Capital Gains Tax Foreign and Temporary Residents - Changing Residency Status Prepared and Presented by: Tom Delany Tax Partner Pty Ltd 3 Inadale Court Toowoomba Queensland 4350 Mobile: 0428 357413 Email: delanyt@bigpond.com
Overview Foreign residents and temporary residents are only liable to capital gains tax (CGT) on gains made from the disposal of taxable Australian property. When you become an Australian resident, or stop being one, the range of assets subject to CGT in Australia changes. Foreign residents are denied access to the 50% general discount (assets held for more than 12 months) from 8 May 2012 for gains accruing after that date. From 1 July 2016, vendors disposing of certain taxable Australian property will have to apply a 10%/12.5% non-final withholding tax at settlement unless a clearance certificate has been issued.
Basic Position A foreign resident or temporary resident can disregard a capital gain or loss unless the relevant CGT asset is a direct or indirect interest in Australian real property, or relates to a business carried on by the foreign resident through a permanent establishment in Australia. Special rules apply for individuals who were Australian residents but have become foreign residents (see also Subdivision 104-I ITAA97) and for foreign resident beneficiaries of fixed trusts. There are also rules dealing with what happens when a foreign resident becomes an Australian resident. Assets acquired before 20 September 1985 are not subject to CGT. For temporary residents there are specific rules where the CGT asset is a share or right acquired under an employee share scheme.
Taxable Australian Property (1) Taxable Australian property includes: a direct interest in real property situated in Australia a mining, quarrying or prospecting right to minerals, petroleum or quarry materials situated in Australia a capital gains tax (CGT) asset that you have used at any time in carrying on a business through a permanent establishment in Australia an indirect interest in Australian real property you and your associates hold 10% or more of an entity, including a foreign entity, and the value of your interest is principally attributable to Australian real property, s 855-15 ITAA97. Taxable Australian property also includes an option or right over one of the above, s 855-10 ITAA97. Certain CGT assets will also be taken to be taxable Australian property if you take the option of choosing to disregard capital gains and losses when you cease being an Australian resident, s 104-165 ITAA97.
Taxable Australian Property (2) Indirect Australian real property interests Indirect Australian real property (IARP) interests are membership interests in an entity that, satisfies two tests: Non-portfolio interest test - An interest held by an entity (the holding entity ) in another entity (the test entity ) passes the non-portfolio interest test at a time if the sum of the direct participation interests held by the holding entity and its associates in the test entity at that time is 10% or more, s 960-195 ITAA97. Principal asset test - A membership interest held by an entity (the holding entity) in another entity (the test entity) passes the principal asset test if the sum of the market values of the test entity's assets that are taxable Australian real property exceeds the sum of the market values of its assets that are not taxable Australian real property, s 855-30 ITAA97. Membership interests include shares and units in taxable Australian real property rich (over 50%) trusts or companies.
Australian Residency The primary test of tax residency is called the 'resides test'. If you reside in Australia, you are considered an Australian resident for tax purposes and don't need to apply any of the other residency tests, s 6(1) ITAA97. If you don't satisfy the resides test, you'll still be considered an Australian resident if you satisfy one of three statutory tests: The domicile test: You're an Australian resident if your domicile (broadly, the place that is your permanent home) is in Australia, unless we are satisfied that your permanent place of abode is outside Australia. The 183-day test: If you're actually present in Australia for more than half the income year, whether continuously or with breaks, you may be said to have a constructive residence in Australia, unless it can be established that your usual place of abode is outside Australia and you have no intention of taking up residence here. The superannuation test: This test ensures that Australian government employees working at Australian posts overseas are treated as Australian residents.
Temporary Residents (1) You're a temporary resident if you: hold a temporary visa granted under the Migration Act 1958 are not an Australian resident within the meaning of the Social Security Act 1991 do not have a spouse who is an Australian resident within the meaning of the Social Security Act 1991. The Social Security Act 1991 defines an Australian resident as a person who resides in Australia and is an Australian citizen, the holder of a permanent visa or a protected special category visa holder. This is different to the standards used to determine tax residency. You could be an Australian resident for tax purposes even if you're not an Australian citizen or permanent resident.
Temporary Residents (2) Anyone who is an Australian resident for tax purposes after 6 April 2006 but is not a temporary resident cannot later become a temporary resident, even if they later hold a temporary visa. Ceasing to be a temporary resident If you cease being a temporary resident and become an Australian resident, you're taken to have acquired assets (other than assets you acquired before 20 September 1985) that are not taxable Australian property for their market value at the time you ceased being a temporary resident. There is an exception to this rule for employee shares and rights.
