Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
Chapter 1 - Foreign income exemption for temporary residents
1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide exemptions from Australian tax on non-Australian-source income for individuals who are considered to be temporary residents of Australia for tax purposes.
1.2 This chapter explains who the exemptions will apply to and what income or gains will be exempt.
1.3 All legislative references are to the ITAA 1997 unless otherwise indicated.
1.4 Given the increasing international mobility of labour - especially skilled labour - countries are adopting a more graduated approach to individuals entering and leaving the residence tax system. For instance, the UK, Singapore and Japan have all introduced an intermediate class of taxpayers who are treated differently from residents and non-residents. Others (eg, Thailand) operate on a remittance basis so that temporary residents are exempt from tax on their foreign source income unless they choose to remit it into the country.
1.5 A Tax System Redesigned noted that the current taxation treatment of foreign expatriates who become temporarily resident in Australia could discourage some multinational enterprises, particularly skill intensive businesses, from locating in Australia.
1.6 Persons working temporarily in Australia are often treated as Australian residents for Australian tax law purposes. Consequently they are taxed on their world-wide income including income from overseas investments, in addition to their Australian salary and other Australian income. That foreign investment income will generally be taxed in another country and so, as well as additional Australian tax to pay, there are increased compliance costs.
1.7 The additional tax expense (on their foreign or non-Australian investment income) is often borne by Australian businesses (those which indemnify employees for additional tax paid), increasing the cost of doing business in Australia. This tax treatment makes Australia a less attractive destination than many other countries for skilled foreigners to work.
1.8 As part of its Stage 2 response to A Tax System Redesigned the Government announced changes designed to reduce the tax burden on temporary residents. These would have the effect of assisting those Australian businesses seeking to attract key personnel to Australia.
1.9 Legislation to implement the measure was twice introduced into Parliament, in the Taxation Laws Amendment Bill (No. 4) 2002 and the Taxation Laws Amendment Bill (No. 7) 2002 . On both occasions it failed to pass the Senate. The Government announced in the 2005-06 Budget that it planned to reintroduce this measure in largely the same form as previously introduced.
1.10 However, re-examination of the measure, in part due to developments since 2002, identified a number of refinements reflected in this Bill.
- Revision of provisions dealing with employment income and gains was required following the recently implemented cross-border employee shares or rights measure. The clarification provided by those changes created potential for characterising income as capital gain rather than employment income, making it possible for temporary residents to gain access to the capital gains tax (CGT) exemption for what was essentially employment income.
- A number of rules that essentially applied to the same individuals as the announced temporary residents measure have been consolidated and streamlined.
- Modifications were also necessary to remove elements that unnecessarily distorted taxpayer decisions. For example, taxpayer reactions to time limits (for instance the four year limit on the exempt visitor exemption from the foreign investment fund rules, and the five year limit on the short-term resident CGT exemption for resident individuals leaving Australia) suggest that an arbitrary time constraint on a tax concession can significantly distort taxpayer decisions.
1.11 Table 1.1 summarises the changes between the existing law, the measure as previously introduced into Parliament and as announced in the 2005-06 Budget and as now implemented in this Bill.
|Existing law||Previously introduced - plus Budget-announced temporary residents rules||This Bill|
Who : Temporary visa holders (who have not applied for permanent visas).
Time limit : Four years.
Exemption : Foreign investment fund rules do not apply.
Short-term residents (capital gains tax)
Who : Resident individuals leaving Australia.
Time limit : Resident for less than five of the past 10 years.
Exemption : Capital gains tax deemed disposal rules do not apply for pre-residence assets, and assets acquired because of someone's death.
Who : Temporary visa holders (who have not applied for permanent visas).
Time limit : None.
Exemption : Foreign investment fund rules do not apply.
Short-term residents (capital gains tax)
Who : Resident individuals leaving Australia.
Time limit : Resident for less than five of the past 10 years
Exemption : Capital gains tax deemed disposal rules do not apply for pre-residence assets, and assets acquired because of someone's death.
Temporary residents (foreign income rules)
Who : Resident temporary visa holders (who have not applied for permanent visas)
Time limit : Four years, must not have been resident within the past 10 years.
Temporary residents (foreign income rules)
Who : Temporary visa holders (other than holders of visas who are able to access benefits similar to Australian citizens or permanent visa holders) unless they have been permanent residents after the rules commence.
Time limit : None.
|Result : Temporary residents taxed on most foreign source income and capital gains.||
: Temporary residents exempt on most foreign source income and capital gains.
Period of exemption depends on type of income.
|Result : Temporary residents exempt on most foreign source income and capital gains for the period they hold a temporary visa. No explicit time limits.|
1.12 These modifications will have almost entirely positive implications for Australian businesses, making the prospect of working in Australia considerably more attractive. They will on balance also make the measure considerably simpler to administer and comply with.
1.13 Temporary residents will be treated more like non-residents than residents for tax purposes. Income related to their Australian employment - including foreign sourced employment income - continues to be taxed by Australia. By continuing to tax employment-related income, Australian labour will not be disadvantaged relative to foreign labour. Australian source investment income (eg, interest and dividends) will still be taxable in Australia.
1.14 This measure is directed at people who are temporary residents. Temporary residents will generally be individuals who are in Australia on temporary visas, without any time limits. However, a person who is, or whose spouse is, an Australian resident for social security purposes will not be entitled to the temporary residents exemptions. Similarly, anyone who is an Australian resident for tax purposes but not a temporary resident after these new rules commence will not be entitled to the exemptions if they ever hold a temporary visa at a later time.
1.15 This Bill provides a tax exemption to temporary residents for all ordinary and statutory income from a foreign source, net capital gains from assets that do not have the necessary connection to Australia and for interest withholding tax obligations associated with amounts owing to foreign lenders. The exemption will not, however, apply to remuneration received for or associated with employment, or for services performed, while a temporary resident. This extends to benefits obtained under employee share schemes.
1.16 This measure also removes the existing four year limitation on the exemption from the foreign investment fund rules for all temporary residents and exempts them from attribution under the controlled foreign company rules and transferor trust rules. It also effectively removes the time limits from the short-term resident CGT exemption from the deemed disposal rule that applies when a person ceases to be an Australian resident.
|New law||Current law|
|Temporary residents will not be subject to Australian tax on foreign source income other than employment income, including amounts otherwise attributed from controlled foreign companies, foreign investment funds and foreign trusts.||Individuals who are residents of Australia are generally subject to tax on all income, including foreign source income.
