In a nutshell... Article published in Issue 15, of The Taxpayer, dated 15 Feb the full article follows

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1 Article published in Issue 15, of The Taxpayer, dated 15 Feb 2010 In a nutshell... Going overseas? Coming home? The tax implications So many Australians leave to take up long-term or even permanent residence in another country, or return home after an extended period, that it is little wonder there is often confusion over the tax implications that can arise from both these circumstances. From the outset, the first question that needs to be settled is: Are you a resident for tax purposes? For the local tax system, there are three status classes resident, temporary resident or non-resident. The tax implications vary depending on the classification, and there are a number of tests that can help determine status. A resident will: Pay tax on Australian and worldwide income Pay capital gains tax on assets, including foreign CGT assets May be entitles to a foreign tax offset, should tax have been paid on foreign-sourced income. However, a deemed non-resident will: Pay tax on Australian-sourced income only Pay CGT on assets that are taxable Australian property Be subject to withholding tax provisions for locally-sourced unfranked dividends, royalties and interest. For an Australian resident who chooses to leave the country permanently, the main tax considerations are the capital gains treatment of assets once they are no longer a resident, and the treatment of Australiansource income from dividends and the disposal of taxable property (that is, real property that is located in Australia). Capital gains or losses are determined as the difference between the market value of an asset at the time the taxpayer becomes a non-resident and that asset s cost base. Note however that the absence rule may be applied to treat the taxpayer s former domicile as their main residence for up to six years from the time they vacate the property and have no other main residence overseas. Beyond that, a partial exemption may be available. The capital gains tax trigger concerned here is called CGT event i1, which brings a potential problem for some taxpayers in that they may be subject to a tax on an unrealised gain, and not necessarily have the funds to pay it. Individuals can therefore make a choice to defer the gain or loss that would otherwise arise. Once a choice is made however, it will apply to all CGT assets held at the time of becoming a non-resident (that is, you can t cherry-pick the assets to get the best tax deal). There can be good reasons not to defer, such as having a surfeit of carry-forward losses that any gains can be offset against, and if the CGT event i1 results in a net loss position on all CGT assets so that it would be better to crystallise that loss now as the foreign tax regime has no such capital gains tax provisions. A taxpayer returning to Australia and becoming a tax resident will from that moment on be taxed on all income from local and worldwide sources. CGT assets will be deemed to have been acquired on the date of becoming a resident, unless the choice had been made to defer gains or losses. In these cases, the relevant asset will retain its original cost base. Note that where the date is when the taxpayer becomes a resident, the availability of the 50% discount for individuals is measured from then, not when the asset was acquired....the full article follows All information provided in this publication is of a general nature only and is not personal financial or investment advice. It does not take into account your particular objectives and circumstances. No person should act on the basis of this information without first obtaining and following the advice of a suitably qualified professional advisor. To the fullest extent permitted by law, no person involved in producing, distributing or providing the information in this publication (including Taxpayers Australia Incorporated, each of its directors, councillors, employees and contractors and the editors or authors of the information) will be liable in any way for any loss or damage suffered by any person through the use of or access to this information. The Copyright is owned exclusively by Taxpayers Australia Inc (ABN ). NOTICE FORBIDDING UNAUTHORISED REPRODUCTION No item in this publication covered by copyright may be reproduced or copied in any form (graphic, electronic or mechanical, or recorded on film or magnetic media) or placed in any computer or information transmission or retrieval system unless permission in writing is obtained from Taxpayers Australia Inc. [email protected], call or download an application form from