Temporary Residents - Example Jack has lived most of his life in London working as a market research consultant. He is single. He owns several apartments in the UK that are leased to tenants and has a share portfolio that provides him with regular dividend income. On 12 December 2013, he arrived in Brisbane to begin work with an Australian company that conducts market research. For the first three years, Jack held a temporary visa and expected to eventually return to the United Kingdom. During this period he was a temporary resident as he held a temporary visa and met the other criteria for being a temporary resident. Jack decided to apply for, and was granted, permanent residence in Australia on 15 March 2017. For assets disposed of between 12 December 2013 and 14 March 2017 Jack was a temporary resident and was only subject to CGT in Australia on any assets that were taxable Australian property. For assets disposed of on or after 15 March 2017 Jack is an Australian resident and is subject to tax in Australia on his worldwide income and capital gains. Any capital gains or capital losses Jack makes on the assets held in the United Kingdom will be subject to CGT in Australia and the cost base for these assets will be set according to the market value of the assets on 15 March 2017. Jack will receive a foreign tax credit for any tax paid in the United Kingdom on those gains.
Ceasing to be a Resident (1) When an Australian resident individual chooses to leave Australia to live overseas permanently or even for several years they are usually classified as a foreign resident for Australian tax purposes from the time of departure. CGT Event I1 happens when an individual/entity becomes a foreign resident and the taxpayer is required to work out whether they have made a capital gain or loss for each CGT asset, with the exception of assets classified as taxable Australian property. Under CGT Event I1 a capital gain or loss is to be calculated based on the difference between: The market value of the asset at the time that the taxpayer becomes a non resident, and The asset s cost base. A capital gain arising from CGT event I1 can be disregarded to the extent that it is in respect of a pre-cgt asset ie it was acquired prior to the 20th of September, 1985 or if it is a personal use asset, or the main residence exemption is available.
Ceasing to be a Resident (2) The consequence of CGT event I1 is that a departing Australian taxpayer is subject to capital gains tax on an unrealised gain when they are not likely to have monies available to pay the tax, as no actual sale of the asset has taken place. Tip Consider strategies including liquidating some assets providing sufficient cash to pay the tax liability. A choice is available, whereby the capital gain or loss which would otherwise arise can be disregarded. Once the choice has been made it applies to all of the taxpayer s CGT assets (with the exception of the taxpayer s assets which are taxable Australian property ). The consequence of making this choice is that each CGT asset is then deemed to be taxable Australian property until the earlier of: A CGT event taking place when the taxpayer no longer owns the asset ie the asset is sold, or The taxpayer becomes an Australian resident again, when a future CGT event will trigger a capital gain or loss.
Ceasing to be a Resident (3) As a result of deeming a CGT asset to be taxable Australian property a disposal while a foreign resident will be taxed in Australia even if the taxpayer is no longer a resident for tax purposes. Importantly, a capital gain arising on the disposal of taxable Australian property while non resident is not capable of being discounted ie reduced by 50% if owned for more than 12 months and is subject to non-resident rates of tax in Australia this creates an incentive not to make an election. Note the proposed changes to the main residence exemption and the nonavailability of the exemption to foreign residents (see later discussion). Significantly more tax may become payable where an election is made to disregard the capital gain arising under CGT Event I1, and a subsequent disposal takes place while a foreign resident of Australia.
Becoming a Resident Section 855-45 ITAA97 provides that for individuals and companies: (1) If you become an Australian resident, there are rules relevant to each CGT asset that you owned just before you became an Australian resident, except an asset: (a) that is taxable Australian property; or (b) that you acquired before 20 September 1985. Similar rules apply to trusts. (2) The first element of the cost base and reduced cost base of the asset (at the time you become an Australian resident) is its market value at that time. (4) This section does not apply to an ESS interest if: (a) Subdivision 83A-C (about employee share schemes) applies to the interest, and the ESS deferred taxing point for the interest has not yet occurred; or (b) the provisions referred to in paragraphs 83A-33(1)(a) to (c) (about start ups) apply to the ESS interest.
General Discount Up to 8 May 2012, the CGT discount of 50% was available to foreign resident individuals who were subject to CGT on taxable Australian property. For assets acquired after 8 May 2012, the discount is generally not available to foreign and temporary resident individuals (including beneficiaries of trusts and partners in a partnership). The discount is apportioned where a CGT event happens after 8 May 2012 and: The assets was acquired before that date, or The taxpayer had a period of Australian residency after that date. CGT events that occurred before 8 May 2012 are not affected.
