VOICE-OVER:
This podcast channel it’s about you, successful international entrepreneurs, successful ex-pats, successful investors. Sponsored by HTJ.tax
DERREN JOSEPH:
So we’re alive. Thank you for joining us, HTJ.tax, a member of Moores Rowland Asia Pacific. Every week we do a live stream talking all things tax, international tax. And today we’re going to talk about US-Australia tax. So, this is being recorded. So, for those on zoom, if you do not want your image to be captured, you need to keep your cameras switched off. We have asked, we’ve invited those that rsvp to submit questions in advance, for those that did thank you very much. We got those, but those who didn’t get a chance to and would like to ask questions, please feel free to type them in the box below. And we will get to them in the order in which we received them.
Now, for those who are joining us for the first time, please bear in mind that we are not giving tax advice. We are all licensed credited tax professionals. So, it’s impossible to give tax advice based on like two seconds of information about your situation, the only person that can advise you, someone, who’s qualified and who knows your situation inside out. So, this is just to consider this information general information. You can even consider it entertainment, but it certainly is not to be construed as tax advice. What we try to do is equip you with the tools needed to engage a tax professional of your choice and the tools and the key concepts that you need to bear in mind as you try to resolve your personal tax situation.
So, having said that without further ado, I introduce James, special tax counsel with Abbott and Mourly and he’s going to give us an overview of Australia tax, and then we’d get into the Q and A which I know you guys are tuned in for. Over to you James?
JAMES MELI:
Okay, thank you for that introduction, and hello everyone out there. Again, Australia is similar in a lot of ways from an international tax perspective to lots of other countries and it’s tax territory or jurisdiction I should say is essentially on two bases. One is residents, we tax our residents on their worldwide income from all sources, subject to any specific in sessions or exemptions. And we tax known Australian residents or foreign residents on there only on their income from Australian sources. And again, there are specific concessions for political reasons, for instance, to attract foreign capital. If you’re a foreign person investing in Australian shares or shares in an Australian company, I should say then with very limited exceptions, a foreign resident isn’t taxed at all on that capital gain when they sell shares. So, central basis residents and, and source, we do have a, a strange kind of halfway measure or hybrid measure where if you’re an Australian resident, but you, you qualify as a temporary resident, which is essential for people that are here on certain types of temporary visas, they are only taxed in Australia on their Australian sourced income, whereas they could generate millions or billions of dollars overseas.
And even if they bring that into Australia, that’s not a tax for as long as they have that, that particular kind of hybrid temporary resident status. So they’re the two main ones, as well as the kind of strange little hybrid basis for Australian taxation. That’s a feat at the individual level, but it also plays out as well in the context of an Australian company and strange companies, texts in Australia where it’s worldwide income, a foreign company is only taxed on a team come from Australian sources. But in that regard, Australia has a very, very broad range of double tax agreements with various countries.
And as you may be aware, and it’s similar in reverse a foreign company that carries on business in Australia, even though under our domestic law source of that income is likely to be Australia and therefore in our domestic tax net, if there’s a double tax agreement with, with that particular country residents country, I should say, then they aren’t taxed in Australia. And the less they have what is known as a permanent establishment in Australia. So a significant enough economic presence in Australia in order to be taxed here.
And if they are taxed here, the tax in Australia back in the old day, the income of the permanent establishment, they’re taxed as a company Australia, doesn’t have a branch profit, remittance tax like a lot of other countries do and it says about how corporate tax system more broadly Australia’s corporate tax rate is actually currently we have a good system for a smaller sort of small to medium enterprises I should say, it’s pretty vast. And that requires that you’re a base rate entity, which isn’t just about size, but also the mix of passive versus active income.
In a sense, if you qualify you’re in the 25% pool, if you don’t qualify, you’re still in the general 30% pool and the Australian corporate tax system is not like the US tax system, which has a more classical corporate tax system or what they call classical corporate tax. We have a meditation system or a franking credit system. So when a company pays tax, it generates franking credits or tax credits. They can attach those tax credits to the cash component of a dividend. It pays out to its shareholders. And if the shareholder is an Australian resident, then they gross up that income to reflect the value of the tax credit, determine what the tax payments they will reduce that by the credit and they pay the difference.
And in fact, if, that their personal rate is less than the corporate tax paid, then they actually get a cash refund of the difference. If you’re a foreign resident receiving a dividend from an Australian company, then if it’s fully franked, then we don’t charge any dividend withholding tax to the extent that it’s unframed. Then we have a 30% withholding tax rate, but again, being, being parties to a multitude of double tax agreements all around them, all around the world that is under those, those various agreements significantly reduced. Sometimes the mill 5%, 15%. It depends on the particular DTA and the particular circumstances. What else in terms of investing into Australia, we also have a beneficial kind of regime in terms of if a company invests in an Australian subsidiary and in the future down the track, if it sells off its Australian subsidiary unless it has certain types of Australian real property assets. So if it’s a non-real property business for parents sells the shares and the Australian subsidiary, and again, there’s no tax, whereas if they ever sold off, if they operated directly in Australia through a payee and they sell that off, then they’re just taxed in Australia in the usual way.
