Implications of no CGT exemption for non-residents
4 December, 2019 | Steve Burnham
Implications of no CGT exemption for non-residents
Welcome to the Tax Wrap podcast, Episode 204. I’m your host, Steve Burnham. Now many listeners will have heard of Ken Mansell. Ken presents our monthly tax update webinars, as well as making many other contributions to the bank of tax and super products and events. I rang Ken, who lives in Canberra, recently to tap into his thoughts on the proposal to exclude non-residents from the main residence CGT exemption.
Hi Ken. Thanks for being with us. I just like to touch base with Canberra every now and then, just to see… you’ve got the finger on the pulse as it were. What do practitioners need to know in the world of tax?
Ken Mansell: Yeah, well we’re getting towards the end of another year, and the government is trying to finalise a lot of legislation that it promised before the election, after the election, and a lot of the stuff that it couldn’t get through in the last parliament.
Steve Burnham: Right.
Ken Mansell: Because they’ve got more Senators now, they actually think they can get some things through that we wish they would never get through.
Steve Burnham: Oh, okay. Is that why… the push is on as it were?
Ken Mansell: Yeah. So the big change that they’re getting through that we don’t want to, they’re trying to get through, is some changes to the main residence exemption.
Ken Mansell: And we don’t want that to happen.
Steve Burnham: …we don’t want that to happen?
Ken Mansell: No.
Steve Burnham: Okay. Tell us what changes are proposed, and maybe we can come back to why that’s not a good thing.
Ken Mansell: So the government proposed it a few years ago, actually two budgets ago, and it’s this idea that non-residents shouldn’t get the main residence exemption.
There’s really just two bits of background you’ve got to understand.
Firstly, the biggest tax concession that any individual gets in their life is the main residence exemption. Super’s close — all the tax free super and concessionally taxed super. But when you look at the tax expenditure statement (the government puts out this analysis of all tax concessions)…
Steve Burnham: …that’s right…
Ken Mansell: …the main residence exemption is about $60 billion a year of less tax. It’s the biggest concession, and the government’s saying to a whole group of people, “If you are a non-resident, then you will not be getting the biggest tax concession you get in your life.” And that’s pretty scary.
Steve Burnham: It is, yep.
Ken Mansell: The problem is that they’re not doing it the way that previous changes for non-residents and capital gains has been done.
Steve Burnham: Okay, well how’s that?
Ken Mansell: Well since 2012, non-residents haven’t been able to claim the CGT discount, which sounds pretty much the same as what we’ve got here, except when some of us who were involved in writing that law there… we wrote it so that if Steve, you bought something today and you became a non-resident for half the period that you owned it when you sold it, you still get the discount for the time that you were a resident.
Ken Mansell: So you have to work out the gain that happened while you were a resident, and you get the discount for that.
Ken Mansell: Whereas this change here, they’ve decided that’s too hard to do, to do that proportionately, and they have said straight up Steve, if on the day that the CGT event occurs…
Steve Burnham: …as in, you sell property…
Ken Mansell: On the day you sign the contract, and you are a non-resident on that day, you get no main residence exemption on that house — at all — ever — on any of the capital gain.
Steve Burnham: …going back for however long you’ve owned it etcetera. Yeah, when you put it that way it doesn’t really seem right.
Ken Mansell: And they’re blatantly obvious about it. Their first example they have in the explanatory memorandum is someone who bought a house in 2010, lived in it for eight years in Australia. So an Australian resident. They went on a short term secondment over to New York, and when they got over there ran into, probably one of Donald Trump’s family members, wanted to marry them, and of course therefore they no longer needed the house. But because they’ve now moved overseas, they’ve locked in overseas, like their dog’s moved over with them and they’ve definitely ticked the non-resident box. And they sell the house in 2020. Well, you’d hope that they get the main residence exemption from 2010 to 2018, when they were residents.
Steve Burnham: For that eight years. Yeah.
Ken Mansell: And then they wouldn’t get the main… But no, this says, even though for eight of the 10 years that this person owned the house, they were a resident in Australia, because on the day that they signed the contract to sell it, they’re a non-resident, they get no main resident exemption. They have to pay the capital gains tax on the whole of the gain from 2010 to 2020.
Steve Burnham: Which is huge. I mean, just looking at the property market in that time, not that that may be relevant, but it’s a huge impost isn’t it? It’s huge.