General Discount Calculations (1) The discount testing period is the period over which the capital gain is accrued. Generally, the discount testing period starts on the day you acquired the asset and ends on the day of the CGT event. Trusts - Discount testing period start date - If you have a discount capital gain as a beneficiary of a trust: for a fixed trust, use the date you became a beneficiary of the trust for a trust that is not fixed: if the gain was received because a CGT event occurred to an asset acquired by the trustee of the trust, use the date the CGT asset was acquired. This includes gains you have received directly or indirectly through any interposed trusts that are not fixed. if the gain was received directly or indirectly through one or more interposed trusts and is linked to a capital gain made by a fixed trust, use the most recent date the trust, directly linked to the trust that made the capital gain, became the beneficiary of that trust.
General Discount Calculations (2) Discount testing period end date - If you have a discount capital gain as a beneficiary of a trust, the end date will be the date you received the gain. Having established the start and end date calculate the number of days in your discount testing period (include the start and end date). Then determine if the CGT asset was acquired on or before 8 May 2012?
General Discount Calculations (3) Assets acquired after 8 May 2012 Was the taxpayer a resident on 8 May 2012? If not and does not become a resident after that then the discount does not apply. If the taxpayer had a period of residency after 8 May 2012 then a pro-rata proportion of the general discount may be available. Compare the number of days of residency and the days that the asset was held to determine the percentage of days (discount percentage) in the holding period that the taxpayer was a resident and they held the asset. Apply the discount percentage to the relevant capital gain. Naturally no adjustment is necessary for losses.
General Discount Calculations (4) Assets acquired on or before 8 May 2012 Did the taxpayer have a period of Australian residency after 8 May 2012? If no subsequent period of residency and a foreign resident on 8 May 2012 then the taxpayer has a choice of using the apportioning method or the market value method. If a subsequent period of residency and a foreign resident on 8 May 2012 then the taxpayer has a choice of using the apportioning method or the market value method. If a subsequent period of residency and a resident on 8 May 2012 then the taxpayer must use the apportioning method (essentially a resident when the asset acquired and on 8 May 2012 but subsequently becomes a foreign resident). Apportioning Method Under this method compare the total period that the asset was held during the residency period to determine the percentage of the discount available.
General Discount Calculations (5) Assets acquired on or before 8 May 2012 Market Value Method The taxpayer needs to determine the market value at 8 May 2012 and the unindexed cost base at 8 May 2012 and with this information the notional gain (if any) to 8 May 2012 can be determined. If the notional gain to 8 May 2012 is greater than the overall gain then apply the 50% discount to all of the gain. If the notional gain to 8 May 2012 is less than the overall gain (shortfall amount) then multiply the shortfall by the number of days of residency after 8 May 2012 and divide by the number of days in the discount testing period after 8 May 2012 and add the notional gain to the product of this calculation.
Disposals by Foreign Residents (1) Where a foreign resident disposes of certain taxable Australian property, the purchaser is required to withhold an amount from the purchase price and pay that amount to the Australian Taxation Office (ATO). The legislation specifies that the withholding is actually on the "first element of the cost base - section 110-25(2) ITAA97 provides that the first element is the total of: (a) the money you paid, or are required to pay, in respect of acquiring it; and (b) the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition). (Note market value substitution rule applies). Foreign resident capital gains withholding first applied to vendors disposing of certain taxable Australian property under contracts entered into from 1 July 2016. A 10% nonfinal withholding was applied to these transactions at settlement. New rules for foreign resident capital gains withholding (FRCGW) apply to vendors disposing of certain taxable property under contracts entered into from 1 July 2017. The changes will apply to real property disposals where the contract price is $750,000 and above (previously $2 million) and the FRCGW withholding tax rate will be 12.5% (previously 10%).
Disposals by Foreign Residents (2) Australian resident vendors selling real property will need to obtain a clearance certificate from the ATO prior to settlement, to ensure they don't incur the 12.5% nonfinal withholding. This existing withholding legislation assists the collection of foreign residents Australian tax liabilities. It imposes an obligation on purchasers to withhold 12.5% of the purchase price and pay it to the ATO, where a vendor enters into a contract on or after 1 July 2017 and disposes of certain asset types (or receives a lease premium for the grant of a lease over Australian real property). The foreign resident vendor must lodge a tax return at the end of the financial year, declaring their Australian assessable income, including any capital gain from the disposal of the asset. A tax file number (TFN) is required to lodge a tax return; they will need to apply for a TFN if they don't have one. The vendor may claim a credit for any withholding amount paid to the ATO in their tax return.
