Thousands of Australian expats face tax slug under changes to CGT main residence exemption
Source:  ABC News  1 January 2020

For decades, Australians living abroad have been able to claim the capital gains tax (CGT) exemption on the family home.

Key points:
– The Federal Government saw the controversial law pass through the Senate in early December
– The change means thousands of Australian expats could be up for hefty capital gains tax bills
– Tax experts argue the measure is draconian and may force expats to return to Australia and sell their homes before June 30

This exemption was available so long as the home was rented out for no more than six years at a time.  But in early December the Federal Government finally passed through the Senate its $581 million plan to change CGT arrangements for people living overseas.  The law basically eliminates the CGT exemption for Australian expatriates that has been in place since September 20, 1985.  It means that potentially thousands of Australians will be hit with capital gains tax if they sold their property while a resident overseas, and the tax bill will date back from the time the owner purchased their home, not the point at which they moved overseas. 

For someone who purchased in the late 1980s, that could mean a hefty tax bill.  But under the law, foreign residents who already held property on May 9, 2017 will be able to claim the CGT main residence exemption, if they sell their property on or before June 30, 2020. 

The changes, first flagged in the 2017-18 federal budget, had received much criticism from the expat community and their advisers, causing the Federal Government to delay the proposed measures until after the election.  But Federal Treasurer Josh Frydenberg told ABC News in July that proposed change “remains our Government’s policy” when asked if it would still proceed.

KPMG tax partner Mardi Heinrich said the policy measure’s pathway through the parliamentary process had been “tortuous”.  “The impact will fall on Australians living overseas currently, or in the future, who sell their Australian main residence while living overseas,” Ms Heinrich said. “It will also apply to foreign nationals who buy a home in Australia to live in while working here, which they then sell after returning to their home country.”  “Furthermore, it will impact Australians who ordinarily live overseas and have their main residence overseas, but who come to reside in Australia for a temporary period.”  The Tax Institute’s senior tax counsel Bob Deutsch called it an “outrageous piece of legislation”.  “No one knows how many people are likely to be affected by these draconian measures, but it will certainly be in the thousands,” he wrote in a blog that he shared with ABC News.  “If we are genuine in wanting to build an agile, innovative workforce we have to do better than this.”

Atlas Wealth Management managing director Brett Evans said a high number of Australian expats would get caught out because many won’t be aware the previous six-year temporary absence rule was no longer applicable.  “In our daily discussions with Australian expats, very few people are aware of what has been proposed,” he said.

The Federal Government made some amendments to its original 2017 proposal that provide taxpayers with exceptions based on certain ‘life events’ such a terminal medical condition, death or divorce. “The hardship relief will only apply where an individual has been a foreign resident for a period of six continuous years or less, and only in very limited and unfortunate circumstances,” Ms Heinrich said. It would also be available if the resident moves back into their home before putting it on the market, she said.

RSM Australia associate director, tax services, Tracey Dunn told ABC News the exemption was unclear in the case of a divorce.  “The legislation and the explanatory memorandum are silent on the impact on Australian tax residents who obtain the ownership interest in a dwelling from a former spouse who subsequently becomes a foreign resident,” Ms Dunn said.  She said if the property is not transferred in accordance with Tax Act, and the spouse transferring it is a foreign resident at the time of the transfer, the Australian resident spouse will only be eligible for a partial main residence exemption on the later sale of the property.  Meanwhile, the foreign resident transferring the property will be ineligible to claim the main residence exemption relating to their period of ownership and the ‘life event’ will not be covered by the Act, she said.  “This is an absurd outcome, particularly considering the dwelling may have been the family home for the entire period of ownership,” Ms Dunn said.

Robyn Jacobson, senior tax trainer at TaxBanter, who had been campaigning against the law, said despite the amendments based on certain life events, major problems existed.  She said the biggest issue was that most people had not kept adequate records about expenses related to property purchases that may date back to the late 1980s.    “The issue is that in calculating the capital gain it [the law] is based on the original cost base,” she said.  “And in many cases adequate record keeping will have not been maintained and people will not be able to establish what their cost base is,” Ms Jacobson added.  “This includes not just the original purchase price, but acquisition costs, holding costs and improvements to the family home.”  Ms Dunn was also concerned that many taxpayers would not have retained CGT records to properly work out their cost base.  “The Government repeatedly ignored calls to allow for a market value uplift for foreign residents on exiting Australia,” Ms Dunn said.  “Unless the Commissioner of Taxation uses his administrative powers to enable former residents to estimate the cost base of their property on a reasonable basis, many former Australians may be unfairly ‘over taxed’,” she said.

To demonstrate how the law change would impact expats, Mr Deutsch gave the example of a fictional couple, Elizabeth and Barry, who purchased a home in Melbourne in Elizabeth’s name on April 1, 1991 for $1.2 million.  In January 2019, Elizabeth gets offered a senior position in a bank in England on an initial two-year contract but renewable by joint agreement.  She accepts and the couple leave for England in April 2019, while renting out the property on a one-year lease.  The job turns out to be a perfect fit and Barry has also found a job in England, so the couple decide to stay there permanently.    On April 1, 2021, the Melbourne property is sold for $4.6 million.  “As a result of the law, if Elizabeth is a foreign resident at the time of sale, which is likely on these facts, she will, quite absurdly, be denied the benefit of the main residence exemption,” Mr Deutsch said.  He said her capital gain based on one of two ways of assessing it, would be $1.8 million ($4.6 million minus $1.2 million reduced by 46.67 per cent).  An alternative, he said, would be for Elizabeth to have come back to Australia and re-establish her Australian residency for the sole purpose of allowing her to sell her property free of a CGT liability, or at the very least a reduced liability.  But he said this posed a “logistical nightmare” and raised a further question as to whether general anti-avoidance rules may apply.  “The scheme gives rise to a tax benefit in the form of an exemption which would not have applied but for her manoeuvre,” he said.   “All this can leave some advisers to expatriates like Elizabeth in quite some quandary as to what exactly is the best advice to give in such cases,” Mr Deutsch said. “In addition, as Elizabeth will be taxed on the capital gain calculated using the original cost base, she will need to have kept accurate records of her purchase.”  He said this was unlikely given her property purchase dated back to 1991.

Australian Taxation Office Reference Links:
Capital gains tax changes for foreign investors
https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-on-capital-gains/Capital-gains-tax-changes-for-foreign-investors/

Foreign residents and main residence exemption
https://www.ato.gov.au/general/capital-gains-tax/international-issues/Foreign-residents-and-main-residence-exemption/