Tax Commissioner responds to High Court decision that the Working Holiday Makers tax is unfair by making tax residency claims harder

Introduced in the name of fairness, the Working Holiday Makers tax, known as the ‘backpacker tax’, has been ruled to be unfair to working holiday makers from 8 countries: the United Kingdom, Chile, Finland, Germany, Israel, Japan, Norway and Turkey.

The ruling was made by the High Court of Australia in Addy v Commissioner of Taxation [2021] HCA 34 (Keifel CJ, Gageler, Gordon, Edelman and Gleeson JJ, jointly) (3 November 2021).

In this article we consider the tax, the ruling and the Tax Commissioner’s response

The Working Holiday Makers tax

The Working Holiday Makers tax was legislated by the Commonwealth Government and applies from 1 January 2017. It is a new tax.

It provides that “working holiday makers” pay a flat tax rate of 15% on the first AU$37,000 of “working holiday taxable income” – see s 3A and Sch 1 Pt III Income Tax Rates Act 1986 (Cth).

“Working holiday makers” are defined as persons holding a Subclass 417 (Working Holiday) visa; or a Subclass 462 (Work and Holiday) visa under the Migration Act 1958 (Cth).

The Subclass 417 visa program is a cultural exchange program which allows young adults (aged 18 to 30/35) from 19 eligible partner countries to work in Australia while having an extended holiday (3 months work in agriculture / healthcare sectors is a requirement).

When the Treasurer introduced the law, he cited fairness:

"The working holiday-maker reform package will ensure working holiday-makers pay their fair share of tax … working holiday-makers who were residents for tax purposes and earning below the $18,200 tax-free threshold were effectively having not just a working holiday but a tax holiday as well” [the Honorable Scott Morrison: Second Reading, Income Tax Rates Amendment (Working Holiday Maker Reform) Bill 2016]

At the initial tax rate proposed of 32.5₵ in the dollar, the estimated additional revenue was $540 million. At the legislated rate of 15₵ in the dollar, the revenue would be $249 million.

An indication of the popularity of the visa program is found in the 2016 Census statistics: there were 129,442 Working Holiday Makers of which 78,763 said they were residents and 50,680 visitors. No details are available of how many claimed to be ‘tax residents’, but it would be substantial to justify the revenue estimate.

The facts in Addy’s case

Catherine Addy is a United Kingdom national. She held a 1 year working holiday visa (Subclass 417), which was extended for another year. Upon her arrival on 20 August 2015, she travelled around Australia and Southeast Asia, and worked on a horse farm for 3 months.

From July 2016 until her departure on 1 May 2017, she lived in a share house in Sydney and worked casually as a food and beverage waitress at two Sydney hotels.

During the 2017 income year, her taxable income was $26,576, upon which she paid tax of $3,986 (a flat tax rate of 15% on every dollar of income). By comparison, an Australian national would have paid tax on that income of $1,591 (mainly because of a tax-free threshold of $18,200).

Ms Addy claimed she was entitled to a tax refund of $2,395, because she satisfied the 183-day test for residency, as defined in subsection 6(1)(a)(ii) of the Income Tax Assessment Act 1936 (Cth).

That is, she was a “resident or resident of Australia” because she was:

The Commissioner considered Ms Addy to be a ‘temporary resident’, that is, a resident for tax purposes because the 183-day test was satisfied. The Commissioner did not argue the proviso to the 183-day test, even though there was a good argument that Ms Addy’s ‘usual abode was in the UK because ‘before her stay in Australia, she had lived in the family home” and “She left a substantial portion of her possessions at that family home and expected to, and did, return there after her stay in Australia”. Perhaps it was because there was insufficient evidence for the second limb - that she did not intend to take up residence in Australia.

But for the “backpacker tax” law, Ms Addy would have been taxed at the lower tax rate because she satisfied the 183-day test for tax residency.

The ruling: the UK-Australia Double-Tax Treaty prohibits tax discrimination

The question the High Court of Australia decided was whether the ‘backpacker tax’ law was inconsistent with the non-discrimination clause in UK-Australia Double-Tax Treaty.