So there’s a bit of a structural bias towards a subsidiary in that, in that regard, but in Australia, you’d have to, well, certainly you would say that compared to the other countries, compared to the US, from what I can tell him in dealing with us advisors over the years, share sales compared to an underlying asset sale is significantly less common in Australia than it is elsewhere in the world generally. And certainly the US specifically. So in terms of, for instance, in investing in Australian property, where, when you’re an overseas investor, like again, like a lot of other countries, Australia kind of covets it’s tax on real property, and you will always tax Australian Australian property if you own it directly.
And even if you own it indirectly, if you own say shares in a company with a chin Australia, and it will say it’s an Australian company that internal it’s Australian property, if you own 10% or more of that company, and more than half, the value of that company is represented by Australian real property. And even if you sold that share that is effectively taxed as if it were a real property. So very much Australia covets, it’s kind of a tax on, on real property. In addition to that, since 2012, there has been this kind of two teed system in terms of residents versus non-residents in terms of investing in Australian assets.
So up until then, and since then, it’s been the same for residents, but different for no residents. But up until 2012, if you invested in, in Australian property, I knew it was a capital asset. So it wasn’t a trading stock. It wasn’t a revenue asset. If you held that for at least 12 months, and you’re an eligible person, so we’re talking about individuals or trusts were to gain flows eventually up to an individual, but not companies because companies were they’re very eligible in disregard. Then you got what is called the general 50% capital gains tax discount.
So if you hold a capital asset for five years, made a million dollars, you could take the first 50%, $500,000 tax rate. And then you’re only assessed on the other, the other 50% or 500 in that example from 2012, that only applies if you’re a resident. And even if you’re a resident for some, but not all of the ownership period, then you have to essentially prorate that, that discount. So that’s disappointing from an investor’s perspective because we in Australia also have sort of a two T rate system. Whereas we have different sets of tax rates for residents versus non-residents the main difference is that residents are eligible for the tax-free threshold.
So they’ll pay tax from there, their first dollar. And because of that, the right up to the maximum tax rate, which is currently 45 here to Australia and kicks in at a relatively low 180,000 AUD, you can get up there very quickly, particularly when we’re talking about a, a capital gain other than just, you know, salary and wage income looking in, in a nutshell, that’s not an Australia’s tax jurisdiction in terms of the practice and dealing with foreign people coming to Australia, Australians departing overseas when a foreign person comes to Australia and they do become an Australian resident.
And we have various residency tests, the 193-day tests, the ordinarily resident test, the permanent abode test. But if you satisfy or fall within any of those, and you become an Australian resident for tax purposes, subject to you, being a temporary resident, all of your worldwide assets come into the Australian tax net at that time at their market value. So that’s something to consider because if you have an asset that you purchased for a million dollars, and by the time that you became an Australian resident, it was worth 10 million. You certainly want to be able to prove that on that particular days that asset was worth 10 million. Because if in the future you sold it for 11 billion. Australia only has the right to tax 1 million of that even though you made a $10 million again. So it’s very important if you’re moving to Australia or you have clients that are moving to Australia to kind of be aware of that gets some contemporaneous and evaluations as friendly as possible, obviously robust and professional, but valuation is often more art than science. So a robust evaluation is high as reasonably possible as well for the incoming individuals.
We also have circumstances where Australians leaving Australia ceasing to be a resident in Australia does have essentially exit techs. So individuals deemed to have disposed of all of their CGT assets other than special classes of professors, code taxable, Australian property, most notably Australian real property. That’s always in the tax net, Australia. Won’t let that go, but they deem the disposal of all other assets, unless the individual essentially makes an election to say, don’t tax me now, text me later when I actually sell.
But in doing that in kind of touching upon what be raised earlier. So that period of time that ownership period over the total ownership period, that they were a foreign resident when they eventually sell that you get the capital gains tax discount. So it’s just something else to be aware of. If you’re nosy leaving in 16 to be a resident. Well, you have clients that look in a nutshell, that’s the Australian tax system.
DERREN JOSEPH:
Alright, fantastic, James. Sorry, someone just messaged me, send me a private message. What’s your full name? Can you type your name because they’re seeing the James and if someone wanted to reach out to you to retain your services, your firm’s services for Australian tax matters, what’s the best way for someone to find you?
JAMES MELI:
Yes, you can email me at the Abbott Mourly email address.
