Great Aussie Attractions: Sun, Surf, and Savings for Expatriates

by Dan Hodgson, KPMG, Sydney
(KPMG in Australia is a KPMG International member firm)

Australia has long been regarded as an attractive destination to live, boasting beautiful beaches, warm weather, and a generally laid back attitude. Recently, new initiatives have been introduced to ease the income tax burden that individuals might otherwise associate with a move to down under.

The Terrain

The Australian government has identified a shortage of skilled labor.¹ Australia's ability to economically compete on a global level is therefore dependent upon its ability to attract internationally mobile, skilled labor. Relevant tax reform is one of the methods chosen to achieve this.

Recent national reports on tax reform have urged policies which foster a more competitive regime for expatriates, with particular emphasis given to reducing the potential for double taxation of expatriates as they move through different jurisdictions. A recent example is the change to the taxation of employee share schemes², to align Australia's domestic tax treatment with OECD recommendations.

Now, in respect of general taxation, Australia has chosen to adopt a graduated approach to individuals who are temporary residents — a method used by many countries with which Australia competes for skilled labor.³

While the personal income tax rates remain the same as for ordinary tax residents, the tax base has been reduced for temporary residents by introducing foreign income exemptions, such that only Australian source income and income from employment will be taxable in Australia.⁴ These exemptions represent a significant change in Australian tax policy.

Similar amendments were introduced to Parliament in 2002. However, the government of the time twice rejected the amendments. The reason given for rejection was that "it was inappropriate as a matter of priority to be providing a tax cut to wealthy overseas executives."⁵ Domestic taxpayers and domestic labor were the more important priorities.

Australia's policy of attracting internationally mobile, skilled labor has since evolved, and, with the change in government, the foreign source income exemptions were passed, with even broader application than as originally proposed in 2002.

Australian Sun Smiles on Temporary Residents

The foreign source income exemptions will apply to "temporary residents" of Australia. A temporary resident is defined as any individual who holds a temporary resident visa, such as the temporary business visa (subclass 457), provided he or she (or the spouse) has not previously been a permanent resident.

Permanent residents of Australia, or individuals married or in a de facto relationship with an Australian citizen, will not be able to enjoy these exemptions.

One provision that was broadened since the original proposals in 2002 is the removal of a time limit on the application of these exemptions. Previously proposed as a four-year honeymoon period, an individual may now continue to be eligible for these exemptions for as long as he or she maintains a temporary residence visa, which may be renewed indefinitely.

For Which Income Will Exemptions Apply?

The tax exemptions have great breadth, leaving only a few income items that will continue to attract a tax liability in Australia.

Prime facie, all foreign source income (excluding employment income) will be exempt. For example, foreign interest, dividends, capital gains, royalties, as well as any other type of income that does not have an Australian source, will not be assessable income for Australian tax purposes.

In keeping with this, only capital gains on assets that have the 'necessary connection with Australia' will be taxable. Assets which have the necessary connection with Australia will be real property, interests in private companies, and interests in public companies to the extent that interest is greater than 10 percent.

Therefore, even when shares in Australian publicly listed companies are sold, it should be expected that any capital gain enjoyed by a temporary resident would generally not be taxed in Australia.

A plethora of other taxes on foreign income and transactions will now also be redundant for temporary residents. Such taxes include the tax on foreign currency gains and losses, the interest withholding tax on foreign mortgage repayments, as well as various record keeping obligations for foreign investment funds and controlled foreign entities.

Planning for the Tax Holiday Expatriate-style

There may be significant income tax savings available in respect of temporary assignments to Australia.

Many assignments may include some type of arrangement regarding tax equalization or protection. Employers, therefore, should review their tax equalization policies to determine whether the benefit from these changes should flow to the assignee or back to the company. It is important to remember that these changes will take effect from 1 July 2006, and may affect both new and existing contracts.

