Clients temporarily living overseas will be looking at ways to minimise their tax exposure. Tim Sanderson looks at ways to save on capital gains tax.
There are many considerations for clients who will become non-residents of Australia for tax purposes while temporarily residing overseas. One key issue is the capital gains tax (CGT) effect on existing assets, which is largely determined by whether the asset is considered to be ‘taxable Australian property’.
For clients holding only real property or business assets, it is generally business as usual from a CGT perspective.
However, careful analysis is required for other assets, including shares and managed funds, to determine whether it is likely to be more beneficial to elect to treat all assets as taxable Australian property or to pay CGT upon leaving Australia and enjoy a CGT holiday while overseas.
What is taxable Australian property?
Taxable Australian property primarily means an ownership in real property that is situated in Australia or mining, quarrying or prospecting right for minerals situated in Australia. It also includes:
- An indirect interest in real property.
- An asset used by the client at any time in carrying on a business through a permanent establishment in Australia.
- An option or right to acquire real property or a business asset mentioned above.
Where a client holds units in a trust or shares in a company, they will have an indirect interest in Australian real property if their interest passes both:
- The non-portfolio test, which requires that the client and their associates have a direct interest in the trust or company of 10 per cent or more.
- The principal asset test, which requires that more than 50 per cent of the value of the company or trust’s assets is Australian real property.
When becoming a tax non-resident, a client can also make an election to treat all other CGT assets as taxable Australian property.
How is taxable Australian property treated for CGT purposes?
Where a client leaves Australia and becomes a tax non-resident, the CGT rules continue to apply to taxable Australian property.
If the asset is retained, no CGT event will occur either upon ceasing Australian tax residency or again becoming an Australian tax resident in the future.
If, after becoming a tax non-resident, the client sells taxable Australian property, any net capital gain will be assessable income, but taxed at non-resident marginal tax rates.
Importantly, CGT concessions such as the ability to offset capital losses against gains, the individual 50 per cent discount and in many cases the various small business CGT concessions, can still be used.
Treatment of other CGT assets
CGT assets that are not taxable Australian property, such as shares and managed funds, are deemed to be disposed of for CGT purposes when a client becomes a tax non-resident, for the market value at that time.
If the assets are subsequently disposed of while a tax non-resident, the CGT rules will not apply. However, tax may still apply to dividend or distribution income received from those assets.
If the assets are retained until tax-residency is re-established, this means they will be acquired for CGT purposes for the market value at that time.
To be eligible for the 50 per cent individual discount on the sale of those assets, the client must hold them for 12 months from the time they became an Australian tax resident.
The election to treat CGT assets as taxable Australian property
If a client wishes to have all CGT assets treated as taxable Australian property, they must make an election under Section 104-165 of the Income Tax Assessment Act 1997.
This election is made in the client’s tax return for the year in which they become a non-tax resident.
Importantly, this election will apply to all of the client’s CGT assets (other than those already considered taxable Australian property).
Its effect is therefore that there is no deemed disposal or re-acquisition of any CGT assets during the period of tax non-residency.
It is not possible to make an election that applies only to a portion of a client’s CGT assets.
Case study
Harry (who has a marginal tax rate of 31.5 per cent) is planning to move overseas immediately for work and will become a tax non-resident. He plans to return to Australia in two years.
He owns 10,000 units in XYZ Managed Fund, which were purchased in 1997 when the unit price was $1.20. The current unit price is $1.80.
Harry’s CGT position will depend on whether he makes an election to have the XYZ Managed Fund Units (and any other CGT assets held) treated as taxable Australian property.
Clearly, in his particular situation, Harry is better off (in relation to this asset) not making an election.
However, each situation is different and a number of factors will generally determine the likely better outcome, including:
- The unrealised capital gains that exist at the time Australian tax residency ceases.
- The length of time that will be spent as a tax non-resident.
- Whether the asset will be retained for at least 12 months once Australian tax residency is re-established.
As a general rule, where an asset has substantial unrealised capital gains and the period of tax non-residency is relatively short, it may be more beneficial to elect to treat the asset as taxable Australian property.
On the other hand, if there is only a small level of unrealised gains, it may be more beneficial to not make the election and realise the gains upon leaving Australia — therefore effectively exempting any gains that occur during the period of tax non-residency.
This is particularly the case where the client will be a tax non-resident for a substantial period of time.
Tim Sanderson is senior technical manager at Colonial First State.
