Taxation For Australian Expatriate

Australians on the move

Australians are well represented in the global, mobile workforce. Many Australian expats become foreign residents for tax purposes (hereto just referred to as “expats”). Many expats will own (and continue to own) TAP upon leaving and will be subject to CGT on the happening of any CGT event in relation to their TAP. The removal of the CGT discount for foreign residents means that if incorrect CGT calculations become subject to amendment, the penalties and interest amounts could be greater. Any concessions or exemptions available, on a similar premise, have become more important. How much more important? Could we say twice as important?

Scope

This article focuses on the two types of CGT assets which are commonly owned by expats when they become foreign residents.

1. The “former” home; and

2. Shares in listed companies.

The former family home

Subdivision 118-B provides an exemption for the whole or part of a capital gain or loss arising from a CGT event in relation to a dwelling that is the individual’s main residence. The exemption is significant. An estimated $30 billion per year in tax revenue is forgone as a result of the CGT main residence exemption.

The basic case is generally well understood. The basic case is where an individual purchases a dwelling, moves into it, lives in it, sells it and moves out of it. An expat’s scenario often follows a different pattern. There may be a period of time between when an expat moves out of the dwelling and when they sell it. Frequently, an expat will rent out their former family home for a period of time after moving overseas before selling it. There can be a number of reasons for this. Nevertheless with the high level of home ownership in Australia, it is very likely that an expat will own a home when they leave and will have not lived in it for a period of time when (if) they sell it in the future.

Absence concession

An individual may choose to continue to treat a dwelling as their main residence for the purposes of the CGT main residence exemption even after they move out. This is on the proviso that no other dwelling is treated as the main residence during the same, overlapping, period. Expats are unlikely to treat another dwelling as their main residence in the overlapping period. Renting a residence is more common. Certainly in the early stages of expat life. Expats that do buy another dwelling in their new home country will not be subject to CGT on gains from property located outside Australia in any case as they are foreign residents and those gains are not considered Australian sourced income. So they will not be treating another dwelling as their main residence in contemplation of Australian tax law.

There is potentially a time limit placed on the period over which the main residence exemption can continue to apply. This depends on whether or not the dwelling is used to produce assessable income such as by being rented out. Where there is no income use, there is no time limit.

Expats who do not rent out their former home have an obvious cash flow issue to deal with. However a slightly more obscure issue may exist with respect to their residency status itself. If an expat retains their Australian domicile then they must establish a “permanent” place of abode outside Australia in order to be a foreign resident in the first instance. Domicile is very sticky and can be hard to shake.

Permanent should be determined in context. It does not mean everlasting or forever. It does mean more than temporary or transitory. If and expat maintains a vacant former home in Australia this could imply an overriding intention to come back. This could in turn suggest any abode outside Australia was only temporary, and therefore not permanent. The result could be that the expat continues to be a resident for tax purposes and subject to taxation in Australia on worldwide income.

In the case where a dwelling is put to an income use - rented out - the dwelling must be disposed of within 6 years in order to be fully exempt from CGT. A very important proviso here is that it must not have previously been put to an income use. Through rent or operation of a home based business, for example. It is necessary that at the time the expat leaves and rents the property out, the expat would have been entitled to a full main residence exemption had they disposed of the dwelling at that time.  For some a disposal within 6 years will not be practical or desirable. The rental income (albeit taxable at non-resident rates in Australia) may present an attractive investment yield. An expat may see property as a very strong long term investment and they might like to continue to hold the property for more than 6 years in order to realise the full potential. Some may have read publications suggesting negative gearing losses should be accumulated in Australia so that they can be used upon a future return or against future capital gains. The property market is expensive to get into and it can be expensive to get out of. Whatever the reason, if the 6 years limit is breached then only a partial main residence exemption is available.

The capital gain or loss when the 6 years limit is breached is calculated using the formula in s118-185(2):

CG (or CL) amount x Non-main residence days

Days in your ownership period

The effect is to pro rata the exemption to reflect the period during which the dwelling was not the actual main residence and not covered by the absence concession. The following example is taken directly from s118-185 by way of illustration.

