Australian residents moving overseas or foreign residents who became Australian residents and are moving back to their home countries can trigger unexpected Australian Capital Gains Tax (CGT) issues.
Generally, the assessable income of an Australian tax resident includes income from all sources, whether in or out of Australia. In contrast, the assessable income of a foreign resident generally only includes income with an Australian source.
In the context of CGT, this means that foreign residents disregard capital gains or losses that happen in relation to a CGT asset that is not taxable Australian property (TAP).
Taxable Australian Property
Broadly, TAP includes:
- Taxable Australian real property (TARP) – e.g., land or buildings that are located in Australia.
- A mining, quarrying or prospecting right to minerals, petroleum or quarry materials situated in Australia
- An asset used in carrying on a business through an Australian permanent establishment.
- An indirect Australian real property.
- An option or right to acquire one of the above assets.
As non-TAP is a unique asset class where the ATO does not levy any CGT on it once you have left the country, a CGT event I1 is triggered when you (an Australian resident) cease your Australian tax residency.
What is CGT event I1
CGT event I1 happens when an individual or company stops being an Australian resident. In this article, we will discuss the CGT event I1 that will happen to an individual who ceases to be an Australian resident.
Under CGT event I1, you are deemed to have disposed your non-TAP at the time of your departure and stop being a tax resident. Consequently, a capital gain/loss needs to be calculated and declared in your departing year Australian tax return. This is commonly referred to as the “deemed disposal rule”.
For an individual taxpayer, this will occur when you no longer satisfy any of the four residency tests – the resides test, the domicile test, the 183-day test and the superannuation test.
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 you become a non- resident, and
- The asset’s cost base.
You make a capital gain if the market value is more than the asset cost base and a capital loss if the market value is less than the reduced cost base.
If you make a capital gain based on the deemed disposal rule, you are required to pay tax at your marginal tax rates on the unrealised capital gain. The practical effect of this is, this may create a cash flow issue since there is no actual sale and no proceeds received.
With proper planning, the cash flow issue can be resolved. For instance, you may seek assistance from a tax advisor to prepare an estimated CGT calculation for you based on the actual/estimated market value of your non-TAP at the date of your departure. Once you know your CGT position, you have a period from the date of your departure till the lodgement date of your tax return to decide whether to take the default position (i.e., deem dispose of all your non-TAP upon departure) or disregard the capital gain/loss. If you lodge your Australian tax return through a registered tax agent, you are entitled to an extended lodgement due date, giving you extra time to consider how do you wish to fund the tax liability i.e., realise your capital gains by selling your assets (e.g., shares) to fund the tax liability, if you choose to deemed dispose your non-TAP upon departure.
There are, however, exceptions to the “deemed disposal rule”:
- A capital gain or loss is disregarded if the asset was acquired before 20 September 1985 (i.e., before the introduction of the CGT).
- If the taxpayer is an individual, they may choose to disregard the capital gain or loss. This choice is evidenced by how the tax return is prepared (i.e., whether the capital gain is included or excluded).
What are the consequences of disregarding the default CGT position?
As an individual, you have a choice to disregard the capital gain or loss which would otherwise arise. Please note that the choice is all in or all out – it cannot be made per CGT asset.
If you made this choice, the assets are taken to be TAP until you dispose of the asset or you become an Australian resident upon repatriation. Effectively, the assets are kept within the Australian tax system.
The result of deeming a CGT asset to be TAP is that a disposal while non- resident will be taxed in Australia even if you are no longer a resident for tax purposes.
Importantly, there were changes to the CGT discount rules from 8 May 2012. Under the new rule, when you dispose of TAP while you are a non-resident, you are no longer entitled to receive the full CGT discount (50%) for a capital gain which would have arisen from the disposal under CGT event I1, even if the asset is owned for more than 12 months. For CGT events that occur after 8 May 2012, a CGT discount is dependent on certain criteria, which can include:
- whether the CGT asset was held before or after 8 May 2012.
- the number of days foreign residents had a period of Australian residency;
- number of days Australian residents had a period of foreign residency.
In addition, you are subject to a higher non-resident rates of tax in Australia. Significantly more tax can therefore 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 non- resident of Australia.
An important note to raise here is, if you are moving to a country and becoming the resident of that country with which Australia has a Double Tax Agreement (DTA), there can be valuable provisions in the DTA that may mean that a disposal while non- resident is not taxable in Australia, even if the election to disregard the deemed disposal rule has been made.
For example, in Article 13 (Alienation of property) of the DTA between Australia and the United Kingdom, and the DTA between Australia and the United States of America, states that so long as the capital gain is taxable in the new country of residence and there is a suitable provision in the applicable DTA, it is possible for a capital gain arising on the disposal to be only taxed in the new country of residence.
Take away notes
As is apparent, tax planning advice should be taken if you are planning to depart Australia and will be retaining ownership of an asset.
Such tax planning should include a consideration of various factors, including cash flow, future plans of returning to Australia, DTA, type of non-TAP you hold (and hence the expectation of whether the market value is going to fall or increase), etc.
If you are departing Australia or have left Australia already, and would like to discuss how this move may affect your Australian tax position, please contact our team at A&A.