Capital gains tax changes on sale of main residence

Capital gains tax changes on sale of main residence – significant impact on Australian nationals living and working offshore

 

Summary

The proposed removal of the main residence exemption will have a significant financial impact on who Australian citizens or permanent visa holders currently living and working overseas and are treated as foreign residents of Australia for Australian income tax purposes.

If, at that time, the individual is a foreign resident, the main residence exemption will not apply. As a result, the capital gain or loss on the disposal of their family home will not be exempt for Australian tax purposes. 

The Bill does not contain any apportionment of the main residence exemption.  This means that the days the dwelling has been owned as an Australian resident for Australian taxation purposes is irrelevant

The following examples should highlight the inequity of the draft bill:

Example 1

Michael and Penny are Australian citizens by birth and are treated as tax residents of Australia. They acquired their home in Port Melbourne on 1 March 1998 for $500,000. In July 2019 Penny is offered a job working full time in London for a contract period of five years.

In preparation for their departure, Michael and Penny put their Port Melbourne house on the market.

After a period of negotiation, they sign the contract to sell the property on 13 September 2019 for $1.65 million.

Assuming that they became foreign residents of Australia for tax purposes from July 2019, they will pay tax on the full $1.15 million capital gain, despite only being foreign resident taxpayers for six weeks at the time that they sell.

This outcome is not affected by:

  • Penny and Michael previously using the dwelling as her main residence; and
  • The absence rule in section 118-145 that could otherwise have applied to treat the dwelling as Penny and Michael’s main residence (assuming all of the requirements were satisfied).
  • See Example 1.1. in the Explanatory memorandum – we could not make this up if we tried.

Compare this result to the same set of facts, but Michael and Penny sold their property whilst they remained tax residents of Australia.

As the property was their main residence, the whole of the capital gain was exempt from tax as compared to being taxed on the total capital gain of $1.15 million if they sold 6 weeks later when they were foreign residents.

 

Background

The Treasurer, Scott Morrison initially announced the proposed changes in the May 2017 Federal Budget. These measures attracted little media attention, as much of the general public and the political commentators believed that these changes were aimed at foreign residents (e.g. non Australian citizens or permanent visa holders), rather than Australian foreign resident tax payers.

The main proposal was to remove the main residence exemption in respect by:

  • denying foreign tax residents access to the CGT main residence exemption from 7:30PM (AEST) on 9 May 2017; and
  • existing properties held prior to this date will be grandfathered until 30 June 2019.

This proposed reform was the subject of a consultation process during July/August 2017 with the release of an Exposure Draft. Numerous submissions were lodged with Treasury.

On February 8, 2018, a Bill, which does not differ from the Exposure Draft, has been introduced into the House of Representatives. 

http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22legislation%2Fbillhome%2Fr6024%22

 

Our key concerns

  1. These rules will impact Australian citizens and permanent resident visa holders who are on existing overseas assignments. These individuals may not be aware of these proposed changes and have made decisions to retain their Australian main residence based on the Australian law at the time of their departure.
  2. It may also affect the decisions of individuals considering future overseas assignments which often form a critical part of their career or professional development as their Australian family home may now become subject to Australian CGT once they leave.
  3. Given the capital growth experienced in the Australian residential property market over the last decade, this might act as a significant impediment for Australian nationals undertaking long term foreign assignments. If these individuals sell their existing Australian main resident, it may be difficult to re-enter the Australian housing market at the same level upon their return to Australia (the writer speaks from personal experience).
  4. The following examples should highlight our concerns:

    ​​​Example 1
    Michael and Penny are Australian citizens by birth and are treated as tax residents of Australia. They acquired their home in Port Melbourne on 1 March 1998 for $500,000. In July 2019 Penny is offered a job working full time in London for a contract period of five years.

    In preparation for their departure, Michael and Penny put their Port Melbourne house on the market.

    After a period of negotiation, they sign the contract to sell the property on 13 September 2019 for $1.65 million.


    Assuming that they became foreign residents of Australia for tax purposes from July 2019, they will pay tax on the full $1.15 million capital gain, despite only being foreign resident taxpayers for six weeks at the time that they sell.

Compare this result to the same set of facts, but Michael and Penny sold there property whilst they remained tax residents of Australia. As the property was their main residence, the whole of the capital gain was exempt from tax as compared to being taxed on the total capital gain of $1.15 million if they sold 6 weeks later when they were foreign residents.

See Example 1.1 (Vicki) from the Explanatory Memorandum – this is the clear intent of the legislation.

The result of this proposed legislation is clearly inequitable and discriminatory.

