Contributed by Associate Professor Justin Dabner, Law School, James Cook University, Cairns, Australia; Principal of Tax Resolutions
“Madam Speaker, fairness is essential to the integrity of our taxation system … anyone on a working holiday in Australia will have to pay tax from their first dollar earned, rather than enjoying a tax-free threshold of nearly $20,000. This will save the budget $540 million … These integrity measures protect those who are doing the right thing. They promote trust. And they’re all part of responsible budgeting.”
Treasurer, the right Honourable Joe Hockey, Budget speech, 12 May 2015
Introduction — (ir)responsible budgeting
One of the more controversial measures of Hockey’s second Budget was to subject those entering Australia under a working holiday visa, and becoming tax residents, to tax at a higher rate, the so-called “backpacker tax”. Under the Budget night proposal, these visa recipients were to lose access to the tax free threshold and be taxed at 32.5% from the first dollar earned.
The outcry from the tourism and farming industries and regional sectors, concerned that a source of cheap labour and locally spending visitors would instead spend their gap years in Canada, South Africa and New Zealand, was deafening. Fruit rotting on the trees, labour hiring practices going underground and the demise of already marginal regional businesses were prophesied.
Many of these complaints came from the government’s own constituents. There had never been any consultation on this measure and the government was forced to admit before a Senate Enquiry that it had not conducted modelling of the proposal’s effect before announcing it. So much for “responsible budgeting”.
The outcry resulted in introduction of the measure being delayed six months from 1 July 2016 to 1 January 2017 while a review was conducted. After much debate in the Senate, where various rates of 10.5%, 13% and 19% were touted, a compromise rate of 15% was struck and the measure passed into law in December 2016. Incomprehensible as it may sound, one effect was to actually reduce the tax rate applying to backpackers who were non-residents and otherwise subject to the 32.5% rate.
Now, after all this, the Federal Court has held that the legislation, to the extent that it applies to backpackers who become tax residents, is invalid!!
Foreign backpackers and the residency test
This problem for the government would never had arisen if foreign backpackers were properly viewed as non-residents for Australian tax purposes. Rather coincidentally to the policy being formulated, the AAT handed down three decisions that seemed to suggest that (at least for the most part) this would be the case. In Re Koustrup and FCT  AATA 126; Re Jaczenko and FCT  AATA 125 and Re Clemens and FCT 2015] AATA 124 (all decided on 6 March 2015), the backpackers at issue were held to be non-residents. In each case, this was at the behest of the ATO seeking to deny the backpackers access to the tax free threshold. Given this tendency to deny backpackers the lower resident tax rates (also see Stockton v FC of T 2019 ATC ¶20-713;  FCA 1679 decided last month), the rationale for the original proposal, and the estimated tax revenue, must be called into question.
Still the government was adamant to ensure that all backpackers, described by the then Prime Minister Turnbull as “white kids, rich, white kids from Europe, who come here on their holidays”, paid tax on the first dollar they earned. These inequitable outlier circumstances that the government was so concerned with are demonstrated in the facts of Addy v FC of T 2019 ATC ¶20-719;  FCA 1768.
Meet Joe Hockey’s and Scott Morrison’s nemesis: Ms Catherine Addy
23-year old Catherine Addy entered Australia, courtesy of her working holiday visa, on 20 August 2015. A British citizen, she had left most of possessions at her folk’s house in Bexleyheath, Kent, and arrived in Australia with nothing but a backpack and a plan to base herself for 12 months at a share house in the Sydney suburb of Earlwood, with her friend Emma.
Had she stuck to this plan, she would have likely been taxed in the same way of the other four backpackers mentioned above and that would have been the end of the story. But inner Sydney has its attractions for a young woman from Bexleyheath and soon she decided to apply for an extension to her visa. Successful, she stayed on, her time in Australia punctuated by a two-month holiday to South East Asia, two months or so working in regional Western Australia (to strengthen her visa extension application) and some short trips to see the best of Australia (including Cairns of course). Eventually though, she became homesick for Bexleyheath and departed Australia on 1 May 2017.
Hi from Australia. It is the ATO and we are here to help
All love affairs risk souring and such, no doubt, was Addy’s with Australia when she subsequently received an assessment for the 2017 year stating that she owed an extra $2,767 on the basis that PAYG had been wrongfully withheld at the resident rates and her circumstances indicated that she had been a non-resident. However, in response to representations made on her behalf by a tax agent, the ATO relented and accepted that she had, indeed, been a resident and, in fact, a refund was due to her. Her love affair with Australia was rekindled.
However, Australia, in the form of the ATO, was to be a very fickle lover and when the further amended assessment was issued it contained a note to the effect that the dreaded backpacker tax had been applied. Jilted, Addy lodged a further objection.
So was Addy a resident or not?
At the hearing, the ATO was reluctant to debate this point, asserting that it had not properly been raised as a ground of appeal but rather this was a test case solely on the point of whether the backpacker tax was voided by the Australia/UK double tax agreement. Nevertheless, his Honour, Logan J, of Stockton fame, was keen to illustrate the points of difference in Addy that supported the conclusion that she was a resident according to ordinary principles. Notwithstanding the room waiting for her in Bexleyheath and nominating herself as a resident of England on incoming passenger cards, his Honour was influenced by the enduring quality of her accommodation in Earlwood supported by postal, banking, medicare and medical records. Stockton was contrasted as “an opportunistic itinerant of no fixed abode or employment” () whereas, for Addy, Earlwood was her home base for employment, living and social purposes (even in the absence of a formal lease).
