Residency – disputes with the ATO

If you live overseas for a period, you may be a “foreign resident” for Australian tax purposes, even though you are an Australian citizen.  Being a “foreign resident” is often advantageous from an Australian tax perspective because, generally speaking, a foreign resident is not required to pay Australian tax on their overseas income (whereas an “Australian resident” is).

Not surprisingly, then, disputes between taxpayers and the Australian Taxation Office (“ATO”) about whether the taxpayer was a foreign resident or an Australian resident during a particular income year (typically, a year when the taxpayer earned significant overseas income) are common.

You will be a foreign resident for an income year if, during the year:

  • Requirement 1: you were in Australia for less than 183 days (or you had a “usual place of abode” overseas and did not intend to take up residence in Australia);
  • Requirement 2: you did not “reside” in Australia; and
  • Requirement 3: you had a “permanent place of abode outside Australia”.

(This is true for many taxpayers; but for some taxpayers, the requirements will be different.)

You need to satisfy all three requirements to be a foreign resident.  Determining whether you satisfy Requirement 1 is  usually straightforward if you were in Australia for less than 183 days;  it is more complex  if you were in the country for longer.  Determining whether you satisfy Requirements 2 and 3 is often an involved process because there is no “bright line” test for these requirements, ie, the tests are “grey”.  How to satisfy Requirement 2 remains controversial – is it enough to show that you were not physically in Australia; or do you also need to show that you severed your associations with Australia? And to satisfy Requirement 3,  you need to show that you had a dwelling overseas that was your permanent home.  Whether you satisfy Requirements 2 and 3  will likely depend on all your circumstances, including, eg, whether you spent time in Australia – and if so, for how long and for what reasons, the nature of your overseas residence (eg, was it merely a dormitory/barracks or was it something more “home”-like), whether your immediate family lived with you overseas, for how long  you intended to live in the foreign country, for how long  you actually lived in the foreign country, how strong  your connection was with the foreign country, whether you maintained a home in Australia while overseas etc.

But even if you can’t satisfy the three requirements, your foreign income might still be (Australian) tax-free.  If the income was earned in a foreign country with which Australia has a ‘tax treaty’ in place, it may be possible to show that, under the treaty, Australia does not have the right to tax you on the income (because only the other country is permitted to tax you).

If the ATO asserts that you’re required to pay tax on your foreign income, the onus is on you, the taxpayer, to show why the ATO is wrong.  This means that it is up to you to provide the arguments and evidence to convince the ATO.   In our experience, you should aim to provide a clear summary of your circumstances during the relevant income year with supporting evidence, and a considered explanation of how your circumstances compare with the those of taxpayers in relevant Court and Tribunal cases.

Posted in Data matching, For accountants, For taxpayers, foreign source income, Residency

Dividend access shares – interaction with the CGT small business concessions

A private company can issue a special kind of share, called a dividend access share (“DAS”).  Broadly speaking, a DAS is a share that entitles its holder to only very limited rights.  The directors of a company may resolve to pay dividends to DAS holders; otherwise a DAS holder has no right to dividends, and also has no voting rights or rights to surplus assets when the company is wound up.

The existence of a DAS can arguably give rise to various tax and non-tax benefits.  However, it can also cause tax ‘headaches’ in some situations.  In particular, it has generally been thought that the existence of a DAS might prevent a company and/or its shareholders from being able to access to the highly valuable “CGT small business concessions”.

Significantly, in a recent case concerning the sale of shares in a private company that had a DAS on issue, the Administrative Appeals Tribunal (“AAT”) held that the existence of the DAS did not prevent the vendor from accessing the CGT small business concessions.  (As a result, the vendor’s $4.3m gain on sale of the shares was tax-free.)

It is likely that the ATO will not be pleased with the outcome of this case; and will decide to appeal the decision to the Federal Court.

In the meantime, in light of this recent case, any taxpayer who has sold a business or business assets and was denied the benefit of the CGT small business concessions due to the existence of a DAS might want to seek advice about the possibility of challenging their tax bill in respect of the sale.