Under the foreign investment fund rules there is a limited exemption for 'exempt visitors' for four years provided they are the holders of a temporary visa.
|Temporary residents are partly relieved of record-keeping obligations in relation to controlled foreign companies and foreign investment funds.||Temporary residents have to keep records in relation to controlled foreign companies and foreign investment funds if they meet the requisite conditions.|
|Temporary residents will be able to ignore capital gains other than gains taxable for non-residents (ie, assets with the necessary connection with Australia) and gains on some employee shares or rights.||Residents of Australia are subject to the CGT provisions in relation to all assets.|
|Temporary residents are exempt from the CGT deemed disposal rule that applies when they cease to be residents.||Short-term residents (ie, persons who have been Australian residents for less than five of the past 10 years) are exempt from the CGT deemed disposal rule that applies when they cease to be residents, for pre-residence assets and assets acquired because of someone's death.|
|A gain or loss made on some employee shares or rights by temporary residents (or those who held them as temporary residents) will be recognised to the extent that it relates to employment in Australia.
There is no change where the discount is taxed at the cessation time nor where the shares, have the necessary connection with Australia.
|The normal CGT rules apply to employee shares or rights once the discount has been taxed. All gains and losses would be recognised for residents but only those on shares or rights that have the necessary connection with Australia would be recognised for non-residents.|
|Temporary residents will be exempt from Australian interest withholding tax obligations.||Residents of Australia are generally required to withhold tax from interest payments associated with foreign liabilities.|
1.17 This measure provides a tax exemption to temporary residents for all ordinary and statutory income from a foreign source (generally income that does not have an Australian source) and net capital gains from assets that do not have the necessary connection to Australia. It also relieves them of interest withholding tax obligations associated with amounts owing to foreign lenders. The exemption will not, however, apply to remuneration received for or associated with employment, or for services performed while a temporary resident. This extends to benefits obtained under employee share schemes. [Schedule 1, item 1, section 768-905 ]
1.18 The exemptions will apply to individuals who are temporary residents for the purposes of Australian tax law.
1.19 The first requirement to be a temporary resident for Australian tax purposes is that the individual holds a temporary visa granted under the Migration Act 1958 . However, an individual who is, or whose spouse is, an 'Australian resident' as defined in the Social Security Act 1991 , will not be entitled to the temporary residents exemptions. In that Act, an 'Australian resident' is defined as a person who resides in Australia and is an Australian citizen, the holder of a permanent visa or a protected special category visa holder. Leaving aside the limitation on the person's spouse, this restriction will only exclude those who are in Australia on a protected special category visa (ie, some New Zealanders). They are excluded from its benefits because they are treated more like Australian citizens than temporary visa holders. In this legislation there is no time limit on how long the tax concessions are available, to simplify the rules and reduce the impact of these rules on taxpayer decisions. Nor does it matter if the person has been a temporary resident before. [Schedule 1, item 2, definition of 'temporary resident' in subsection 995-1(1)]
1.20 The policy underlying the definition of 'temporary resident' is that a temporary resident's connection with Australia is more tenuous than for other residents (referred to in this explanatory memorandum as permanent residents) and so a temporary resident should be treated more like a non-resident than a resident for tax purposes. Further, since temporary residents cannot benefit from Australian public spending to the same extent as permanent residents (for instance temporary visa holders are less often entitled to social security payments, Medicare and free public education) they should not have to support that spending to the same extent.
1.21 Where individuals have access to all or most of the benefits that Australian permanent visa holders or Australian citizens have despite being on a temporary visa, it is logical that they should bear the same responsibility as other Australian residents to fund Australian public spending. That greater access to benefits can be obtained by protected special category visa holders and by someone whose spouse is an Australian resident for social security purposes. A person who is an Australian citizen, or whose spouse is one, does not need the inducement of tax concessions to come to, or return to, Australia for short periods. Likewise, those who at some time have the degree of connection with Australia to warrant full residence taxation will not be excused from that obligation in the future (ie, they will be treated as permanent residents) if they again become Australian tax residents. That is, they will not ever be a temporary resident after that time. This approach also removes the need for additional provisions (including deemed disposal rules for CGT purposes) when such persons cease to be permanent residents. If the person who holds the temporary visa does not have a spouse, the condition concerning the person's spouse is irrelevant. [Schedule 1, item 2, definition of 'temporary resident' in subsection 995-1(1)]
1.22 Since there is no requirement in the definition of a 'temporary resident' to be an Australian resident for tax purposes, the provisions can theoretically apply also to non-residents who are in Australia on temporary visas. However, since non-residents are not taxed on their foreign income or on net capital gains from assets that do not have the necessary connection with Australia, the provisions will make little difference to them (there is an exception for capital gains on some employee shares and rights that relate to employment in Australia). In particular, the provision that states that employment income and like amounts are not non-assessable non-exempt income does not of itself make these amounts assessable income for non-residents [Schedule 1, item 1, note to subsection 768-910(3)] . 'Temporary resident' is defined not to exclude non-residents, simply to make it easier to determine if a person is a temporary resident. Further, the taxation of non-residents from countries with which Australia has tax treaties, will continue to be governed by the treaties.