2 The Taxpayer 15 February Issue /2010 Going overseas? Coming home? Tax implications? By Andy Nguyen When the late Peter Allen sang his rendition of I still call Australia Home, the tax implications of returning to Australia after many years overseas was probably the last thing on his mind! With so many Australians leaving for overseas permanently or returning after an extended period there is often confusion as to the Australian tax implications which may arise. This article examines a range of issues which may have to be considered upon becoming a non-resident or resident for Australian income tax purposes. Back to basics: resident or non-resident? In determining the tax implications if one decides to leave Australia or return to Australia, the threshold question that needs to be asked is whether the taxpayer, either upon leaving or returning, is an Australian resident for income tax purposes. For Australian income tax purposes, a taxpayer can be classified as either: a resident temporary resident (eg. those on a 457 Visa), or non-resident (ie. not satisfying the relevant conditions to be either an Australian resident or temporary resident for income tax purposes). On that premise, the tax implications will vary depending on the classification. There are a number of tests and indicia in determining whether a taxpayer is a resident under s6(1) of Income Tax Assessment Act 1936 (ITAA36). This article does not analyse those tests, however, Taxation Ruling TR 97/18: Income Tax: residency status of individuals entering Australia and IT 2650: Income Tax: Residence Permanent place of abode outside of Australia provide detailed consideration of the relevant factors in determining tax residency for inbound and outbound individuals. As an aside, a taxpayer may also be a dual resident for tax purposes. In other words, the taxpayer demonstrates factors which indicate that they satisfy the conditions to be a tax resident of Australia and also of a foreign jurisdiction. Generally, there are tie breaker tests under the various tax treaties entered into by Australia to determine whether Australia or the foreign jurisdiction has the primary taxing rights. Implications of being a resident/nonresident Importantly, an Australian resident for income tax purposes will: pay tax on their Australian and worldwide sourced income pay tax on post-cgt (ie. post 20 September 1985) assets, including foreign CGT assets, and to the extent that any foreign tax is paid on their foreign sourced income, the taxpayer may be entitled to a foreign tax offset which is capped at the Australian tax which would otherwise be payable on that income. In contrast, a taxpayer who is considered to be a nonresident for Australian income tax purposes will: pay tax on Australian sourced income only pay tax on capital gains from CGT events happening to taxable Australian property (eg. real property located in Australia), and be subject to the withholding tax provisions from the receipt of unfranked dividends, royalties and interest from Australian sources. NOTE: The term taxable Australian property replaces the necessary connection with Australia (applicable from 12 December 2006). The tax rules are different again for those classified as temporary residents. The impact of the tax rules affecting temporary residents will not be considered in this article. What happens if I choose to leave Australia permanently? If an Australian resident chooses to leave Australia to live overseas permanently, such taxpayers would typically be classified as non-resident for Australian income tax purposes. At the time of leaving, the main Australian tax implications that need to be considered are as follows: CGT event I1 will apply to CGT assets held by the taxpayer once they are no longer an Australian tax resident (refer below for detailed discussion), and

3 the taxpayer will be assessed thereafter only on income from Australian sources (eg. dividends from Australian shares) and from the disposal of taxable Australian property (eg. Australian real property). CGT event I1 deemed taxing upon becoming a non-resident From a CGT perspective, at the time that a taxpayer becomes a non-resident for Australian income tax purposes, CGT event I1 is triggered. The taxpayer is required to work out whether they have made a capital gain or loss for each CGT asset owned by the taxpayer, except for certain of the assets which are classified as taxable Australian property. NOTE: Taxable Australian property generally includes: taxable Australian real property (ie. real property situated in Australia) an indirect Australian real property interest (eg. shares in a land rich company holding Australian real property) a CGT asset which has been used in carrying on a business through a permanent establishment in Australia a right or option to acquire any of the preceding category of assets, and a CGT asset whereby a choice to defer a capital gain or loss under CGT event I1 has occurred (refer below for comment). The capital gain or loss is determined as the difference between the market value of the asset at the time that the taxpayer becomes a non-resident and that asset s cost base. However, any capital gain arising from CGT event I1 may be disregarded to the extent that it is in respect of a pre-cgt asset (acquired prior to 20 September 1985), is a personal use asset, or where the main residence exemption applies. NOTE: the absence rule may be applied to treat the taxpayer s former domicile as their main residence for up to six years from the time that they vacate the property and have no other main residence overseas. Beyond that time frame, a partial exemption may be available if the property is subsequently disposed. No money to pay the tax? In practice, the trigger of CGT event I1 means that taxpayers will be subject to tax on an unrealised gain in respect of which