The non-discrimination clause is Article 25(1) of the Treaty, which provides:

"Nationals of a Contracting State [the United Kingdom] shall not be subjected in the other Contracting State [Australia] to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State [Australia] in the same circumstances, in particular with respect to residence, are or may be subjected." [emphasis added by the High Court]

The High Court of Australia considered that if a United Kingdom national is “doing the same work, earning the same income, under the same ordinary taxation laws” as an Australian national, then if they are a resident for tax purposes, they are entitled to be taxed on income at the same rate as Australian nationals (not at a higher rate) because of the non-discrimination provisions in the Australia-UK Double-Tax Treaty (United Kingdom- Australia International Convention).

The High Court found that:

“In the present case, the application of the ordinary taxation laws – the basis of the charge and the method of assessment in relation to the taxable income of Australian nationals and nationals of the United Kingdom in the same circumstances – was the same, but the tax rate was not.” [judgment, paragraph 34]

And:

“the more burdensome taxation imposed on those holding a working holiday visa, which depends upon being not an Australian national, contravenes Art 25(1)” [judgment, paragraph 31].

The High Court of Australia concluded that the ‘backpacker tax’ was inconsistent with the Treaty, and that the Treaty ‘prevailed over’ the ‘backpacker tax’ because the tax was more burdensome than the taxation imposed on an Australian national.

It was an unfair tax.

As a result, the backpacker tax did not apply to Ms Addy and she was entitled to be taxed as Australian resident and receive a tax refund.

The Tax Commissioner’s response

The Commissioner has made clear in the ATO Decision Impact Statement (17 December 2021) that it will limit the significance and impact of decision:

"Most holders of working holiday visas will not be residents of Australia. … But for unusual circumstances, the taxpayer in this case would not have been a resident of Australia.”
Note that Ms Addy’s Australian residency for tax purposes was ‘largely not disputed’ by the Commissioner in the proceedings and so no explanation was given for why Ms Addy’s circumstances were unusual.

This table of Working Holiday Maker tax returns processed, 2018–19 to 2020–21 extracted from the Commissioner of Taxation Annual Report 2020-2021, shows that substantial amounts of tax were withheld and assessed from working holiday makers at the 15% flat rate:

TABLE 3.14	2018–19 tax returns	2019–20 tax returns	2020–21 tax returns
Number of tax returns lodged by working holiday makers	99,895	81,182	287
Average taxable income	$22,891	$25,095	$19,049
Average income tax withheld	$3,975	$4,560	$3,089
Average income tax assessed as payable	$3,886	$4,322	$2,982

 

The ATO has given no estimate of how many of these working holiday makers claimed residency for tax purposes.

In the Impact Statement, the Commissioner makes clear that residency claims (for tax purposes) by working holiday makers will now be harder to make:

“Regarding the 183-day test, the Commissioner considers that for most people entering and remaining in Australia on a working holiday visa their usual place of abode will remain outside Australia and they will not have an intention to take up residence in Australia. The latter is not shown by merely holding an intention to stay in Australia for a length of time much less by having some intention to stay for an undetermined period. Credible evidence will be needed to show that the taxpayer is not a temporary visitor. The securing of a different type of longer-term visa may be such credible evidence.”

“Should a taxpayer wish to contend that they are a resident … the Commissioner will expect an explanation as to why they consider that they are a resident and may ask for supporting evidence.”

The ATO has issued a practice note to employers: Do you employ working holiday makers? on 21 December 2021 which sets out its guidance:

If you employ working holiday makers, regardless of the country they are from, you must continue to withhold 15% tax from their pay – unless you receive a pay as you go variation notice from the ATO.

This follows the recent decision by the High Court in the matter of Addy v Commissioner of Taxation. The decision means an eligible working holiday maker may be tax assessed the same as an Australian resident, if they are both:

If your employee is a working holiday maker from one of the above countries and an Australian resident for tax purposes, they can lodge a tax return at the end of the income year to receive a tax refund (where eligible).

Summary

Nationals from 8 tax treaty countries can take advantage of the decision in Addy’s case if they can prove Australian residency for tax purposes. The countries are: United Kingdom, Chile, Finland, Germany, Israel, Japan, Norway and Turkey. Nationals from these countries represented more than 35% of Subclass 417 visas granted in 2020-21.

To be taxed at the same rate as Australian nationals, nationals of these 8 countries need to satisfy the Commissioner either that their usual place of abode is not outside Australia or that they intend to take up residence in Australia, so as to take advantage of the lower rate of tax available to Australian nationals. The Commissioner will require an explanation and credible evidence.

If not, the tax treaties provide no special protection and the tax treaty nationals will be taxed on income at the same rate as working holiday nationals of other countries: a flat 15₵ in the dollar.