DERREN JOSEPH:
Okay, all right. Fantastic. So, I’m just going into the questions that were submitted again. For those who have not yet submitted and want to ask a question. You can just feel free to type it in one of the boxes below. Okay.
TONY ANAMOULIS:
That’s all right. Can I just interject for a sec talking, just give the details of James’ email address? It is james.meli@abbottmourly.com.au. Okay. So, anybody who wants to touch base with James and perhaps retain the services of James, just flick him an email, and we’d be quite happy to assist you guys. Thanks, Derren.
DERREN JOSEPH:
Wonderful. Thanks a lot for that Tony. So, I’m just going to jump through the questions that were submitted. Hopefully, we can get through all of them in time. So, this one is from Maggie. Maggie’s asking, I have a question about CGT capital gains taxes. If you sell an investment property in Australia, I understand that it will be liable for capital gains tax in the US however will capital gains tax paid in Australia be offset against any amount owing to the US? The answer to that is usually yes, the US does recognize foreign tax credit. So, that’s a possibility. The second part of her question will the tax breaks are available for me in Australia for this and the bracket shows principal residence exemption, the 50% reduction for owning the property for a long time, that’s a close quote. Would that carry over to the US although they calculate it in their own way regardless?
Now, there is a principle residence exclusion. Assuming that you resided in it for two of the most recent five years, you will get an exemption on any capital. The capital gains tax liability to the US it’s 250 if you’re single and 500,000 US dollars if you are filing jointly. So, it’s not exactly as Australia does it, but there is a recognition that, hey, this was not really an investment property, at least not 100%. I lived in it, it’s my primary residence. So, you do get a tax break in some way.
JAMES MELI:
Yes. I’ve dealt with this in the past. In terms of where we have some property that was your main residence, but over the total ownership period, it was also an investment property. Then we have an absence, what they call an absence rule. Where if you rent it if you live there, then you moved out, you can rent it for up to six years, and then when you sell it, it’s still completely tax-free. If you rented it out for 10 years, the four years after the end of the six-year absence rule, there would be a pro-rated kind of calculation. The taxable portion is taxed in the usual way. You’ll get a 60% discount. All of those things. And the exempt component is 100% exempt. So, you can be in a situation where you just purchased the property. You live there, you had this huge capital gain, which is completely tax-free in Australia. It might still be assessable in the US because they have caps. That’s one of the few circumstances where, you know, America doesn’t have a more taxpayer-friendly kind of outcome than Australia, because we have an uncapped main residence exemption. Whereas from their perspective, it’s kept at say mentioned the 250 or the 500, but that’s the US. So, you also have to do the exchange.
DERREN JOSEPH:
Exactly. Thanks. Thanks all for that. And the final part of Maggie’s three-part question is, is there a formula to calculate what my potential liability might be in the US? Yes, there is, but it’s probably a bit too involved to just explain for you to replicate it. But essentially, you take what the sales proceeds would be, and you deduct the selling expenses, commissions, whatever. And you also get to deduct what we call the basis, or how much you paid for it. Plus any capital improvements that you may have made and the delta on that. Now, if it is that you didn’t rent it out for a certain period of time, then maybe some depreciation recapture, and it gets a bit complicated that way, but essentially that delta between what you paid for it, and the sales proceeds will be, that’ll be the taxable gain at least from a US perspective. Okay.
Next question. In terms of leaving Australia and James, I know you mentioned this, how has that exit tax triggered, like in the US, it’s triggered if your net assets are in excess of $2 million, or if you’re average tax bill for the prior five years were excessive, let’s say $170-175k. How was it triggered in the US?
JAMES MELI:
And then again, this goes back to my point about the US having a more pro-taxpayer kind of. Because what you mentioned that 2000 or $2 million thresholds is it’s effectively an exit tax-free threshold. That if you’re not especially wealthy, you’re not in that net from an Australian tax perspective, unless the only assets you have are taxable Australian property, most notably real property. If you had shares, even if you had a tiny share portfolio of $10,000, and it’s sitting on a $2,000 unrealized capital gain, if you cease to be a resident, you are deemed to have sold it and triggered that $2,000 gain, unless you as an individual make the election to say, don’t tax me now, tax when I actually sell, which you know, from a practical perspective, makes sense, because you’re going to have a real tax liability and no incoming cash on a deemed disposal, but the downside is you’re, you’re giving up that capital gains tax discount going forward. So, to answer the question, yes, if you’d get that $ 2 million kinds of free kick in terms of your asset position, it’s just you’re in.