There is a flip side. Under the new legislation, only expenses that were necessarily incurred in deriving income that is assessable in Australia will be allowable deductions. For example, tax losses from the rental of a temporary resident's principal residence in his or her home country that are currently available as an Australian tax deduction, will no longer be allowed under the new legislation.

The Highs and Lows of Australia's Tax Climate

It has been said that these laws "… should enable foreigners to legitimately park money in offshore tax havens and live tax-free in Australia, so long as they paid tax on their Australian income"⁶ — and this comment certainly has credence.

Although money may be legitimately and tax effectively "parked" offshore, employment income within Australia will still be subject to Australian tax, which, it has been said, remains too high.⁷ A recently released report on international benchmarking of Australia's taxation⁸ compares Australia's top marginal personal tax rate of 48.5 percent with the OECD average of 46.7 percent.⁹ However, this report has found that overall, Australia is a low tax country by comparison with other developed countries. Specifically, it found that Australia has the eighth lowest tax burden of the 30 OECD countries when comparing the ratio of tax to gross domestic product.¹⁰

Perhaps More Heaven than Haven?

The international benchmarking report also indicates that Australia experiences positive net migration of high skilled persons from nine of the top 10 countries / regions to which high skilled persons in Australia depart.¹¹

This report was prepared prior to the foreign income exemptions passing into law. It could be argued, consequently, that the attraction of Australia as a destination for foreign investment and expatriates is now greater.

It would appear that there are many factors for high skilled people migrating to Australia,¹² including stable political institutions, personal/civic liberties, potential gross earning opportunities, the cost of living, the availability of education and health services, leisure opportunities, climate and environment, and life-style preferences.¹³

Despite the benefits provided to expatriates by Australia's foreign source income exemptions, when combined with the relatively high rates of personal income tax that still apply to employment income, the country's appeal must be more than fiscal. It is unlikely that Australia could be "marketed" purely as a tax haven or as a low tax region to attract international labor. As mentioned earlier, other factors make up the decision-making "equation" when choosing Australia — or any other location — as a business and assignment destination.

Suitably, the foreign source income exemptions go some way to "neutralize" the tax effect of high marginal Australian income tax rates, and when combined with the many other attractions that the country has to offer, Australia becomes an appealing temporary assignment prospect.

Footnotes:

1. Department of Employment and Workplace Relations, 2001, quoted by Senator Coonan, Senate Hansard, 27 June 2002.

2. New International Tax Arrangements (Foreign-owned Branches and Other Measures) Act 2005. For more analysis of the taxation of share schemes in Australia, see Hayse, N., "Cross-Border Equity Compensation in Australia – Clarity at Last?" in KPMG LLP's The Expatriate Administrator, Spring 2006, Vol. 1.

3. For example, the U.K. has special tax treatment for individuals whose intention to remain in that jurisdiction is only for 23 months or less; Singapore also has a special regime for 'not ordinary residents', as does Japan.

4. Tax Laws Amendment (2006 Measures No 1) Act 2006.

5. Mr. McMullan, House of Representatives, Hansard, 27 June 2002.

6. John Garnaut, "Tax break offered to foreign workers," Sydney Morning Herald, 24 February 2006.

7. Australian Chamber of Commerce and Industry, International Tax Comparison Supports Need for Reform, 12 April 2006.

8. Treasury Press Release No.021, International Comparison of Australia's Taxes, 2006, Warburton Hendy.

9. International Comparison of Australian's Taxes, 2006, Warburton Hendy ("Warburton Hendy report" ), available at http://comparativetaxation.treasury.gov.au. This report was commissioned and released by the Australian Government Department of Treasury.

10. Ibid.

11. Ibid.

12. KPMG, International Comparison of Australia's Taxes, Tax in Focus, 13 April 2006.

13. See "Australia: A Wealth of Opportunity," Australia's Department of Communications, Information Technology and the Arts, 2003, at http://www.dcita.au/cca. Also see http://www.investaustralia.gov.au.

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