Contents
- What is CGT event I1?
- What time does CGT event I1 occur?
- How to calculate the capital gain or loss?
- Exception for Taxable Australian Property
- Election to defer CGT
- The amount of unrealised gain at the time the taxpayer becomes a non-resident
- The risk that another CGT event occurs and that CGT event is not eligible for the CGT discount
- The complications presented by international taxation
- Pre CGT asset
- Other exclusions
- The interaction with joint ownership
What is CGT event I1?
CGT event I1 addresses a situation where an individual or company owns CGT assets and ceases being an Australian resident for taxation purposes.
The rules addressing the operation of CGT event I1 are contained in section 104-160 and section 104-165 of the Income Tax Assessment Act of 1997.
The objective of the CGT event (in conjunction with CGT event I2 which deals with trusts) is to prevent a taxpayer from becoming a non resident for taxation purposes and then avoiding Australian tax on the subsequent realisation (or another circumstance that triggers a CGT event) of a CGT asset which is not Taxable Australian Property.
CGT event I2 therefore imposes a taxation point to capture a capital gain or capital loss that accrues to the taxpayer from the time of acquisition to the time residency changes.
In this way, any capital gain which accrues between the time of residency changing to the time a CGT event happens to a CGT asset is disregarded. This is because the Australian tax law does not capture capital gains made on assets which are not Taxable Australian Property whilst an individual or entity is a non resident.
Remember that Taxable Australian Property refers to any of the following, as set out Division 855 of the ITAA 1997:
- Australian real property
- An indirect interest in Australian real property e.g. through shares or units in a land rich entity.
- A CGT asset that the taxpayer has used to carry on a business through a permanent establishment in Australia.
- An option or right over one of the above.
What time does CGT event I1 occur?
CGT event I1 occurs at the time the individual or company ceases to be an Australian resident for taxation purposes.
How to calculate the capital gain or loss?
All CGT assets of the taxpayer will be subject to the CGT event (with certain asset exceptions addressed below). Therefore, the taxpayer will need to calculate the capital gain (or capital loss) separately on each CGT asset owned just before the time the person ceases to be a tax resident. The taxpayer will make a capital gain if the market value of the asset exceeds its cost base. The taxpayer will make a capital loss if the market value of the asset is exceeded by the reduced cost base.
Exception for Taxable Australian Property
Importantly, CGT event I1 does not apply to Taxable Australian Property. Certain assets which are TAP were defined earlier in this articles.
Election to defer CGT
Importantly, there is a choice election available to an individual taxpayer to disregard the capital gain or loss on CGT assets which flows from CGT event I1 and to defer the tax to another point in time. The election means that CGT assets which are not inherently Taxable Australian Property are taken to be Taxable Australian Property and CGT is deferred until the earlier of:
- The time an alternative CGT event happens to the asset.
- The time the taxpayer once again becomes a tax resident.
The election is made in respect of all CGT assets which are subject to I1.
The taxpayer must be an individual to make the election. This election is not available to a company.
There are some important matters to consider in making the decision whether or not to make the election. Relevant factors to consider include:
- The amount of unrealised gain at the time the taxpayer becomes a non resident.
- The risk that another CGT event occurs and that CGT event is not eligible for the CGT discount.
- The trade off between the benefits of deferring tax and the potential for increased capital gains by making the election, particularly in light of the reduction to the CGT discount for a non resident to reflect the period of non residency.
- The complications presented by international taxation.
These four matters are addressed in further detail below.
The amount of unrealised gain at the time the taxpayer becomes a non resident
The election will perhaps be less preferable to a taxpayer in any of the following circumstances:
- Where the capital gain is minimal at the point residency changes as there is no significant tax burden to wear by not making an election.
- Where there is a capital loss on assets that can be crystallised.
- Where the taxpayer has other capital losses that may offset the capital gain. Particularly if the taxpayer is moving overseas indefinitely, it may be worth utilising capital losses (if any) as these would otherwise be wasted. The capital loss can only be applied against capital gains tax imposed by Australia, not capital gains tax (or a similar tax) imposed by another country.
- Where the value of the asset is expected to increase significantly following the date the taxpayer ceases to be a resident. This would result in a greater portion of the increase in value of the asset being subject to Australian tax.
In these circumstances, particularly where the capital gain under I1 is minimal, there may be greater benefit in not making the election.
The election also broadens the potential capital gain captured under the Australian tax system, as the calculated capital gain will include the gain (if any) which accrues from the time residency changes to the time a CGT event occurs, or the time the taxpayer again becomes a resident of Australia. Whereas if the election was not made, such accrued gain would not be subject to CGT.
The risk that another CGT event occurs and that CGT event is not eligible for the CGT discount
The CGT discount is only available in respect of certain CGT events. This includes CGT event I1. However, certain CGT events do not attract the CGT discount. Therefore, there is a risk that if, following the taxpayer becoming a non resident, another CGT event happens that the capital gain would not be discountable for the taxpayer.
The trade off between the benefits of deferring tax and the potential for increased capital gains by making the election, particularly in light of the reduction to the CGT discount for a non resident to reflect the period of non residency.
A capital gain from CGT event I1 is eligible for discount under the CGT regime. However, remember that the discount percentage (50% for individuals) is required to be reduced to deny the taxpayer with the discount to the extent that the taxpayer accrues a capital gain while they are a foreign resident.