  1. Will this cause panic sales in the rule up to 30 June 2019??
  2. This bizarre result as highlighted above is further re-enforced by the following example taken from the draft Explanatory Memorandum:

 

Example 1. 2

Amita acquired a dwelling on 20 February 2003, moving into it and establishing it as her main residence as soon as it was first practicable to do so. On 15 August 2020 Amita signs a contract to sell the dwelling and settlement occurs on 12 September 2020.

Amita used the dwelling as follows during the period of time for which she owned it:

  • residing in the dwelling from when she acquired it until 1 October 2007;
  • renting it out from 2 October 2007 until 5 March 2011 while she lived in a rented home in Paris as a foreign resident (assume the absence provision applies to treat the dwelling as her main residence);
  • residing in the dwelling and using it as a main residence from 6 March 2011 until 15 April 2012;
  • renting it out from 16 April 2012 until 10 June 2017 while she lived in a rented home in Hong Kong as a foreign resident (assume the absence provision applies to treat the dwelling as her main residence); and
  • residing in the dwelling from 11 June 2017 until it was sold.

The time of CGT event A1 for the sale of the dwelling is the time the contract for sale was signed, that is 15 August 2020.

As Amita was an Australian resident for taxation purposes at that time (as she had re‑established her Australian residency) she is entitled to the full main residence exemption for her ownership interest in the dwelling as it is, or is taken to be, her main residence for the whole of the time that she owned it.

So Amita who has been a foreign resident for a significant period during the ownership of the main residence will be fully exempt from CGT on the sale of the main residence, whilst Michael and Penny (Example 1) who have been foreign residents for only 74 days out of the last 7136 days will pay Australian CGT on the whole of the gain.

This is the intended consequence of the draft legislation. The draft bill is legislation is clearly inequitable and discriminatory.

7.When reviewing the documents in the public domain it would appear that these changes were portrayed as being aimed at temporary or foreign residents, not Australian citizens or permanent visa holders and have therefore attracted little media attention. The lack of media attention has not generated the public debate that such a drastic change warrants.

8.Our concerns are supported by the following comments made by the Federal Government:

8.1.Reducing Pressure on Housing Affordability — capital gains tax changes for foreign investors. This was the title of the relevant section in Budget Papers No2 where the proposed measures were first outlined.

8.2.Improving the integrity of capital gains tax rules for foreign investors. This was the title of fact 1.6 which appeared on the Budget Website.

8.3.Fact sheet 1.6 went further making the following comments::

  • The Government is introducing reforms to reduce the avoidance of capital gains tax in Australia by foreign investors.
  • This will send a clear message to foreign investors that if they wish to acquire Australian residential property, they will have to comply with our stringent capital gains tax rules

8.4.Treasury in seeking public comments on 21 July 2017 made the following statements:

  • As part of the 2017-18 Budget, the Government announced that it would be making capital gains tax (CGT) changes for foreign residents.
  • From 9 May 2017 the Government will remove the entitlement to the CGT main residence exemption for foreign residents that have dwellings that qualify as their main residence. Therefore any such capital gain or loss arising upon disposal of a foreign resident’s main residence will need to be recognised.

8.5.Numerous submissions were to Treasury outlining a number of issues. As indicated earlier, these submissions were ignored. Begs the question as to why public submissions are requested. 

9.Many of the submissions to Treasury  asked that they consider a similar grandfathering approach to that adopted when the 50% CGT discount was removed for Australian residents with a period of foreign residency after 8 May 2012 as contained in Subdivision 115-B of ITAA 97.

9.1.The operative provisions for the reduction (sections 115-105 to 115-120 of ITAA 97), which were enacted by the Tax Laws Amendment (2013 Measures No 2) Act 2013 (Act 124 of 2013), implement a 2012-13 Budget measure announced on 8 May 2012.

9.2.It should be noted that these amendments did not affect other rules in the CGT regime, such as the application of the main residence exemption.

9.3.Individuals who were foreign or temporary residents on 8 May 2012 can receive the CGT discount for the gains from a CGT asset that accrued prior to the announcement of the measure. The market value of the CGT asset at 8 May 2012 is required to quantify the gain attributable to that earlier period. This gain continued to qualify for the 50% CGT discount.

9.4.The effect of the measure was to:

  • retain access to the full CGT discount for discount capital gains of foreign and temporary resident individuals in respect of the increase in value of a CGT asset that occurred prior to 9 May 2012;
  • remove the CGT discount for discount capital gains of foreign and temporary resident individuals that arise after 8 May 2012; and
  • apportion the CGT discount for discount capital gains where an individual has been both an Australian resident and a foreign or temporary resident during the period after 8 May 2012:
    • the discount percentage is apportioned to ensure the full discount (50 per cent) applies to periods when the individual was an Australian resident.

