Welcome to our tenth episode of the #Expatchat podcast where we discuss the latest tax and financial issues affecting Australian expats.
In today’s chat we discuss:
- Inheriting Property As An Australian Expat
- Recent Updates From the ATO Regarding the Residency Tests
- Expat Q&A – Buying Property in Australia
- Expat Q&A – Lodging Tax Returns in Australia
Topics, articles and events featured in this podcast:
Expat Chat Ep 10 – Inheriting Property As An Expat, Domicile Tests & Expat Q&A
Brett Evans: G’day expats, and welcome to episode 10 of Expat Chat. How’s things back in Australia, James?
James Ridley: It’s good today. We’re quite lucky. It’s lovely. It’s actually about 31 degrees, so it’s starting to heat up. Summer’s finally here. Bit of a smoke haze again. I would say those fires are still raging, but there’s been a bit of relief recently, so it’s been a lovely day.
Brett Evans: Good. Now, I think we’re crossing paths here, because we’re getting cooler as you speak, which is nice. So we’re down from the highs of the high 40s and down into the 20s now, which is nice, so thoroughly enjoying it. What are we talking about today, mate?
James Ridley: So on today’s agenda, we’ve got a few queries about when you inherit a property as an Australian expat, whether it’s investment property or a former main residence, how that’s treated. I supposed we can go down to the different sides of that, transacting, selling it, CGT, and then we’ll also tie that into a recent update just on what’s going on with the main residence exemption.
James Ridley: And then, I want to recap on the domicile test, because there’s been some recent news released by the Commissioner of Taxation, the ATO, so that’s really good. That’s important, and that also relates the Harding case, which a lot of people should be aware of by now.
James Ridley: And then finally, I’ve got several questions that I’m just going to throw up there we received from people. Again, they’re mainly CGT and tax related, which I think are pretty important because people forget these things. So that’s on the agenda for today’s topics.
Brett Evans: Fantastic. And as always, we start the session off with a disclaimer.
James Ridley: That’s right.
Brett Evans: The information you hear or see on Expat Chat is for your entertainment only and should not be construed as personal financial advice. Please speak to a professional if you seek personal advice.
Inheriting Property As An Expat
James Ridley: That’s right. Very well then, Brett, as always. Now jumping into it, inheriting a property as an expat, let’s just start from square one. Let’s not worry about the MRE changes just yet, because that just makes it a bit more convoluted and complicated. So when we inherit a main residence and we’re an Australia expat, we do get some sort of relief regarding the sale of that property, and you might want to delve into that about that period after.
Brett Evans: Yeah. Look, essentially, this is going to become a big issue for Australian expats, especially because we do have an ageing population as sort of the baby boomers are getting towards the end of the life cycle, and we’re going to see quite a large transition of assets from one generation to the next.
Brett Evans: There are tax laws in place to help people, both residents and non-residents, with the transition, and essentially, what you’re leading to is the two year rule, where essentially from the day that, I guess, the holder of the estate, the mom, the dad, whoever it may be, passes away, you have two years to be able to decide and act on what to do with that property without sort of complicating any taxation issues, so it’s more than enough time. If you haven’t decided in two years, then you’re probably not going to decide at all.
James Ridley: No, that’s right. And I mean, you can branch off to sort of two scenarios there. Someone that receives the inherited property might actually choose to move into it, establish it as their main residence exemption, and therefore, there’s no sort of lapse in that period of it being a main residence. So the exemption still is in existence, and then they might sell it five years later after, when they move out.
James Ridley: The other alternative is that, whilst it might not be a property they want to live in, they might choose to rent it out. Now, if they rent it out, they still can rent it out within that two year period and sell it. That’s fine. It must means that they’ve made use of getting an additional income source for that two year period.
James Ridley: If they choose to rent it out indefinitely for a period, then yes, after the two year rule, they essentially treat it as a normal CGT asset if they’re an ordinary Australian tax resident, as well as a non-resident at present. They will still benefit from a partial main residence exemption based on the time in which, I suppose, the deceased lived it and treated it as a main residence.
James Ridley: Now, when we tie this piece of legislation into the updated changes or the changes that are coming through with the removal of the main residence exemption, they are going to be pretty damaging, should we choose to sell it at certain periods.
Brett Evans: Yeah, exactly right, and I think, do you want to touch on a bit how that apportionment works, excluding the proposed changes to the main residence exemption that are in front of the Senate as we’re speaking right now? Do you want to just talk about how, under the existing/old rules, how that apportionment works?
James Ridley: Yes. So under, I suppose, the current rules, which touch wood let’s hope they stay in effect, but that might kind of drop out soon, if they were say a non-resident and they received a main residence and they choose to sell that property say five years later, they’re still a main residence. You’re correct in they will always get an apportioned partial main residence exemption on that period. Usually what accountant will do, they either request a formal valuation on the date of passing, or they’ll look at that property, and they’ll use, I suppose, the days of period in which the person held it as a normal main residence, versus the days you technically held it as an investment property.
James Ridley: Going back then, they can work out a percentage to apply to the total capital gain, and then they’ve also got to factor in the case that you’ll be applying non-resident tax rates, so you’ll technically always pay a large amount of tax. Now that’s, I suppose, how it operates right now. Should they remove the main residence exemption for Australian expats when you factor in estates and these kind of inherited properties, that’s when rather than, I suppose, a very small or potentially small tax bill, you’ll have quite a large one, because it’s encompassing the total timeframe in which that property has been, I suppose, in the family technically, owned by the mother, and then inherited.