Ken Mansell: I know we don’t have big houses like you guys have in Sydney and Melbourne, but we have a street in Canberra where all the embassies are, and the houses around there sell for — probably like a two bedroom apartment in Melbourne, for $3.x, $4.x, $5 million, and things like that. I know some accountants who advised the person there, who had owned that house since the early 1990s when they bought it for a couple of hundred thousand dollars, it’s now worth four million bucks. They were seconded overseas, over to the World Bank, and they’ve decided to stay there.
Ken Mansell: There is a $3 million gain on that house.
Steve Burnham: Amazing.
Ken Mansell: Most of that was while they were resident, but if they sold that house today, instead of paying no tax, they’ll be paying tax on a $3.5 million house, and that’s going to be close to a million dollars in tax, given their marginal tax rates and things. So this is a change of $1 million for someone.
Steve Burnham: Yeah. I’ve just had a thought, I mean, I’m not a practitioner, Ken as you know, but I like to ask the questions. I know that the word “intention” crops up a lot in some tax legislation. So for that eight years, going back to this example of the person who went to New York and bought Donald Trump’s, well you know, let’s get back to the example. During those first eight years, she intended to be an Australian. She intended to live in that house. Even just from that point of view, it doesn’t really seem right. But anyway, I’m interrupting.
Ken Mansell: Yeah, yeah. The real problem here is that the standard answer that you are currently giving to that person as they’re heading over to New York, is now wrong. Because what you’d say… They’d come to you and go, “Look I’ve owned this house for eight years, but I’m not going to live in it for the next eight years. I’m going to rent it out. Can I still get the main residence exemption?” And the answer you would have given was, “Well, yes. Renting it out, you can continue the main residence exemption for another six years. We call it the six-year rule. You can keep it for six years, and if you don’t rent it out, you can keep your main residence forever, but most people will rent it out. You’ve got to come back every six years and re-establish your residence, and then you can go over again, and you’ll never have to pay any capital gains on tax on that.”
And that sounds right, except you said that to the person who went over to New York. They think they’ve got six years. But if they become a non-resident, they decide not to come back, and they sell it, they’re not extending the main residence for another six years, they’re… What’s the difference of extending? They’re getting no main residence exemption at all.
Steve Burnham: No.
Ken Mansell: They’re not extending it for the time they were in New York, they’re actually destroying it for the time that they were in Australia, living in their house. And this is the real challenge that we’ve got now. Someone goes overseas and they say, “Look, I think I’m coming back in two years time. Can I get the main residence exemption?” You give them the six-year rule, but then you have to say, “But, if you become a non-resident, it looks as though you’ve locked in over there, then you won’t get any main residence exemption, unless you come back, re-establish your residency in Australia, and then sell the house.”
So I can imagine the client saying, “I’m not spending $15,000 on flights and three months worth of rent and things like that. I’m not spending that to come back and re-establish my residence.”
Steve Burnham: Every few years, yeah.
Ken Mansell: And you say, “You do know it’s going to cost you $1 million in tax if you don’t.”
Steve Burnham: Then they might change their mind. It might be worth…
Ken Mansell: “Oh I’ll bring the family, we’re having a six month holiday where we can re-establish our residence back in Australia.”
Steve Burnham: So the six-year rule still sticks, does it, even with this proposed change?
Ken Mansell: The six-year rule still exists as long as you remain a resident, or you re-establish your residency when you finally come back and sell it.
Ken Mansell: So if on the day you sell it, you are a resident, you are not a non-resident (I hate double negatives) — if on the day you sell it you are a resident, then the six-year rule is exactly the same.
Ken Mansell: So there’s no change to the six-year rule in Div 118 of the ’97 Act at all, but you’ve got to remember to get into Division 118 in the main residence exemption in the first place. There’s going to be a clause that says, “By the way, if on the day the CGT event occurred you were a non-resident, please don’t read the rest of Division 118, because you don’t get any main residence exemption at all.” You don’t even get into the six-year rule because you’re not in the “any year” rule.
Steve Burnham: Right, right. Yeah. I know that the Board of Taxation is… I think it’s currently looking at the definition of residency, non-residency. Does that have any implications for this proposed change?
Ken Mansell: Well, it will. It will, but they’re really looking at a definition of residency and non-residency to create hard and fast — they call them bright lines, the Board of Taxation. Because currently we’ve got four tests, and the first one is the resides test, which is the case law, which can… it’s really hard to understand. And then you’ve got the other tests which talk about “have you established a permanent place of abode in another country?”
