Australians travel far and wide around the world to pursue their careers. Many Australian expatriates intend to return to Australia one day while others become enamoured with life overseas and settle permanently outside of Australia. However, just because you are not physically in Australia does not mean that you are relieved from your Australian taxation obligations, especially if you invest in Australian property. That is why it is important to understand your Australian tax obligations and get them right, lest you find yourself confronted by the Australian Taxation Office with a nasty surprise down the track.
Tax residency status
The first thing you need to determine when you are planning to leave Australia is your future tax residency status because this will determine how you will be taxed in Australia going forward. The tax residency rules are not straightforward and are not the same as your citizenship, nationality or residency status for immigration purposes. You may be an Australian citizen by birth but you may still be treated as a non-resident for Australian tax purposes.
There are generally four tests to determine whether you will remain a tax resident of Australia after you leave. You will be treated as tax resident of Australia if you pass any of the following tests:
This test looks at where you live as your settled or usual place of residence. It is one of those tests that are not ‘black and white’ and requires you to consider a number of factors, including:
- Your nationality
- Where you were physically present and the duration
- Your residency history
- Where you carry out your habitual mode of living
- Your reasons for being absent from the relevant country
- Whether you have family
- Your economic and business ties with the country
- Where you have a home
No one factor is determinative and all the factors must be considered together to reach an ‘on balance’ conclusion. The rule of thumb adopted by the Australian Taxation Offi ce is that you have to leave Australia for at least two years before you may start arguing that you have become a non-resident.
Physical presence test
This test is arguably the most simple test to apply – if you have physically been in Australia, continuously or intermittently, for more than one half of the Australia income year (from 1 July to 30 June), you will be a tax resident of Australia.
This test requires you to determine the country of your domicile. If your domicile remains in Australia and you do not have a permanent place of abode outside of Australia, you will be treated as an Australian tax resident. Regarding the concept of ‘domicile’, the general rule is that you acquire your ‘domicile of origin’ at birth. For example, if you were born in Australia, your domicile of origin is in Australia. However, your domicile may change if you adopt a ‘domicile of choice’ later in life, which occurs if you decide to make a different country your permanent home.
This test is also relatively straightforward – if you are a member of the Commonwealth Superannuation scheme, you will be a tax resident of Australia. People who usually fall under this category are Commonwealth Government employees who serve in an overseas country (e.g. Australian diplomats).
Tax on income and capital gain
Under the Australian tax law, if you are a tax resident of Australia, your worldwide income and capital gains are generally subject to Australian tax. If you are a non-resident, only your Australian sourced income and capital gains on ‘Taxable Australian Property’ are taxable in Australia.
Unfortunately, any income or capital gain associated with a property located in Australia will always be treated as having been sourced in Australia, so it is very likely that the property will always give rise to Australian income tax (which includes capital gains tax (CGT)) implications in the future, regardless of whether you remain a tax resident or become a non-resident of Australia.
In addition to the domestic rules, if your destination country has a Double Tax Agreement (DTA) with Australia, the provisions of the DTA may override the domestic law in both Australia and the other country. However, the DTA usually grants an exclusive taxing right over the property to the country in which the property is located. Therefore, it is unlikely that the DTA would alter the Australian tax outcomes under the domestic tax law in Australia.
Even if, for one reason or another, a foreign country also taxes the same income or capital gain, the Australian tax rules will generally provide a foreign income tax offset on any foreign tax paid on the same income or capital gain, which will provide relief from double taxation.
Further, although Australian tax residents are taxed on their worldwide income and capital gains, they are also entitled to the tax-free threshold and lower marginal tax rates. As a tax resident of Australia, up to the first $18,200 of your taxable income in the year ending 30 June 2014 is currently tax-free. In contrast, non-residents are not eligible for the tax-free threshold, which means that they are subject to Australian tax on every dollar they earn that is sourced in Australia.
Notwithstanding the above, non-residents are not subject to the\ Medicare Levy (currently at 1.5% of taxable income, which will go up to 2% from 1 July 2014) while residents are required to pay Medicare Levy by default unless a specific exemption applies, for example, if the resident is in receipt of a war veteran pension.
Generally, for the transition year during which you become a non-resident (or revert from being a non-resident to a resident), you will be eligible to claim a part year tax-free threshold based on the number of months during which you were a resident, including the changeover month.