James Ridley: And then, selling after the 30th of June 2020 date, you’ll incur CGT all the way back until the day that your family member purchased that property. However, you will still get the benefit of being able to discount the capital gain, up until 8th of May 2012. So just, I suppose, a side note of what that is, the side note there is that, on the 8th of May 2012, the ATO and the government removed the 50% CGT discount concession for non-residents.
James Ridley: So that means that, if we’re selling a property, then up until that date, yes, we can discount the capital gain, especially if it’s been owned for a few years. That’s great. Now, that’s important, because it means that’s likely the day in which the accountant will want you seek evaluation, because it’s essentially going to lock in the period of capital gain up until that date. There’s a clear distinction between what you can discount and apply that 50% concession, and then going forward, that’s all going to be a 100%, or I suppose, you’ll have to pay tax on a 100% of the capital gain and you’ll have to apply non-resident tax rates.
James Ridley: So it can be quite complex in terms of the way the accountant’s going to work it out, and if you seek a market valuation, it’s usually a lot easier for you to assist the accountant, but also it might work in your favour as well. Also touching base on the valuation, don’t use realestate.com.au or a real estate agent. It needs to be from an accredited valuer. It can’t just be someone that doesn’t have some formal qualification or registration.
Brett Evans: So the CGT liability will occur, assuming the main residence exemption changes go through potentially today. That is in the case of someone selling two years after the person providing the beneficiary with the property has passed away. So if they sell it within that two year period, they get that main residence exemption, so there’s no issues there, but if it goes two years and one day after they passed away, with the proposed changes, then potentially there could be a capital gains liability going as far back as 1985.
James Ridley: Absolutely, and that’s why it’s so scary. I mean, you’re right in terms of there is going to be a transition of wealth happening over the next 5, 10, 15 years as the baby boomers start to obviously retire and pass away, which I don’t like saying, but there is going to be a very large potential, I suppose, tax revenue that might be sourced, but remember, it’s all dependent on the time in which that transaction happens.
James Ridley: If you’re signing the contract and you’re a non-resident, yes, it’s going to apply there. If you sign that contract and you’re a normal Australia tax resident, then the old rules still apply to you, and there’s likely to not be that large tax bill that would have to be paid, and that’s the clear distinction. See?
James Ridley: This is what’s really confusing about this piece or this amendment, because I think it’s going to cause a fire sale, or everyone’s going to be selling their properties. But if they just hold it, they maybe reestablish their residency tax residency in Australia in the future, the old rules still apply.
Brett Evans: Yeah. Look, I think from an Australian expats point of view, those people who are informed and aware of the changes can navigate it. The ones I worry about are the other 98% of Australian expats out there who don’t know this even exists.
James Ridley: Yeah. Yeah, that’s right. It’s funny how often we have that conversation with, I suppose, new clients. Well, they don’t even know what the main residence exemption is, and then you educate them and they don’t know that it’s been going on in the background, and you sort of you apply the websites. They will have been on our blog and seeing that we’ve been tracking it since day one. They said, “Oh, I’ve come across that, but I didn’t think it applied to me,” but it absolutely does.
James Ridley: One other sort of, I suppose, item that we haven’t really touched on is, when an Australian expat inherits investment property, which is completely different, and it doesn’t associate with the main residence exemption and the piece of legislation that’s going through. If you’re an Australian expat and you’re inheriting an investment property, which has never been lived in and it’s always been an investment property, then yes. You’ll take on the cost base that previous owner had when they first purchased it, and again, the rules will apply where you can’t discount the capital gain after the 8th of May 2012. So you might have to go out and seek a formal historical valuation, and that’s how that operates, completely different in the way it operates with the changes to the main residence exemption now.
Brett Evans: And I think it’s also important to point out too that the tax rates for Australian expats are very different to Australian residents. So when we’re talking about CGT liabilities, we’re talking about that kicking in at 32.5% on the first dollar of gain, which is quite expensive.
James Ridley: Yes. Yes, absolutely, absolutely. You’re spot on. I mean, if we’re talking about properties that might be sold that have been in the family since 1995 and they’re in those areas, Sydney and Melbourne, I mean, you could be seeing capital gains of well over $2 million dollars. I mean, I’ve seen a case recently where the house they purchased was worth $400,000.00, and they’re going to auction in February, and now it’s valued at $3.4. I mean, you look at the capital gain on that. They sold that after 30th of June 2020. I did the calculation. The tax bill was more than $600,000.00 to the ATO. I couldn’t believe it.
Brett Evans: Yeah, treasury officials would be meeting their revenue targets, wouldn’t they?
Main Residence Exemption Update
James Ridley: But these are the things that we could see happen, so that’s why, hopefully, we know what’s going to happen over the next few weeks, and I mean, this sort of ties into the MRE update. I mean, Brett, what’s happening today? What’s on the docket today?
Brett Evans: Okay. So right now as we speak, I’ve got the Dynamic Red, which is a fascinating document. It’s like a live feed on what’s happening with the senate. The senate is going to be discussing this as they’re debating the bill. Today, it’s had the first reading in the senate, it’s had the second reading in the senate, and then it was adjourned. So potentially, right now, it is on the order that they will be discussing this, and the senate’s proposed to adjourn at 7:20 p.m. Canberra time, so 6:20 p.m. Queensland time, and then you can minus six hours to get Dubai time and London time and so forth. So essentially-
James Ridley: So not much longer actually.
Brett Evans: No, no, it’s not long.
James Ridley: I mean, Queensland time, it’s 4:05 p.m., so two and a bit. I wonder if they’ll get to it.
