Introduction
Whenever an individual relocates overseas, there are a number of potential tax issues to consider from both a home country and destination country perspective and critically, the interactions between the two (if any).
Australia’s “exit tax” and the making of “exit elections”
Clients are often surprised to learn that Australia has an “exit tax”, that is, in relation to all assets other than a limited class of assets including Australian real property, an individual is deemed to dispose of their CGT assets on the date they cease to be an Australian resident for their market value on that date.
Individuals do, however, have the option to defer taxation until actual disposal, however, whether or not this “exit election” should be made depends on variables such as:
- the level of unrealised gain;
- whether there are any capital or tax losses available; and
- the expected future performance of the asset.
Another key consideration is that the “exit election” in an all-or-nothing election, meaning that you cannot pick and choose on an individual asset basis which will trigger the exit tax and which will be subject to the exit election.
Disdvantage of making an “exit election” – impact on 50% CGT discount
If an individual decides to make an “exit election”, then with limited exceptions under particular Double Tax Agreements (such as with the US and UK), the relevant assets will forever remain within the Australian tax net.
Ordinarily,where an individual holds a CGT for at least 12 months, they are generally entitled to the 50% CGT discount, meaning that they halve a capital gain before including it in their assessable income (the other half being completely tax-free!).
However, from 8 May 2012, foreign residents have been ineligible for the 50% CGT discount and in the context of individuals that are both Australian resident and foreign resident at different times over the ownership period of the asset, the maximum 50% CGT discount rate is reduced to the extent of foreign residence.
This is another critical factor which feeds into the decision as to whether or not to make an exit election (although again, special overriding rules can apply under specific Double Tax Agreements in particular circumstances).
Impact on controlled entities
When an individual ceases to be an Australian resident, it may have a cascading effect on the residence of entities that they control. For example:
Companies
Under Australian domestic tax law, a company that is incorporated in Australia is always a resident of Australia for tax purposes, however, if you remain the directing mind of the company and the country you move to has a ‘central management and control test’ for corporate tax residency purposes, the company may also be a tax resident there.
In this situation, if Australia has a Double Tax Agreement with that other country with a corporate residency tie-breaker rule, it would generally assign sole tax residence to the country in which central management and control resides.
Australia and the US do not have corporate tie-breaker rules under the Double Tax Agreement and this can give rise to complications.
Trusts
Broadly, a trust is an Australian resident trust if the trustee is resident in Australia. If you are the sole trustee of a family trust and you relocate overseas ceasing to be an Australian resident, then although there may be a time lag between you ceasing to be a resident and the trust ceasing to a resident, unlike individuals, when a trust ceases to be an Australian resident it triggers an “exit tax” and there is no scope to make an “exit election” as they are only open to individuals.
SMSF’s
The concessional superannuation environment means that SMSFs are a popular and ever-growing retirement vehicle. However, with the global mobility of the workforce, many people live and work overseas for extended periods of time.
One of the critical conditions of complying fund status (which is required to maintain access to the relevant tax concessions) is that the fund’s central management and control is ordinarily in Australia.
There is a special concession where ‘central management and control’ is temporarily outside Australia for up to 2 years, however, if an individual departs Australia indefinitely or intends to remain outside for more than 2 years then they cannot take advantage of this concession even if they actually return to Australia within the 2 year time limit.
If the central management and control test cannot be satisfied, then there is a significant risk of ceasing to be a complying fund which means that both the current year income and capital value of the fund (other than certain contributions) is subject to tax at 45%!
There are a number of options to ensure that an SMSF retains complying fund status around the central management and control issue. Which particular strategy to implement depends on your particular circumstances although any such strategy must be in place prior to your departure!
It is also important to recognise that the US does not recognise the special nature of an SMSF and therefore, in certain circumstances, the income of an SMSF can be taxed to an individual personally in the US.
US grantor trust rules
The US have extremely broad-reaching rules known as the grantor trust rules that can operate to tax an individual that has settled money or otherwise provided a benefit to the trust within 5 years of becoming a US resident.
For example, assume an Australian resident individual establishes an Australian family trust. The individual’s lawyer or accountant gifts the usual $10 settlement sum to establish the trust and then the individual subsequently settles $100,000 on the trust in order for it to make various investments. The individual is the trustee or the sole director of the corporate trustee.
Three years later the individual takes up a business or employment opportunity in the US and becomes a US tax resident. The US grantor trust rules can apply to tax the individual personally in the US on the income of the trust regardless of where the trustee actually distributes the income.
Forward planning
The process of determining the tax implications of ceasing to be an Australian resident is known as “pre-departure planning”.
On the other side of the equation, the tax implications of becoming a foreign resident in the particular jurisdiction is known as “pre-arrival planning”.
Ensuring that your pre-departure planning strategies dovetail with your pre-arrival planning strategies is the key to ensuring that you are able to make fully informed decisions and avoid any nasty surprises.
Through our international affiliate network (www.primeglobal.net), we can help you seamlessly transition anywhere around the world.
Specifically in relation to the particular pre-departure and pre-arrival planning issues to consider when relocating to the US, please see our link below:
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Disclaimer – This article does not constitute specific advice and cannot be relied upon as such.