So residents and non-residents is hard, but in the absolute obvious case where I had my Australian citizen moving to New York, marrying there, taking their name off the Australian electoral role, having all their bank accounts over there. No matter what changes, that person’s going to be a non-resident, and they’re going to lose the main residence exemption.
Steve Burnham: Yeah. Yeah. Sorry, you were going to say?
Ken Mansell: Oh, I should mention that there’s one exemption and one grandfathering, which I think I need to get onto.
Ken Mansell: So the first is the first exemption is, and this is different from the bill that they tried to introduce back in 1997.
Ken Mansell: They’ve accepted some bad things can happen. So I might give you the advice that if you do go overseas, you will become a non-resident for the four years you’re over in New York, but you need to come back to sell the house. But while you’re overseas, a “life event” (and I’m using the act’s words) might occur which means you might have to sell the property while you’re a non-resident, and it would be unfair for you to lose the main residence exemption for that life event. So there’s only really three life events. If you or your spouse or a child under 18 dies, if you or your spouse or a child under 18 gets a terminal medical condition, or you get divorced in the first six years that you are a non-resident, you can still get the main residence exemption.
Ken Mansell: So again, if my wife and I went overseas… she’s a doctor, so say she works for some amazing hospital. We became non-residents, and then she realised that, today being my 21-year anniversary, she decided it was time to get someone younger and fresher, and as a part of the agreement, we couldn’t work out who was getting the house, so we sold it. Even though we’re non-residents because we’ve been non-residents for less than six years, we can still get the main residence exemption on that one.
Steve Burnham: For your Australian property?
Ken Mansell: Yeah, for the Australian property.
Ken Mansell: So that’s the first exemption. I don’t know how helpful it’ll be, because yeah. There is one scary thing.
Steve Burnham: What’s that?
Ken Mansell: I can imagine a client coming to me who had become a non-resident, has a house in Australia, has been non-resident for six years. Five years, sorry. And I say, “How’s the family?” He says, “Great.” I say, “What are you calling about?” He says, “I’m calling about selling my house in Australia, the $10 million property on the Harbour.”
Steve Burnham: Right.
Ken Mansell: But then I could say: “Could you change the first answer? Could you tell me that your relationship’s not going well and you’re getting divorced? Because if you get divorced, there’ll be no tax on the house, but if you don’t get divorced…”
Steve Burnham: Or how about you pass away?
Ken Mansell: [Laughter] yeah. You’re a bit darker than me Steve….
Steve Burnham: Speaking of dark things, what about deceased estates? What if a non-resident, say someone, that person who went to America, they sadly die. The beneficiaries, is there any implications for them?
Ken Mansell: Yeah, because we know that if I get a house from my father who passed away… If it was his main residence, my ownership period will assume his main residence. So the time that he held it under the main residence exemption. But if he’s a non-resident, on the day that he dies, when it gets transferred to me, any time that he had where it was his main residence, I can’t get the main residence exemption on.
So I could get a house… Again, my father, let’s say he’s from Southern Europe or something. He comes over to Australia, builds a house. We grow up in it, we live in it. He decides for the last three years of his life that he’s going to go back and live in the motherland, wherever it was. So he’s a non-resident on the day that he dies. When that house gets transferred to me, I get his cost base, we’re assuming it’s post CGT…
Steve Burnham: …right…
Ken Mansell: …I get his cost base, but I get no main residence exemption that covers any of the gain of his life, because he was a non-resident on the day that he died.
Ken Mansell: So it’s just nasty.
Steve Burnham: So, it’s affecting the tax outcomes of more than just the owner of the property, it’s their beneficiaries etcetera as well.
Ken Mansell: The last thing I kind of mentioned before, I just got to get through that grandfathering thing.
Steve Burnham: Yes, yes.
Ken Mansell: This is the timely part. This is the part where practitioners will — probably straight after Christmas because no one wants to talk to you now — need to sit down with clients and have a chat.
Ken Mansell: Obviously this was first announced… well not obviously. This was first announced on 9 May, 2017, in the budget.
Ken Mansell: And so, if you owned a house before 9 May, 2017, these rules will not apply to you if you sell your house before 1 July, 2020.
Steve Burnham: Okay. Yeah. That’s-
Ken Mansell: So what that means is, you’ve owned your house for, like the example before, like our lady who bought the house in 2010 and then in 2018 moved to New York. So she definitely owned the house before 9 May, 2017.