Brett Evans: I know. And looking at it right now, they’ve got a fair bit to get through still, so it’s going to be interesting to see. But when they get through stuff, they get through it pretty quickly, so that list could shorten up very quickly. Good opportunity. What we’ve tried to do is certainly, based on our advocate services we provide to Australian expats and educating everyone around the world, Facebook groups are a great tool, enable us to broadcast quite quickly and put the information in everyone’s laps for them to digest. We’re obviously conscious. We don’t want to be spamming these groups all the time. Big updates, we put up there, but we don’t post all the time.
Brett Evans: But what is probably a good opportunity to talk about is, we do have a Facebook group called the Australian Expat Financial Forum, and I encourage those who are on Facebook to join that. The reason being is, we provide all updates in there. So if you want a condensed feed of just information that pertains to you as an Australian expat managing your finances, is living overseas, rather than chasing around Google, as well as our Facebook page Atlas Wealth Management, in there, we provide a very condensed and topical update quite regularly on Australian expat issues that are affecting Australian expats.
Brett Evans: So I encourage everyone to go on to Facebook. If you are on Facebook, the Australian Expat Financial Forum is the name, type in, fill in your details. Obviously, we want to know that you’re an Australian citizen, where you’re living, and those sort of things, just to make sure we’re not letting people in who aren’t applicable, because the last thing we want is people in their spamming. Also, encourage everyone to actually engage in the group. We’re trying to get that group really firing, because I guarantee the issues that you’re having, someone else is having, and ask questions, get the dialogue going. James and I will be on their quite actively to try and stoke the fires, I guess, of thought and questions, but if you do have burning questions, by all means, jump in there and ask away.
James Ridley: Yep. Absolutely. I think, obviously, probably I’d say, if there is an update this evening about this current legislation, it’ll be in our group straightaway as well, so that’s good.
Brett Evans: It will. Yep.
Domicile & Residency Test Update For Australian Expats
James Ridley: The next item that I wanted to sort of touch base on was a bit of an update from the ATO about this domicile test and residency and how it feeds into the Harding case. Quick recap of the Harding case. I mean, it’s something that was in the news quite heavily early in the year, and a lot of Australian expats were sort of um’ing and ah’ing and quite nervous about it, because it was about a gentleman that’s… I’m going to read out a bit of the summary just so you know what we know.
Brett Evans: No, please do.
James Ridley: Mr. Harding, he departed Australia in 2009 to live and work in the Middle East. He had moved between fully furnished apartments in Bahrain, whilst waiting for his wife and child to join him. Now, the ATO assessed Mr. Harding on the basis that he was a tax resident of Australia, but arguing that the taxpayer did not have a permanent place of abode outside Australia, because the apartment was only temporary, so that’s the domicile test that they’ve applied there. The full federal court overturned the federal court’s decision ruling that a permanent place of abode should be interpreted more widely to consider whether a person is living permanently in a particular country or state, and not just a permanent place of a specific house, flat, or dwelling, so that’s really good.
James Ridley: They’re broadened, essentially, the definition there, and that’s what was so important about the Harding case, because yes, a lot of the times, depending on the situation, you might have some accommodation that’s provided. You might be living in a furnished apartment, you might have some sort of agreement, but for all intents and purposes, if that location, that state, that country is now your permanent residence, and that’s your domicile, that’s that they’re trying to be a bit more flexible on.
James Ridley: So a really important update, and I suppose, the relevant factors that they consider when it’s discussed in the domicile test, and there’s obviously the other tests that they look at for tax residency, but the main one is intended and actually length of stay, including the continuation of that stay, so people that are in FIFO rosters can’t really, I suppose, become-
Brett Evans: Claim that? Yeah.
James Ridley: Yeah, exactly right, and I know some of them would love to and they try to, but it’s essentially running the gauntlet. If they catch you, you’re done. Existence of an established home overseas, that might be that furnished apartment, which is essentially what was trying to be construed there, and then existence of a resident in Australia while overseas, so that’s one thing that I do see Australian expats sort of get hung up on.
James Ridley: They want to move overseas, reside overseas permanently, but then they leave their main residence in Australia vacant. Which listen, that’s something that the ATO can lean on. They say, “Listen, you’re maintaining a domicile in Australia. Why? You’re still maintaining those ties here financially and physically. Why wouldn’t we still nominate you as an Australia tax resident?” But really, it’s case by case and it’s based on all the facts.
Brett Evans: Yep. And I think it’s good to see common sense prevailing. I’ve met a number of people here in both Dubai and the UAE and the GCC region, who have been in these types of accommodation for four and five years.
James Ridley: Yeah, absolutely.
Brett Evans: As far as they’re concerned, they’re permanently based overseas. Their domicile’s overseas, their abode’s overseas. Just the fact that they don’t want to buy furniture, they don’t want to have the hassles of running around, and quite often, it’s a lifestyle choice they just don’t want the the issues of looking after a place. They want to walk in and the knives and forks are all provided. They just don’t want the issues.
James Ridley: I mean, I imagine, well, you’re an Australian expat now, Brett. I mean, I imagine one of the issues would be, if they leave the country, they’ve acquired all this furniture. “Shit, what do we do? Do I flog it off to another Australian expat for very cheap?” Or there’s those pain points. Do you bring it back? I mean, a lot of locations, depending on it’s probably not great furniture, you bought it because it’s facilitating that need, that necessity to have a lounge room, chairs, and those sort of things.
Brett Evans: I’ve always said, man, I think IKEA’s growth is on the back of Australian expats, because you just buy a IKEA furniture. You use it for four or five years, then you throw it out. If you’re a member of any of the Australian expat Facebook groups, you’ll see, on a daily basis, people in there posting, “Relocation. Want to get rid of a dishwasher, want to get rid of a fridge, blah, blah, blah, blah.” So it is an issue, that’s for sure.