DERREN JOSEPH:
Okay. Got you, thanks a lot for that. Another somewhat related question. So when someone is giving up the US tax status, it’s normally done in tandem with giving up whatever their residence permit, a residence card, the green card may have been owed, surrendering a US passport, right? And then you alert the tax office, the IRS that you are leaving the US permanently by filing something called a Form 8854 and that’s it. So from a tax resident’s perspective, you’ve severed ties with the US once you leave. From Australia’s perspective, I know you’ve explained the exit tax, what other steps does one need to take to sever tax residency with Australia when they leave?
JAMES MELI:
Yes, these are all good questions. From a practical perspective, you don’t have to do anything. And most people, most people don’t do anything because they’re not aware of it. But essentially it’ll be based on how you prepare your tax return, in a self-assessment environment for the year that you lead. If I were to leave today, in what is for us the 2022, the back end of the 2022 income or financial year, then in my return, if I return that deemed capital gain. I’m taken to have essentially chosen not to make the exit election. If I don’t return that deemed gain, I will be taken to have made the election to say, don’t tax me now, tax me when I actually sell in the future. And if I go to The Bahamas for the 10 years, I’m supposed to, when I eventually sell, I’m supposed to return that game here in Australia, to be honest, I don’t know how Australia polices that, but by the letter of the law, that’s what you’re supposed to do. And again, if I held the shares for 10 years, so I bought them in 2012, left in 2022, sold them. When in 10 years time after I’d been in non-resident for 10 years. in 2032, then for the first half of the period, I don’t get the discount.
DERREN JOSEPH:
Gotcha. Thank you. Thanks a lot for that. Moving on. Okay. So, someone says, this is a quick question, but they like, so it’s probably not going to be a quick question. So if someone is working remotely in Australia for a US employer, they’re still a full-time employee of this US company, not an independent contractor in Australia. Do they pay us social security charges on their salary or Australia and the tax resident in Australia?
JAMES MELI:
Yes. So there, there are factual variables here, but yeah, high level, if I, for instance, you know, I’ve been to the US holidays, but I’m not a US citizen, don’t have green card, none of that. I could work as a full-time employee for a US company and the US company, as I’m taxing her in Australia. The source of my employment income is where I physically am. Notwithstanding that, I’m paid by a US company. And as Australian residents, individuals working in Australia, they are required to pay Australian superannuation. Now that’s different if I support and there is an agreement I should say, between Australia and the US as to coverage for those types of payments. If I am a US citizen, I’m spent here for a period of time, it might be more than three months short terms economy. But as long as in those circumstances, I continued to be paid in the US then the US company doesn’t also have to pay superannuation in relation to my time here. But short of that the starting point is Australian residents working in Australia for a foreign company, it pays Australian superannuation.
DERREN JOSEPH:
Okay. So that’s pretty clear. And of course, there’s a totalization agreement between the US and Australia, meaning that they’re not going to pay social charges on both sides. So, and since they are based in Australia, there is a case leveraging that tax treaty for them not to pay the social security charges in the US. But as I reflect on that question, this kind of connects to a point that you made when you, when you gave your intro. So this person is not working for an Australian company, they’re working for an American company. Is there a risk that their presence on Australia’s soil can constitute a permanent establishment to that US company?
JAMES MELI:
Yes. And if there is, then I’m not sure what the US equivalent is. We, we, that is the Australian system, the Australian taxation office has both public rulings saying, this is our, our stated view. They have private rulings where someone says, look, these are my circumstances. This is what, how I think I’ll be taxed. What do you think yet? Yes or no, but they also have these products, or they call them products called ACO interpretive decisions. And they are not quite as, as formal, excuse me as a public ruling, but it must have come about in someone’s loss, they’ve approached the tax office and they’ve said, oh, there’s a bit of an issue here. We’re going to provide some public guidance as to how we would interpret this issue. Now you would expect most governments around the world. They’d be pretty pro revenue, any kind of gray area in the legislation or the case law that would kind of apply to benefit them and look to be fair taxpayers do the reverse, but there is an ATO in the interpretive decision and a toyed, albeit it relates to someone who was working in Australia, working from home, actually for a New Zealand company. And the outcome of that was that that person working in their home study was taken to be a permanent establishment falls, that New Zealand company. But there are, there are two critical things. One in that instance, that individual was reimbursed for all of their expenses. So that allowed the ATO to take the view that well, that, that study, that home study is really available to the Kiwi company because they’re footing the bill effectively. So the short of that, if I weren’t doing that, I’d say that that’s a critical distinction. And therefore you’re kind of differentiating the circumstances to that situation. But even if it is taken to be a PA, the next question is, well, what profit is attributable to that PA? So if that person, in this instance, was someone who handled the phones. So if I’m not sure it was completely administrative, but in the grand scheme of things, it, it wasn’t, you know, high value add services that were here. So if that were the case, that the threshold question, is there a PA like it, yes or no, hopefully, you know, if yes, well, what are they actually doing? How much value is being created? He, and you know what if anything can be transferred price back to the mothership to legitimately reduce the profit that is attributable to Australian tax.