1.23 This Bill makes ordinary income derived from a foreign source during the period the taxpayer is a temporary resident non-assessable non-exempt income. This measure also applies to all statutory income that has a source other than Australia, including amounts otherwise attributable from a foreign company or a foreign trust, on which the taxpayer would otherwise be taxed. This extends to amounts derived through partnerships and trusts but not to amounts derived by other taxable entities (eg, not where a trustee is taxable under section 99 or 99A of the Income Tax Assessment Act 1936 (ITAA 1936)). There is no exemption for Australian source income. It follows from this that expenses or losses incurred in earning this income are not deductible and that these amounts will not reduce tax losses. Net capital gains are dealt with separately (see paragraphs 1.31 to 1.34). Further, it also follows that temporary residents who are also Australian residents for tax purposes, will not be able to claim foreign tax credits for tax paid on foreign income that is no longer assessable. [Schedule 1, item 1, subsection 768-910(1)]
1.24 This measure, however, does not exempt any income or remuneration that in any way relates to employment or services performed by the taxpayer while the taxpayer is a temporary resident of Australia. That includes income derived by the individual from the performance of contracts. Such income will continue to be taxed in Australia. Any discount on employee shares or rights will continue to be assessable according to Division 13A of Part III of the ITAA 1936 (or section 26AAC of the same Act). These exceptions to the general rule for temporary residents are to prevent the exemptions from making the employment remuneration for temporary residents less costly than for other Australian residents. Another objective is not to allow the foreign employment income to be totally tax-free since foreign tax will usually not be payable on that income. Where the person is a resident and is employed overseas for a minimum of 91 days, the exemptions available under sections 23AF and 23AG of the ITAA 1936 may be available. These new provisions will not have any effect on the operation of those sections. [Schedule 1, item 1, subsections 768-910(3) to (6)]
1.25 Because of the need to make a timing connection between the amounts that would otherwise be assessable and the person's residence status, the provision dealing with statutory income refers to the person being a temporary resident when the amount is derived by the taxpayer. For the purpose of this provision, the person is said to derive the amount of statutory income when all of the conditions for it to be statutory income have been satisfied. For example, an amount might otherwise be attributed from a controlled foreign company if the person is an attributable taxpayer at the end of a statutory accounting period of the foreign company. That is when the otherwise attributed amount would be said to be derived by the taxpayer and so the question then becomes whether the person is a temporary resident at that time. [Schedule 1, item 1, paragraph 768-910(1 )( b) and subsection 768-910(2)]
1.26 Specifically excluded from the temporary residents measure is income included in assessable income under Division 86, that is alienated personal services income. Alienated personal services income may be earned through an entity, however since it actually relates to income from personal services it is appropriate to ensure that this income is excluded from the exemptions under this measure. [Schedule 1, item 1, paragraph 768-910(3 )( c)]
1.27 Since ordinary and statutory income from a foreign source of an eligible temporary resident is essentially exempt from Australian taxation, it is also necessary to exclude temporary residents from attribution percentage calculations that may be required under the rules that attribute income from controlled foreign companies. The effect of this is to relieve temporary residents of the compliance burden associated with these calculations and the associated record-keeping requirements. [Schedule 1, item 1, section 768-960 ]
1.28 The existing 'exempt visitor' exemption from taxation under the foreign investment fund rules is replaced by an exemption for temporary residents. Again, there is no limit on how long that exemption may be used. This was a part of rationalising the various exemptions available to persons temporarily in Australia. They are also relieved from the record-keeping requirements of these rules for the notional accounting period of the foreign company, foreign trust or foreign life policy for which nothing will be attributed to the temporary resident. [Schedule 1, item 1, section 768-965 ]
1.29 A temporary resident who is an attributable taxpayer in relation to a foreign trust will not be attributed with any income of the trust under the transferor trust provisions while a temporary resident. This is achieved by saying that the person is not a resident for the purpose of section 102AAZD of the ITAA 1936 at any time the person is a temporary resident. However, the person will still be required to keep certain records (under section 102AAZG of the ITAA 1936) that would be relevant to any period when the person is not a temporary resident. [Schedule 1, item 1, section 768-970 ]
1.30 Any interest in a foreign trust held by a temporary resident may be ignored if subsection 96C(6) of the ITAA 1936 has to be applied. As a result of the general exemption provided by this Bill, the temporary resident would not be taxed under section 96B on any foreign source income of the trust. [Schedule 1, item 1, section 768-975 ]
1.31 Temporary residents will be exempt from Australian tax on many capital gains. Conversely, many capital losses they make will be ignored for Australian tax purposes. They will however still be liable for Australian tax on net capital gains for which non-residents are taxable, and on net capital gains arising from some employee shares or rights to the same extent the discount is taxed under Division 13A of Part III of the ITAA 1936. The general treatment of their capital gains and losses mirrors the treatment of non-residents and the treatment of gains or losses from some employee shares and rights is discussed in paragraphs 1.36 to 1.50. Temporary residents are treated the same as non-residents for CGT purposes because that matches the treatment of their investment income and reduces compliance costs. [Schedule 1, item 1, section 768-915 ]
1.32 Section 136-40 would normally apply when a non-resident becomes an Australian resident to fix a cost base for the person's assets that do not have the necessary connection with Australia. That rule will not apply when a non-resident person becomes a temporary resident [Schedule 1, item 1, section 768-950 ]. Clearly, if the person does not become an Australian resident for tax purposes the rule does not apply in any case. Non-application of this rule reflects the policy of treating the person as a non-resident for CGT purposes. Instead, a cost base for these assets will need to be determined only if and when that person becomes a permanent resident (see paragraph 1.20). That is when the person ceases to be a temporary resident but remains, or becomes, an Australian resident for tax purposes. There is an exception to these rules for some employee shares and rights (see paragraphs 1.37 to 1.39) [Schedule 1, item 1, section 768-955 ].
1.33 In the reverse scenario, when an Australian resident ceases to be a resident for tax purposes and becomes a foreign resident, the person is effectively deemed to have disposed of all assets that do not have the necessary connection with Australia. This rule is called CGT Event I1 (section 104-160). The purpose of this rule is to capture the gain or loss on those assets that accrued while the person was a resident. That rule will not apply to residents who are temporary residents and who become non-residents. That is the purpose of the words 'or immediately before the CGT event'. Again, this reflects the policy that a temporary resident is treated as a non-resident for CGT purposes and so there is effectively no change in residence status as far as the CGT rules are concerned. Of course, the rule cannot apply to a temporary resident who never became an Australian resident. [Schedule 1, item 1, section 768-915 ]
1.34 The law currently contains some exceptions to the above deemed disposal rule. One of those concerns individuals who have been Australian residents for less than five of the preceding 10 years (subsection 104-165(1)). The deemed disposal rule does not apply to some of their assets that do not have the necessary connection with Australia. That exception is being replaced with the exemption for temporary residents [Schedule 1, item 1, section 768-915 and item 20 ]. However, Australian residents who are in Australia at the time of Royal Assent of this Bill will still be able to take advantage of it for up to five years, but only on one occasion [Schedule 1, item 21 ]. The other existing exceptions to the deemed disposal rule remain unchanged.