James Ridley: Yeah, absolutely. And I mean, one of the most important things about sort of this announcement is that they are revising this 28 year old rule. I think that the rule that they’re referring to, if anyone wants to Google it when they are bored for some fun reading, is taxation ruling IT2650. So it’s pleasing to see ATO, they’ve indicated willingness to revise this ruling to obviously broaden the definition of Australian expats permanent placement of abode or within that domicile test.
James Ridley: That’s really exciting, because it means a lot more people that are um’ing and ah’ing about whether they are a non-resident or still a normal Australian tax resident, it might be more flexible to become more sort of a non-resident, but it is case by case, which they try and really emphasise. So it’s likely that they don’t want too many people to claim they’re a non-resident now, because of missing out on paying tax on maybe a tax free income in the Middle East.
Brett Evans: Yeah, exactly right. And again, it’s a step in the right direction, which given the news coming out of Australian expat land over the last 12 to 24 months, it’s a change. Usually, it’s going the other way, so it’s good to see there’s a bit of clarity around that anyway.
Atlas Wealth Management Receiving a Commendation at Expat Awards
James Ridley: Yeah, that’s right. And I suppose, going back to the main residence exemption update, I think the last episode, we talked about the amendment to living those life events and excluded foreign persons. Yeah, we did, we did. We raised what they were. Yeah, okay, so that’s good. And I suppose, what else is also a recent update that I think the company’s received out of U.K.? Was that right?
Brett Evans: Yeah. So last week, the Forum for Expatriate Management, which is virtually a global group that heavily works in the area of global mobility, corporations moving employees around the world, they had their EMMA’s, which would be the awards for… I always forget the acronym here, so I’m just going to bring it up on the screen right now as we speak. It’s always the way. Where are we here? Sorry.
Brett Evans: Yeah, so we were a finalist in the Expat Banking and Financial Services Innovation of the year at the EMMA’s, and though we didn’t win, which is a shame, we were highly commended, and the company that beat us is a small little company, that a lot of Australian expats might be aware, of called HSBC. So for a company of our size to go toe to toe against the likes of HSBC and get pipped at the post, we’ll take that as a win. At the end of the day, we’re out here sort of competing with some giants, and for us to just be recognised, that’s great. Goes to show that we are making a difference and people are recognising it.
James Ridley: Yeah, that’s right. And I suppose it’s exciting to know that who we’re going up against. It’s almost David and Goliath and that sort of scenario, where you’ve got HSBC that, the size of their resources compared to us, it’s ridiculous.
Brett Evans: Exactly. We’re like rounding error for their budget.
Catch Up Concessional Contributions for Expats
James Ridley: That’s right. One thing I was going to mention about coming back to inheritance, inheriting properties, capital gains, all those sort of things, a lot of people probably aren’t aware of an item, which is referred to as the catch up concessional contribution, and this is something which I think is going to be quite critical for Australian expats in the event this legislation gets put through, because it is a way that, I suppose, under the right guidance, you can reduce your capital gains tax bill, and it does depend on your Superannuation balance. I think the level’s under $500,000.00.
Brett Evans: $500,000, yeah.
James Ridley: Yeah. So under $500,000.00, also depending on your age, I think is a factor if you meet the work test, those sort of things, but essentially, depending on when you last contributed to Super, you can accrue $25,000.00 per annum now of concessional contributions. Now, concessional contributions, these are the contributions that previously your employer paid on your behalf into your Australian Super fund, so they do make that cap.
Brett Evans: Is that before tax?
James Ridley: Yep. Yeah, exactly right, before tax. And then when they go in there, 15% contributions tax comes out of them, but the benefit there with this catch up rule is that we can accrue these over the next few years, and essentially, over a five year rolling period, we can accrue $125,000.00 worth of concessional contribution. That’s really crucial, because that means you can essentially use that deduction in the future to offset a capital gain, and you might be asking yourself, “Why?”
James Ridley: Now, the main reason is just to save yourself a significant amount of tax, because as we know, tax within Super on the contributions, tax rate is only 15% versus what you would pay as a non-resident, which is 32.5% up to $90,000.00, 37% up to $180,000.00, and then 45%, so be wary of doing that. Obviously, seek advice on that kind of strategy because it is pretty complex, but essentially, they are starting to accrue now if you’re not contributing to Super, which is something that you can use in the future to offset large capital gains.
Brett Evans: It’s one of those things where, done right, it’s an incredible asset, i’ll put that in inverted commas for Australian expats. You obviously need to make sure you’re not breaching caps and all those sort of things and making sure that you are eligible. There’s nothing worse than putting a truck load of money into Super to try and claim a deduction to find out you’re not eligible in the first place, whether it’s because your balance is too high or any other reasons as well too. So that’s one definitely we say, don’t try and work it out on the back of a napkin. Definitely seek advice.
James Ridley: No, absolutely. For that massive advice, general advice disclaimer, make sure you seek personal advice on that specific topic and strategy, and I’ve alluded to the fact that you can use that kind of strategy to operate with a foreign super fund as well, especially if you come back retired and you leave it there, and that foreign pension or Super fund isn’t technically declared a foreign Super in the eyes of the ATO, because the ATO, there’s not too many. I think it’s only U.K. pensions, as we’ve mentioned before. So essentially, working with that, as well as the non-concessional contribution caps, you can obviously get a lot into Super quickly.
Brett Evans: You can, and I think you’ve hit the nail on the head there. If you’ve got, say, a Provident Fund in Hong Kong, as far as the ATO’s concerned, that’s just like an investment account. There’s no preservation rules, there’s no quarantining of entitlements, so as far as they’re concerned, it’s just no different than having cash in the bank.