Ken Mansell: And now she is a non-resident, and she’s never moving back to Australia, and she’s locked in, and she’s enjoying living in the Big Apple and everything’s wonderful. You’re going to have to say to her “If you sell this house after 30 June, 2020, you will pay capital gains tax on the entire gain. You’ll get a bit of a CGT discount for the time that you were a resident, but you’ll be paying it on the entire capital gain. If you sell this house before 1 July, 2020, you will pay no tax on the gain at all. Zero.”
So she’s got to make a choice now. Do I put it on the market quickly and get it sold before 30 June, or by 30 June, or do I keep the house, and in six years time when I want to sell it, do I come back to Australia, re-establish my residency, live in Australia for six months just to avoid paying some tax?
Steve Burnham: That’s amazing.
Ken Mansell: And that’s the conversation you’re going to have to have with people.
Steve Burnham: Yeah. Yeah. Gee, imagine being her real estate agent if she puts it on the market. “You’ve got to sell it before June 30. Quick. Come on. Get cracking.”
Ken Mansell: I reckon I’m going to drive around that one street in Canberra, you can go drive around Toorak, and I’m going to knock on the doors and say, “Look, are you a non-resident? Would you like me to buy your house for you? I can do the tax work for you on that house.”
Steve Burnham: Yeah, exactly.
Ken Mansell: Yeah, it really is a mess, because, yeah…
Steve Burnham: I was going to say…
Ken Mansell: …it means that there’s going to be a really tight timeframe.
Steve Burnham: It is. It is.
Ken Mansell: I should say, it’s still a bill. It may not get through the Senate, but the Senate is a lot more likely to pass it now than it was when the Greens and Labor had effectively a casting vote. They don’t have that anymore. There’s the cross bench. The government does not have to talk to the Greens, or Labor, to get this bill through. [NOTE: The bill was passed by both Houses on December 5, 2019]
Steve Burnham: No, but there’s still Jacqui Lambie, and Pauline Hanson, and all those. Is it in the Senate now?
Ken Mansell: Well, so it was originally passed by the House of Reps. Went to the Senate but was never voted on, because they would never get it through. That was before the election. Now it’s still in the House of Reps. It was supposed to be debated on the, I think it was Tuesday the 26th of November, but as of the 28th, it hasn’t been. It wasn’t debated on that day because other things came up.
So it is on the green and the red, which are the programs for the Reps and the Senate. They’ve got dates for this to be voted on, so it is going to a vote. And if it gets up, there’s going to be… And it won’t be a lot of clients, it’ll be one or two clients, but you’re not talking about claiming $150 laundry expense. You’re talking about $1 million worth of tax.
Steve Burnham: That’s amazing.
Ken Mansell: But even if they don’t get it up now, if they don’t get it through the Senate, they may try again and we might be having this conversation in February or March or April or May or June. “Could you sell the house in the next two days? Because it needs to be sold.” Yeah.
Steve Burnham: Yeah, that’s pretty amazing. Well there’s obviously got to be some changes, perhaps to the timing, but there doesn’t have to be. Nothing’s set in concrete with this government, it seems.
Ken Mansell: Well the timing may not, because the original bills had the same, you had to sell it by 1 July, 2019. So the original bill had, you had to get it all sorted. So they’ve given one extra year because it didn’t get passed by parliament, but they’re still backdating it all the way back to houses that were-
Steve Burnham: Budget night, 2017.
Ken Mansell: … 9 May, 2017, yeah. It’s pretty nasty.
Steve Burnham: Yeah, I see.
Ken Mansell: In many locations, there’s a U.S. Australia business forum, or a Hong Kong Australia business forum. All those business forums have made representation to the government to say, “This is ridiculous. So many of our members have houses that they’ve lived in back in Australia, that you’re going to take away their main residence exemption from.” The expat community know about this. So if you do have expats as clients, they may have already heard about it through their expat community.
Steve Burnham: Course. Course. Well, the thing is, the global market. I mean, there are a lot more people coming and going in the country, and leaving the country and coming back again these days. So it has implications going into the future, of course.
Ken Mansell: Yep.
Steve Burnham: All right. Okay Ken, that has been very informative. Thank you for your time.
Ken Mansell: No problems.
Steve Burnham: Say hello to Canberra from all of us in the rest of the country.
Ken Mansell: I shall.
Steve Burnham: We’ll talk to you soon.
Ken Mansell: Done.
Tax Wrap speaks with Ken Mansell on how the proposal to deny the main residence CGT exemption to non-residents has huge tax outcomes.