DERREN JOSEPH:
Gotcha. That’s really helpful to know. Now, given that we live in unprecedented times, right? There’s a health situation. We can’t mention the name because it gets censored. Right. But there’s a health crisis, right? So for some people, I don’t know whether it’s this person’s situation, right. But suppose that they weren’t Australia, Australia, not by choice, but they were unable to return. In this case to the US. Would there be any sort of concession offered by the ATO?
JAMES MELI:
Anecdotally, there has been, and anyone in any of it, if you fall within our, any of our resident’s tests, technically you’re in the next step is to look at a double tax agreement and the residency tiebreaker rules in terms of that agreement. And if you’ve got the first tiebreaker rule is usually, do you have a permanent home wherever you have opponents. Some people are wealthy enough to have a permanent home in both places. And then you go down to the next one, ultimately it gets down to wherever your personal and economic relations are closer. So looking at most people’s circumstances, if they’re stuck in Australia, they’re their family or the majority of their family, the majority of their assets are overseas. Then the ATO didn’t make any kind of administrative concession in that condition context. Then you would still say in the DTA, well, looking at the tiebreaker rules, I fall within the domestic Australian rules as a US citizen or a continuing resident based on dorsal or whatever it is in my own country, on a domestic resident, under their system, the tie-breaker this particular tiebreaker applies. And on that basis, I’m actually a resident over there.
DERREN JOSEPH:
Okay. All right. That’s super helpful to know. Someone just put a question in the zoom, but I finished questions on the other platform before I switched back to zoom. I’ll do one more from here. I want to gift my rental property back into the US, to my kids. They haven’t said where the kids are, but, okay. So what are the tax implications from both the US and Australian perspectives of gifting rental property? Now I’ll just comment on the US side. So, yes but you know, assuming, so this ties back to whether the person, generally speaking, they transfer a sort of person who’s giving the gift, the person’s giving the gift. That is the person who bears the responsibility for the transfer tax for the gift tax. So that’s, that’s generally speaking. So if it were, if the property were in Australia, we can have a discussion about tax domiciles, but because it’s in the US, it’s a US Situs asset. So assuming that they are domiciled in the US and this person didn’t give enough facts and circumstances to make a determination, but we can, let’s assume that they can gift property to the kids up to their lifetime exclusion which is around $12 million for those seeming that it’s less than $12 million a return would be filed, but no gift taxes payable, because it’s within the lifetime exclusion.
JAMES MELI:
If they are not domiciled in the US, then their lifetime exclusion doesn’t apply because they’re not US tax domicile. So, that will be, that may trigger a gift tax, but let’s assume that they will use US-domiciled to keep it simple. But what about from an Australian point of view, seeing that they are tax residents in Australia? Sure. So, I’m assuming that the owner that they don’t, or is the gifter for lack of a better word is the Australian resident. So in those circumstances, even though it’s a gift outside an estate context, so we, we don’t have state taxes or inheritance taxes. So if it passed under a will, it’s a different story. But if someone gives an asset, a capital gains tax asset, then they are deemed to have disposed of it for its full market value. So there’s no difference from a tax perspective, whether they had gifted it to their adult child, or they had sold it for its market value to, to an independent third party from their perspective. It’s the same. If the recipient was an Australian resident, then Australia doesn’t have a gift tax. And in the context of a gift can, can in certain circumstances be considered ordinary income, but a gift between a parent and a child for no reason, but natural love and affection. That is outside our income tax net.
DERREN JOSEPH:
Okay. So the time stands for that. Hopefully, that answers your question. Just to add though. So I want to correct what I said, I said, Donny Donner. So as James, you said the right thing. So like the person that’s gifting, that typically would bear the tax burden in the US if there is any. Now, if it is that you guys are in Australia on a permanent basis, and in fact, you can be seen to be domiciled in Australia, at least from a tax perspective, then you are no longer us tax domicile. And therefore, as I mentioned before, that exclusion doesn’t apply and the exclusion is actually much lower at $60,000.NSo that hole is worth more than that $60,000 then a gift tax may apply. And now in terms of the kids, when they received the home, it’s interesting to know the basis in the home and the value of the home. So just in case, they go on to sell it at some future point in time, the basis is yours is whatever your basis was and is. So there’s no step-up in basis upon the transfer. So I don’t know if that can help in your tax planning, but I think the important thing is to figure out whether you are, and that this is a test of and circumstances whether you are, or not US tax domicile, because that would have a huge impact on how such a transaction will be treated. So you’d want to talk to a tax professional and get a determination on that hold that helps. So I want to jump to the question that was just posted by Mr. See, Mr., or Miss See in zoom. So Australian resident for tax naturalized, US citizen, trying to minimize CGT capital gains tax payable in the US. If I open a retirement account in the US and pay money into it for future use, is it a tax deduction against my CGT, as there is, hey, in Australia when I make a concessional contribution to the super okay?