Posted in General

Money from overseas that the ATO alleges is your “foreign source income”

If a significant sum is transferred to you from overseas, the ATO will be alerted to the transfer and may seek to tax the amount on the basis that it represents income or gains made while you were an Australian resident.  Usually the ATO will give you some warning that it intends to do this and will allow you an opportunity to contact the ATO if you believe the amount is not taxable.  If you don’t contact the ATO within time or you do contact the ATO but, despite your explanation, the ATO is not satisfied that the amount is not taxable, then the ATO may proceed to issue you with an assessment or amended assessment which treats the amount as your income or gains.  Once the assessment is issued you are obliged to pay the amount owed under the assessment.  If you fail to do so, the ATO can take enforcement action, eg, by issuing a garnishee order to your bank or employer.

In order to challenge the ATO’s assessment, you will need to provide the ATO with evidence that the amount you received from overseas is not income or gains you made while you were an Australian resident.  While you would generally need to “lodge an objection” to have an unfavourable assessment overturned, the ATO may tell you that it is sufficient to provide relevant evidence to the ATO (without lodging a formal objection) and that they will overturn the assessment if the evidence is satisfactory.  Despite this, it may still be advantageous to lodge a formal objection at the outset; whether or not this is so will depend on your specific circumstances, including whether there is an impending time limit for lodging an objection.

Either way, the key to having the assessment overturned will be providing relevant and genuine evidence that supports your claim.  This is not always straightforward.  It can sometimes be difficult to prove a “negative” fact, eg, that you did not earn an amount of income or that you did not sell an asset, which are the kind of facts you will often need to prove.  To succeed, you will likely also need to explain what the amount does represent – eg, income or gains made before you became resident, a gift, inheritance, loan proceeds etc.  The mere fact that an amount is transferred to you by a relative will not necessarily indicate that the amount is a gift.  This is particularly so if the relative received the amount from a third party before transferring it to you; and if the third party was a company the amount might even be a deemed dividend under the interposed entity rules in ‘Division 7A’.  Further, although the ATO might say you should provide particular information or documents to prove that the amount is not taxable, the particular documents the ATO requests may not necessarily be helpful or relevant; often you need to think laterally about what other material (which the ATO has not specifically asked for) could be provided to support your case.

While the ATO may initially be sceptical about your assertions that the amount from overseas is not taxable, if you can supply a clear and compelling explanation of how you came to obtain the funds and why they should not be taxed, together with relevant and truthful evidence that supports your explanation, then, in our experience, the ATO will likely be willing to promptly revise its position.

Posted in Data matching, For taxpayers, foreign source income, General

Div 7A – Unit trusts & UPEs to trust income

This post is intended for readers who are already familiar with the concepts of Division 7A, ‘unpaid entitlements to trust income’, section 109N complying loans, and “sub-trust” arrangements of the kind described in Taxation Ruling TR 2010/3 and Practice Statement PS LA 2010/4.

ATO ID 2012/74 is about the application of Division 7A to an unpaid present entitlement to trust income (“UPE”) owed by the trustee of a fixed trust to a private company unitholder (where the trustee is an associate of the private company’s shareholder(s)). The ATO states that the UPE is not “caught” by Division 7A – this is so even though the UPE has not been converted into a section 109N complying loan, and there is no explicit sub-trust arrangement in place.


The situation considered in ATO ID 2012/74 (“Specific Situation”) is as follows:

  • the trust is a unit trust in which unitholders have proportionate, fixed entitlements to capital and income of the trust;
  • the unitholders have unpaid entitlements to trust income (“UPEs) in proportion to their respective unitholdings;
  • the trust capital is applied by the trustee in arm’s length, income-generating investments;
  • the unitholders have consented to the trustee using the UPE amounts to reduce debts of the trust (which reduction is intended to improve the net asset position of the trust).

(If the UPEs constitute deemed loans from the unitholders to the trustee, adverse consequences could arise under Div 7A because:

  • the unitholders are private companies; and
  • the trustee is an ‘associate’ of the private companies’ shareholder(s).)


Based on TR 2010/3, the ATO should treat a unitholder’s UPE as a deemed loan (from the unitholder to the trustee), only if, under a consensual agreement, the unitholder:

  1. does NOT call for payment of their UPE; and
  2. does NOT call for the trustee to invest their UPE at a commercial return solely for the unitholder’s benefit.