You bought a house in July 1990 and moved in immediately. In July 1993, you moved out and began to rent it. You sold it in July 2000, making (apart from this Subdivision) a capital gain of $10,000. You choose to continue to treat the dwelling as your main residence under s118-145 (about absences) for the first 6 of the 7 years during which you rented out the house. Under this section, you will be taken to have made a capital gain of: $10,000 x 365/3,650 = $1,000.

Not so fast

Most expats confronting these issues presently will have left Australia after 20 August 1996. The dwelling, therefore, will have first been put to an income producing use after that date. This is a critical date in the context of this discussion because the capital gain or loss subject to the partial exemption in these circumstances is calculated with reference to s118-192. Section 118-192 provides that if the dwelling is first used to produce assessable income after 20 August 1996 then the individual is taken to have acquired the dwelling at the time it was first used to produce assessable income. The deemed acquisition cost is the market value at the time the income producing use began. The effect is that only the gain or loss that accrues during the period after it first becomes income producing is potentially exposed to CGT.

It is worth keeping in mind that whilst the deemed acquisition rule in s118-192 subsumes all the elements of the cost base up until that point and the actual costs before that time become irrelevant, the cost base can increase as a result of costs incurred after the deemed date of acquisition. Second, third, fourth and fifth element costs can all be incurred after the property is put to an income use and there seems to be no reason why they cannot be taken into account when calculating any capital gain or loss. Examples would include second element “incidental costs” on disposal such as advertising costs and agent’s fees. Further examples might be third element costs not subject to deduction like renovations or improvements.

The deemed acquisition rule creates a ‘deemed ownership period’ such that the denominator in the formula in s118-185(2) becomes the number of days between the date when the dwelling was first used to produce income and the date of disposal. For the purposes of calculating the ownership period or deemed ownership period, the period ends on settlement of the sale contract. This, of course, can be in contrast with the CGT event timing rules contained in section 104-5 which provide that CGT A1 event, for example, happens when a disposal contract is entered into.

The absence concession and the deemed acquisition rule are important concessions for homeowners generally and expats especially. Failing to recognise them and apply them correctly could lead to paying more tax than is legally due. With the removal of the CGT discount for foreign residents it is potentially doubly important and valuable for expats.

The following example illustrates the correct application of the absence concession as it interacts with the special rule in s118-192.

Peter purchases a dwelling in Sydney in March 2014 for $500,000 and uses it as his main residence (with no income use) for 2 years. In March 2016 he moves to Bangkok and rents out the dwelling in Sydney. He becomes a foreign resident at that time. The market value of the dwelling at that time is $600,000. In March 2024, Peter sells the property for $1,200,000. No other dwelling will be treated as his main residence for Australian tax purposes after he left Australia. The capital gain is calculated as follows:

($1,200,000 - $600,000) x 2 year/8 years = $150,000.

If the CGT discount were still available, the assessable capital gain would be $75,000. Tax at the non-resident rates is $24,375. Without the CGT discount, the assessable capital gain is $150,000 and the tax is $51,900. 

Making the choice

There are no formal procedures to follow in order for an individual to choose the main residence exemption. Not including an assessable capital gain in the tax return for the year of disposal will be evidence that the choice has been made. Therefore, the choice does not need to be made at the time the dwelling ceases to be the main residence. The choice does not need to be made when the dwelling is first put to an income use. It does not need to be made at the time when (if) the 6 year time limit is reached. It does not need to be made when the dwelling is disposed. It only needs to be made when the relevant tax return is being lodged. No documentation needs to be created or kept ‘on file’ at any of those times.

The expat has planning opportunities as there is a long period of hindsight which can be analysed when making the choice. There is also possibly a long period of time during which expats can plan and budget for any possible CGT expenditure on the eventual sale of the former home that they moved out of when going overseas.

