

- 1 -

1 June 2015

Tax White Paper Task Force

The Treasury

Langton Crescent

PARKES ACT 2600

Submitted online via

Dear Sir / Madam

Submission - Response to Re:think Tax Discussion Paper

We at Chapman Eastway are thankful to Treasury for the opportunity to express our interest in tax reform, and for the opportunity to represent our clients as part of the process.Established in 1897, Chapman Eastway has a 118 year history of partnering closely with our clients to achieve their goals and aspirations.

Our client base is diverse, both in industry spread and geographical location. It entails a wide range of industries and sectors, from primary producers to financial services providers, from family businesses to not-for-profit and philanthropic organisations. We service a range of entities mostly in the small to medium enterprisespace, including ultra-high net worth families and individuals, companies, self-managed superannuation funds, partnerships, and trusts.

In our experience and expertise, we have observed that there are various ways that the Australian taxation system may be simplified for various taxpayers and indeed for the Australian population as a whole.

In this respect, we have approached our submission with a clear goal in mind: "Lower, simpler, fairer." Our vision and objectives are very much aligned with that of Treasury.

Our submission focuses on addressing:

• Individual tax residency; and
• Administration of our tax system.

In particular, we refer to the questions posed within the Re:think Tax Discussion Paper dated March 2015 (at pp193-196 of the Paper), and draw your attention to the fact that our submission relates to the following:

4. To what extent should reducing complexity be a priority for tax reform?

6. What should our individuals income tax system look like and why?

56. What parts of Australia’s tax system, and which groups of taxpayers, are most affected by complexity? What are the main causes of complexity?

60. What processes or systems currently being used by businesses and individuals could the ATO better utilise to lower the compliance costs of the tax system?

Please find enclosed our submission in response to the Tax Discussion Paper (12 pages in total, including this page).

Should you have any queries regarding this submission, please contact Guy Grinham or Judy Tse on (02) 9262 4933, or via email: or .

Yours faithfully

Chapman Eastway

Guy Grinham

Principal

Encl

Submission - Response to Re:think Tax Discussion Paper

1 June 2015

Background

In the 2014 income year, Australia saw 2,033,800 incoming immigrants and 1,075,400 outgoing migrants, resulting in a net increase of 958,400 people from migration alone. Similarly, the 2013 income year saw a net increase of 955,100 peoplefrom migration.

In the 2013 income year, 12.3 million individual income tax returns were lodgedwith the Australian Taxation Office (“ATO”), raising approximately $159,800 million in revenue for our government. This is expected to increase to $174,500 million for the 2014 income year.

We note that 70% of these 2013 income tax returns were lodged by a registered tax agent, with a mere 21% of individual taxpayers using the ATO’s E-Tax software to manage their own tax affairs.

The statistics suggest that our current individual tax compliance system is complex, and indeed may be too complicated for non-tax professionals. We propose that our tax system be simplified so as to encourage and foster timely and accurate compliance with our tax laws, and by a greater proportion of the Australian population.

When we consider that revenue raised from individual taxpayers comprises almost half of revenue for ourgovernment every year at 47% (as compared to 22.6% in company and resource rent taxes)it follows that there are significant benefits to be reaped from investing in improving our tax system with a special focus on individual taxpayers. We want our system to welcome more new taxpayers, to increase the level and accessibility ofeducation provided to taxpayers about our system, and to make it a simpler and fairer system for all involved.

As such, our system needs to operate in a way which encourages a culture of compliance, seeks to treat taxpayers equitably, and makes it easy for taxpayers to comply so as to aide the efficient collection of revenue and reduce the costs incurred in this regard.

In particular, due to the vast growth of peopleboth moving to Australia and moving from Australia overseas, the determination of tax residency status of each individual taxpayer continues to be of critical importance. Importantly, tax residency has the responsibility of directing what income and gains are taxable for each individual taxpayer and therefore the extent of their tax filing and payment obligations. Put another way, one could argue that Australia’s entire tax system is based on the concepts of residence and source.

Key Issues with our Current Residency Tests

S6(1) Income Tax Assessment Act 1936 (Cth) provides for four tests to determine if an individual is a resident of Australia for income tax purposes, as follows:

1)Residence according to ordinary concepts;

2)Domicile and permanent place of abode test;

3)183 day and usual place of abode test; and

4)Commonwealth Superannuation fund test.

Equality

Three of these four tests (with the exception of the Commonwealth Superannuation fund test) are ultimately based on a weighing of individual facts and circumstances. It follows that there can be a great degree of subjectivity when applying these tests. Moreover, it is very possible that persons with generally similar fact patterns are regarded as holding different Australian tax residency statuses due to minor and/or immaterial variations totheir facts and circumstances.

