Contributed by Andrew Henshaw, Director and Patrick Simon, Law Graduate, Velocity Legal
Close to three years since they were first announced, the “legislation by press release” changes to the CGT main residence exemption (MRE) for non-residents are finally now law (foreign resident main residence rules).
Under the new foreign resident main residence rules, most non-residents have until 30 June 2020 to sign a contract to sell their former Australian main residence, with the benefit of the MRE (either on a full or partial basis). For any sale contracts entered into after that date, the majority of Australian expats (ie non-residents) will not be entitled to apply the MRE at all for any capital gain made on their former Australian main residence.
The foreign resident main residence rules will severely impact Australian expats who own Australian real property that they previously lived in, and “increases the stakes” of determining whether a person working overseas (particularly an Australian citizen) is a “resident” or “non-resident” for tax purposes. On a more positive note, some of the most severe impacts can in many situations be properly managed through appropriate tax planning.
How can non-residents use the MRE in the first place?
Under the MRE, an individual may disregard a capital gain from the sale of a dwelling that they treat as their main residence. Where a dwelling is not the taxpayer’s main residence for their entire “ownership period”, the MRE applies on a partial, pro-rata basis. Further, an individual may elect to continue treating a property as their “main residence” under various absence rules –– either for an unlimited period or a maximum period of six years if the property is used to produce assessable income (ie rented out).
Thus, prior to the foreign resident main residence rules, a person could purchase a property in Australia, live in the property for a period of time and then live elsewhere (either in Australia or overseas), and still access the MRE on the sale of that property (either on a full or partial basis).
What are the core changes?
First announced on 9 May 2017, the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures) Act 2019 received royal assent on 12 December 2019. The Act amends s 118-110 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) to deny the MRE to individuals who, at the time a CGT event happens, are either:
- an “excluded foreign resident”, or
- a foreign resident who does not satisfy the “life events test”.
This means that under the foreign resident main residence rules if a person is a “foreign resident” (ie not a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (Cth) at the time of sale), their entitlement to the MRE is completely denied as though they had never been entitled to the MRE.
Perversely, if the same individual requalifies as an Australian tax resident before the time of sale, the MRE can apply once again, causing the MRE to “switch on” and “switch off” as a person’s residency status changes.
“Life event” exception
In very limited circumstances, an individual who has been a foreign tax resident for six years or less will still qualify for the MRE if they experience one of the following “life events”:
- the individual, their minor child or their spouse experiences a terminal medical condition
- the individual’s spouse or minor child passes away, or
- the individual separates or divorces their spouse or former spouse.
It is retrospective
To be clear, the foreign resident main residence rules are retrospective in substance (if not form). Unlike the changes to the 50% CGT discount for foreign residents (which applied from 8 May 2012), these changes impact the entire capital gain made from the date on which the asset was first acquired, rather than just the date on which the changes were introduced. While taxpayers still have a window of opportunity to sell before 30 June 2020, those who do not may have their entitlement to the MRE retrospectively extinguished. This is best illustrated through the following example.
On 15 January 1995, Max purchases his dream home in leafy Eaglemont for the total sum of $150,000. Over time, Max becomes a leading engineering expert. In 2018, Max is offered a three-year fixed-term position with a company in Germany. Max accepts the job, rents out the Eaglemont property, moves to Germany, and becomes a foreign tax resident on 1 July 2018. Max meets a charming woman named Helga who completely sweeps him off his feet. The pair quickly realise that they are soul-mates, Max realises that his life is now in Germany and sells the Eaglemont property for $1,650,000 in 2021. Max makes a capital gain of $1,500,000, with no recognition for the fact that Max lived in the Eaglemont property for 20 years. In addition, Max also cannot apply the 50% general CGT discount for the period from 1 July 2018!
The importance of “tax residency”
In certain circumstances (and particularly for Australian expats), determining whether someone is or is not a resident of Australia and when that person’s residency status changes can be quite a task.