1.35 Where an employee is granted shares or rights under an employee share scheme, before or after coming to Australia, the taxation treatment of the discount at which they were granted is governed by Division 13A of Part III of the ITAA 1936. Where part of the relevant employment is performed outside Australia, only part of the discount is taxed in Australia. This is the case whether the discount is taxed upfront (at the time of acquiring the shares or rights or when the person becomes employed in Australia) or at a later cessation time. There is no change to this for those who are or were temporary residents at any time in the period of relevant employment or when the discount is to be taxed. To avoid doubt this is explicitly stipulated. [Schedule 1, item 1, paragraph 768-910(3 )( d)]
1.36 The overriding policy consideration when it comes to the treatment of gains or losses on employee shares or rights held by temporary residents is to make sure that their employment remuneration while in Australia is subject to Australian tax despite the concessions being provided to them. Net gains on employee shares and rights are not totally ignored which would otherwise often be the case under the general CGT treatment of temporary residents. To do so would invite too much restructuring of employment remuneration to obtain tax benefits, to the disadvantage of other Australian resident employees. Their treatment will depend on whether the shares or rights are assets that have the necessary connection with Australia and on when the discount is taxed. The following paragraphs discuss the various possibilities in turn.
1.37 Where employee shares or rights do have the necessary connection with Australia (eg, shares in an Australian private company) there is no change to their treatment for CGT purposes. Their cost base is determined by Subdivision 130-D and depends on when the initial discount is taxed. Because part of the relevant employment to which the shares or rights relate may be performed outside Australia, only part of that initial discount may be taxable in Australia. However, because gains or losses on them would be counted for CGT purposes whether the person is a non-resident or a resident the whole gain or loss is counted.
1.38 Where the employee share or right does not have the necessary connection with Australia (eg, shares in a foreign company or a portfolio interest in an Australian public company) the CGT treatment depends on when the initial discount is taxed. There are no changes to the CGT treatment where the discount is taxed at a cessation time. If that time occurs before the temporary resident becomes a permanent resident (see paragraph 1.32), the cost base of the shares or rights is set by subsection 130-83(3), but any gain or loss that arises from a CGT event happening before becoming a permanent resident is disregarded [Schedule 1, item 1, section 768-915 and item 30 ]. The cost base is re-determined at the time the person becomes a permanent resident and replaces the cost base determined under section 130-83 [Schedule 1, item 1, subsection 768-955(2)] . In addition, the shares or rights are treated as being acquired at that time [Schedule 1, item 1, subsection 768-955(3)] . If a CGT event then occurs the normal CGT rules apply and there are no further CGT concessions. Any gain or loss that accrues between the cessation time and when the person becomes a permanent resident is ignored. If the cessation time occurs after the person has become a permanent resident, section 130-83 operates normally [Schedule 1, item 1, subsection 768-955(4)] . Again, there is no further CGT concession.
1.39 There are changes to the CGT treatment where the original discount on shares or rights that do not have the necessary connection with Australia is taxed upfront [Schedule 1, item 1, paragraphs 768-920(1 )( c) and (d) and (2 )( d) and (e)] . This taxing point may be in the income year in which the person becomes an employee in Australia for Division 13A purposes or at the time the shares or rights were granted to the employee. The cost base of the shares or rights will be their market value at the time they were granted, under section 130-80 or 130-85.
1.40 In either case, some or all of any gain or loss is to be recognised (it normally wouldn't be counted by someone who is being treated as a non-resident) because of the connection with the person's employment in Australia. Accordingly, only the portion that has that connection is to be recognised. The rest of the gain or loss will be disregarded. The proportion is the same as that used for determining how much of the original discount is assessable income. These modifications to the CGT rules for employee shares or rights will apply to both residents and non-residents who are or have been temporary residents.
1.41 Only shares or rights acquired under an employee share scheme, or shares obtained as the result of exercising a right acquired under an employee share scheme, are covered by these new rules [Schedule 1, item 1, paragraphs 768-920(1 )( a) and (2 )( a) and (c)] . The latter shares are called 'derived shares' in this Bill and the rights that were exercised to obtain them are called the 'original rights' [Schedule 1, item 1, subsection 768-920(2)] . This Bill deals separately, but in similar fashion, with each of these cases. Because of the operation of section 139DQ of the ITAA 1936 and an amendment to that section so that it also applies for the purposes of these new provisions dealing with temporary residents, the rules will also apply to matching shares or rights acquired in connection with the 100 per cent takeover or restructure of a company [Schedule 1, item 1, notes to subsections 768-920(1) and (2) and items 8 to 10 ].
1.42 Next, the person holding the shares or rights must have been engaged in some of the employment to which the shares or rights relate in Australia as a temporary resident [Schedule 1, item 1, paragraphs 768-920(1 )( b) and (2 )( b)] . This latter condition is there to relate the relevant employee shares or rights, or the derived shares, to the person's status as a temporary resident. If the person does not perform any of the relevant employment in Australia as a temporary resident, the new rules do not apply even if the person still holds the shares or rights during some of the time in which the person is a temporary resident. To avoid doubt, it is made clear that it does not matter whether the person is still a temporary resident, a permanent resident or a foreign resident when the relevant CGT event occurs [Schedule 1, item 1, subsection 768-920(3)] .
1.43 The final pre-condition for application of the new rules concerns when they are applied. That time is when a CGT event happens to the shares or rights or the derived shares for the first time [Schedule 1, item 1, paragraphs 768-920(1 )( e) and (h) and (2 )( f) and (i)] . Two classes of CGT events are ruled out. The first is Event I1 (see paragraph 1.33) because ceasing to be an Australian resident is not to be relevant to temporary residents for all CGT assets including these employee shares or rights. However, that event could still be the trigger for application of these rules if the person had already become a permanent resident and then ceased to be an Australian resident [Schedule 1, item 1, paragraphs 768-920(1 )( f) and (2 )( g)] . The provision would not then be applied to any further CGT events happening to those shares or rights. The second type of CGT event that will not trigger application of these rules is where any capital gain or loss from the event is disregarded because of another provision in Part 3-1 or 3-3 [Schedule 1, item 1, paragraphs 768-920(1 )( g) and (2 )( h)] . A typical example of this would be where a roll-over is allowed. Explicitly stating that a capital gain or loss arises under this provision despite the new general CGT concession for temporary residents, indicates that this provision would be triggered by a CGT event that would otherwise result in a gain or loss that would be disregarded by that general CGT concession [Schedule 1, item 1, subsection 768-920(5)] .