Disposals by Foreign Residents (3) Australian resident vendors can avoid the 12.5% withholding by providing one of the following to the purchaser prior to settlement: for Australian real property, a clearance certificate obtained from the ATO; for other asset types, a vendor declaration they are not a foreign resident. Foreign resident vendors may apply for a variation of the withholding rate or make a declaration that a membership interest is not an indirect Australian real property interest and therefore not subject to withholding. Purchasers must pay the amount withheld at settlement to the Commissioner of Taxation. A vendor may be disposing of multiple properties in one transaction, the combined value of which exceeds $750,000. The withholding is based on the market value of a property being disposed of not a combination of all the properties being disposed of.
Disposals by Foreign Residents (4) Some assets are not subject to the withholding including: taxable Australian real property with a market value of less than $750,000. This ensures the vast majority of residential house sales will be unaffected by this measure an indirect Australian real property interest providing a company title interest with a market value of less than $750,000 transactions conducted through an approved stock exchange or a crossing system (for example, disposal of shares in dark pools) transactions subject to another withholding obligation securities lending arrangements, as these don't trigger a CGT liability for the vendor and therefore no payment obligation is imposed transactions where the vendor is in external administration or transactions arising from the administration of a bankrupt estate, a composition or scheme of arrangement, a debt agreement, a personal insolvency agreement, or same or similar circumstances under a foreign law.
Disposals by Foreign Residents (5) Clearance certificates - A clearance certificate provides certainty to purchasers regarding their withholding obligations. It confirms the withholding tax is not applicable to the transaction. A clearance certificate is valid for 12 months from the date of issue to the entity that it is issued. The Australian resident entity (or their representative) will need to complete an online Clearance Certificate. Where there are multiple Australian resident vendors disposing of the asset, each vendor should apply for a separate clearance certificate in their name only. Australian residents not required to lodge tax returns, such as aged pensioners, are still required to obtain a clearance certificate. If you are a foreign resident there is no point in you lodging an application. However if you may be entitled to a variation to the withholding rate, then you can lodge a variation request.
Disposals by Foreign Residents (6) Vendor declarations - For all other asset types subject to foreign resident capital gains withholding, the vendor may provide the purchaser with a vendor s declaration to specify withholding isn't required on the acquisition of the asset. There are two types of vendor declarations: residency declaration not an indirect Australian real property interest declaration. Variations - Vendors can apply for a variation where: they're not entitled to a clearance certificate a vendor s declaration is not appropriate 12.5% withholding is too high compared to the actual Australian tax liability on the sale of the asset.
Disposals by Foreign Residents (7) Reasons for a variation include: the vendor will not make a capital gain on the transaction (for example, because they will make a capital loss or a CGT roll-over applies) the vendor will not have an income tax liability (for example, because of carriedforward capital losses or tax losses) a creditor of the vendor has a mortgage or other security interest over the property, and the proceeds of sale available at settlement are insufficient to cover both the amount to be withheld and to discharge the debt the property secures a creditor acquires legal title to the property (that is, becomes the purchaser) as a result of an order for foreclosure, and its security would be further diminished as a result of having to comply with the withholding obligation.
Disposals by Foreign Residents (8) Variations To apply for a variation, the vendor, the vendor s representative or vendor s creditor needs to complete the online variation form. Vendors need to calculate their reduced rate of withholding. This could be a rate between nil and 12.49%. A variation notice applies to the specified vendor and applicable asset on the notice. If an asset is acquired from multiple vendors, each vendor will need to supply the purchasers with separate variation notices if a reduced rate of withholding is to apply. A variation notice is valid up to and including the expiry date on the notice for the listed vendor and applicable asset on the notice.
Main Residence and Foreign Residents (1) On 9 May 2017 the Government announced that Australia's foreign resident capital gains tax (CGT) regime will be extended to deny foreign and temporary tax residents access to the CGT main residence exemption. This change applies from the date of announcement. Properties held prior to this date will be grandfathered until 30 June 2019. Exposure Draft Legislation provides: Individuals who are foreign residents at the time a CGT event occurs to a dwelling in which they have an ownership interest are not entitled to the main residence exemption.
Main Residence and Foreign Residents (2) Critique of the Exposure Draft The EM to the Exposure Draft provides that it is a housing integrity measure that is designed to prevent foreign residents from being entitled to the CGT main residence exemption and the measure is said to reduce the pressure on housing affordability. While the measure will prevent foreign residents from accessing the CGT main residence exemption, it will also prevent Australian citizens who have been Australian residents for tax purposes for years from accessing the CGT main residence exemption if they are foreign residents at the time the CGT event occurs. There is no policy reason for denying Australian citizens the CGT main residence exemption in these circumstances. At a minimum, the measure should be redrafted so that taxpayers would only be taxed proportionally based on the period (ie number of days) of non-residency as a fraction of the entire ownership period. The measure may reduce the amount of residential property on the market as Australian citizens may continue to hold property they may otherwise sell during periods where they become foreign residents.
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