Shares in listed companies

CGT event I1 happens when an individual (or company) stops being an Australian resident. An assessable capital gain will occur if the market value of a CGT asset owned at the time of the event is greater than the cost base. A capital loss will occur if the market value of a CGT asset owned at the time of the event is less than the cost base. Any capital gain will be subject to the CGT discount if the relevant asset had been held for more than 12 months (excluding the day of purchase and sale). However CGT event I1 can only apply to CGT assets which are not TAP. Therefore, it will not happen in relation to a dwelling in Australia. CGT event I1 applies to all other CGT assets except TAP. However, this article focuses on shares in listed companies (shares). Section 104-165 provides that an individual may choose to disregard a capital gain or capital loss from CGT event I1. There are consequences to making such a choice. Shares covered by this choice will be taken to be TAP which means that any subsequent CGT event happening to them will be subject to Australian tax despite the fact that the individual will be a foreign resident at the time As with the choice to apply the main residence exemption, no formal procedure is required. A choice will be reflected by the manner in which the relevant tax return is prepared. Unlike the main residence exemption, however, this choice must be made for the tax return for the year when the change of residency occurs. A taxpayer cannot wait until the shares are actually disposed of (or are subject to a CGT event I1 other than disposal).  The default position for some expats is that they will not have actually made any choice at all. Therefore, they will be deemed to have chosen to disregard the CGT event I1 by virtue of the fact that nothing is included in the relevant tax return. It is suggested that these expats will most likely be in the default position out of ignorance of the existence of the law itself.

Others however may have strategically, actually, chosen to disregard the event.

Whatever the reason, an individual who retains shares covered by such a choice will be exposed to CGT on any increase in value that accrues after they leave Australia. And now, critically, that increase in value (which occurs whilst a foreign resident) will no longer be able to be reduced by the CGT discount.

Where it is assumed that the value of the shares will increase after leaving Australia then it is likely that it will be beneficial to recognise the capital gain under CGT event I1 when the change of residency occurs. Where it is assumed the value of the shares will decrease, the best course of action is probably to sell them. The tax saved on a dollar lost will always be less than a dollar.

Possible strategies

Disregarding for a moment the cases where ignorance of the law itself leads expats into the default position and not declaring a capital gain, the major reason for choosing to disregard a capital gain from CGT event I1 is probably cash flow. Without actually selling the shares, how does an expat come up with the cash to satisfy a tax liability? Notwithstanding, the benefit of squaring away a tax liability upon leaving (if it is believed the shares will continue to rise in value) is worth striving for. That is, capital growth free of tax. In Australia at least.

Many expats will have left Australia for greener financial pastures. There may also be a significant time lag between when the individual ceases to be a resident and when any tax is actually due. During that time the expat will know exactly what the tax liability is and they can potentially save for it. For example. An individual who changes residency on 1 October 2014 may have till May 2016 to settle any tax liability that may have arisen as a result of a CGT event I1 that happened on 1 October 2014. They have approximately 18 months to save it up. Some of the shares could be sold to pay the liability. Any increase in value of those shares would, under such a strategy, not be subject to CGT either.

Expats should not settle for the default position if they have shares in their portfolio whose market value is less than their cost base. They should actively take the steps to realise the losses in the relevant tax return. In other words, not choose to disregard the CGT event I1. Assuming, of course, that they think the shares will rise in value again to one day be saleable at a value higher than the value when the change of residency occurs. Not disregarding CGT 2 is like a wash sale without the parts that the ATO finds offensive because there is no actual sale or disposal. The Explanatory Memorandum to the Bill which removed the CGT discount for foreign residents makes the point that capital losses will still be available for foreign residents and can be used to offset future capital gains. So if there are other assets in the portfolio that one day may be subject to CGT (for example, ‘pure’ TAP assets) then the crystallized losses will reduce the CGT impact on the disposal of those assets. The losses on the shares can be “banked” in other words.

Mistakes can be rectified.