So from the US, oh, so I see a second message. I don’t have a US retirement account currently. So the different types of US retirement accounts, I know in the EU and in Australia, the big thing is a super right. So that’s the main game, but in the US, they are personal retirement accounts. They are the company-sponsored ones. And even in terms of your personal retirement account, it could be pre-tax. So, you reduce your taxable income, or it can be post-tax. It can be after-tax money that you’re going to put in. If it’s pre-tax, then you pay tax. When you pull it out if it’s after-tax, would he pull it out? It will be tax-free upon retirement, right? So what it does, so the tax concession really is on your earned income. So if it is that you have a salary and you’re going to put it into one of those funds, that it, for which the benefit is it reduces your taxable income. It will reduce your own income, not necessarily any capital gains. So if it is a unit process of selling, whatever it is, I don’t think it can be used to reduce imminent capital gains. However, there are ways in which you can put an appreciating asset in a retirement portfolio. And most famously, I think within recent time, I think it’s Peter Thiel who put his early Facebook shares into a retirement fund, and they weren’t worth that much when he put them in.
But apparently, there were a couple of billion dollars right now. So to the extent….The biggest drop in market cap in US corporate history. So the point is that if it is that you want to open a US retirement account to hold custody, at least of an appreciating asset that may be possible, and you can speak to a US financial planning professional to make that happen. So, I’m not sure what your intention was, but if it to invest an appreciating asset yes. If it is to offset capital gains taxes that are imminent, probably not. Hope that helps. Okay. Switching back to the other list of questions. Okay. If someone has that, okay. And I see where this person, so this person is in Australia and they want to, they want to set up all of, they probably have already set up an LLC, a limited liability company in the United States. And there’s this perception that once you form a company offshore, somehow you magically going to save money, I guess, all the movies and what Hollywood tells us, but that clearly is not going to save you any money, James?
JAMES MELI:
Yeah. So, this happens all the time. And then people in Australia and read, you know, in the financial papers that Apple doesn’t pay any tax here. And the differences Australia is in a corporate chart. Australia is at the bottom. And in that scenario, all of the value that has been created is largely in intellectual property, created multiple tiers upstream and the entity that owns.
DERREN JOSEPH:
Sorry, James, you’re on mute. James, you need to unmute yourself, Sorry, your need for like 10 seconds. Could you rewind that?
JAMES MELI;
I got a phone call coming through, sorry. So Australia is at the bottom. If valuable IP is created upstream offshore, you can charge significant fees to the Australian entity, which pools, what would otherwise be Australian tax profit out of the country. So it increases deductions in Australia, pushes up income in low, or sometimes no tax jurisdictions. But that is just the structure of the international tax system because it was created after, oh, I actually between world war I and world war two in a completely different world. And that all of the problems that we have in terms of base erosion and profit shifting it’s because it’s very square, peg round hole stuff. The system is very physical or it’s designed for a physical world. And we do, we live in a digital world if you flip it. And the directing mind, what we call the central management and control of a company is in Australia. And you incorporate an entity anywhere in the world. The definition of an Australian resident company is an entity that, or a company that is incorporated in Australia. So it’s not that if it’s incorporated in the US, Lithuania, or anywhere, or if it’s not incorporated in Australia, it carries on business in Australia. And it has either, it has its central management and control in Australia, which has high level strategic. Decision-making is not the day-to-day ops or operations, or it has its voting control by Australian resident shareholders, which is invariably the case. So it’s very easy for an entity that just incorporates or an Australian individual that just incorporates a company overseas to, to render that Australia, that foreign company, an Australian resident for tax purposes. And that is because a couple of years back in 2016 there was a high court case. And the issue was, well, if this is a two-prong test, it carries on business in Australia. And to either central management and control voting, then you know, what constitutes carrying on a business. And that, that case essentially said, look, if you’re making high-level strategic decisions, then at least in part you’re making you’re, you’re carrying on a business here in Australia. So the same set of facts, making decisions here, high-level strategic decisions here in Australia can satisfy both of the two prongs, the carrying on a business and the central management and control. So, that was the question. What is it, a two-prong test or is it a one-prong test?