For example, the cases of Sneddon v Federal Commissioner of Taxation [2012] AATA 516 and Dempsey v Federal Commissioner of Taxation [2014] AATA 335 demonstrate that there were many similarities between the facts of the two taxpayers including number of days spent in Australia, accommodation provided by their employer for their exclusive use, salary being received in their Australian bank accounts and property, mortgage and personal items remaining in Australia. It would be logical to conclude that the facts of the two cases are sufficiently similar so as to give rise to the same residency result.

And yet, this was not the result as the taxpayer in Sneddon was held to be resident while the taxpayer in Dempsey was held to be foreign resident.

This raises real concerns of why individuals with substantively similar facts and circumstances should hold different residency statuses, as residency plays a critical role in determining what items of income and gains are subject to tax in Australia, as well as the tax rates applicable thereon.

Simplicity

Another issue with the current residency tests is the heavy and complex compliance burden imposed on individual taxpayers and also on the tax authorities and judicial system. In an effort to comply with the rules which are far from simple, the burden and costs are high due to the factthateach determination of individualtax residency generally depends on a consideration of all personal facts and circumstances. This means that the vast majority of taxpayers cannot simply use an objective checklist-type approach to determine their residency status, and have the confidence that they can rely on this with an appropriate degree of certainty that it will not be challenged or overturned by the ATO.

The current complexities in our system inevitably give rise to ambiguity, as well as excessive (and what should be avoidable) government costs for residency related disputes between the Commissioner and individual taxpayers.We believe that these costs could be much better spent in proactively investing for the future, and focussing on addressing more complex tax matters.

Moreover, significant compliance costs are incurred at both the individual employee and employer levels. Often employers who are required to withhold tax at differing levels depending upon the residency status of the employee are ignorant or ill-informed of their obligations, and/or incur additional compliance and administration costs at the expense of their income generating business activities.

Certainty

Current legislation, ATO rulings and guidance, and case law do not operate coherently so as to allow taxpayers to draw clear and helpful conclusions as to what their residency position may be, when either migrating into Australia or moving from Australia overseas.

The current ‘case by case’ approach to residency typically requires those moving to or departing Australia to seek out specialist tax advice and assistance to determine their residency, as well as to help them meet the corresponding tax filing and paying obligations.

The complexity of Australia’s tax laws are such that they operate as barriers to effective and efficient compliance. This is accentuated by the fact that the level of certainty provided by the current tax laws is generally low, such that for instance a seemingly immaterial change in a taxpayer’s circumstances has potential to give rise to an adverse change in their tax residency, and therefore radically change the tax outcomes of their circumstances.

The system as it currently operates has real potential to foster a culture of non-compliance. Accordingly given the current opportunity for reform, it is time to undertake a comprehensive review of our residency tests as relating to individual taxpayers, with the objective of making them “lower, simpler, fairer” within the wider context of our tax system.

Individual Tax Residency – Inbound

In view of the above we turn to focus on the residency tests as they apply to foreign nationals moving to Australia (the ‘inbound’ scenario).

We note the residency tests that particularly relate to foreigners moving to Australia are the ordinary concepts test and 183 day test (tests 1 and 3 respectively).

In an increasingly digitised and globalised economy, it is critical that Australia urgently revisit and review its individual tax residency laws so as to assess the extent to which our current laws facilitate (or inhibit) the mobility of talent and capital into Australia. Where we identify gaps and areas for improvement, they need to be addressed proactively.

We recommend that the following reforms be considered to help enhance the equity, efficiency and simplicity of the individual tax system with respect to residency status notably by a greater reliance on objective tests and measures.

Recommendation 1–Our domestic tax law should include a ‘de minimis’ exemption so that those individuals physically in Australia for a period less than for instance, 45 days are specifically exempt fromAustralian income tax (and any related tax filing obligations).

Under the current tax law, foreign residents earning Australian source income are taxed on that income and are required to lodge annual income tax returns. This responsibility is imposed and enforceable on any foreign resident, irrespective of the duration of their stay or the scale of their Australian source earnings. The imposition of such strict administrative obligations on short term visitors could have an adverse impact of deterring inbound work travel, thereby limiting the associated economic benefits this injection of talent would otherwise bring to our economy. The ‘de minimis’ exemption would be consistent with the exemption currently offered by various other jurisdictions, particularly within the Asia-Pacific region, and make Australia a more attractive place for global short term labour.

Recommendation 2 – 183 day test (test 3) should not be qualified by the ‘usual place of abode’ criteria.

A test based on objective information such as a physical presence test (ie, based on days count) is simple to applyand could provide greater certainty for individual taxpayers who need to determine their residency, as well as for individuals seeking to visit Australia and needing information on their expected Australian tax obligations. The test could instead be reworded to the effect that where an individual is ‘present in Australia for at least 183 days in a rolling 12 month’ period, then they will be regarded as resident of Australia for tax purposes. This would be consistent with the corresponding New Zealand tax laws.

