Tax issues to consider when moving overseas

The reopening of borders, following COVID-19 lockdowns, has resulted in an increase in people choosing to move overseas. It is, therefore, timely to revisit some of the income tax implications of such a move.

When you move overseas the first tax issue is to determine whether you retain your Australian tax residency status or become a non-resident under Australian domestic tax law. It is important to note that various factors need to be considered in determining tax residency status, and a temporary move overseas may not be sufficient to cause you to cease being a tax resident of Australia.

Where Australian tax resident status is maintained, the taxpayer is subject to tax on both Australian and foreign sourced income, including the disposal of all assets regardless of where they are located.

Where the taxpayer becomes a non-resident, the tax implications are more complex and potentially more costly. This is particularly the case as Australia has deemed disposal rules that apply on a change in residency, and certain concessions do not apply to non-residents in the same way they apply to Australian residents.

Regardless of an individual’s resident status, the domestic tax law of the country to which the taxpayer is relocating should also be considered, along with the application of any Double Tax Agreement.

Example – Max and Sophie

Consider a couple, Max and Sophie, who move to Europe to take advantage of job and travel opportunities. They own the following assets:

• a main residence in Melbourne;
• a rental property in Queensland;
• a portfolio of Australian and foreign listed shares; and
• an investment in an Australian managed fund.

Assuming they become non-residents of Australia upon departure, how do the CGT rules apply to the above assets? Is there a difference if the assets are disposed of before the change of residency? What else do they need to consider to plan ahead?

Deemed disposal of CGT assets when ceasing to be an Australian tax resident

When a taxpayer becomes a non-resident, CGT Event I1 applies to treat all CGT assets (other than Taxable Australian Property (TAP)) owned by the taxpayer to have been disposed of for their market value at the residence change time.

Examples of non-TAP assets include:

• a rental property located in a foreign country;
• shares and other investments (excluding indirect Australian real property interests); and
• collectibles and personal use assets (excluding Australian real property such as a holiday house).

Any resultant capital gains from CGT event I1 would qualify for the 50% CGT discount subject to the 12-month ownership rule being met.

What is TAP?

As mentioned previously, CGT Event I1 doesn’t apply to TAP. TAP is defined in s.855-15 and includes Australian real property and indirect Australian real property interests. For shares and other investments to be indirect Australian real property interests, the taxpayer needs to own 10% or more of the underlying entity and the entity’s underlying value must be principally derived from Australian real property. For the purposes of this article, we have assumed Max and Sophie’s share portfolio and managed fund investment are not TAP.

For Max and Sophie, their TAP will therefore consist of real property situated in Australia, being their main residence and the investment property. TAP assets remain in the Australian tax net, with any subsequent gain on such assets remaining taxable in Australia even if sold while Max and Sophie are non-residents.

If the non-resident then disposes of a non-TAP asset that has been subject to CGT Event I1, any capital gain or capital loss arising on the actual disposal will be disregarded for Australian tax purposes under s.855-10. The tax implications in the foreign country will still need to be considered. If the non-TAP assets are still owned when the taxpayer re-establishes their Australian tax resident status (for example by returning to live indefinitely in Australia) there will be a deemed acquisition of the relevant asset for its market value at the residency change time.

For Max and Sophie, they would be deemed to have disposed of their share portfolio and their investment in the Australian managed fund.

Importantly, and assuming the relevant assets have been owned for more than 12 months prior to the deemed disposal at residency change time, they will be eligible for the 50% CGT discount on any resulting capital gains from CGT event.

The main residence in Melbourne and the Queensland investment property are TAP and therefore will not be affected by the deemed disposal rules.

Electing out of CGT Event I1

It is possible to make an election to opt out of CGT Event I1, so the deemed disposal will not apply. Therefore, no CGT liability arises at the residency change time. Once the election is made it applies to all CGT assets covered by CGT Event I1, meaning you can’t pick and choose which non-TAP assets the election applies to, and has the effect that these non-TAP assets will be treated as if they were TAP assets. This means that there are no further CGT implications until a CGT event happens to the asset, e.g., an actual sale of the asset.

Therefore, Max and Sophie could elect for there to be no deemed disposal of their share portfolio and investment in the managed fund, meaning these assets would remain subject to CGT in Australia on an eventual sale.