Section 170 of the ITAA 1936 provides the time frames within which a taxpayer can amend a prior year income tax return. The general rule is that a 2 year amendment period will apply to individuals although there are instances where a 4 year period will apply. Note that the 4 year period may apply if the individual is a potential beneficiary of a trust notwithstanding they may not have received any distributions from the trust. In the context of CGT event I1 the amendment periods may work in an expat’s favour.

As previously alluded to, an expat could have been deemed to have made a choice to disregard a capital gain or loss from CGT event I1 without having actually made an active choice. If they did not know CGT event I1 existed, they will not have included a capital gain or loss by virtue of this ignorance. Not by virtue of having chosen to disregard it. This would be a mistake that could be rectified within the given timeframes. If the shares had increased in value since the CGT event I1 (change of residence) occurred, it could be a windfall for the taxpayer. They could amend the relevant return to include the assessable gain from the CGT event I1, after applying any available losses and the CGT discount if the shares were held for more than 12 months. They would then benefit from the fact that the increase in value whilst they were a foreign resident would be effectively tax free. They will know exactly what that increase in value is and the tax that they are therefore saving. This could be compared with what the amended assessment plus interest would be. It’s not often that you can apply the benefit of hindsight concurrently with a present decision making process.

Market valuations 

A market valuation of shares in listed companies at any point in time is a simple exercise. Obtaining a market valuation for a dwelling at a particular time is not a simple exercise. The ATO guide “Market valuation for tax purposes” provides that “valuations undertaken by persons experienced in their field of valuation would be expected to provide more reliable values than those provided by non-experts.” As such, it is suggested that property valuations be obtained from valuers who are registered with the relevant government boards, if they exist in the State where the property is situated, or members of professional bodies such as the Australian Property Institute and the Royal Institute of Chartered Surveyors.

There is no legislated time at which market valuations must be obtained. Contemporaneous valuations, as close to the relevant time as possible, will probably be more accurate, less costly and more persuasive. For expats who will be subject to the deemed acquisition rule in s118-192 for a dwelling that was the main residence, it is suggested that a valuation be undertaken as close to the time of first income producing use as is possible.

A taxpayer may request a private ruling from the ATO to determine the market value of a CGT asset.

Record keeping

Sections 121-20 and 121-25 in combination provide that records which could reasonably be expected to be relevant in working out a capital gain or loss from a CGT event must be kept for a period of five years after the CGT event.

For expats for whom the deemed acquisition rule in section 118-192 applies, the relevant records would include the market valuation of the dwelling at the date it was first used to produce assessable income. They would also include some kind of description as to how the valuation was arrived at. Documentation in relation to subsequent costs which may fall into one of the elements of the cost base of the dwelling after that time must also be retained.

Expats who held shares when they left must retain the documents showing the date and cost of acquisition.

Taxpayers are not only required to retain records in relation to a specific CGT event for 5 years but also for 5 years after any further CGT event to which the first CGT event is relevant. Where CGT event I1 results in a capital loss, the relevant documentation in relation to calculating that loss must be retained for 5 years after the losses are fully offset against future capital gains. In the extreme, where no future assessable capital gains are realised, this could be forever. The only relief will be death because carried forward capital losses die with a taxpayer.

In order to relieve the burden of keeping relevant records, and knowing where they are when an expat is on the move, they could make use of a CGT asset register as per s121-35. The requirements to satisfy under this section are not very onerous and a properly maintained CGT asset register would seem to be a neat solution to the documentation hassle for the expat owning TAP.

Conclusion

Moving and living overseas and becoming a foreign resident does not necessarily relieve an Australian from tax responsibilities in Australia. The potential taxing events, however, are limited. In the context of CGT, the removal of the CGT discount for foreign residents for gains accruing after 8 May 2012 means that errors in calculation could be more expensive than they were before. The removal also means that the concessions and strategies available to minimise the base CGT should be revised and recalled by expat taxpayers and their advisers.