The Government has released draft legislation removing the CGT main residence exemption for foreign residents, which if legislated, may affect your clients.
The Government has released draft legislation removing the capital gains tax (CGT) main residence exemption for foreign residents. If legislated, foreign residents may be liable for significantly greater tax when they sell their former home. Clients affected may wish to take advantage of the transitional rules which apply until 30 June 2019.
Under the current CGT provisions, foreign residents are liable to pay CGT where they have an interest in taxable Australian property, e.g. residential properties.
For taxation purposes, under current legislation, foreign residents are entitled to the CGT main residence exemption in the same way as individuals who are residents of Australia. That is, they may be able to disregard some or all of the capital gains or losses incurred from the disposal of a residential property that was their main residence at any stage throughout the ownership period.
Under the proposed changes1, individuals who are foreign residents at the time of a CGT event in relation to a dwelling they own in Australia, are not entitled to any CGT main residence exemption. This change will apply to CGT events that occur on or after 7:30pm on 9 May 20172, unless transitional rules apply (see transitional provisions below).
Consequently, a foreign resident will be assessed on the full capital gain or loss that arises from the sale of their property that may have been their main residence prior to moving overseas.
If legislated, this proposal could result in a significant CGT liability for individuals who are foreign residents when they sell their former home.
It is important to bear in mind that a foreign resident individual is not eligible for the 50 per cent CGT discount3 if the dwelling was acquired after 8 May 2012. For dwellings acquired prior to 8 May 2012, there will be a proportioning of the 50 per cent CGT discount depending on various factors4.
Case study 1: Main residence exemption not available
Shane acquired a dwelling on 20 October 2010 for $500,000. He moved into it immediately and established it as his main residence.
On 20 August 2017, Shane vacated the dwelling and moved to London for new work opportunities. He became a foreign resident for tax purposes from that time onwards. Shane rented the dwelling while overseas.
On 1 October 2020, Shane signs a contract to sell the property for $1,000,000, as he has no plans to move back to Australia in the foreseeable future. Shane is a foreign resident for tax purposes at the time.
As Shane is a foreign resident at the time of the CGT event (the time of CGT event A1 for the sale of the dwelling is the time the contract for sale was signed), he is not entitled to the main residence exemption in respect of his ownership interest in the dwelling.
This is despite the fact that the dwelling was his main residence for over six years when he was living in Australia, as periods where the property was a main residence are not recognised if at the time of the disposal the taxpayer is a foreign resident. Furthermore, the six-year absence rule which would otherwise have applied to treat the dwelling as his main residence also does not apply.
Shane will not receive any main residence CGT exemptions, but may receive a partial 50 per cent discount.
Strategy: Regain tax residency where possible before selling
Under the proposed new rules, only property owners who are foreign residents at the time of the CGT event are prohibited from applying the main residence exemption. Individuals who have periods of non-residency during the ownership period will still qualify for the main residence exemption if they return to Australia and regain residency status for tax purposes before selling.
Case Study 2: Main residence exemption still available
Caleb purchased an apartment on 1 March 2005, which he moved into and established as his main residence.
For a five-year period between 2010 and 2015, Caleb was a foreign resident for tax purposes, as he worked overseas. While living overseas, Caleb rented the apartment out. Caleb then moved back into the apartment in 2015 when he returned from overseas and became a resident for tax purposes.
On 1 October 2020, Caleb signed a contract to sell the apartment. As Caleb was an Australian resident for taxation purposes at the time of the CGT event, he is entitled to the full main residence exemption. For the five-year period that Caleb was overseas, he was able to treat the dwelling as his main residence under the ‘six-year absence’ rule.
Under transitional provisions, the amendments to the main residence exemption do not apply to dwellings that are held prior to 7:30pm on 9 May 2017, if a CGT event relating to the dwelling occurs on or before 30 June 2019.
If legislated, this could result in foreign residents who are unlikely to re-establish Australian tax residency, rushing to sell their former home in Australia prior to 30 June 2019 to qualify for the main residence exemption.
Case Study 1: Alternative
If Shane (Case Study 1) sells his former main residence prior to 30 June 2019, he would be able to apply the main residence exemption under the transitional provisions and not have to pay any capital gains tax.
Main residence exemption: Deceased estate
The removal of the main residence exemption also applies to deceased estates. The main residence exemption does not apply if:
* The deceased person was a foreign resident at the time of their death; or
* The beneficiary who inherits an ownership interest in the dwelling is a foreign resident at the time of the CGT event.
Deceased was a foreign resident
A beneficiary or trustee of a deceased estate is not entitled to the main residence exemption where the deceased was a foreign resident at the time of death.
However, resident beneficiaries continue to be entitled to the main residence exemption for any period accrued in their own right.
For the purposes of the apportionment calculation, the days for which the deceased held the ownership interest in the dwelling are treated as non-main residence days.
Case Study 3: Deceased foreign resident
Three years prior to his death, Edward moved to the United States. At the time of his death, Edward was a foreign resident for tax purposes.
Edward owned his dwelling in Australia for 15 years, which he lived in from when he purchased it until he moved overseas.
Ruby, Edward’s daughter, inherits the dwelling. Ruby moves into the dwelling and establishes it as her main residence immediately. She continues to reside in it and use it as her main residence until she sells it four years later.