From a practical standpoint, in determining whether or not to make the election, Max and Sophie would need to calculate their tax liability on any assessable net capital gain or loss resulting from CGT Event I1. Then, they would need to compare this amount to an estimate of tax liabilities if the non-TAP assets are sold at a future point in time as though an election to opt out of CGT Event I1 has been made. In doing this comparison, they need to consider any reduction in the availability of the 50% CGT discount in the future for the period that they were non-residents, any foreign tax liabilities on an actual disposal as well as taking a guess on the likelihood of an increase in the value of the asset.

If Max and Sophie don’t have surplus cash, they would also need to consider how to fund any tax liability if they decide not to make the election to opt out of CGT Event I1.

Does the 50% CGT discount apply to non-residents?

The full 50% CGT discount is not available to non-residents. However, a pro-rata discount may be available for the period the taxpayer was a resident.

So, if Max and Sophie were to dispose of their investment property prior to ceasing their Australian residency, they would be entitled to the 50% CGT discount on the full capital gain. But, if they wait until they are non-residents to dispose of it, they will only be entitled to a partial discount for the period they were Australian residents.

Furthermore, if Max and Sophie make the election for CGT Event I1 not to apply to their non-TAP assets, any subsequent actual disposal of their non-TAP assets whilst they are non-residents will remain subject to Australian CGT with a partial loss of the CGT discount.

Depending on the amount of the gain, and the period of non-residency, this can have a significant financial impact. Thus, careful consideration is required in order to decide whether or not to opt-out of the CGT Event I1 at residency change time in relation to non-TAP assets.

What about the main residence exemption?

Non-residents are generally denied access to the main residence exemption (MRE). For a non-resident to be able to access the MRE, the non-resident must be an “excluded foreign resident”, i.e., they cannot have been a foreign resident for more than 6 years and must also satisfy the life events test, which relates to terminal illness of the taxpayer, their spouse or child under 18, death of their spouse or child under 18 or a CGT event due to a family law matter.

Importantly, the test time for the MRE exclusion for a non-resident is the date when the contract for the sale of the main residence is executed. Accordingly, if Max and Sophie were to dispose of their Australian main residence prior to becoming non-residents, even if settlement is after they have left Australia, the MRE could still be available (assuming other requirements of the MRE are met).

In contrast if Max and Sophie were to dispose of their Australian main residence home whilst they are non-residents, they will be subject to CGT on the disposal (unless they are excluded foreign resident). Importantly, there is no cost base uplift at the time they became non-residents, so the CGT will be calculated based on the original cost base. They will also not be entitled to the full CGT discount.

Alternatively, if their personal finances allow holding onto the main residence and only disposing of it after their Australian residency is re-established, the MRE may again be available.

For further discussion on this topic, please see our previous article here.

Some practical considerations

Prior to moving overseas, it is critical to work out potential tax liabilities on the deemed disposal of non-TAP assets, as well as estimated tax liabilities arising on any actual disposals of assets while being an Australian resident. These amounts then need to be compared with disposals while being a non-resident. This analysis can then be used to assist in making decisions on whether to keep or dispose of assets.

The need to fund a tax liability or fund a home overseas will also need to be taken into account. For example, can Max and Sophie afford to purchase or rent a home overseas if they keep their Australian properties, or do they need to sell them? If they financially need to sell, it will be a lot simpler to sell before leaving Australia. If asset values have not increased dramatically, the tax implications might not be significant. But for those with assets that have large unrealised gains, it is necessary to undertake the cost benefit analysis, particularly with the partial loss of the 50% CGT discount. It is better to know upfront what assets may need to be sold prior to ceasing Australian tax residency status, to provide funding for overseas expenditure, rather than having an unexpected sale to meet financial needs during the period when the asset owners are non-residents. This is particularly important where tax concessions, such as the MRE are no longer available for non-residents.

When practical, it may be preferable to retain the properties and dispose of them after re-establishing Australian residency.

In addition to the Australian tax implications discussed above, the tax implications in the overseas jurisdiction will need to be considered, including whether there is any relief available under a Double Tax Agreement. This could be relevant to an actual sale of assets while being a non-resident, or on any deeming rules that may apply to assets owned when leaving that country to return home to Australia.

Previous articles regarding Australian tax residency

For further discussion on residency disputes and cases around federal, state taxes, and the application of Double Tax Agreements, see these articles:

Residency for Individuals: the ATO view

Tax residency – flaws in the ATO’s ‘checklist’ approach

Residency Status – the ATO is watching!

Can I still access the CGT main residence exemption when a DTA makes me a non-resident?

Look to your Trust – Is “Mr Hyde” lurking amongst its layers of beneficiaries?

Removal of NSW surcharge provisions for foreign persons

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