James Ridley: Yeah, that’s right. I think, most of the time, they treat it as a foreign trust. I had a call with a gentleman earlier today. He had a Canadian RRSP, which is essentially their retirement scheme, but based on the legislation and previous rulings, the ATO doesn’t actually treat that as a foreign pension. You can’t do a direct transfer from an RRSP into an Australian Super Fund. They treat it as a foreign trust, and if you have a good accountant, they can do workings on the original capital, and then there’s capital gains and investment income. Technically, capital gains, investment income, that is taxable, and then, I suppose, the refund of the original capital isn’t taxable in the eyes of the ATO. So different tax payments, and it’s always important to receive those private rulings as well.
Brett Evans: Look, it is. I think that’s the thing. With good advice, everything can be navigated, but don’t be one of those people that does something, and then seeks advice after, because no one has a time machine, they can’t go back in time and change it. So if you’re thinking about doing any of these sort of things, these, what we call, CGT events, always seek advice, because whether you zig or zag can make a big difference to your bottom line.
James Ridley: Yeah, that’s right. And I think one of the questions that I’m going to, I suppose, throw out to us is provided by someone, one of the groups, and it was about tax credits. It’s an important one, because taking a step back, if you’re paying tax to say the U.S. or the IRS or the HMRC or whoever it might be, first on say taxable Australian property, a sale of a taxable Australian property, the ATO isn’t going to acknowledge that sort of foreign tax credit, when the ATO technically should have paid or received tax first on that transaction.
James Ridley: Yes, the DTAs do exist, but they don’t exist in that manner where the ATO’s going to acknowledge something, which they should have received tax on it first. It’s quite common with the IRS and the 401K pensions, when you might pay tax on a foreign income stream from the 401K pension to the ATO first, when in fact, you should have paid tax to the IRS first, and the IRS won’t acknowledge that tax credit. That’s not why the DTA exists in that manner. So it’s important to have an understanding of that.
Brett Evans: Exactly right, and I think the important thing is, your jurisdiction will quite often govern your actions. So what an Australian expat in the U.S. does is very different to what an Australian expat in Hong Kong does, very different than what an Australian expat in Dubai does, and so on and so forth. So I think it’s understanding the moving parts of the jurisdiction you’re in, how that works with Australian tax laws, to ensure that you’re making the most out of your time.
Atlas Wealth Interview in The Financial Review on Exchange Traded Funds
Brett Evans: And I think, last week, you were interviewed by the Australian Financial Review on exchange traded funds and the complexities there. I mean, that’s a common one that we see all the time, and I’ll put a link to the article in the show notes below. The biggest issue that we see with a lot of these things is, it’s so easy to buy exchange traded funds now, and people are trying to do the right thing. They’re trying to invest. However, when you do that in Australia versus moving to United States, suddenly those exchange traded fund investments can be a bit of a poison pill sort of brewing in the background, because they’re classified as PFICs. Do you want to run thorough what a PFIC is and just what you’re talking about in that article?
James Ridley: Yeah, yeah, absolutely. And it’s the same sort of similar trend in Denmark as well on these sort of things. They require that market to market election, which means this is ridiculous, but yeah, no. I mean, so people that reside in the U.S., you need to be aware of what a PFIC is, or a passive foreign investment company.
James Ridley: Now, a PFIC is any foreign company or trust that produces 75% or more of its gross income through passive means, or 50% or more of its assets produce passive income. So it can be things like Australian managed funds, it can be Australian exchange traded funds, listed investment companies, Australian real estate investment trusts, sort of all those types of things. Sometimes, even a Superannuation fund can be deemed to be a PFIC in the eyes of the accountant and the IRS.
James Ridley: So the reason why we don’t want to hold these or expose ourselves to these kind of investment holding is, because they attract the highest federal tax rate, U.S. federal tax rate, on the year to year capital gains, which we don’t technically realise, so that means we’re paying tax on something we haven’t realised, as well as the income. Now, if it’s a case where we haven’t ever declared these type of investments to the IRS, it’s likely that you will need to because that’s why FATCA exists as well as common reporting standards, so they might not already know.
James Ridley: And if it’s a case we haven’t, then there’s different sort of avenues you can take to, I suppose, cleanse yourself of this kind of PFIC, whether it’s a case you actually sell it down, you pay the tax that’s due, you purge the PFIC tank, you rebalance into U.S. domicile ETFs, and there’s different choices you have and strategies. But you shouldn’t expose yourself to these type investments, because they can be, I suppose, quite punitive in the type of tax treatment that the IRS levies.
James Ridley: Now, on the Denmark side, Denmark has a similar rule, but you’d don’t get levied at the highest tax rate, but they do require you to do a market to market election on the unrealized gain of that specific investment, much like a mutual fund, a foreign managed fund each year. So it means you’re paying tax on something you haven’t realised, and usually, a case you don’t actually get to use the losses that might incur in one year to go back and redo it so it resets the current base essentially.
Brett Evans: You sort of-
James Ridley: Unfortunately, that’s the way those rules.
Brett Evans: Just to break it down, so I bet you they take the value on the 1st of January of the year. They take the value on the 31st of December, and if the 31st of December value is higher than the 1st of January, then they’ll work out how much unrealized gain. So you haven’t sold it, but it’s just gone up in value. They’ll work out the unrealized gain, and then go from there.
James Ridley: Pay tax on that. Absolutely.
Brett Evans: Yep.
James Ridley: And I mean, what’s ridiculous is, yes, it’s gone up in value, but it’s highly likely that ETF is also paid out some sort of dividends to you as well, so they can add it in as well. And depending on where it’s residing and where it’s domiciled, if it’s obviously an Australian expat holding ETFs back in Australia, you’re going to be an Australian domicile so there are PFIC. You’ll be paying additional tax there as well, so very healthy.
