Australian tax residents are taxed on their worldwide income whilst non-residents are generally only subject to Australian tax on their Australian sourced income. Given the stark difference in tax treatment it is important to stay on top of one's tax residency status when one is an expatriate leaving Australia or migrating to Australia. For individuals failing to do so, this can lead to overseas income being unexpectedly taxed in Australia, losing out on the full benefit of the 50% capital gains tax (CGT) discount when one sells Australian land or losing access to the principal place of residence CGT exemption.
Australian Residency Tests
An individual is an Australian tax resident if they meet any one of the following tests:
- the individual ordinarily resides in Australia (relevant factors in determining this include the individual's intentions, family/business/employment ties with Australia, social and living arrangements, and the location of the individual's assets);
- the individual has an Australian domicile unless they have a permanent place of abode it overseas;
- the individual has been physically present in Australia for 183 days or more in a financial year, unless their usual place of abode is overseas and they do not intend to take up residence in Australia; and,
- the individual is a member of one of the specific Commonwealth government superannuation schemes (e.g. public servant or member of the armed forces), or they are a spouse or child under 16 years of such a member.
The Harding Case
The Australian residency tests are fact based and can be difficult to apply. The recent Full Federal Court case of Harding shows this. In that case an Australian engineer who had lived in the Middle East for six years was found not to be an Australian tax resident because he lived permanently in a particular country or state and consequently had established a permanent home overseas. This was so even though Mr Harding lived in serviced apartments in the six years and effectively 'lived out of his suitcase' during that six year time period.
The Court noted that when determining the tax residency of an individual, the phrase "permanent place of abode" should be interpreted more widely than by reference to the individual's house or dwelling and consideration be given to whether the individual is living permanently in a particular country or state.
The Court held that Mr Harding had permanently based himself in Bahrain and therefore ceased his Australian tax residency status. Harding's case has provided some clarity on the "permanent place of abode" test.
Although the Court found that he met the Australian domicile test, the Court considered that Mr Harding did not ordinarily reside in Australia since he was living and working in the Middle East.
The impact on Mr Harding of not being an Australian tax resident was favourable for Mr Harding because the employment income he derived whilst working overseas (which was tax free in the Middle East) was not taxable to him in Australia.
The Harding case shows how important it is to manage your tax residency status. Individuals who plan to move overseas with the intention of remaining overseas for period of time exceeding 6 months (whether for work or otherwise) should obtain specialist tax advice prior to leaving Australia. Doing so will enable the individual to undertake certain actions which will hopefully result in his or her Australian tax residency status being clearer. Such steps may include setting up a permanent home overseas by leasing an apartment and buying furniture. Other actions to evidence a change of tax residency include relocating most of your assets overseas (particularly your daily transactions bank account), removing your name from the electoral roll, moving your immediate family overseas and planting economic and social roots in the new overseas location.
Double Tax Agreement (DTA)?
Mr Harding lived in Bahrain which does not have a DTA with Australia. If he had relocated to a country which does have a DTA with Australia and if he had been considered a tax resident of both countries, the DTA may operate and apply a tie breaker test to determine in which country he will be considered a tax resident.
Capital Gains Tax (CGT)
Knowing when you cease to be an Australian tax resident is relevant for Australian CGT for two reasons. Firstly, you are deemed to have disposed of all your CGT assets which are not taxable Australian property for their market value when you cease to be an Australian tax resident. Broadly, 'taxable Australian property' consists of Australian land interests and a 10% or more ownership interest in a company or unit trust that is "land rich". That is, on ceasing Australian tax residency status, you are deemed to have sold all of your assets other than an interest in Australian real property. You can choose to disregard a capital gain made on this deemed disposal, but this means that should you later sell the capital asset after you have become a non-resident you must pay Australian CGT on any capital gain made. Whether you choose to disregard the capital gain depends on the asset's profile and also whether a DTA may apply to prevent later CGT.
Secondly, because of a change in law on 12 December 2019, if you are not an Australian tax resident at the time you dispose of your residential property in Australia (which was previously the principal place of residence for your family), you will not qualify for the principalplace of residence exemption from CGT unless you satisfy the life events test.
You satisfy the life events test if, at the time of the disposal of your residential property in Australia, you were a foreign resident for tax purposes for a continuous period of six years or less and, during that time, one of the following must have also occurred:
- you, your spouse, or your child under 18, had a terminal medical condition;
- your spouse, or your child under 18, died; or,
- the CGT event involved the distribution of assets between you and your spouse as a result of your divorce, separation or similar maintenance agreement.
Seek Proper Tax Advice
The above discussion is a small window into a vast topic of tax residency and its implications. The key 'take home message' is if you (or your loved ones) plan to migrate from or to Australia then they should get specialist tax advice before leaving or arriving in Australia. This is to ensure a leaving expatriate properly cuts their Australian ties. In the inbound situation there may be actions that can be taken before one lands in Australia to minimise Australian tax.
For instance, an employment bonus for work done overseas by a non-resident should be received overseas before the non-resident becomes an Australian tax resident so it is received free from Australian tax.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.