The recently concluded Harding litigation (Harding v FC of T 2018 ATC ¶20-660,  FCA 837; Harding v FC of T 2019 ATC ¶20-685,  FCAFC 29) illustrates that determining whether an individual is a resident of Australia can be extremely difficult, as the majority of the residency tests contain difficult legal terms such as “reside”, “domicile”, “permanent place of abode” and “usual place of abode”. Australian expats have often sought to argue that they are not a resident of Australia for tax purposes (often due to foreign-sourced income). With the removal of the MRE for non-residents, taxpayers in certain situations may be more inclined to be treated as a resident of Australia! This is best illustrated through another example.
Rewind to 2018. Max is also offered a senior role with an Australian company in Northern Australia. Max is based in Broome, but also has significant travel commitments across the Asia-Pacific region, and spends 200+ days per year outside of Australia. Max moves to Broome and rents out the Eaglemont property. Later, Max sells decides to the Eaglemont property for $1,650,000 in 2021. Despite spending a significant amount of time out of Australia, Max is likely to be a tax resident and so can apply the MRE (and the absence extensions). Max’s capital gain is nil.
Any individual who spends substantial time overseas and intends to rely on the MRE should seriously consider seeking specialist advice regarding their tax residency before selling their property.
Impact on deceased estates
The MRE can also apply where a trustee or beneficiary of a deceased estate disposes of a property that was either the main residence of the deceased or the main residence of the certain beneficiaries (or both).
The foreign resident main residence rules introduce similar, but subtly different, changes regarding deceased estates. In general, the trustee or beneficiary of the deceased estate will be denied the MRE:
- for the deceased’s ownership period, if the deceased had been a foreign tax resident for a continuous period of six years or more immediately before their death (and therefore an “excluded foreign resident”), and
- for the trustee or beneficiary’s ownership period, if the relevant beneficiary had been a foreign tax resident for a continuous period of six years or more immediately before the CGT event (and therefore an “excluded foreign resident”).
Perversely, there may be situations in which the “deceased estates” exemption would apply, but not the regular MRE.
In Example 1, Max was not entitled to apply the MRE when he sold the Eaglemont property as a foreign resident. In the current example, Max tragically passes away while the property is being advertised for sale. Max’s father (Doug, who lives in Australia) is recorded as the trustee of Max’s estate. Because Max has not been a foreign tax resident for a continuous period of six years or more immediately before his death, Doug (as executor) may be entitled to apply the MRE on the sale of the property.
Transitional provisions until 30 June 2020 –– still time to avoid retrospective tax
Although the foreign resident main residence rules operate retrospectively, foreign residents who would otherwise be affected will be entitled to disregard the new rules and apply the MRE if:
- a CGT event occurs in relation to the dwelling on or before 30 June 2020, and
- the foreign resident held an ownership interest in the dwelling before 7:30 pm on 9 May 2017.
The upshot of these transitional provisions is that Australian expats who purchased their main residence property on or before 9 May 2017 still have a window of opportunity to claim the MRE if they take action to trigger a CGT event (such as entering into a contract to dispose of the property) before 30 June 2020.
Any foreign tax resident who intends to sell their Australian main residence prior to 30 June 2020, or to apply the life events MRE exemption, should take proactive steps to obtain a Foreign resident capital gains withholding variation certificate well in advance of the sale. This will ensure that when the settlement date arrives, the purchaser will not be required to withhold any component of the purchase price on account of the CGT withholding provisions.
The way forward –– planning opportunities remain
The timer is now ticking down towards the 30 June 2020 deadline, from which non-residents will be completely disqualified from applying the MRE in most situations.
Individuals who are set to be affected by the new changes will only be able to avoid incurring a tax liability on their Australian main residence by:
- triggering a CGT event (such as entering into a contract to sell the dwelling) on or before 30 June 2020
- applying the “life events” exemption, or
- relocating to Australia prior to selling the property (ie commencing tax residency).
The foreign resident main residence rules will severely impact Australian expats who own Australian real property that they previously lived in, and “increases the stakes” of determining whether a person (particularly an Australian citizen) working overseas is a “resident” or “non-resident” for tax purposes. All hope is not lost however, as in many situations some of the most severe impacts can be properly managed through appropriate tax planning.
[This article was originally published in CCH Tax Week on 31 January 2020. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]