CGT Main Residence Exemption - Significant Discriminatory Changes and Still No Legislation

Current Status Legislation enabling the removal of the CGT main residence exemption from foreign residents was originally scheduled for debate on October 16, 2018, in the Senate. In a nutshell, the Government's current draft legislation provided that, with effect from July 1, 2019: Individuals who sell their main residence and who are a foreign resident at the time of disposal will no longer be entitled to the main residence exemption - this would include Australian citizens or permanent residents living overseas who are non-residents For individuals, the date of the disposal of their interest in a property will generally be the time a contract for sale is entered into. The Bill does not currently provide for any apportionment of the main residence exemption. This means that any days the dwelling has been owned as an Australian resident for Australian taxation purposes are irrelevant in calculating any CGT liability. Non-residents inheriting Australian real property may be significantly impacted, with the legislation prohibiting them from claiming the main residence exemption with respect to parental property. Wills should be amended to provide protection where possible. At the Tax Institute's National Convention on March 15, the Assistant Treasurer, Stuart Robert, apparently hinted that the Government had purposefully not proceeded with the legislation and the legislation did not feature in the recent 2019 Federal Election debate. Currently, the timing of the Federal election meant that it was extremely unlikely that any draft legislation could be considered again in the Senate before the end of the financial year and before the proposed start date of the legislation on July 1, 2019. There is some possibility that any legislation introduced after in that time might be backdated, but that would be very unusual, and therefore in the absence of any statement by the Government regarding their intent, the options in descending order of probability are probably: The legislation is simply allowed to lapse New draft legislation is introduced after July 1, 2019, with the introduction of any measures delayed until July 1, 2020, and New draft legislation is introduced after July 1, 2019, with the introduction of any measures backdated to July 1, 2019 It's extraordinary that this level of uncertainty has been allowed to continue, and it is probably an accurate reflection of the importance the Government attaches to the expatriate community - particularly in an election year.

Introduction

In the 2017 Federal Budget the Government announced an intention to remove any entitlement to the capital gains tax (CGT) main residence exemption for foreign residents and temporary residents. For the purpose of these changes all Australian expatriates (citizens and permanent residents) who are non-resident for tax purposes are considered "foreign residents".

Background

The "main residence exemption" provides Australian taxpayers with an exemption from capital gains tax (CGT) where their property is, or has been, their family home, subject to meeting certain criteria. Until these recent changes the provisions meant that capital gains made in relation to a qualifying main residence were exempt from Australian CGT; and that this exemption applied perpetually to properties that were never rented out, and for a further period of six years from when a property was rented out - this is called the "six year rule". The exemption only applies where there is no other property nominated as a main residence and, when a property is re-occupied as a main residence, the six-year exemption period resets.

The 2017 Budget introduced the following intended changes:  

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

Following the Budget there was an extensive consultation period and some hope existed that the legislation would be significantly scaled back. Most of the changes had been announced on the back of moves to "reduce foreign ownership" in Australia residential property and it was thought that the extension of these changes to Australian citizens and permanent residents may have been an "unfortunate oversight". This did not prove to be the case, with Bills introduced to Parliament on February 8, 2018 reflecting early Budget announcements - with the only change being that temporary residents in Australia, who qualified as tax residents, would not be subject to the legislation. Consequently, while temporary residents were provided with continuing protection, Australian citizens and permanent residents who were non-resident for tax purposes would continue to be adversely impacted by the changes.

In summary, the proposed legislation introduces some very extreme "cliff effects" when it comes to the treatment of capital gains associated with the sale of property in Australia - and it is our position that no expatriate Australian should now proceed to sell a property in Australia without first obtaining prior professional tax advice. In addition, expatriates who have significant amounts of accrued capital gains in Australian property - and that will certainly be the case for expatriates who have held property in Sydney and Melbourne over the last 5 years - should now seek professional advice with respect to whether they should sell their properties prior to June 30, 2019 if there is any doubt that they will return to Australia in the short to medium term and therefore be resident at the time of any property sale. We have provided a summary of the changes to the legislation below, and republished some of the frankly extraordinary examples provided by the Government in its Explanatory Memorandum.