the taxpayer may not have the funds to pay the tax. Therefore, for individual taxpayers, a choice can be made to disregard the capital gain or loss which would otherwise arise. It is important to note that once the choice is made it applies to all CGT assets (except those assets which are classified as taxable Australian property, such as Australian real estate- refer: s (3)) held by the taxpayer at the time they become a non-resident. Therefore, a taxpayer cannot cherry pick the eligible CGT assets for which they wish to defer a capital gain or loss. In addition, if the taxpayer makes the choice to defer, each CGT asset is deemed to be taxable Australian property until the earlier of: a CGT event which occurs and the taxpayer no longer owns the asset (ie. the asset is disposed by the taxpayer), or the taxpayer becomes an Australian resident again. The purpose of deeming CGT assets to be taxable Australian property is to ensure that those assets can be taxed in Australia upon subsequent disposal, notwithstanding that the taxpayer is no longer a resident for tax purposes. Why not make the choice? As noted, the lack of funds to pay tax arising from a CGT event I1 would often be the reason that a taxpayer opts to defer the gain. However, there may be compelling reasons to not elect to defer, which include: where the taxpayer has significant carry forward tax losses which they can recoup against a capital gain arising from CGT event I1 alternatively, if CGT event I1 gives rise to a net capital loss position on all eligible CGT assets, it may be advantageous to crystallise that loss (as no tax would be paid in any case and the foreign jurisdiction in which the taxpayer intends to reside may not have a regime to tax any future capital gains), and if the taxpayer believes that there may be a significant capital gain in the future from a particular CGT asset, it may be in the taxpayer s best interests to pay the tax upfront (and thereby exit the Australian CGT regime), as the other foreign jurisdiction may not have comparable CGT provisions (such as New Zealand) or impose lower rates of tax. If the taxpayer subsequently returns to Australia, a market value step up of the asset s cost base would be available if residency is resumed (refer below for comment). Similarly, consideration should also be given as to whether there is a Double Tax Treaty between Australia and the foreign jurisdiction in which the taxpayer will be

4 residing and, if so, what are the resultant tax implications. Whether a choice is made to defer the capital gain or loss would need to be made on a case by case basis. Notwithstanding, that there may be favourable outcomes in having CGT event I1 being triggered, taxpayers should also be wary of the tax implications in the foreign country where they intend to reside and seek foreign tax advice accordingly. An example of how CGT event I1 applies is illustrated as follows: Example 1: Leaving Australia Tom Collins, a renowned bar tender, decides to permanently leave Australia to work the bar scene with his brother in New York on 1 August At that time, Tom has no intention to return to Australia and prima facie, will not satisfy the definition of a resident for income tax purposes. In addition, Tom does not have any carry forward tax losses from prior years and has not derived any capital gains for the income year. At the time that Tom leaves Australia, he owns the following assets: A townhouse in Melbourne, which he purchased for $500,000 in March The townhouse is now worth $900,000. Tom was living in the property as his home before he left and was able to find a tenant to live in the property soon after arriving in New York. Whilst in New York, Tom intends to live with his brother. An apartment in London, which he purchased in July 2007 for $300,000 AUD. He is currently renting this property to a tenant and is deriving rental income. Surprisingly, the property now has a market value of $280,000 AUD. Shares in BHP Billiton, which he acquired in May 2009 for $100,000. The market value at 1 August 2010 is $150,000. A speedboat which he has left in storage in Australia as he was unable to find a buyer prior to leaving. The boat was purchased in March 2006 for $11,000. It was subsequently sold on ebay for $4,000 in September What are the tax implications for Tom Collins with respect to his Australian and foreign-based assets? CGT event I1 is triggered with respect to the CGT assets owned by Tom except for his townhouse in Melbourne (which is taxable Australian property). On that basis, there would a capital gain on the BHP Billiton shares of $50,000. A capital loss would arise with respect to the London apartment of $20,000 and a capital loss on the speedboat of $7,000 (although the loss on the boat would be disregarded as it is a personal use asset ). In this regard, on 1 August 2010, Tom may choose to defer the capital gains or losses for all the eligible CGT assets as a result of him becoming a non-resident. If he chooses to defer the capital gain, the choice will apply to all the CGT assets which he owns at that time. Therefore, no capital gains will immediately arise in respect of Tom s shares in BHP Billiton as a result of making that choice. On this basis, the capital loss from the London apartment is