1.44 If the person is a temporary resident or a foreign resident when the first possible trigger event occurs, the person makes a capital gain or loss that is not disregarded [Schedule 1, item 1, subsections 768-920(4) and (5)] . The amount of the gain or loss is a proportion of the amount of gain or loss that would otherwise be disregarded (because the person is a temporary resident) or not made (because the person is a foreign resident). The process for the calculation of the gain or loss is a two-step process [Schedule 1, item 1, subsections 768-920(6) and (9)] .
1.45 The first step is to calculate the amount of the gain or loss that is to be adjusted. This is called the notional gain or loss and is the capital gain or loss that would have arisen for a permanent resident from the time of acquisition of the shares or rights, or the original right in the case of derived shares, until the time of the CGT event. In the case of shares or rights acquired from an employee share trust, the time of acquisition is when the temporary resident first acquired a beneficial interest in the share or right [Schedule 1, item 1, subsection 768-925(2)] . Where the CGT event happens to a derived share the relevant starting time is when the taxpayer first acquired a beneficial interest in the original right [Schedule 1, item 1, paragraph 768-925(2 )( b)] . Matching shares or rights to which subsection 139DQ(1) of the ITAA 1936 applies will be taken to be acquired when the employee shares or rights in the old company were acquired. The cost base to be used in this calculation is that which would be obtained by applying section 130-80 or 130-85 as the case requires, with any modification required by section 134-1 in the case of derived shares [Schedule 1, item 1, subsections 768-925(1) to (3)] .
1.46 The second step is to apply two factors or fractions in turn [Schedule 1, item 1, section 768-930 ]. The first fraction seeks to determine the amount of the notional gain or loss that may be apportioned to the period ending at the cessation time. Even though the shares or rights may not be qualifying shares or rights, the cessation time is still defined in Division 13A of Part III of the ITAA 1936. In the case of derived shares, the relevant cessation time is that of the original rights that were exercised to obtain those shares [Schedule 1, item 1, subsection 768-940(1)] . The amount is determined using a simple comparison of days before the cessation time and days ending at the time of the CGT event [Schedule 1, item 1, subsections 768-935(1) and 768-940(1)] . If the CGT event occurs before the cessation time for the shares or rights or the original rights, the whole of the notional gain or loss is counted at this stage [Schedule 1, item 1, paragraphs 768-935(3 )( a) and 768-940(3 )( a)] .
1.47 The second factor is based on how much of the relevant employment for which the shares or rights were granted was performed in Australia. This fraction is that which was implicitly used in calculating how much of the original discount was to be included in assessable income. It is the ratio of the amount included in assessable income under Division 13A (or the amount that would have been included but for subsection 139BA(2) of the ITAA 1936) and the amount of the discount calculated for the purposes of Division 13A. Application of this fraction results in the amount of the gain or loss that is not disregarded being an approximation of the amount that was remuneration for employment in Australia. That amount is then used in calculating the taxpayer's net capital gain or net capital loss for the year. The rest of the notional gain or loss is disregarded in that calculation. [Schedule 1, item 1, subsections 768-935(4) and 768-940(4)]
Example 1.1: Capital gain made while still a temporary resident
Emma from England is granted shares (with a total market value at the time of A$100,000) under an employee share scheme on 1 February 2006 for the three years of employment beginning on 1 January 2006. She comes to Australia as a temporary resident on 1 January 2007 (at which time she also becomes an Australian resident for tax purposes) and completes the remaining two years of the employment to which the shares relate in Australia. Emma elects to have the discount assessed in that income year. Assume that the cessation time for the shares occurs on 1 June 2009. Emma who is still a temporary resident disposes of the shares on 1 July 2009 for A$130,000.Emma's notional capital gain is $30,000. The first fraction is 1216/1246 and the fraction derived from the Division 13A calculation is 2/3. Therefore, the capital gain from this sale to be used in the calculation of her net capital gain for the income year ending 30 June 2010 is:
$30,000 * (1216/1246) * (2/3) = $19,518
1.48 In this situation, a proportion of the gain or loss that has accrued up to the time the person became a permanent resident must be added to a capital gain or loss that would otherwise be recognised [Schedule 1, item 1, subsections 768-920(7) and (9)] . The two-step calculation is slightly different from that discussed in paragraphs 1.45 to 1.47. Again, the first-step is to calculate the amount of the gain or loss that is to be adjusted (ie, the notional gain or loss). This is the capital gain or loss that would have arisen from the time of acquisition of the shares or rights, or the original rights in the case of derived shares, until the time of becoming a permanent resident. The same special rules apply as were discussed in paragraph 1.45. This calculation may be done by reducing what would otherwise have been the notional gain or loss by the amount of the actual capital gain or loss that would be taken to be made apart from this set of rules [Schedule 1, item 1, subsection 768-925(4)] . The main reason for this modification is because at this point (of becoming a permanent resident), the individual must determine a new cost base for these shares or rights and the CGT provisions apply without concession from then on [Schedule 1, item 1, section 768-955 ]. It is the amount of the gain or loss that accrued up to that time that is then dealt with.
1.49 Again, the first factor to be calculated is described separately but similarly for the case of shares or rights acquired under an employee share scheme and for derived shares [Schedule 1, item 1, subsections 768-935(2) and 768-940(2)] . In this case, the denominator of the fraction is the number of days up to the time of becoming a permanent resident because that is the period over which the notional gain or loss accrued. The numerator in the case where the cessation time occurs before the person became a permanent resident is the number of days up to that cessation time. Where the person became a permanent resident before the cessation time, the factor is one. The notional gain or loss is multiplied by this fraction [Schedule 1, item 1, subsections 768-935(2) and 768-940(2) and paragraphs 768-935(3 )( b) and 768-940(3 )( b)] .
