Residency reforms a matter of urgency

Residency rules are a fundamental building block for determining how an individual will be taxed in Australia that also carry superannuation implications. For example, there are residency rules for SMSFs for them to remain a complying fund.

Existing Australian individual income tax residency rules have remained largely unchanged since they were introduced in 1930. It is not unexpected, given the current definition of resident was enacted over 80 years ago, that the current rules are no longer fit for purpose, which has the potential to undermine the integrity of the income tax system. The global environment has changed significantly and the residency rules no longer reflect modern work patterns in Australia, nor have they kept pace with changes in the nature of travel, work practices or the complexity of modern remuneration.

It is generally accepted there are four tests for determining whether an individual is a resident under the current rules:

• residence according to ordinary concepts (or the resides test),
• the domicile and permanent place of abode test,
• the 183-day test, and
• the commonwealth superannuation fund test.

An individual only has to pass one of these tests to be considered a resident of Australia. The level of analysis required is often significant and costly and a basic letter of advice could cost a significant number of individuals many thousands of dollars. This burden is particularly acute given the self-assessment nature of the income tax system in Australia, and the potential for penalty and interest liabilities to arise should an individual incorrectly apply the residency rules.

The Board of Taxation (BOT) has entered the fold by submitting a report to government following its self-initiated review of the individual income tax residency rules. The BOT has in effect laid the groundwork for future possible changes to outdated residency tax rules.

Following an extensive consultation process, it has concluded the existing residency rules are no longer appropriate as the fundamental basis of individual income taxation. The case for change is strong and can be summarised as follows:

1. the rules no longer reflect global work practices in an increasingly global mobile labour force that have changed both the frequency and nature of interactions with the residency rules,
2. they impose an inappropriate compliance burden on many taxpayers with relatively simple affairs as the rules are inherently uncertain to apply, include outdated concepts and rely on a weighting system that leads to inconsistent outcomes, also giving rise to integrity risks, and
3. are an increasingly prevalent area of dispute for taxpayers and the ATO given the fundamental difference in tax consequences for residents and non-residents – this is illustrated by the increased number of court decisions and ATO private rulings issued since 2009.

As an indicator of possible reforms, the BOT made the following recommendations in its report to government:

• the board recommends modernising the residency rules via reconsideration of the underlying policy settings and replacing the residency definition with new, enhanced principles-based rules that focus on certainty, simplicity and integrity,
• the board recommends the government legislate to adopt a policy statement that provides legislative guidance on the parameters of individual residency,
• the board recommends two separate residency tests be adopted, for inbound individuals and outbound individuals respectively,
• the board recommends each residency test begin with a primary bright-line test to remove the facts and circumstances-based tests for the majority of individuals,
• the board recommends a secondary test based on applying the facts and circumstances of an individual against a list of key factors be adopted. A weighting for each of the relevant factors to provide greater certainty and simplicity in determining the outcome warrants consideration,
• the board recommends the new residency test for outbound individuals ensures all residents remain resident unless and until tax residency is established in another jurisdiction, and
• the board recommends the new residency definition not include the superannuation test, which deems an individual is a resident.

The existing law has created a perfect storm of increased costs and reduced efficiency, as well as the potential for anomalous or manipulated outcomes that lead to inequity and reduced integrity.

We will need to wait and see how quickly the government responds to the report and in the meantime we have to live with the inadequacies of the current rules.