also disregarded. As noted, the deferral does not apply to Tom s Melbourne townhouse as this is taxable Australian property. To the extent that the choice is made, all CGT assets are deemed to be taxable Australian property. This means that any subsequent disposal of the London apartment or shares in BHP Billiton would be subject to the Australian CGT provisions notwithstanding that Tom is a non-resident. To the extent that the Melbourne townhouse was Tom s main residence prior to him leaving, he can apply the six year absence rule from the date of him leaving to live with his brother (ie. he has no other main residence). If the property is subsequently sold, a partial exemption may be available if the absence period exceeds six years or if he has another main residence (eg. he acquires a property in New York). If a choice is not made, exemptions aside, Tom would be assessed on a capital gain of $30,000 (ie. $50,000 gain from the BHP Billiton shares less $20,000 loss from the London apartment), upon becoming a non-resident. What If I decide to return to Australia? If a taxpayer returns to Australia permanently after a long absence overseas, the main tax implications to consider are as follows: The taxpayer, provided that the relevant criteria are satisfied, would become an Australian resident for income tax purposes. From that point, income derived by the taxpayer from Australian and worldwide sources will be taxed in Australia (subject to the application of any tax treaties). CGT assets are deemed to be acquired by the taxpayer at their market value on the date that the taxpayer becomes a resident. Therefore, capital gains arising upon subsequent disposal will be calculated as the difference between the capital proceeds received and the market value cost base at the time that Australian tax residence resumes. However, if a choice had previously been made under CGT event I1 to defer the capital gain or loss for assets owned when the taxpayer was previously a resident, then the asset is deemed not to have been acquired upon the taxpayer becoming a resident but merely retains its original cost base (as opposed to a market value cost base). This also applies similarly to pre-cgt assets. Where CGT assets are deemed to be acquired from the date on which the taxpayer becomes an Australian tax resident, availability of the CGT

5 50% discount for individual taxpayers would be measured from the date of becoming a resident and not when the asset was actually acquired. Where the CGT asset is foreign real property which is the taxpayer s main residence, the main residence exemption may apply from the time at which the asset was purchased until the time the taxpayer returns to Australia and resides in another property which they treat as their main residence. The deemed acquisition date for CGT purposes does not impact the period in which the property was owned as the taxpayer s main residence (refer to ATO ID 2003/826). In addition, as noted, where the taxpayer had previously resided in Australia and had a property which was their main residence, the absence rule may apply to that property such that there is a full or partial CGT exemption available upon their resumption of residency. If a foreign asset is disposed of after resuming Australian residency, a foreign tax offset may be available to the extent that foreign tax has been paid. Where the taxpayer controls a foreign company whilst living overseas, upon their return to Australia as an Australian tax resident, any income that is derived by the company may be attributed to the taxpayer and taxed in Australia under the Controlled Foreign Company rules (provided that certain conditions are met). Similarly, such attribution may also apply where the taxpayer holds and interest in a foreign investment fund. Note: These provisions are presently under review and therefore changes to the law might occur. Example 2: Returning to Australia After spending five years in New York, John Collins (who is Tom Collins brother) decides to return to Australia to settle down with his fiancé in December At the time he left for New York, John had no intention of returning to Australia and was considered to be a non-resident for Australian tax purposes at that time. He had made a choice to defer the capital gains with respect to CGT assets which he owned at the time that he departed Australia in order to avoid the application of CGT event I1. At the time that John leaves the United States, he owns the following assets: A house in Sydney which he had purchased prior to departing. Similar to his brother, he had lived in the property as his main residence and rented out the property just prior to leaving for New York. The property was purchased in February 2001 for $400,000. The current market value of the property is $800,000. The tenant has left the property and John intends to live in the property with his fiancé upon his return. An apartment in New York which he purchased and lived in upon arriving in New York. He purchased the apartment for US$750,000 in January The apartment is worth A$1,000,000 in December His brother, Tom, who is living in New York has made an offer for the property, however, John has mixed feelings about selling. Shares in Pear Inc which he bought for US$10,000 in February