1.50 Finally, the same proportion as discussed in paragraph 1.47 is applied to the resulting amount [Schedule 1, item 1, subsections 768-935(4) and 768-940(4)] . The resulting adjusted notional gain or loss is then added to what would otherwise have been the capital gain or loss, to arrive at the actual capital gain or loss to be used by the taxpayer in determining the net capital gain or loss for the year [Schedule 1, item 1, subsection 768-920(7)] . For the purpose of determining whether the capital gain is a discount capital gain (see Division 115), the time-of-acquisition rules that would ordinarily apply when the person becomes a permanent resident do not apply. Instead, the shares or rights, or the derived shares, are taken to be acquired when the original shares or rights were granted [Schedule 1, item 1, subsection 768-920(8)] .
1.51 The standard amendment periods apply to most elements of this calculation. However, as with taxation of the original discount under Division 13A of Part III of the ITAA 1936 there could be some delay before the taxpayer is more certain of the extent to which the relevant employment is or will be performed in Australia. The same deadline for amendment applies to the determination under these provisions of the capital gain or loss made from a CGT event happening to the shares or rights to allow for amendment to the fraction implicitly used in Division 13A and discussed in paragraphs 1.47 and 1.50. [Schedule 1, item 1, section 768-945 ]
1.52 Interest paid by a temporary resident to non-residents will be exempt from all interest withholding tax and withholding obligations. The interest income derived by the non-resident will also be non-assessable non-exempt income unless it is derived in carrying on business through a permanent establishment in Australia. The exemptions will apply to all non-resident lenders, including non-resident partners in partnerships, non-resident beneficiaries of foreign trusts who are presently entitled to the income and non-resident trustees of foreign trusts. A resident trustee who would be taxed under section 99 or 99A of the ITAA 1936 (but not subsection 98(3) or (4)) would not be exempt from tax on the interest. [Schedule 1, item 1, section 768-980 ]
1.53 While withholding tax would otherwise be a liability of the overseas lender, it is generally the case that institutional lenders would require the Australian resident to compensate them for the additional tax incurred in lending money to an Australian resident. Therefore, this measure not only reduces compliance costs for the temporary resident, it also indirectly reduces their Australian taxation costs. It is primarily targeted at pre-existing loan arrangements and therefore does not extend to Australian resident lenders nor to Australian permanent establishments of foreign lenders.
1.54 Subject to paragraph 1.56, the amendments apply for income years that begin on or after the 1 July next following the date of Royal Assent for this Bill. In relation to CGT events, the amendments apply to events happening on or after that 1 July. The amendments to the cost base rules for CGT assets generally, and for employee shares or rights, apply to persons becoming Australian residents, whether temporary or permanent residents, after that 1 July. [Schedule 1, subitems 40(1), (2), (4), (5), (8) and (9)]
1.55 While the amendments affecting the application of the CGT rules to temporary residents apply from that 1 July, they can apply to matching shares or rights acquired on or after 1 July 2004 because of the amendments to section 139DQ of the ITAA 1936. [Schedule 1, subitems 40(3) and (6)]
1.56 The amendment to exclude temporary residents from withholding tax obligations applies to payments of interest made on or after the date of Royal Assent. [Schedule 1, subitem 40(7)]
1.57 A number of consequential amendments have been made because the existing exemption from the foreign investment fund rules (for exempt visitors for four years) is being replaced with an exemption for temporary residents. First, there is the repeal of the existing exemption contained in the foreign investment fund rules and the insertion of a reference to the new exemption for temporary residents in those rules [Schedule 1, items 14 and 15 ]. Next there is the insertion in the Dictionary of a definition of a 'foreign life assurance policy' and the amendment of the existing definition of 'notional accounting period' to take account of foreign life policies [Schedule 1, items 38 and 39 ]. Finally, references to the term 'exempt visitor' in various tax laws needed to be changed [Schedule 1, items 3, 11 and 12 ].
1.58 In a similar fashion, a reference to the new exemption from the controlled foreign company rules for temporary residents is inserted into those provisions. [Schedule 1, item 13 ]
1.59 Two consequential amendments insert references to some of the new rules into the table of provisions which lists non-assessable non-exempt income. [Schedule 1, items 16 and 17 ]
1.60 Changes have been made to two tables in the CGT provisions dealing with the time of acquisition of CGT assets and the cost bases of those assets to reflect the modifications to those rules for temporary residents and for when they cease to be temporary residents. [Schedule 1, items 22 to 25 ]
1.61 Finally, notes have been amended or inserted into the ITAA 1936 (mainly in the provisions dealing with interest withholding tax) and the ITAA 1997 (in the CGT provisions) to act as signposts from other parts of the law to these provisions dealing with temporary residents. [Schedule 1, items 4 to 7, 18, 19, 27, 28, 31, 32 and 34 to 37 ]
1.62 The New Business Tax System is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings, as well as providing a sustainable revenue base so the Government can continue to deliver services to the community.
1.63 The measure dealing with the taxation of temporary residents of Australia contained in this Bill is part of the New Business Tax System.
1.64 The exemptions for temporary residents are designed to achieve two related objectives. First, the measure seeks to attract internationally mobile skilled labour to Australia. Secondly, it will assist in the promotion of Australia as a business location, by reducing the costs to Australian business of bringing skilled persons to work in Australia.
1.65 The temporary residents measure arises directly from recommendations of the Review of Business Taxation. The genesis for the implementation options that are discussed here can be found at Recommendation 22.18 of A Tax System Redesigned .
1.66 The Government announced in the 2005-06 Budget that it planned to reintroduce legislation that would exempt temporary residents from income tax on most foreign source income and gains on foreign assets for four years (the original implementation option). The previous legislation was twice introduced into Parliament in 2002 but failed to pass the Senate. Subsequent re-examination of the measure, in part due to changes in the law since 2002 (eg, in the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Act 2005 ), identified a number of refinements (reflected in the new implementation option) which simplify the measure and reduce compliance costs. As a result, the new implementation option for temporary residents being enacted in this Bill is broader than the original implementation option.
1.67 The original option provides an exemption for temporary residents for four years (provided they had not been resident in Australia in the preceding 10 years), which would apply to:
- all foreign source income of eligible temporary residents (other than employment income) including income of controlled foreign companies, other foreign companies and foreign trusts on which they would be otherwise taxed;
- net capital gains, other than net gains taxable for non-residents (ie, those with the necessary connection to Australia), and gains on portfolio interests in Australian publicly listed companies or Australian unit trusts; and
- interest withholding tax obligations in respect of liabilities regardless of when incurred.