10.Under these rules the reduced discount percentage applicable to a discount capital gain for an individual in respect of whom the discount testing period (DTP) started on or before 8 May 2012 who was an Australian resident on 8 May 2012 is calculated under s 115-115(3).

  • days in DTP – apportionable days as foreign resident ÷ 2 × days in DTP

11.The recommendation that a similar rule as contained in Subdivision 115-B be introduced into Subdivision118 –B. This modification will prevent the inequitable result as illustrated previously in Example 1.

11.1.Using the facts in Example 1, we highlight the equitable result:.

  • Days in DTP = 7136
  • Days as foreign resident = 74
  • Capital gain subject to CGT under proposed Government approach =$1,150,000 x(7136/7136) = $1,150,000
  • Capital gain subject to CGT under proposed modification = $1,150,000 x(74/7136) = $11,925

12.The proposed amendments are seeking to remove the existing partial main residence exemption (commonly called the 6 year rule).

12.1.The partial main residence exemption applies to the portion of the capital gain or loss that relates to the period when the dwelling was the individual’s main residence. The individual accounts for the portion of the capital gain or loss for the period they owned the dwelling for which it was not their main residence (apportioned on a number of days basis). It will no longer apply if, at the time a CGT event occurs to the ownership interest in a dwelling, the individual that owns it is a foreign resident.

12.2.The following example taken from the draft Explanatory Memorandum illustrates the impact:

 

Example 1.4 – loss of partial exemption

Terry acquired a dwelling on 20 August 2010.

On 13 November 2019 Terry signs a contract to sell the dwelling and settlement occurs on 11 December 2019. At this time he was a foreign resident.

Terry used the dwelling as follows during the period of time for which he owned it:

  • renting it out from when he acquired the property until 5 June 2011;
  • establishing the dwelling as a main residence and residing there from 6 June 2011 until 17 June 2019; and
  • leaving the property vacant from 18 June 2019 until it was sold. From 19 June 2019 Terry resided in London.

The time of CGT event A1 for the sale of the dwelling is the time the contract for sale was signed, that is 13 November 2019.

As Terry was a foreign resident at that time he is not entitled to the main residence exemption in respect of his ownership interest in the dwelling, even though he used the dwelling as his main residence for part of the time that he owned it.

13. We asked that where an individual who was a foreign resident as at 7.30pm AEST on 9 May 2017 and whose partial main residence exemption period before 7.30pm AEST on 9 May 2017 be allowed to choose a "market value" method. however this recommendation was ignored

14. We note that Treasury adopted a similar grandfathering approach in s 115-115(4) and (5) to calculate any reduction in the discount percentage applicable to their discount capital gain when modifying Subdivision 115-B. By doing so, any capital gain which accrued before 9 May 2012 remains eligible for the full CGT discount.

15. A key part of Australia’s taxation laws are Australia’s Double Taxation Treaties. Many of these treaties have non-discrimination articles which are for the most part are consistent with Article 24 of the OECD Model Convention. Under this non-discrimination article, nationals of the foreign country cannot be worse off under taxation or connected laws than an Australian national in the same circumstances.

15.1.Paragraph 1 of Article 24[1] provides:

Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected’

15.2.OECD commentary on paragraph 1 of Article 24[2] provides that it:

‘Establishes the principle that for the purposes of taxation discrimination on the grounds of nationality is forbidden, and that, subject to reciprocity, the Nationals of a Contracting State may not be less favourably treated in the other Contracting State than nationals of the latter State in the same circumstances.’

15.3.We believe the OECD is saying that when a tax is imposed on nationals and foreigners in the same circumstances, it must be in the same form as regards both the basis of charge and the method of assessment, its rate must be the same and, finally, the formalities connected with the taxation (returns, payment, prescribed times, etc.) must not be more onerous for foreigners than for nationals.

  • It is difficult to see how the proposed legislation will satisfy these requirements.

If you require any additional information or wish to discuss any of the points raised in our release, please do not hesitate to contact me on 61 3 8554 0200 or 61 418 844 105.

 


 

OECD, “Model Tax Convention on Income and on Capital (Condensed Version)”, 22 July 2010, Article 24 Non Discrimination, para. 1, p. 35.  

[2] OECD, “Model Tax Convention on Income and on Capital (Condensed Version)”, 22 July 2010, Commentary on Article 24 concerning non-discrimination, para. 5, p. 333.  

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