It’s just that one set of facts can satisfy books. Now that was not necessarily intended. The high court gave basically caught blind for the ATO to really take everyone to town, to their credit so far, they haven’t done that. And the treasury and the government had actually flagged it. There will be changes to residency because previously they said in carrying on a business, you actually looked at the operations on the ground. If you had a factory in Venezuela, even if central management and control were here, you weren’t carrying on a business here in Australia. So, that could legitimately be a foreign resident company. The problem is having a foreign incorporated company being an Australian tax resident is that it will pay tax over there in a source country. If there is corporate tax, which generally there is, it’ll also pay tax here in Australia. Australia’s corporate tax rate is high. So ordinarily, even though it provides straight, provides credit, there will be a top-up tax, but you’ll only generate tax credits. So franking credits or imputation credits to the extent of the tax actually paid here in Australia. So if you paid 20% overseas and you’re a 30% company here in Australia, you’d pay an additional 10, 10% top tax here, but you’d only generate the $10 worth of franking credits, even though you paid $30 in tax.
So that will push up your effective tax rate because when the dividend is paid up to an Australian resident, shareholder, it’s only partially franked, and that will pay tax at up to 45% minus the maximum 10% so that they’ve got some significant top-up tax to pay. So yes, you can certainly just do that, but it, it, that’s the first hoop to jump through the second hoop to jump through. Even if the foreign entity remains a foreign tax rep resident is Australia’s controlled foreign company rules, and Australia has essentially a Western high taxing Western Alliance, really, where if you’re a listed country. So we’re talking the US the UK New Zealand, France, Germany, Japan, I think is on the list, but essentially those listed countries effectively say, if you’re carrying on a business over there, and it’s an active business, it’s not a tainted business or a passive business, you won’t be Australia. Won’t tax you as in the shareholder, if with, with very limited exceptions, what they call eligible, designated concession income, which I’ve never actually dealt with that issue for the US but the main one, for instance, say I incorporated by company in New Zealand carries on business in New Zealand, but it makes a capital gain, New Zealand don’t tax capital gains, but that is considered to be kind of CFC income.
So it’s actually taxed and it’s attributed to me as in the shareholder, it’s an attribution regime it’ll tax me directly. So really there are two hoops to jump through if your want to successfully offshore one, the residency issue, cause a foreign incorporated company can very easily be considered an Australian tax resident, although watch this space because the legislation is changing, we’re about to go through a, an election. So I don’t know what the appetite is, if that isn’t squared away before, before the election, but certainly, you know, it’s on the writeup. The second hoop is even if you jumped through the first two successfully, is it a controlled foreign company? Almost certainly if it’s a wholly-owned subsidiary or it’s wholly owned by me as an Australian resident, absolutely. It’s a CFC. They shouldn’t become, does it have any extreme attributable income that depends on where the income is generated and the type of business or type of transactions that it enters into. And if there is attributable income, then say there’s a hundred thousand dollars worth of attributable income of my foreign company. I personally, as the shareholder, and I’m taxed on that income.
DERREN JOSEPH:
Well, well answered it. You know, I think you covered everything there and it’s, I don’t know where it comes from, but probably just like you, I face this type of question multiple times every week, I guess somebody read something or they saw something and they are convinced and they argue with me, I’m going to form this company and I’m good. It’s not going to be taxed and money doesn’t come back in, but you’re right.
JAMES MELI:
But that’s, that’s great, that’s a great point because that, in that structure, to the extent that it works, it, it relies on not being found out. And that’s not, that’s not a tax strategy.
DERREN JOSEPH:
That’s just criminal activity.
TONY ANAMOULIS:
And, you’ll be looking at four walls, a quadrangle.
JAMES MELI:
Yeah. Yeah. The linchpin of your strategy is not being detected. Then you may want to rethink that strategy.
DERREN JOSEPH:
Exactly. Okay. Onto something less glamorous, we’re going to talk about retirement planning now. So Liz is asking how the four, three B, which is a public sector, retirement fund IRAs, individual retirement accounts in the US, and Roth IRAs, which would be after-tax money. As we discussed earlier, hold withdrawals from that in the US tax in Australia as she’s an Australian tax resident.
JAMES MELI:
Sure. So if it’s a public sector fund, it would depend on the of it. I’ll start that again. There are two things if you can’t, when you moved to Australia, actually transfer, your balance to an Australian fund. When I was talking about that, but talking about what happens when you actually commit whatever conditions of release over in the US and you’re actually pulling out, pulling out funds in those circumstances, the double tax agreements, regardless of the domestic rules in either country, the double tax agreements, ordinarily keys, and then from remembering the US-Australia DTA can use taxing rights to the Australian, so the residents country of the individual, not the source country of the pension. So if that’s the case, that payment, if it’s assessable in Australia, even though it’s not assessable in the US then you kind of blow it up that the tax benefit from a US perspective by being an Australian resident and the reverse is also true. You could be in receipt of a tax-free pension in Australia, but leaving a country that taxes that the DTA assigns sole taxing rights to the other country and you get taxed.