Current Status of Legislation

We believe that very forceful representations made by Australian Chambers of Commerce located overseas, chiefly in Asia, led the Government to re-consider the legislation's "unintended consequences" and to withdraw from actively proceeding with the Bill during the election period - but they did not publicly renounce it either. They clearly thought to leave it as unfinished business for a Labor party which had a strong lead in the polls. The measure had quite strong bi-partisan support; as the Senate report of March 23, 2018 illustrates below - but it is hard to see it being an early focus of the Morrison government.

2.32 The committee acknowledges the concerns expressed regarding the changes to the CGT main residence exemption for foreign residents including Australian citizens and permanent residents living and working overseas that may be affected by the changes. The committee acknowledges those people who may be affected by these changes and notes that it is the government's responsibility to ensure that they are made aware of the changes and the transitional arrangements, so they can plan accordingly.

The Impact of the Proposed Changes

The Explanatory Memorandum published with the legislation summarises the "before and after" situation for individuals as follows:

New Proposed Law	Current Law
Individuals who are foreign residents at the time a CGT event occurs to a dwelling in which they have an ownership interest are not entitled to the main residence exemption	Individuals who are foreign residents are entitled to the main residence exemption in the same way as individuals who are residents of Australia for taxation purposes.

In effect, the timing of any sale can now be a crucial concern, and to illustrate just how inequitable and extreme those timing issues can be, consider Example 1.2 provided in the Explanatory Memorandum below:

Vicki acquired a dwelling on 10 September 2010, moving into it and establishing it as her main residence as soon as it was first practicable to do so. On 1 July 2018 Vicki vacated the dwelling and moved to New York. Vicki rented the dwelling out while she tried to sell it. On 15 October 2019 Vicki finally signs a contract to sell the dwelling with settlement occurring on 13 November 2019. Vicki was a foreign resident for taxation purposes on 15 October 2019. The time of the CGT event A1 for the sale of the dwelling is the time the contract for sale was signed, that is 15 October 2019. As Vicki was a foreign resident at that time she is not entitled to the main residence exemption in respect of her ownership interest in the dwelling. Note: This outcome is not affected by Vicki 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 Vicki’s main residence from 1 July 2018 to 15 October 2019 (assuming all of the requirements were satisfied) .

This example demonstrates that the Government is comfortable with policies which introduce significant cliff effects, and to blithely penalise individuals who move internationally rather than domestically for work or personal reasons. The cost impact of this policy can be very substantial, and in an effort to attach some figures to the impact we provide some indicative figures in the download "Vicki has a Major Tax Problem". Remember in this context that any capital gain which occurs whilst you are non-resident will attract "non-resident" tax rates - which start at 32.5% with no tax free allowance.

Another, instructive but slightly more complex scenario, is provided in Example 1.4 of the Memorandum.

Terry acquired a dwelling on 20 August 2008. 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: • establishing the dwelling as a main residence and residing there from when he acquired the property until 31 January 2010; • renting it out from 1 February 2010 until 5 June 2011; • re-establishing the dwelling as his 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 as a foreign resident. 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. Terry first used the dwelling to produce assessable income, by renting it out, on 1 February 2010. However, the special rule for when a dwelling is first used to produce assessable income (which would allow him to be taken to have acquired the dwelling for its market value at that time) will not apply. This because he is not entitled to a partial main residence exemption at the time the CGT event occurs. This is because Terry was a foreign resident at the time CGT event A1 occurs to the dwelling.

We have always supported the continued investment by Australian expatriates in Australian residential property because it represents both a hedge against movements in the local Australian real estate market and adverse currency movements. These recent changes, together with the withdrawal of the 50% CGT discount for non-residents in 2012, will however significantly impact any analysis of whether property should continue to be held in Australia.

For expats aged 65 years of age and over selling their Australian main residence, remember that it has been possible since June 30, 2018 to make "downsizer" contributions of up to $300,000 each into superannuation - subject to meeting certain eligibility requirements. This may introduce significant flexibility in a very small number of situations, given recent restrictions on making super non-concessional contributions.

In summary, the Government effectively continues to support domestic mobility, and to penalise international mobility. It is quite obvious that all the major parties continue to work on the basis that there are "no votes" in the Australian expatriate community.