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

Legislation enabling the removal of the CGT exemption from foreign residents was scheduled for debate on October 16, 2018, in the Senate. However, the legislation was withdrawn from discussion by the Government. Some reports suggested that the Government was reconsidering its stance, but it may simply have been "clearing the decks" of any contentious legislation. The legislation was not considered by the Senate in their final sessions in December 2018, and now there must be some concern about whether, given that an election must be held by the end of May 2019, that the legislation will actually be reviewed prior to the election of a new Government. In many ways this is the worst result, you can often plan around a poor result, but not around uncertainty of this nature. To his credit, the shadow Labor Treasurer - and probable Treasurer post May, 2019 - has criticised these delays and there is a suggestion that Labor would seek to exclude Australian citizens and permanent residents from the scope of the legislation.

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

The very forceful representations made by Australian Chambers of Commerce located overseas, chiefly in Asia, which we believe led the Government to re-consider the legislation's "unintended consequences" need to continue with a view to having the Government formally withdraw the legislation. With the Government currently staring down an electoral loss of major dimensions that shouldn't be impossible. The only issue is whether a resurgent Labor party might resurrect the legislation given that it earlier attracted 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 a Labor 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 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 elegibility 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.