DERREN JOSEPH:
Right. And I just, so I want to continue from where you left off, because we one would find because, you know, into Australia’s and international jurisdiction for people who work with multinationals. So it’s not uncommon for Americans to do a stint in Australia and then return to the US so they work with an Australian subsidiary of, you know, one of the big tech companies or one of the big financial institutions. And they returned to the US and when they returned to the US, invariably, because they spend time in Australia, they have a super now they can’t, it’s not really portable. It’s not easily portable, so they need to leave it in Australia until they retire. And now upon retirement, it’s like, okay, I want to access that money. How am I going to do so? So as you pointed out, it may be tax-free to Australia, but it’s taxable in the US. Now, I just commented. I know you didn’t ask about this, but I’m just commenting in general. So we see three approaches from a US tax perspective. They are adventurous tax professionals. They say, well, you know, the Australian super is actually like a social security program, not in the actual legislation, but in legislative intent, because in parliament, when it was being created and when it’s being modified it, I believe it was mentioned that the intent is for it to replace its predecessor, which is an, in fact, a proper social security program, as we know it. So these glamorous US tax professionals say it’s social security. So it’s not taxable in the US we think that that is an extreme position. You take that position at your own risk and the IRS may come after you and with interest and penalties and whatever. So that is, that is a more dangerous position to take. On the other hand, you can just look at it as a straightforward distribution and some sort of forensic analysis would be needed to determine, okay, what is the basis and the superannuation, how much was originally in, right? And then what is the delta between the contribution and its present value in that delta? It will be subject to tax upon distribution. So as in, well, you pull it out, it’ll be taxed at ordinary tax rates. So that’s the other extreme. It’s very conservative. And, and to be honest, that’s the one we would feel comfortable with. There’s a middle ground. Some people look at, especially with self-managed funds. So, some people say, well, you know, more than 50% of the value in the super is my contribution as opposed to an employer. So it’s me. So therefore I want to treat it as a ground to trust, and it can be treated as a ground with trust in the US tax rules. In that case, you don’t wait until there’s a distribution. As there is growth in the fund on an annual basis, it can be declared and subject to taxes in the US, but that has some complications as well because there are debates, there was an article that was published in one of the peer-reviewed legal journals in the US that were exploring that option of looking at it as a foreign ground to a trust. And then they’re saying, okay, well your contributions, okay, that’s fine. We can look at it as a grantor trust. If they fund we’ll declare a 5520, and you upload that to the IRS and you pay taxes on your personal tax return.
But what about if you were employed at some point in time, what about your employer contributions? Would that be part of a grant to trust or would that actually be a non-ground to a trust? And so that, that becomes a bit complex. And then what about if the fund was used to invest in, you know, in a pooled investment scheme, some funds in Australia, right? So, oh, it’s an equity fund. So it’s a POS, it’s a possibility that it would trigger something called PFX or passive foreign investment company tax treatment, which again is not to the taxpayer’s advantage. So we think that on the, so this is on the other side, in terms of someone being us tax resident with an Australian super and receiving a distribution, they probably need to sit with a tax professional to really go through the pros and cons of each of the possible approaches to see what would work most efficiently, given your unique circumstances. Hope that helps. So Liz has come back. Now she’s asking, so I’m just reading it for those who are not on zoom. So in response to my questions, so she’s in Australia with us pensions, any monies that have withdrawn from the 403B or from the IRA funds are taxed in Australia. If you’re a resident for tax purposes in Australia. And she’s asking roughly what rates of tax would be applied.
JAMES MELI:
And it depends on you. We don’t have to separate tax rates for different types of income. Generally, it’s just all pooled. So if you have any other type of income, it just all goes into the one pool and it’s assessed at your marginal tax rate based on what bracket you fall in, in that year up to a maximum, currently 40, 45, plus the Medicare levy of 2%.
DERREN JOSEPH:
Right. And they have the opposite obtained sit in the US as well. You will be taxing on your marginal tax rate as well because all ordinary income is just kind of pooled together. Yeah. Okay. So it is the top of the hour. Unfortunately, we’ve come to the end. I know there were a few questions we didn’t get to, I apologize, maybe next time, but if you want to reach out to James directly, his email address is, one more time, jamesmeli@abbottmourly.com.au. Fantastic.
TONY ANAMOULIS:
Now, I’m just wondering with the next one, when we do a next one, think of a topic that the viewers, you know, the listeners want to hear, I guess, and we can have, so we can bring James back onto it for another session, you know?
DERREN JOSEPH:
Absolutely. As it was a lively discussion. I really do get to go through all the questions posed. So, you know, if you want James back comment below or send us an email asking, please bring James back. So, I’m Derren Joseph we’re HTJ.tax tax. Again, this will be available wherever you get your favorite podcasts, you will be able to get it. See you next time. Thank you very much. Bye-bye.
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