The ATO concludes that there is no deemed loan in the Specific Situation because, in the Specific Situation, the unitholder DOES call for the trustee to invest their UPE at a commercial return solely for the unitholder’s benefit.

This is because, in circumstances where:

  • unitholders have UPEs in proportion to their respective unitholdings;
  • the UPEs are applied by the trustee, in a commercial manner, for trust purposes; and
  • unitholders have proportionate fixed entitlements to capital and income of the trust,

each unitholder’s UPE will, in effect, be invested at a commercial return wholly for the benefit of the unitholder.


Where beneficiaries under a trust consider that trust profits can be better utilised by the trustee than by the beneficiaries, beneficiaries may wish for the trustee to retain use of profits. However, if (i) the trustee has already created an entitlement in a beneficiary to profits (which is likely to be the case if the trustee has resolved to distribute all trust income for a year), (ii) the beneficiary is a private company whose ultimate owner’s marginal tax rate exceeds the company tax rate, and (iii) the trustee is an associate of the company’s owner, it may be difficult for the trustee to retain use of the profits without either a deemed dividend arising under Div 7A, or the ultimate owner becoming liable to pay “top up” tax on an actual dividend.

In order for the trustee to retain use of the profits without either of those unfavourable consequences resulting:

  • usually it would be necessary to use a 109N complying loan or a sub-trust arrangement of the kind described in TR 2010/3 and PS LA 2010/4; but
  • in the case where the beneficiaries of the trust are unitholders who have proportionate, fixed entitlements to the capital and income of a trust, and have UPEs in proportion to their respective unitholdings, 109N complying loans and explicit sub-trust arrangements might not be necessary.  Instead:
    • it may be possible for the trustee to retain use of the profits (to which unitholders have already become entitled) merely by keeping the UPEs on foot, provided that the trustee invests the UPEs on an arm’s length, commerical basis (cf how the UPE was used in the Montgomery Wools case [2012] AATA 61) (“UPE Method”). This is what ATO ID 2012/74 (discussed above) seems to suggest; or
    • it might be possible for the trustee to pay the unitholders their unpaid entitlement amounts, and for each unitholder to then invest the amount they have received back into the unit trust (“Investment Method”). On the basis that unitholders have proportionate, fixed entitlements to the capital and income of the trust, and have UPEs in proportion to their respective unitholdings, depending on the terms of the trust deed, the Investment Method would not necessarily trigger adverse consequences under Division 7A (see section 109J).

It is interesting to compare other tax consequences of these two Methods:

  • Under the Investment Method, a unitholder could potentially obtain tax recognition for the amount they invest in the trust (ie, the amount that was formerly their UPE amount). The amount might be recognised as 1st element cost base of new units (if additional units are issued proportionately to all unitholders in respect of the invested amounts), or as 4th element cost base of the unitholder’s existing units (if no additional units are issued in respect of the invested) amounts).
  • Under the UPE Method, query whether a unitholder could obtain tax recognition for the UPE amount.
Posted in Division 7A, For accountants, Trusts, Unpaid present entitlement

Does a change to a trust trigger capital gains tax? – Update

Whether varying the terms of a trust will trigger a capital gains tax (“CGT”) liability is the subject of a recent ATO ruling (Taxation Determination TD 2012/21 – issued on 24 October 2012).   TD 2012/21 is the ATO’s final ruling on this topic  – a draft (TD 2012/D4) was issued earlier this year, and discussed in my post of 8 July 2012.

The final ruling is (even) more favourable than the draft.  The draft ruling stated, in effect, that a variation to the terms of a trust would generally* not trigger a CGT liability provided the variation was made pursuant to a valid exercise of a power contained in the trust deed.  The final ruling confirms the statements in the draft, but also extends the “relief” to variations that are made by court order.  (This could be relevant where, eg, a trust deed does not permit the trustee to make a desired variation, but, following a successful application to the Supreme Court, the court orders the variation.)

*CGT could apply if, eg, the variation causes a particular asset of the trust to be held subject to a new charter of rights and obligations.

Posted in For accountants, For lawyers, Resettlement, Trusts