Major tax shocks await the unwary Australian expatriate

Signed employment contract - check. Passport renewed - check. Airline tickets booked - check. Analysed the capital gains consequences of CGT event I1- Check…no wait, what?!?

Living and working overseas has many benefits. Travel not only broadens the mind; international employment looks good on pretty much any resumé.

Many foreign countries have significantly lower tax regimes than Australia and this can be a major drawcard for an Australian expat selecting that country to live and work in.

It is, however, the Australian income tax ramifications of moving abroad that are often overlooked.

The Australian Taxation Office (ATO) - under Section 104.160 of the Income Tax Assessment Act 1997 (ITAA 1997) to be precise - stipulates that upon ceasing Australian tax residency, a taxpayer is deemed to dispose of all assets that are not considered “taxable Australian property”.

Another ruling, Section 104.165 ITAA 1997, then goes on to state that while these deemed disposal provisions apply automatically, there is the ability to “opt out” thereby choosing to disregard making a taxable gain or loss.

Opting out, however, is an all or nothing approach. There is no ability to have a foot in both camps by undertaking a deemed disposal to only some of your of non-taxable Australian property assets.

There are five categories that comprise taxable Australian property as defined at section 855.15 ITAA 1997, extract as follows:

Of particular relevance for many potential expatriates and their accompanying family members are publicly listed shares, be they Australian or internationally listed, and foreign-owned assets such as property.

By and large, an Australian tax resident – for simplicity meaning someone that lives in Australia - is subject to tax by the ATO on their worldwide income. In contrast, a non-resident for Australian tax – for simplicity meaning someone that does not live in Australia – is subject to tax on a much narrower scope of income.

As a non-resident, capital gains on the sale or disposal of listed shares and international assets/investments fall outside the ATO’s taxing jurisdiction. Accordingly, capital gain event I1 kicks in by applying the deemed disposal provisions, which effectively removes the asset from the Australian tax net.

For any budding lawyer reading this article or someone familiar with legal concepts, this is akin to the principle of “double jeopardy”, that is an individual cannot be charged with the same crime twice.

Once an asset has been disposed of – even if by way of a taxation deemed disposal – then the capital gains tax liability crystalises at that moment.

When the asset is then sold or disposed of, any capital gains consequence at that point is disregarded. Any subsequent profit made is, in a word, non-assessable.

A deemed disposal is a notional transaction. The capital gain is computed as the difference between the cost base (generally, purchased price plus transaction costs) and the market value of the asset/investment as at the date of ceasing Australian tax residency. With international asset/investments the market value is simply converted into Australian dollars.

Avoiding an unexpected tax shock

For those that don’t own any assets that are considered taxable Australian property, then Capital Gain event I1 has little relevance. But for those that do, the tax bill can be large….and often unexpected.

So, what about that $300,000 worth of shares you inherited a few years ago?

While you may not have actually bought these - as you inherited them - in the eyes of the ATO the tax cost base could actually be the amount that the deceased had originally bought them for.

If they had paid, say, $120,000 ten years earlier, then there is actually $180,000 of unrealised profit that could form part of these deemed disposal provisions.

Previously vested employee shares are another common example. There are many instances where these may have doubled or tripled in value, sometimes even more, creating significant unrealised capital gains.

Capital gain event I1 can even reach assets that are not income-producing. This could include an overseas holiday home, overseas property that extended family members may reside in, and even vacant land if it is situated overseas.

Clearing up CGT uncertainty

Upon returning to live in Australia, thereby resuming Australian tax residency, the “Deemed Acquisition” provisions (section 855.45 ITAA 1997) apply to treat the market value of any non-taxable Australian property asset/investment as the reset taxation cost base.

As a side note, the 50 per cent CGT discount that ordinarily applies after 12 months of ownership, regarding the Deemed Acquisition provisions, requires ownership to be 12 months from the date of commencing Australian tax residency.

The ability to live and work overseas can bring significant professional, lifestyle and financial advantages.

Even though the ATO may tax certain unrealised capital gains in the financial year of departure, the silver lining is that the ATO’s CGT exemption continues to apply until the expatriate moves back to Australia.

Trying to avoid the ATO or hope they won’t notice that property investment income, capital gains tax debt or rental income is not an option, especially in light of the tax office gaining greater powers to access landlords’ bank accounts.

Where there is uncertainty as to how these laws may affect you, arranging a consultation with a qualified accountant – preferably one that specialises in tax residency – would be wise. 

With a bit of tax planning, combined with professional advice, you may even be able to use these tax provisions to your financial benefit.