The tax laws could be structured such that residence based on physical presence only is limited to the first two years that an individual taxpayerlodges their Australian income tax returns.

For instance, we could create an integrity rule for individual taxpayers who have already lodged two income tax returns, whereby it captures taxpayers who seek tospend less than 183 days in Australia over the rolling 12 month period, where they would otherwise not meet the criteria to be regarded as resident. Here we could introduce an additional test which they need to meet – for instance, taking into account a taxpayer’s physical presence in prior income years as well as their physical presence in the current income year.

Recommendation 3 - Tax concessions could be introduced for individuals who file their first two income tax returns as tax residents.

The existence of a tax concession specifically for new residents is likely to incentivise foreign nationals to seek residency in Australia and to correctly disclose their residency status in their income tax returns. For instance, the concession could be calculated as a fixed percentage on the individual’s taxliability and it would be easy to apply and calculate.

To further simplify this particular concession, a blanket non-refundable tax offset could alternatively be applied for the first two income tax returns that an individual lodges as a resident.

Alternatively, we could limit the operation of the temporary resident regime currently available to certain temporary visa holders, to a maximum two year period. That is, for the first two income tax returns that an individual lodges as a resident, they would be assessable on employment income from all sources globally, and only Australian source investment income (ie, per the current temporary resident provisions).

The current temporary resident concessions give rise to issues of inequality whereby it is possible for two taxpayers with substantively similar facts and circumstances to hold different residency statuses (ie, one as a resident and one as a temporary resident), simply due to differences in the type of visa that they each hold. As an example, we refer to the Special Category visa (subclass 444) held by certain New Zealand nationals, which renders them eligible for the temporary resident concessions. However this visa also allows them to access certain benefits which would otherwise be limited only to Australian nationals, thereby raising into question why such tax concessions should exist for these visa holders. The change to a maximum two year period would have the effect of alleviating any such issues of inequality.

Individual Tax Residency – Outbound

We now turn to consider the residency tests as they apply to Australian residents moving overseas (the ‘outbound’ scenario).

We note that the residency tests of particular relevance here are the ordinary concepts test, domicile, and Commonwealth Superannuation fund tests (tests 1, 2 and 4 respectively). The Commonwealth Superannuation test (test 4) is by its nature an objective test and so will not be specifically considered here.

We have chosen to focus on the ordinary concepts and domiciletests (tests 1 and 2 respectively), both of which entail a high degree of subjective interpretation and determination as evidenced by ATO rulings such as Taxation RulingIT 2650, and case law. In particular, recent decisions handed down by the courts point to the fact that our residency tax laws are difficult to apply with certainty,particularly in light of the increasing prominence of a truly global labourforce and marketplace. By the same token, whether the relevant tax laws themselves are outdated is also called into question.

We maintain that a comprehensive review of the residency tests as relating to outbounds will importantly contribute to the objective of having a “lower, simpler, fairer” tax system. The consequences of such a system include greater rates of accurate and timely compliance, and more efficient revenue raising.

Recommendation 4 – the ordinary concepts and domicile tests could be simplified through the introduction of more objective criteria, and a lesser emphasis on subjective factors such as the concept of ‘permanent place of abode’ and the intention to eventually return to Australia on a permanent basis.

One area of concern is the concept of permanent place of abode; it is not easyto apply despite its seemingly straightforward ordinary meaning. In Federal Commissioner of Taxation v Applegate [79 ATC 4307], the leading case on this concept, it was held that a permanent place of abode does not have be everlasting or forever. However it does need to be more than a temporary or transitory place of abode.

And yet, as the world continues to shrink through globalisation and advancement of technology, it is not difficult to see that the establishment of what the ATO or courts might regard as a permanent place of abode could in many scenarios be difficult – for instance, consider an Australian national who moves to Singapore for work purposes, and who returns to Australia for one weekend a month to see his family members who continue to live here. Under the current tax laws, it is unlikely that he would be regarded as having established a permanent place of abode overseas.

There is opportunity tocreate greater certainty for such individuals (of which the pool is rapidly growing) by ensuring that both the ordinary concepts and domicile tests are simplified. This equips them to make a reasonable and confident determination of their Australian tax residency and therefore what income and gains are reportable and taxable in their income tax returns.

The intention to return to Australia indefinitely (at some point after permanent departure) is one factor that should be given less weight when determining an individual’s tax residency. Australia is a country which many nationals choose to return to after a period/s of living overseas. The economic, social, cultural and physical environment and other favourable factors including climate, personal freedoms and relaxed lifestyle contribute to make Australia an extremely desirable location to live, as evidenced through the large numbers of inbound migrants. With this in mind, where Australian nationals move overseas but provide evidence that they intend on returning to reside in the future (eg, by not selling their home or assets in Australia in the meantime), we should not rely on such an intention to deem them to fail the ordinary concepts or domicile tests and thereby continue regarding them as residents.