The market value of those shares in December 2010 is A$8,000. Shares in BHP Billiton which were purchased for A$10,000 in May The market value of those shares in December 2010 is A$20,000. The shares were then subsequently sold in March 2011 to fund the wedding. A rare antique cocktail shaker which was bought in Australia in May 2002 and which John had taken with him when he left Australia. The cocktail shaker was acquired for $1,000 and has a market value of $1,500 in December What are the Australian tax implications for John Collins with respect to his Australian and foreign based assets when he resumes Australian residency? John s property in Melbourne would retain its original cost base of $400,000 as the asset was taxable Australian property and therefore CGT event I1 did not apply when he left Australia. As this property was previously John s main residence prior to him leaving for New York, he would be entitled to a partial main residence exemption. Broadly, any capital gain would be apportioned between

6 the times in which it was John s main residence relative to the total time in which he owned the property. The six year absence rule would not apply in this case if John had chosen another main residence during that time (ie. his New York apartment). If John s New York apartment was his main residence at the time of acquisition, upon his return to Australia, he would be entitled to the main residence exemption from the date of acquisition time until he moves into his Melbourne property (refer ATO ID 2003/826). If he chooses to sell the property to Tom, then a partial exemption may be available (depending on the length of time before he disposes of the property after he moves into his Sydney home). In calculating the capital gain, the apartment would have a deemed market value cost base of $1,000,000 (being the market value at the time residency commenced). Note that the six month rule under s does not apply in this instance as the taxpayer is not moving from an existing main residence to a new dwelling which is to become his main residence. The shares in Pear Inc are deemed to have a market value cost base of $8,000 as at December 2010 (ie. the date that he becomes an Australian resident). Any dividend income which is subsequently received by John would be assessable in Australia as he is an Australian resident. He may be entitled to foreign tax offsets for any taxes which have been paid with respect of that dividend in the United States (such as withholding tax). The shares in BHP Billiton are deemed to have a market value cost base of $20,000 as at December The cost base would be used in determining the extent of any capital gain or loss when the shares are disposed in March He would be able to benefit from any franking credits attached to any dividends paid prior to disposal (subject to the 45 day holding rule). No CGT discount would be available as the shares have not been held for at least 12 months from the date of deemed acquisition. The antique cocktail shaker is a CGT asset. It would have a cost base of $1,000 as a choice under CGT event I1 had been made. This cost base would be used to calculate any future capital gains or losses upon disposal. Application of Double Tax Treaties Where applicable, consideration should also be given to the impact of Australia s Double Tax Treaties, when a resident is to become a non-resident, in particular the impact of the treaty on the taxpayer s CGT assets. For example, under Article 13(6) of the United States treaty with Australia, where a taxpayer leaves Australia with CGT assets which are not taxable Australian property (eg. Australian shares), becomes a United States resident and a deferral under CGT event I1 has been chosen, any gain on subsequent disposal would be subject to tax only in the United States. Consequently, any Australian capital gains (as a result of the asset being deemed taxable Australian property) would be disregarded as the terms of the treaty provide the sole taxing rights to the United States, and the treaty overrides the domestic provisions which govern the operation of CGT event I1. In other jurisdictions, there may not be a similar clause in the relevant treaty or there may not be a treaty at all. In such circumstances, any subsequent disposal by the non-resident taxpayer may be subject to tax in Australia and the other jurisdiction. Therefore, before a resident taxpayer moves overseas, it may be worthwhile comparing the tax payable as a result of CGT event I1 if no election to defer is made, with the possible Australian or foreign tax exposure if the asset is subsequently disposed whilst the taxpayer is a non-resident. Comment Due care should be taken when considering the tax implications of departing or returning Australian taxpayers when there is a change in residency status. Therefore, the threshold question as to whether the taxpayer is a resident or non-resident should be reviewed to ensure that the starting point is correct. Only from that point can the tax implications be identified and properly analysed. So next time you happen to hear the Boy from Oz s rendition or a variation thereof on television, spare a thought for the application of CGT event 1I or perhaps the market value cost base rule upon an Aussie s return.