1.68 In addition, the exemption from the foreign investment fund rules for exempt visitors would no longer be restricted to four years for taxpayers holding temporary visas, but would apply to exempt visitors for as long as a temporary visa was held.
1.69 A 'temporary resident' is essentially defined as someone who was an Australian resident for tax purposes for less than four years, who was on a temporary visa and had not applied for a permanent visa, and who had not been an Australian resident for tax purposes in the preceding 10 years.
1.70 The new implementation option however now provides an exemption for temporary residents, which applies - for as long as the individual is a temporary resident - to:
- all foreign source income of temporary residents (other than employment income) including income of controlled foreign companies, other foreign companies and foreign trusts on which they would otherwise be taxed;
- net capital gains, other than net gains taxable for non-residents (ie, those with the necessary connection to Australia) or those on employee shares or rights to the extent the discount is taxable in Australia; and
- interest withholding tax obligations in respect of liabilities regardless of when incurred.
1.71 Apart from the removal of the four year limit the only change to this aspect is the extension of the exemption to net gains on portfolio interests in Australian companies and unit trusts.
1.72 The new option also partly relieves temporary residents of record-keeping obligations in relation to controlled foreign company and foreign investment fund rules.
1.73 As for the definition of a 'temporary resident', there is no requirement that the individual has not been an Australian resident in the preceding 10 years.
1.74 However, the definition does not include 'temporary visa holders' who hold temporary visas that allow them to receive benefits similar to those permanent visa holders receive. These people are identified as those individuals who are 'Australian residents' as defined in the Social Security Act 1991 , which would include for example, New Zealand citizens (resident in Australia for taxation purposes) who are classified as 'protected special category visa holders'. It also excludes an individual whose spouse is an 'Australian resident' for purposes of the Social Security Act 1991 .
1.75 The exemptions will also be denied to anyone who has been a permanent resident after the rules commence. A permanent resident is someone who is a tax resident of Australia but who does not satisfy one or more of the above requirements to be a temporary resident.
1.76 The requirement that the individual be a tax resident has also been removed in this new option.
1.77 The term 'temporary resident' now determines eligibility for all aspects of the announced measure, including the exemption from the foreign investment fund rules. Therefore while the existing exemption for 'exempt visitors' from the foreign investment fund rules will (as under the original option) no longer be restricted to four years, it will now apply as long as the individual is a 'temporary resident' (not an 'exempt visitor').
1.78 Another significant change to the original option is a modification to an existing CGT exemption for short-term residents departing Australia (ie, those who are resident for less than five of the past 10 years) from the deemed disposal rule that would otherwise apply. This concession would be absorbed into the temporary residents measure, so that it is no longer restricted by time limits, and would apply as long as the individual is a temporary resident. However, the exemption will no longer apply to any individual who has been a resident for less than five of the past 10 years when they leave Australia, but will be limited to temporary residents. There will, however, be a transitional rule so that the concession will continue for a period of five years for other permanent residents who would otherwise be adversely affected.
1.79 The general principle that capital gains or losses will not be disregarded to the extent they relate to employment remains the same in the new option. However, clarification of the taxation of cross-border employee shares or rights since the original implementation option was introduced into Parliament has made it possible to be more specific about the instances where gains or losses related to employee shares or rights will not be disregarded.
1.80 Therefore the main differences between the original option and the new implementation option are:
- changes to the definition of a 'temporary resident';
- removal of various time limits;
- changes to CGT treatment - temporary residents are now only to be taxed on the same assets as non-residents, whereas previously they were treated more as a hybrid of residents and non-residents; and
- clarification of capital gains that are considered to be related to employment in Australia (and therefore to which the exemption does not apply), especially in the area of employee shares and rights.
1.81 This measure will impact on people holding temporary visas granted under the Migration Act 1958 who are in receipt of income from foreign sources or who hold foreign assets, and who do not have access to benefits (whether directly or indirectly though their spouses) similar to those available to the holders of permanent visas.
1.82 A reference to temporary visa holders may include people who enter Australia under the economic, international and social/cultural visa streams and also people in Australia on student visas.
1.83 The main impact of the changes (to the original option) will be on temporary residents who remain in Australia for longer than four years. Currently, this is approximately 7 per cent of temporary visa holders. About 90,000 temporary visa holders are potentially impacted. Unlike the original implementation option, the new option will deny treatment as a temporary resident to those on temporary visas whose spouse is an Australian citizen or has a permanent visa. No data on the number of these were available.
1.84 Businesses that employ, or are run by, people who qualify for this exemption may receive an indirect benefit as a result of this measure. This will occur in instances where businesses make normalisation payments to compensate their employees for the potential increase in their overall taxation costs that can occur as a result of their coming to Australia for a short period.
1.85 The measure will also impact on intermediaries, such as accounting firms, that act on behalf of taxpayers or businesses affected by this measure.
1.86 There will be administrative impacts on the ATO with the introduction of this measure.
1.87 The original option would be expected to significantly reduce compliance costs for individuals when preparing their tax returns, as temporary residents would generally only need to declare income (other than employment income) from Australian sources. Information in relation to foreign income and most capital gains would no longer be required for Australian tax purposes, provided that income or gain was not related to Australian employment. While these changes would mean a net benefit for temporary residents, there would have been some additional costs involved in determining whether some items of income or gains related to Australian employment.
1.88 Similarly, providing an exemption from interest withholding tax obligations will also, where applicable, result in reduced compliance costs for these taxpayers in relation to their Australian tax obligations.
1.89 For businesses and intermediaries, (eg, tax agents) affected by this measure, initially there would have been a small cost associated with the training of staff and the modification of internal systems that deal with remuneration to remove the need for normalisation payments. Once any necessary training or changes have been implemented no ongoing compliance costs would have been expected for these businesses.
1.90 The intermediaries would have the usual requirement to keep up to date with a new area of the law and its interpretation. There is no data available on the costs of these intermediaries (eg, on what proportions of their businesses are concerned with cross-border employee taxation) that would be needed to make an estimate of this impact. However, the new law would mean new business for them.
1.91 The original option would have administrative impacts for the ATO. These centre on the need to interpret the new law as well as ensuring instructional material, return forms and associated instructions reflected the new law. The ATO would also have to deal with computer system changes and compliance issues to ensure that the measure is working as intended.
