CGT changes to be a train wreck for some Deceased Estates

The Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No.2) Bill 2018 proposes, amongst other things, to remove the CGT main residence exemption for non-resident individuals effective from 9 May 2017, which is also a change that will impact on some deceased estates.

The amending legislation was introduced into the House of Representatives on 8 February 2018, and subsequently passed without amendment on 1 March 2018. The Bill has been referred to the Senate Economics Legislation Committee which will deliver a report following their enquiry into the Bill by 23 March 2018.

BNR Partners has long voiced concerns with the proposed amendments, especially their adverse significant impacts on deceased estates which will deny access to the CGT main residence exemption for the full period of ownership of the property, where the deceased was a non-resident as at the date of death.  Refer to our earlier post here.  

Accordingly, we lodged a submission to the Senate Economics Legislation Committee on 5 March 2018 detailing our serious concerns regarding the proposed amendments and suggested alternate amendments which are more equitable and less draconian. A copy of our submission can be downloaded here.

Key proposed amendments

Very broadly, the key amendments in the Bill concerning the removal of the CGT main residence exemption for individual taxpayers and deceased estates are summarised below:

  1. Removal of main residence exemption for individual taxpayers

The Federal Government announced in the Federal Budget on 9 May 2017 that the CGT main residence exemption would be removed for foreign residents who would otherwise have been entitled to the exemption effective from 9 May 2017.

The residency tests that generally apply for income tax purposes will be applied to determine whether an individual is a foreign resident at the time in which they enter into a contract for the sale of their main residence.  

Where a person is a foreign resident at that time of contract, he or she will have to recognise any capital gain or loss arising on a disposal of that main residence where the contract for sale is entered into on or after 9 May 2017.  Any resulting gain will be applied to the entire period of ownership, and not just the proportional period the person was a non-resident.  Such a capital gain may only be reduced to the extent of any capital gain that accrued up to 8 May 2012, as the property will be treated as a normal property.

However, under transitional provisions the proposed amendments do not apply to dwellings held by such individuals before 9 May 2017 provided the sale of the ownership interest in the dwelling occurs on or before 30 June 2019.

  1. Removal of main residence exemption – for deceased estates

The impact of the removal of the CGT main residence exemption on deceased estates differs depending on whether the deceased was a foreign resident or an Australian resident at the time of their death as respectively discussed below.

Deceased was a foreign resident at time of death

The effect of removing the CGT main residence exemption on a deceased estate where the deceased was a foreign resident from 9 May 2017 is as follows: 

  • A trustee of a deceased estate cannot apply the main residence exemption on any disposal of a dwelling owned by the deceased if that person was a foreign resident at the time of their death. This applies retrospectively to the entire ownership period, and ignores any period of occupancy of the deceased as a tax resident during their ownership.  
  • Similarly, a beneficiary of a deceased estate is not entitled to any portion of the CGT main residence exemption which accrued in respect to the ownership interest in the dwelling of a deceased individual if the deceased had been a foreign resident at the time of death.
  • A beneficiary will therefore only be entitled to a partial CGT main residence exemption which subsequently accrues in their own right. This will require that person to be an Australian tax resident at the time of entering into a contract to sell their ownership interest in the dwelling.
  • No CGT main residence exemption will be available if the deceased person was a foreign resident at the time of their death, and the beneficiary that inherits the ownership interest in the dwelling was also a foreign resident at the time of entering into a contract to sell their ownership interest in the dwelling.

Deceased was an Australian resident at time of death

By contrast, the effect of removing the CGT main residence exemption on a deceased estate where the deceased was an Australia resident from 9 May 2017 is as follows: 

  • If the deceased was a resident of Australia for taxation purposes at the time of death, then the main residence exemption accrued by the deceased in respect to the dwelling continues to be available to the trustee of the deceased estate or the beneficiary of the deceased who is bequeathed the property under the estate.
  • However, the beneficiary is denied any additional component of the main residence exemption that accrued in their own right if they were a foreign resident at the time at which that person enters into a contract to sell that dwelling. Broadly, where such a scenario occurs it will be necessary to apportion the periods of ownership of the deceased resident and the foreign beneficiary to ensure that a partial main residence exemption is available in relation to that period of days in which the deceased resident used the dwelling as a main residence.

Transitional provisions

Transitional provisions also apply to ensure that the proposed amendments do not apply to a capital gain or loss arising from the sale of the main residence by an individual who acquired that dwelling as a beneficiary of a deceased estate before 9 May 2017. This transitional relief will only be available where an individual acquired the property as a beneficiary of a deceased estate and at all times from immediately before 9 May 2017 until immediately before entering into a contract for the sale of dwelling prior to 30 June 2019, the ownership interest in the dwelling was held by that individual beneficiary, the deceased person or the trustee of the deceased estate (or a combination thereof).

BNR Partners’ Submission

BNR Partners expressed the following concerns regarding the proposed amendments in our submission to the Senate Economics Legislation Committee:

  • The process of determining whether a particular individual is a foreign resident will impose an administrative burden and significant cost on Australian taxpayers and deceased estates, as determining a taxpayer’s tax residency status can often be a highly complex and subjective process as illustrated in various recent judicial decisions.
  • The proposed residency rules provide an unfair advantage for a member of a Commonwealth Superannuation Scheme compared to other Australian citizens seconded overseas who are not members of such superannuation funds. This is because a member of a Commonwealth public sector superannuation fund will be able to apply a CGT main residence exemption that allows such a person to rent their property for up to 6 years whilst living away from home provided they do not acquire another main residence during that period. This is anomalous because all other Australian employees similarly seconded overseas will not be able to rely upon this 6 year absentee exemption.
  • The removal of the main residence exemption as at the date of death is punitive in that the deceased taxpayer’s entitlement to the CGT main residence exemption is determined at a single point in time and does not take into account the full period of their ownership of the property. In this sense, the proposed changes are essentially retrospective and apply from the date of the original purchase, to bring the deceased’s dwelling within the CGT regime even where for the bulk of the period of ownership of the dwelling, they had otherwise been an Australian resident for income tax purposes. This is inequitable and will serve as a deterrent to Australian citizens seeking developmental work opportunities overseas as they may be concerned at the risk of being taxed on any gain made on the sale of the main residence should they be a foreign resident at the time they pass away, or make the decision to sell the property whilst abroad.  
  • The proposal to defer the application of the proposed amendments to 30 June 2019 in respect of pre-9 May 2017 acquired ownership interests in dwellings, is too limited especially in the context of the deceased estate of a foreign resident, as the administration of estates is demonstrably becoming more complex and litigious, and often unlikely to be finalised prior to the end of the proposed transition period on 30 June 2019.

Our proposed recommendations concerning the amending legislation included the following:

  • All Australian citizens working overseas should be entitled to apply the absentee exemption which will allow them to effectively rent out their Australian home during the period of any secondment for up to 6 years provided that person does not acquire another main residence during this period. Similarly, where a person dies whilst overseas, the trustee of the deceased estate should be permitted to rely upon this absentee exemption.
  • Alternatively, such persons should be able to establish a market value for the cost base of their dwelling at the time they cease using it as a main residence thereby ensuring that any foreign resident will only be subject to a capital gain which reflects the appreciation in value which has occurred from the time they ceased to be an Australian resident.
  • Where a life interest is established under the will of a non-resident taxpayer, that it the residency status of a life tenant which should establish their eligibility for the CGT main residence exemption.