Per subsection 115-115(2) of the ITAA 1997, if the discount testing period starts after 8 May 2012, the following formula is to be used to calculate the CGT discount percentage allowed in respect of the capital gain:
Number of days during discount testing period that the relevant taxpayer
were an Australian resident for taxation purposes (but not a temporary resident).
2 x Number of days in discount testing period
The percentage will be 0% if the taxpayer were a foreign resident during all of the discount testing period.
Per subsection 115-115(3) of the ITAA 1997, if the discount testing period starts on or earlier than 8 May 2012 and the taxpayer was a tax resident on 8 May 2012, the following formula is to be used to calculate the CGT discount percentage allowed in respect of the capital gain:
Number of days during discount testing period – number
of apportionable days that you were a foreign resident or a temporary resident
2 x Number of days in discount testing period.
Note that the discount testing period is a reference to the period which starts on the day the taxpayer acquires a CGT asset and which ends on the day the CGT event happens.
Note that an apportionable day is a day which happens after 8 May 2012 and is during the discount testing period.
Per subsection 115-115(4) and (5) of the ITAA 1997, if the discount testing period starts on or earlier than 8 May 2023 and the taxpayer was not a resident on 8 May 2012, then there is an alternative formula to be used to calculate the CGT discount percentage allowed in respect of the capital gain:
| Percentage using market value | ||
| Item | Column 1 If the excess from paragraph (d): | Column 2 Then, the percentage is: |
| 1 | Is equal to or greater than the amount of the discount capital gain | 50% |
| 2 | Falls short of the amount of the discount capital gain | Worked out under subsection (5) |
The relevant formula referenced in subsection (5) is extracted below:
If subsection (4) does not apply, the following formula can be used to calculate discount percentage:
Number of apportionable days the taxpayer was a resident (not temporary resident).
2 x Number of days in discount testing period
It is best to understand the CGT percentage formulas and the impact on the decision to make an Taxable Australian Property election with a simple example.
Assume James purchased a CGT asset (not Taxable Australian Property) on 1 July 2010. The cost base of the asset was $100,000. James was an Australian resident on 8 May 2012. James moves overseas on 1 July 2015 and ceases to be an Australian tax resident on that date. The market value of the asset at this date is $300,000. James makes an election to defer tax under CGT event I1 by converting the asset to Taxable Australian Property. James sells the asset on 1 July 2021, triggering CGT event A1. At this time, the market value of the CGT asset is $500,000.
Here, James’ capital gain would have been $200,000 if the election had not been made ($300,000, being the market value of the CGT asset at the time of the CGT event less $100,000, being the cost base of the CGT asset). This capital gain would eligible for the full discount percentage of 50%. Therefore, the net capital gain (assuming no other capital gains or capital losses) would have been $100,000.
Instead, his capital gain is $400,000 ($500,000, being the market value of the CGT asset at the time of the CGT event less $100,000, being the cost base of the CGT asset).
Further, based on the application of section 115-115(2) and the following formula:
Number of days during discount testing period that the relevant taxpayer
were an Australian resident for taxation purposes (but not a temporary resident).
2 x Number of days in discount testing period
James’ discount percentage 22.72%. That is: 1,826 (number of days between 1 July 2010 and 1 July 2015) / (2 x 4,018 number of days between 1 July 2010 and 1 July 2021).
Therefore, his net capital gain (again, assuming no other capital gains or capital losses) is $309,120.
By making the election and having part of his capital gain discount percentage reduced, James’ will be taxed on an additional $209,120 (i.e. $309,120 – $100,000).
The complications presented by international taxation
If a taxpayer becomes a foreign resident and makes an election and then disposes of CGT asset, there may be some complications experienced in determining the rights of different countries to tax that disposed asset. If there is no tax treaty in place between Australia and the relevant country, it is possible that double taxation outcomes can arise. The complications presented by international taxation may deter a taxpayer from making an election.
Pre CGT asset
A capital gain or capital loss which results from CGT event I1 will be disregarded if the relevant CGT asset was acquired by the taxpayer prior to 20 September 1985.
Other exclusions
A capital gain or loss from CGT event I1 will be disregarded if it relates to a share or right held by a taxpayer that constitutes an employee share scheme interest which has not been subjected to tax by operation of Division 83A of the ITAA 1997.
A capital gain or loss from CGT event I1 will also be disregarded if taxpayer was a temporary resident (only) just before the time the event occurs.
The interaction with joint ownership
If joint owners have an interest in a CGT asset, either as tenants in common or joint tenants, the CGT consequences described above only apply in respect of the interest held by the relevant party. Remember that joint tenants are presumed to have equal interests in a CGT asset.
For example, assume Wayne and Karen have an equal share interest as tenants in common in a particular CGT asset. Then assume Wayne becomes a foreign resident but Karen does not. CGT event I1 (and the decision around whether to make an election) will be applicable for the ½ interest held by Wayne. The ½ interest held by Karen will be unaffected by CGT event I1. However, if Karen triggers a CGT event based on her dealings with the interest she holds for example, if the CGT is sold, then CGT will continue to apply. In that instance, Karen would have triggered CGT event A1 and she will be required to calculate the capital gain which relates to her ½ interest in the CGT asset.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.