Capital gains tax discount
Before 8 May 2012, regardless of your tax residency status, if you make a capital gain and you have owned the Australian property for at least 12 months, you as an individual will be eligible for the 50% CGT discount, which has the effect of halving the capital gain. However, the CGT discount is no longer available to individuals and beneficiaries of trusts who are nonresidents in respect of taxable capital gains accrued on CGT assets (which include Australian properties) after 8 May 2012.
If you are a non-resident and you acquired a CGT asset in Australia after 8 May 2012, you will not be eligible for the 50% CGT discount at all if you make a capital gain upon the sale of the asset. If you bought the asset before 8 May 2012 and sell it after that date, you may elect to use the ‘market value approach’ – you may choose to apply the 50% CGT discount to any accrued capital gain up to 8 May 2012 based on the market value of the asset on that day and pay full CGT without the discount on any capital gain accrued after that point. If you do not choose this approach, you will not be eligible for the CGT discount on the entire capital gain.
Under the draft law, there is no specific requirement for you to obtain a formal valuation of the asset by a qualified valuer. However, you will need to be able to defend the market value adopted. Therefore, it may be advisable that you obtain a valuation of the property that you owned before 8 May 2012 as at that date to preserve the CGT discount that had accrued on the property before the date.
Changing your residency status
In addition to the above, if you change your tax residency status from being a tax resident to a non-resident when you leave Australia or at a later stage, you will have a decision to make – you may either be treated as if you have disposed of all of your CGT assets that are not Taxable Australia Property at their market value (which could give rise to an immediate and hefty tax bill!) or you may choose to disregard the capital gains (or capital losses) until you actually sell the relevant assets. In contrast, Taxable Australian Property will always be taxable when you sell it. The choice you make may have a signifi cant fi nancial impact.
For instance, if you choose not to pay tax when you stopped being an Australian tax resident and the asset has increased in value when it is subsequently sold, you will be paying more tax than if you have chosen to pay tax at the lower value at the point of your departure under the deemed disposal rules.
The term ‘Taxable Australian Property’ is relatively narrow by defi nition, which generally includes Australian real estate, Australian mining and resources rights, CGT assets that are used in carrying on business through a permanent establishment in Australia, and indirect interest in real estate through interposed entities where you own 10% or more of the entity and more than 50% of the market value of the entity’s assets is attributable to Australian real estate.
In other words, the special tax rules associated with changing your residency status will not generally change the Australian taxation implications associated with your Australian properties regardless of whether you remain an Australian tax resident or otherwise.
For completeness, if you retain a property that was your main residence in Australia and do not rent it out, the property will continue to enjoy CGT-free treatment, provided that you do not buy another home elsewhere. If you rent your Australian home out but do not buy another home elsewhere, you may continue to treat the Australian property as your tax-free main residence for up to six years. If you had never used the property to derive income until that point, the market value of the property at that point will become the cost base of the property for future CGT purposes if the property is subject to Australian CGT.
Many Australian expatriates choose to continue owning Australian rental properties when they leave Australia, regardless of whether they will remain as an Australian tax resident. In many instances, the properties may be negatively geared, so they will generate tax losses in Australia. The tax loss rules generally operate in the same fashion regardless of your tax residency status.
If an Australian expatriate has incurred a revenue loss on an Australian investment property (i.e. the property has given rise to a net rental loss), the tax loss may be carried forward indefinitely for recoupment against any future worldwide income and/or capital derived by the expatriate if they are a tax resident of Australia or any future Australian sourced income and/or capital gain if the expatriate is a non-resident.
If the investor has incurred a capital loss (i.e. upon the sale of the property), the capital loss may be carried forward indefinitely, but can only offset any future capital gain derived by the Australian expatriate. Further, if a tax resident of Australia incurred a tax loss that was sourced outside of Australia, the tax loss may generally be used to offset their Australian income. This is not so for a non-resident as the associated foreign income that gives rise to the tax loss is not taxable in Australia.
The above is only a broad snapshot of the Australian tax rules that may apply to Australian expatriates. These rules are often highly complex and must be carefully applied to your specific circumstance. To that end, professional tax advice is highly recommended. Apart from being able to provide you with specific advice, your adviser will be a valuable resource to help you comply with your Australian taxation obligations during your absence, whether your departure will be permanent or you intend to return to Australia at some point in the future.
Eddie Chung is partner, tax & advisory, property & construction, at BDO (Qld) Pty Ltd.
This article was published in the June 2014 edition of Your Investment Property magazine. You can subscribe to the magazine here.