Brett Evans: I think the best way to describe the PFIC, and this is what I often talk to clients about in terms of just break it down to really simple metrics, if it’s in the business of doing something, it’s not a PFIC. ANZ bank, BHP, Telstra they’d actually actively businesses. They’re not accruing income from residual income, passive income coming through.
Brett Evans: Obviously, a Vanguard or Beta shares, or any of those sort of things, even managed funds, it’s amazing how people still have a Colonial First State managed fund. They’re in the business of investing in other businesses, so they’re not the business of being in business. So I tell clients to consider the key issues. Is what you’re investing in, is it a business? Or is it investment? And if it’s an investment, then you need to consider.
James Ridley: Yeah, that’s right. And I think a lot of people still forget about the listed investment companies, because they look like an ASX traded company, but they’re not, and a common one that I actually come across is AFI, but I know why I commonly come across that one, because it’s used to be heavily voiced in a book that obviously gets updated every year. I believe they’re shoeless of some sort.
Brett Evans: That’s right. You can’t afford shoes.
James Ridley: But no, when you head over to U.S., if you’re holding these type of investments, it’s not sensible. It’s not suitable to your new tax residency and that’s why you need to have a review. Yes, previously it might have been sensible. They pay good dividends, capital gains, those sort of things, but obviously it’s important that you might have to cleanse the portfolio or hit the refresh button, seek advice. There’s still ways that you can create wealth in a great manner from a tax efficient point of view, but it’s just honestly stepping out and seeking that advice, so that’s an important one to go down the PFIC route.
Expat Q&A – Buying Property in Australia
James Ridley: One of the questions that I might as well raise while I’m here is, I might read it out because it’s quite a long one actually. So a couple residing in Hong Kong, they’re looking to currently buy a house in Perth. They’re not going to rent the house, but their intention is to do an extensive renovation or rebuild, and expect to complete it in the next two to three years, and once they’ve completed it, they’re looking to live in the house, or return back to Australia. They want to know whether they can keep this property, capital gains tax exempt, if they bought it right now? I mean, what’s your thoughts on that, Brett? They’re not actually moving into it at any point.
Brett Evans: No. So they’re buying it as an investment property, so they’ve never lived in it formally as a PPR?
James Ridley: That’s right, and they’re not renting it out there. They’re just buying it, so it is some sort of investment. Correct, yep.
Brett Evans: Yep. So classified as a taxable Australian property, and obviously, any gains that they would accrue would be at the non-resident marginal tax rate for the time that they’re overseas. So essentially, if they are going to buy it as an investment living in Hong Kong, buying it back in Australia, I guess that starts the counter when it comes to a CGT point of view, and then any gains that accrue in that period will be assessable at the non-resident marginal tax rate, and then when they move back into it after the renovations have happened, then they’ll get the main residence exemption as an Australia resident.
Brett Evans: But I think this is an important one, because I think people don’t realise this. There still will be that liability for the period that they’re a non-resident. So we see a lot of property spruikers encouraging people to buy investment properties as an Australian expat, and then they’ll say, “I won’t sell it until I’m back in Australia, so I won’t pay non-resident capital gains tax.” But it follows you. So if you had a property for five years as a non-resident, and then five years as a resident, it was an investment property and being rented out for the whole 10 years, essentially you’ll have a non-resident marginal tax rate liability on the five years that you’re a non-resident, even if you were to sell that when you’re back in Australia.
James Ridley: Yeah, that’s right. I mean, you’re always going to have some sort of CGT payable there. You’re not going to get a benefit of the discounting method, and that’s why you need to seek that valuation essentially when you return, because when you seek that valuation, in that case, yeah, listen it’s treated as an investment property. There’s no way that they can make the first two to three years CGT exempt. They’re not moving into it. They’re leaving it vacant. It’s likely that, after they’ve done the renovation and the rejuvenation, the day that they move into, that’s probably when they should seek a valuation.
James Ridley: They can, I suppose, corner off that period, two, three years of growth, what it’s worth now, “Okay, we know that, that’s what it’s worth,” factor in the capital improvements, and going forward, be treated as a normal main residence, so that’s pretty straightforward. You can’t keep that property CGT exempt, because you’ve never had the opportunity to move into it and establish it as your main residence. That’s why.
Expat Q&A – Lodging Tax Returns in Australia
James Ridley: The next question is a very common one and it’s one that I constantly see and we’ve already tied into it. I’m a tax resident in the U.K. Sorry, an Australian expat that’s a tax resident in the U.K. living there. The question is, “I haven’t lodged a tax return in Australia for five years. I have a rental property and a former main residence, which are both being rented at present. There isn’t much of a loan left on these properties. I have to pay tax to the HMRC on this income every year. Do I need to pay tax in the ATO? And if I do, will get a tax offset or credit of some sort from the ATO based on tax that I paid to the HMRC?” So this is something, which I sort of already addressed this, but it’s pretty obvious, this one.
Brett Evans: Look it is. I mean, you have to declare any revenue, what they call Australian sourced income, to the ATO. Where it’s been found it’s a bit of an issue is the sovereign state of where their money’s earned gets the first taxing right, and then your resident state, e.g. U.K. in this case, gets the remainder. So essentially, the way a double taxation government works, to ensure there’s no double taxation, what they’ll do is, they’ll take into account the tax you’ve already paid in one jurisdiction, and then if there’s any extra tax to pay in your home jurisdiction, e.g. the place that you live, then it’ll be added on top from there.
