Tax Residency Meaning and Its Impact on Your Tax Return
Understanding the tax residency meaning is essential, as these rules play a fundamental role in determining how individuals engage with Australia’s income tax system.
These rules dictate which income is taxed in Australia, at what rates, and impact capital gains tax outcomes, the Medicare levy, and the taxation of Australian-sourced dividend and interest income. Residency status also affects an employer’s withholding obligations and is crucial in tax equalisation work for expats.
While many assume that being a tax resident aligns with their citizenship or immigration status, this isn’t always the case.
So, in this guide, we’ll explore the nuances of tax residency, how it impacts foreign source income and if you pay taxes in Australia.
Categories of Residency and Their Tax Implications
Being a resident for tax purposes is distinct from your permanent home or residency status for other reasons, such as immigration. It’s possible for someone to be a non-citizen or not have permanent residency in Australia and yet be considered an Australian resident for tax purposes.
Individuals can be categorised into three groups based on their tax residency status:
- Australian residents for tax purposes
- Temporary resident
- Foreign resident
Australian Resident for Tax Purposes
If you meet any of the established residency tests, you fall into this category. As a result:
- All worldwide income must be declared, even if taxed overseas.
- A foreign income tax offset can be claimed to reduce Australian tax on the same income.
Individuals who don’t satisfy any residency tests are considered foreign residents. Their tax implications include:
- There is no tax-free threshold or exemption from the Medicare levy.
- Obligation to declare any income earned in Australia, including capital gains on taxable Australian property, in their tax return.
Holding a temporary visa and ensuring neither you nor your spouse are Australian residents as per the Social Security Act 1991 places you in this category. For these individuals:
- Only income earned in Australia and income from short-term overseas employment or services need to be declared.
- Other foreign-sourced income and capital gains are exempt.
Note: Separate rules apply to working holidaymakers and dual residents (see discussion below).
Key Tests to Determine if You’re a Tax Resident
To ascertain if you’re an Australian resident and have to pay tax, the Australian Taxation Office employs four different tests:
|The Resides Test
|This test evaluates whether you reside in Australia based on the ordinary meaning of the term. Factors considered include physical presence, intention, family ties, asset location, and social arrangements.
|The Domicile Test
|Here, you’re deemed a resident if your domicile (a legal concept of a permanent home) is in Australia, unless it’s proven that your permanent abode is outside the country.
|The 183-Day Test
|If you spend more than half the tax year in Australia and don’t have a usual place of residence outside Australia, you qualify as a resident under this test.
|The Commonwealth Superannuation Fund Test
|This is specific to certain Australian Government employees. They, along with their immediate family, are considered residents irrespective of other factors.
Practical Scenarios: Tax Residency in Action
Here are a few practical scenarios to help you understand the meaning of tax residence more clearly.
Relocating to a Foreign Country for Work
Alex, an Australian citizen, accepts a two-year work assignment in Germany. He decides to rent out his Australian property during his time abroad.
While in Germany, Alex rents an apartment and integrates into the local community, but he doesn’t make any long-term commitments like buying property. His parents and siblings still reside in Australia, and he has a clear plan to return there after his assignment ends.
Under the resides test, Alex doesn’t reside in Australia during his assignment. However, the domicile test could be applicable:
- Alex’s domicile remains in Australia since he was born and raised there, and he has a clear intention to return after his overseas assignment.
- The fact that he rents out his property in Australia doesn’t necessarily mean he has abandoned it as his permanent place of abode. Instead, it might be seen as a temporary arrangement during his assignment.
- His frequent communication with family and occasional visits to Australia strengthen the argument that his permanent place of abode remains in Australia.
Studying in Australia
Raj, originally from India, arrives in Australia on a student visa to pursue a two-year master’s programme. He intends to stay on the Gold Coast for the duration of his studies and possibly work for a year afterwards. Currently, Raj has a part-time job at a local cafe to support himself during his studies.
He also rents an apartment near his university and spends most of his holidays exploring Australia.
On occasion, however, he intends to take short trips back to India to visit his family.
Even though Raj is in Australia on a temporary student visa, under the resides test:
- He has been living in Australia for a considerable time due to his two-year study programme.
- His usual residence is in Australia, as evidenced by his rented apartment.
- The frequency and duration of his stay, combined with his employment and study commitments, indicate a strong association with Australia.
- Thus, Raj would be considered an Australian resident for tax purposes and would need to declare his worldwide income, including any income he might earn during his short trips to India.
Extended Overseas Trip
Sarah, originally from Australia, decides to move to the US for a five-year period. In the US, she rents a home and integrates into the local community, making friends and possibly even working there.
Back in Australia, she decides to rent out her property for the duration of her stay in the US.
Her intention when moving was to experience life in the US for a significant period, but she hasn’t made a final decision about where she will settle long-term.
Under the resides test, Sarah’s prolonged physical absence from Australia and her integration into the US community suggest she didn’t reside in Australia during her five-year stay.
The domicile test might also indicate she’s a foreign resident:
- While her original domicile is in Australia, her ‘permanent place of residence’ during this period appears to be in the US due to the length of her stay and her establishment of a home there.
- Renting out her Australian property further indicates a shift in her place of residence. Even though she retains ownership of the property, her decision to rent it out suggests she doesn’t see it as her primary residence during her time in the US.
A Government Employee on Assignment
Clara, an Australian citizen, works for the Australian Government and is eligible to contribute to the Public Sector Superannuation Scheme (PSS).
She is sent on a three-year assignment to the UK to work at the Australian Embassy. Clara’s husband and two children, both under 16, accompany her to the UK. They rent out their house in Australia and live in a residence provided by the embassy in the UK.
Despite Clara living and working in the UK, under the Commonwealth superannuation fund test:
- As an eligible contributor to the PSS, Clara, along with her spouse and children under 16, are considered residents of Australia for tax purposes, regardless of their physical location or other factors.
- This means Clara would need to declare her worldwide income in Australia, even if she pays tax on it in the UK. However, she might be eligible for a foreign income tax offset to reduce potential double taxation.
Working Holidaymakers and Dual Residents: A Closer Look
While the general rules of tax residency apply to most individuals, there are specific considerations for two unique groups: working holidaymakers and dual residents.
Individuals who come to Australia under visa subclasses 417 or 462 are classified as working holidaymakers. Unlike regular residents or foreign residents, they are subjected to fixed tax rates on their earnings in Australia. This means that regardless of the amount they earn, they will be taxed at a predetermined rate, which is different from the progressive tax rates that apply to other residents.
Providing this special provision ensures that those on working holidays are aware of their tax obligations without the complexities of variable tax rates.
Dual Residents and the Tax Treaty
Dual residency arises when an individual is considered a resident for tax purposes in both Australia and another country. These situations can lead to complexities, especially when it comes to avoiding double taxation on the same income.
Thankfully, Australia has double tax treaties with several countries. These treaties contain ‘tie-breaker’ provisions that help determine which country has the primary right to tax specific types of income.
For example, factors like where an individual has a permanent home, where their personal and economic ties are stronger, or where they habitually reside can influence which country gets the taxing rights.
Dual residents should be aware of these treaties to ensure they meet their tax obligations in both countries without being unfairly taxed twice.
Understanding your tax residency status is crucial in ensuring you meet your tax obligations and can avail of any benefits or offsets. Given the complexities of tax residency and its implications on your tax return, it’s always wise to seek professional advice to ensure compliance.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.