1.92 The overall cost of these administrative changes, however, is not considered to be significant and was to be absorbed as part of business as usual.
1.93 The original option when re-announced in the 2005-06 Budget had a revenue cost of $105 million over the forward estimates period ($50 million in 2007-08 and $55 million in 2008-09).
1.94 The New Business Tax System, including this measure, is intended to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings.
1.95 The measure dealing with the taxation of temporary Australian residents will contribute to these broader economic goals by removing impediments that will assist in attracting internationally mobile labour to Australia. It will also have the effect of reducing business costs (fewer or no normalisation payments) where foreigners are employed temporarily in Australia. Australia should then benefit from the dynamic effects of having business located here, as well as from the expenditure, profits and local employment that such businesses may generate. In addition, the bringing to Australia of foreign executives and skilled employees will facilitate the transfer of new management techniques and information and skills to the Australian economy.
1.96 While this option would have provided a benefit there is neither reliable data nor modelling available as to the size of that benefit.
1.97 The changes to the original option (ie, removal of time limits etc) will mean greater compliance cost reductions than would be possible under the original option, by applying the concession to affected taxpayers regardless of the length of their stay and by simplifying the CGT rules for them. This measure is expected to encourage temporary residents to come to Australia to work here for longer periods. Compliance costs will be further reduced because a number of similar measures have been brought together in one area of the law. However the extent of the reduction in compliance costs is not quantifiable because of lack of data on compliance costs relevant to this area of the law and the asset portfolios of temporary residents.
1.98 Those permanent residents who may be affected by the restriction of the short-term residents CGT exemption on departure from Australia may have additional CGT to pay on a subsequent departure as well as additional compliance costs in calculating that tax. However, they will be relieved of some compliance costs associated with the existing exemption. These impacts can not be quantified because of lack of data on the numbers affected and on their asset portfolios. Tax returns do not require identification of net capital gains arising from individual CGT events nor of net capital gains that are disregarded. The changes to this CGT exemption (to restrict the exemption to temporary residents) may negatively impact on a small group of permanent residents currently not in Australia who return to Australia some time in the future and then leave again. However as mentioned above a transitional rule will operate for five years.
1.99 Some additional compliance costs will be incurred by those who are or have been temporary residents when a CGT event happens in connection with employee shares or rights that relate to employment in Australia. With the exception of those who are foreign residents when the event happens, the additional compliance costs will be incurred to obtain the benefit of a tax concession. Again, no data are available to allow an estimate of the additional compliance costs, which would require information on temporary residents holding employee shares, when they were granted, when they are disposed of and when the persons leave Australia. While the new option is more explicit in this regard there would have been some compliance costs involved in complying with the original option.
1.100 The changes to the original option should result in reduced costs for businesses that employ temporary residents and provide normalisation payments to compensate employees for potential increases in overall taxation during their period of employment in Australia. These businesses will no longer be required to compensate employees who remain in Australia for longer than four years, or who would have breached the requirement for the short-term resident CGT concession. It will probably also mean less tax-induced changes in personnel.
1.101 Business will also benefit as key personnel from overseas may now be more willing to come to Australia as a result of the change in their Australian tax obligations.
1.102 Changes to the original option (ie, the removal of the four year limit, simplification of the rules relating to the CGT concession, and removal of the residency requirement etc) should not result in any additional costs, as the changes to information products have not yet been undertaken for the temporary residents measure, so the further changes to the announced measure can be easily accommodated.
1.103 The changes should actually result in a reduction in costs for the ATO in administering the new law partly because they have facilitated the consolidation in the law of a number of similar measures. However, the references to the Social Security Act 1991 in the definition of a 'temporary resident' will add to costs for the ATO compared with the original version. On the other hand, the removal of the requirement that a temporary resident be an Australian resident for tax purposes will make it easier to determine if the person is a temporary resident. Similarly, some of the changes to the tax treatment of temporary residents (eg, for CGT) should make administration easier while some (eg, on employee shares) may make it more difficult.
1.104 The revenue cost of the new option over the forward estimates period is $75 million ($36 million in 2007-08 and $39 million in 2008-09) including the relatively small cost of the changes from the original option. The reduction of the cost from that identified for the original option is entirely due to the use of better information.
1.105 The changes to the original measure will further assist in attracting internationally mobile labour to Australia and keeping them here for as long as there is a good business case, by removing possible distortions to individual's choices due to arbitrary time limits.
1.106 The measure dealing with the taxation of temporary residents to Australia was accepted by the Government in its Stage 2 response to A Tax System Redesigned and was announced on 11 November 1999.
1.107 Extensive consultation was conducted on the original option before its previous introduction into Parliament in 2002. For instance a consultation workshop was held in May 2000 in relation to the initial announcements made by the Government. In addition, the Treasury has also received further submissions dealing with the taxation of temporary residents in Australia.
1.108 Discussions have also taken place with the then Department of Immigration and Multicultural and Indigenous Affairs in relation to the visa requirements for people seeking to enter Australia. The Department of Education, Training and Youth Affairs was also consulted in relation to people in Australia on student visas.
1.109 In regard to the changes to the original option, confidential consultation with a small number of tax practitioners and academics in the field has also been conducted, especially on the changes dealing with employee shares or rights. The changes proposed were generally considered to be reasonable. Some concern was expressed about tying the concept of a temporary resident to the treatment of the person's spouse for social security purposes. However, no better way of addressing the perceived integrity concern that led to this feature (see paragraph 1.74) could be found. There also was some opposition to the continued application of CGT to employee shares or rights that relate to employment in Australia. In order to keep the measure closely aligned to its underlying policy of not exempting employment income of temporary residents, and in order to avoid the creation of additional incentives to restructure employment remuneration to obtain tax benefits to the disadvantage of other Australian resident employees, the concerns expressed over these rules were not able to be accommodated in the final measure.
1.110 This proposal dealing with the taxation of temporary residents is expected to address issues concerning the employment of skilled temporary residents in Australia. The introduction of this measure will therefore help promote Australia as a business location.
1.111 The changes to the original option will further enhance this aim by removing elements that may distort taxpayer choices, and by reducing compliance and administrative costs.
1.112 The Treasury and the ATO will monitor this taxation measure as part of the whole taxation system, on an ongoing basis.