Brett Evans: But certainly, we do surprisingly come across a lot of people who haven’t done tax returns on Australian sourced income, and I think they’re almost frozen by fear. Whereas, when you go down and sit down with them, in this case here, because the loan’s almost paid off, therefore, he definitely positively geared, so there will be quite a bit of tax to pay there. But sometimes, there’s no tax to pay because it’s either negatively or neutrally geared. So yeah, you will have a couple fines and those sort of things, but I tell you what, get on the front foot, because the ATO is getting better and better at managing and sort of deciphering all this information and they need to get stuck into it.
James Ridley: Well, that’s right. I mean, I think there was an announcement early in the year about how the ATO, if they knew that you’re away and you had a tax debt coming after you, they weren’t afraid to hand out fines, or even throw in some general interest charges as well, what you might have to owe both respectfully. So yeah, their systems are getting better, yeah. You’re right, in terms of this person. They haven’t lodged five years worth. They should have. There’s likely to be tax owed, payable to the ATO, and because they’ve paid tax to the HMRC, because it’s not, I suppose, the country in which these properties are, it’s highly likely that they will not receive any foreign tax credits for that tax paid. So, yes, in this situation, unfortunately, it’s highly likely that they will get double taxed.
James Ridley: One thing that I can think of that they could look at doing is, they could get their tax returns in Australia up to date for each year. Yes, they’ll pay some tax for each year, but then they could approach their U.K. accountant. So this is actually what should have occurred, or finally gone about and done it, “Is there any way that I can amend my previous U.K. tax returns to incorporate some of these tax credits for each one of these years?” It’s unlikely, but it’s probably the one thing that they could look at doing to try and recoup some of their over tax from the HMRC sided.
Brett Evans: Yep. Now, look, definitely, because what should have happened was the lion’s share should have been paid to the ATO, and they’ll still ask for that, and then HMRC gets any bits and bobs after that. There would be, from a cash flow point of view, quite a bit of gap to fund, because I dare say, even if the HMRC was going allow them to revise their previous statements, previous returns, it’s not like they’re going to give that money back to them. They’re just give it off the next one.
James Ridley: No, that’s right. I highly doubt it, but it’s just one avenue they can look at taking, to be honest, but because there’s also tax that’s overdue, just remember that the ATO isn’t afraid of applying general interest charges on outstanding ATO debt, and generally just charges. There’s not like interest the RBA cash or anything like that. It’s in between 9% to 11%. So if you haven’t lodged these things, you’re not sure, contact your accountant or contact us, and we’ll put you in touch with the accountant we use, just because it’s important that you do get squared away, and yeah, don’t live in fear. Just get it all up and running and above board.
Brett Evans: Exactly. Yep, I totally agree, and I think it’s, like we say one more time, it’s little things done right that Australian expats get a good experience or a bad experience overseas, and sticking your head in the sand doesn’t achieve any of that, and more and more people are getting caught in the web of data sharing, connectivity between tax authorities, and from our point of view, there really is no excuse that any of the regulators have accepted in the past about ignorance or not being aware.
James Ridley: Yeah, okay. That’s what I was actually going to ask you. I haven’t come across it before and I didn’t know it was actually a tax rule existing in Canada. Deemed disposition. It’s similar to a deemed disposal event, but the accountant I spoke to seemed to think that, deemed disposal, if you’re leaving Canada permanently and you’ve been there for 10 years, even though you own foreign property, you’re required to do a deemed disposal on this property even though that it is residing in Australia. If there’s capital gains, you have to pay some sort of tax.
James Ridley: Now, I haven’t come across it. My reading of the legislation says Canadian taxable property, so I think he’s misinterpreted. But have you ever come across that before, I suppose, just with anything like that deemed disposition? I know that’s quite alarming, because in that situation, that specific Canadian resident would have to pay tax on his Australia properties that he would not have sold, and highly likely he will never receive a tax credit for that tax that he’s paying to the Canadian revenue agency either. So that’s why I can’t imagine that, that would be the rule of law there, because it wouldn’t make sense.
Brett Evans: No. I mean, it’s even worse than the U.S. and we normally think that’s the worst.
James Ridley: Exactly. Canada’s pretty good actually. They’re usually quite nice.
Brett Evans: Yeah. That’s right. Good skiing too.
James Ridley: Yes, that’s right. Although, when I went skiing in France, that was pretty amazing, but I won’t digress. But anyway, Brett, that’s probably it. We’ll probably wrap it up there. I mean, there’s going to be pretty important update hopefully in the next two hours on the MRE. We’re watching that like a hawk. So that will go out to the socials, LinkedIn, Facebook, Twitter, as well as on Instagram as well.
Brett Evans: Yep. And also just to encourage people, if you’re watching this on YouTube, give us a thumbs up and subscribe, because certainly by doing that, the way the algorithms work, it’ll put this in front more Australian expats and more expats like you. It helps us get the word out there. At the end of the day, being forewarned is forearmed. So I think it’s gone from a nice thing to have now to being quite imperative in terms of having the information at your hands when you’re making these decisions.
Brett Evans: So on YouTube, thumbs up and a subscribe. If you’re listening to this on the podcast, certainly we’d love any reviews as well too. The more reviews we get, obviously the more that Apple’s going to share this with others and it just helps us get the message out there, because I think as everyone can see, especially in the last two months of Expat Chats, we are building up to quite a pace of change, and from my point of view, and I think you agree, James, we’re not going to see this die down. It’s just going to be change, change, change, change, change, probably for the next 10 years. So not to say that it’s the end of the world for Australian expats, it just means that you can’t just be, “She’ll be right, mate,” is not a way to manage your money as an Australian expat.