His Honour reiterated his caution given in Stockton that residency was to be determined on the facts and not to be decided by whether a taxpayer enjoyed a particular class of visa. Additionally, as to the relevance of the room available to her back in Kent, this was just symptomatic of the times where “empty nester” parents might care for some of their adult children’s possessions and there was always the contingency that they might return, but this did not make the parent’s home their child’s place of abode.
This conclusion also meant that Addy was a resident pursuant to the 183-day test (in the absence of a usual place of abode outside Australia). Consistent with his Honour’s conclusion in Stockton, satisfaction of this test did not have the effect of rendering the taxpayer a resident for the whole year (even after she had physically departed Australia) such that no pro-rating of the tax free threshold would then be required. Rather, she was a part-year resident with her residency ceasing in May and so only entitled to a pro-rated threshold.
The backpacker tax and the double tax agreement
The operative elements of the backpacker tax are contained in s 3A and Pt III of Sch 7 to the Income Tax Rates Act 1986. The effect is that recipients of certain working visas are not entitled to the tax free threshold and face a lowest marginal rate of tax of 15%.
In the political hurly burly of the enactment of the backpacker tax, it is surprising that no one in the government seemed to have identified how the non-discrimination clauses in Australia’s double tax agreements with the US, Germany, Finland, Chile, Japan, Norway, Turkey and, Addy’s country of birth, the UK, would interact with this measure.
Article 25 of the UK agreement can be paraphrased, in this context, as stating that nationals of the UK are not to be subject to tax in Australia that is “other or more burdensome” than that to which Australian nationals “in the same circumstances, in particular, with respect to residence” may be subjected. The term “national” is defined in Art 3 in terms of citizenship or a right to abode (in the UK) or a right to permanent residency (in Australia). The issue was, therefore, whether Addy, as a UK national, was being subjected to a more burdensome tax than an Australian national in the same circumstances.
In the absence of Australian precedent on this article, his Honour exhaustively explored overseas authorities including those of New Zealand, France and Germany. Reference was also made to the OECD commentaries and British and Italian commentators.
One argument of the Commissioner readily rejected by his Honour was that if Addy was not subject to tax in Australia the income would escape tax altogether. This proposition was not to have any bearing on how the article was to be interpreted.
Another argument rejected was to the effect that as Art 25 required a comparison between the tax payable “in the same circumstances”, then the comparison had to be between that payable by Addy and by a notional Australian who held a working holiday visa. As such a visa could not be issued to an Australian, no comparison was possible and so Art 25 was not engaged. This came down to the interpretation of “in the same circumstances” and while a New Zealand authority applied a strict test of “substantially identical” (rather than “roughly the same” or the OECD’s “substantially similar”) his Honour distinguished the outcome in that case as applicable to companies not individuals. Ultimately, his Honour concluded that the inability of a national of Australia to hold the visa held by the foreign national was not relevant to the question of what might constitute the same circumstances for comparative purposes ().
Referring to the definition of “working holiday maker”, his Honour concluded that the more burdensome tax rate applied only to individuals who were not nationals of Australia. As a disguised form of discrimination based on nationality, this was, indeed, prohibited by Art 25 (, ).
There are limits to the application of the article. The OECD commentaries acknowledge that while the article focuses on discrimination based on nationality, whether direct or indirect, it does not extend to prevent differences in treatment based on residency. This is made clear by the express qualification in the article to the effect that residents and non-residents are not to be regarded as being in the “same circumstances” for the purposes of the comparison ().
Conclusion — rare phenomenon?
The dearth of Australian authority on the non-discrimination article underscores how exceptional the backpacker tax really is. The whole saga of its announcement through to implementation has demonstrated breath-taking incompetence. If the case is not reversed on appeal (and it would be surprising to this writer if it were), then will the government seek to shore up the legislation or repeal it and hope that our memories dim with the ravages of time? It might also hope that we forget that last year the government had to relax the working holiday visa conditions due to a large fall in working backpacker numbers and a loss of their spending in regional towns.
First though, there will be refund credits (including interest) to deposit in overseas bank accounts of erstwhile residents (estimated at 75,000 taxpayers and hundreds of millions of dollars in an ABC news report). Although this will cost the revenue in the immediate term, in due course the payments may be recouped if there is a reinstatement of the higher marginal rates to those backpackers charmingly described by his Honour as opportunistic itinerants with no fixed abode, ie non-residents.
Importantly, the analysis in the decision confirms that the application of the non-discrimination article is a rare phenomenon. The distinction between the taxation of residents and non-residents is not imperilled — an important consideration as the government moves to remove from non-residents access to the principal residence CGT exemption, to accompany the removal of the 50% discount some years ago. However, the 65% tax rate applied to Departing Australia Superannuation Payments (that has applied from 1 July 2017 after Addy had left Australia) might not fare so well.