Rental Property CGT and Residency Issues

Question

3 February 2016


Good morning Julia.


I need help in working out if there are any Principal Place of Residence (PPR) CGT issues for a client who is currently working in Hong Kong. They pay rent in Hong Kong for their living arrangements.

The client has one house in Australia in which they first lived (before renting) when they purchased the property. As such, they want to try and keep the house as their PPR by utilising the 6 year temporary absence rule.

Putting aside the factors in determining if someone is a resident or not,
I think the issue that I’m having problems understanding is the impact of CGT of being a resident versus a non-resident and the PPR.

The house is negatively geared. In the income year of 2014 (first year overseas) the tax return was prepared on the basis that the taxpayer was a resident of Australia. The overseas income and foreign tax credit (FTC) was included in the return with the Australian salary and rental loss resulting in a tax refund of the Australian PAYG Withheld.

In the 2015 income year if the taxpayer was treated as a resident of Australia the full 12 months wage and FTC from Hong Kong would be included in the return resulting in nil tax to pay after accounting for the loss from the rental property.

This means of course that the rental property loss is all used up. If however the taxpayer was a non-resident then, as I understand it the loss would be carried forward and offset against future Australian income.

I have read that Section 36-10 of the tax act reduces the carried forward losses by any exempt income received.

My questions:

1) If as a non-resident, does this mean the tax loss is reduced by the wage received in Hong Kong?

2) If by being a non-resident for tax purposes are there any issues that could compromise the CGT status of the PPR in Australia, keeping in mind the taxpayer could come back to Australia to protect the 6 year temporary absence rule?

3) Do you have any advice that would enhance the taxpayer’s position on the basis that they could be a resident or a non-resident depending on the advice to protect the 6 year temporary absence rule?

I trust I have been succinct enough.

Thanks for your help.

Danny Gray

Answer


1) No
2) NO
3) Better to be a non resident and no choice
Succinct questions allow me to give direct answers but here is the story behind them.
Firstly, we don’t really have a choice about them becoming a non resident by the sounds of it, unless it is something like a FIFO and the family stays here or they don’t set up a proper home overseas I feel they are a non resident. Here is a link to a ruling with lots of good examples in particular paragraph 33
http://law.ato.gov.au/atolaw/view.htm?Docid=ITR/IT2650/NAT/ATO/00001

If a non resident has a rental property in Australia they are still subject to Australian tax at non resident rates on it. If the property makes a loss these losses can be carried forward and offset against future Australian income. In order to carry these losses forward an Australian income tax return must be lodged for each year. The carried forward losses described above are reduced by any exempt income received (section 36-10) but section 36-20 states that this does not include income made exempt by Section 128B which is income taxable overseas by a non resident, under the rules of a double tax agreement deciding which country has final taxing rights, generally this means Hong Kong gets wages, interest & dividends but Australia gets rent earned in Australia.
As long as they established their main residence exemption before they became a non resident they are entitled to use section 118-145 to protect their home while they are overseas, for up to 6 years if they earn income from it, indefinitely if it is not earning income. The authority for this is the example in 118-145 (1997 ITAA) which covers moving overseas.
Note they cannot reset the 6 year rule under section 118-145 by just coming back here on a holiday. They have to set up home again.
Further even if they buy in Hong Kong they can choose not to cover that property with their PPR and continue to cover the Australian home. It is great they get all the normal rental property advantages without the exposure to CGT.
In the year they left the country you just pro rata the tax free threshold by putting in the date they left the country at A2 (in the 2015 tax return form)

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