The assessable capital gain is $100,000 after applying the general 50 per cent discount*, but before applying any other exemptions.
The deceased estate main residence exemption provisions apply to Ruby’s sale of the dwelling as follows:
* The period that Edward owned the dwelling (15 years) is treated as non-main residence days; and
* The period from when Ruby moved into the property until she signed the contract for sale (four years) is treated as main residence days.
Therefore, the amount of capital gain that Ruby has to include in her assessable income in the year she disposes of the dwelling is:
$100,000 x 15/19 = $78,947
* As the dwelling was purchased before 8 May 2012 and Edward had a period of Australian residency after that date, there should be an apportionment of the general 50 per cent CGT discount.
Foreign resident beneficiary inherits main residence from a resident deceased person
If the deceased was an Australian resident for tax purposes at the time of death, the main residence exemption accrued by the deceased for the dwelling continues to be available to the beneficiary(ies) of the deceased estate who are bequeathed the property. This includes the exemption attributable to:
* Periods during the deceased’s lifetime where the dwelling was their main residence;
* The period that occurs within two years of the deceased’s death; and
* The period following the deceased’s death where the dwelling was the main residence of an individual who was the spouse of the deceased immediately before their death and/or an individual who had a right to occupy the dwelling under the deceased’s will.
However, the beneficiary is denied any additional component of the main residence exemption that they accrued in their own right if they were a foreign resident at the time
of the CGT event.
How will the ATO collect tax from foreign residents?
Foreign residents are required to lodge tax returns if they have derived Australian assessable income, including assessable capital gains. The Commissioner of Taxation has a number of powers to assist in the collection of these liabilities, depending on the circumstances.
Where the taxpayer has other investments, the Commissioner may seek a freezing order (Mareva injunction) against those assets, which can then be applied to the taxpayer’s tax liability.
The Commissioner may also issue a notice under s255 of the ITAA 1936 to a person who is in control of a foreign resident’s money, requiring that person to pay the foreign resident’s tax.
From 1 July 2017, purchasers of Australian property where the purchaser has reason to believe the vendor is a foreign resident, are required to pay 12.5 per cent of the purchase price to the Commissioner. This amount will be withheld from the payment the purchaser makes to the vendor5.
3. The 50 per cent CGT discount is not available to any taxpayer where the asset is disposed of within 12 months of acquisition – s115-40 Income Tax Assessment Act 1997 (ITAA 1997).
4. Subdivision 115-B, ITAA 1997.
5. Subdivision 14-D, Schedule 1, Taxation Administration Act 1953 imposes a non-final withholding obligation on the purchaser of certain Australian real property where the property is acquired from a foreign resident. Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Act 2017 increased the withholding amount to 12.5 per cent for properties with a market value of $750,000 or more, for acquisitions on or after 1 July 2017.
1. If legislated, non-residents will still be able to take advantage of the ‘six-year absence rule’ when disposing of a main residence on or after 1 July 2019.
2Under the proposed changes to the CGT main residence exemption for non-residents, which of the following statements is correct?
a. The proposal only applies to contracts of sale entered into on or after 1 July 2018.
b. Capital gains incurred by a non-resident upon selling a former main residence will be taxed at Australian resident tax rates.
c. When a non-resident inherits a main residence of a deceased person who was an Australian tax resident, they are not entitled to the general two-year exemption.
d. If a foreign resident becomes an Australian tax resident prior to selling the main residence, they will be able to utilise the CGT main residence exemption.
3.Susan purchased a property in Australia in 2013, which she lived in for a few years before moving permanently to the United Kingdom in 2017. Unfortunately, Susan died in 2018 while a tax non-resident. She bequeathed her property to her son, James, who is an Australian tax resident. If the proposed CGT main residence changes are enacted, which of the following statements are correct?
a. James will not pay any CGT as long as he sells the property within four years of Susan’s death.
b. James will not pay any CGT as long as he sells the property within two years of Susan’s death.
c. James will be liable for full CGT if he does not move into the property before selling.
d. James will not pay CGT as long as he moves into the property for at least six months before selling.
4. In 2020, Wayne sells his main residence which he has owned for seven years. Throughout his period of ownership, Wayne lived overseas for five years between 2014 and 2019. Upon returning to Australia in 2019, he moved back into the property. Wayne doesn’t own any other property. The gross capital gain is $300,000. What is the amount of taxable capital gain?
5. Which of the following correctly describes the transitional provisions under the proposed changes to the CGT main residence exemption?
a. Changes to the main residence exemption will not apply to dwellings held prior to 7.30pm on 9 May 2016, if a CGT event relating to the dwelling occurs on or before 30 June 2018.
b. Changes to the main residence exemption will not apply to dwellings held prior to 7.30pm on 9 May 2017, if a CGT event relating to the dwelling occurs on or before 30 June 2019.
c. Changes to the main residence exemption will not apply to dwellings held prior to 7.30pm on 9 May 2017, if a CGT event relating to the dwelling occurs on or before 30 June 2018.
d. Changes to the main residence exemption will not apply to dwellings held prior to 7.30pm on 9 May 2016, if a CGT event relating to the dwelling occurs on or before 30 June 2020.