James Ridley: No, that’s right. And I mean, further on the points that you just made, hop on YouTube. If you’ve got questions, those sort of things, feel free to comment on underneath there with your questions, or send them in to [email protected], just so we can raise them and contact you, or bring them up on another Expat Chat, because like Brett said previously, it’s highly likely that you have the same complexities that someone else does on the other side of the world with the same issues and uncertainties. That’s for sure.
James Ridley: One other thing that I was going to mention, RBA rate cut didn’t happen. I’m not sure if you picked up on that, but I was shocked. I thought they were going to give it to us just because it’s Christmas time, end of the year, just sort of get that cushiony feeling, but they didn’t. I was shocked.
Brett Evans: Well, I think, if you look at the RBA minutes, they basically said there has been a pick up in the property market, which is what they’re concerned about.
James Ridley: Melbourne, Sydney, yep.
Brett Evans: Yeah, and look, I was having a good conversation with my wife last night about it. I said what I am sincerely worried about at the property market is, it’s okay for a property market, a share market, any sort of investment market to appreciate in value, but as long as the fundamentals justifying that level are maintained. So as a share market example, share price is rising. You want to see that the earnings are rising to justify the higher share price.
Brett Evans: My concern about the property market at the moment, yes, the RBA is saying that they’ve navigated that quite effectively and that’s why they’re not cutting rates, is, there is no fundamental supporting an increasing property market. We have wages going backwards, so that’s always a concern, because we’ve seen from the Australian Bureau of Stats, the numbers of defaults are on the increase, while interest rates are record lows.
Brett Evans: So to me, I don’t know. I mean, yes, I’m not surprised that there wasn’t a rate cut, given the fact that property has ticked up. What I am concerned about is the state of play for property over the next one and two years. We’re seeing cost of living going up, we’re seeing wages going down, and it wouldn’t surprise me if the economy does hold, that the RBA actually increases rates in the next 12 months.
James Ridley: Yeah, okay. I mean, plenty of economists are suggesting that they’ll still go ahead with another rate cut early next year, but there’s a lot of, I suppose, macros that could impact that, especially living on the U.S. side as well, what’s going to happen with the upcoming election, the U.S. dollar, the strength of that, the Trump, the trade war. There’s just too many, and then in the background, also Brexit, which that seems to have gone quiet for a little while.
Brett Evans: It has and again, I think there’s a lot of macro events, and when we say macro events, like geo-political that do encompass the world, and it does affect Australia and the idea to be able to do this stuff very carefully, because interest rate differentials between Australia and the U.S., that makes a difference on the Australian dollar. There’s a lot of moving parts to a lot of these things, and look, it’s something that we’re in a very much a state of change at the moment, internationally, and Australia’s all along for the ride unfortunately.
James Ridley: Yeah, that’s right. I mean, what’s your personal opinion? The Australia dollar, I mean, do you think has much more to depreciate at all? I mean, there’s probably too many things to really take into account for that question, but what do you see getting?
Brett Evans: I can’t see getting much. There’s something that will drive it down, there’s something that will drive it up. What will drive it down is further rate cuts, and we saw by the RBA not changing rates, the Australia dollar increased, as simple as that. If the RBA did increase rates, then yes, that will bring the dollar down. If we saw the U.S. increase rates, that would also bring the dollar down because global investors are looking for-
James Ridley: Looking for cuts.
Brett Evans: Yeah, global investors are looking for yield, so they want investments. If the U.S. decrease rates, then essentially, that could actually bring the Australian dollar higher, because people will probably come out of U.S. dollars into Australian dollars. So there’s a lot of those things, and then that’s not even talking about the free trade agreements between Australia and China and how that’s going to play out with the trade wars between U.S. and China as well too.
Brett Evans: So that will have an effect on the Australian dollar as well. So it is like tapping your head, rubbing your stomach at the same time, and chewing gum, and hopping on one leg. Now, there’s always different bits and pieces going on, so certainly, do I see a lower dollar? I’ll give it a 20% chance, but that’s only on the basic fact that, A, either RBA cuts rates, or B, the U.S. increases rates, and I don’t think either will happen in the short-term.
James Ridley: Yeah. I know. I mean, well said. As always, Brett, wealth of a knowledge. That’s why I love talking to you. But anyway, let’s wrap this up now, so I suppose final sign off. Individuals, they can go to… I mean, where are all these podcasts held now? They’re on YouTube obviously. They’re on-
Brett Evans: They’re on YouTube. They’re on Apple Podcast, so if you just type in Aussie Expat Podcast. What we’ve started to do, and I think this is probably the easiest way people can find our podcast is, go onto our website, atlaswealth.com, and then under resources, there’s podcasts, and then you’ll see each of the episodes, all the Expat Chat’s in there, along with links to the topics discussed, if there’s documents or articles, as well as full transcript of the whole thing.
Brett Evans: So if you don’t want to listen to our dulcet tones and you prefer to read it, then you can read it there as well too. So we’re trying to make this information as available as possible, but also the links to Apple, as well as Sound Cloud, as well as YouTube, they’re all in that on the website as well too.
James Ridley: Okay. Awesome, Brett. Well, thanks for your time again. Obviously, I know your day’s just getting started, so I’ll let you kick start it. Hopefully you get a coffee in to you and our day’s just winding down.
Brett Evans: Yep. And just a little bit, I know we’ll keep everyone posted on how we go today with the senate. I dare say, by the time this podcast is released, it’ll all be announced anyway, but we’ll certainly be putting that up on our social media channels as well too.
James Ridley: That’s it. All right, Brett, I’ll let you go.
Brett Evans: All right, James.
James Ridley: Thanks for your time.
Brett Evans: Have a good day.
James Ridley: See you, everyone, Bye.
Brett Evans: Thanks, mate.