Relocating to the UK? Tax issues for Aussie ex pats

Introduction

With uncertainty surrounding the fallout from the UK’s decision to leave to European Union, it is reasonable to assume that the steady stream of Australians heading to the UK is likely to slow (at least temporarily) and those living in the UK may even return. However, the UK generally, and the city of London specifically, will continue to attract working Australians in a variety of industries.

Whenever an Australian relocates to another country it is critical that they carefully consider:

1. whether they will cease to be an Australian resident for tax purposes;

2. if so, whether they will be subject to Australia’s ‘Exit Tax’;

3. if so, whether they should make an ‘Exit Election’ to defer the taxing point until actual disposal;

4. if an exit election is made, the impact foreign-residence has on eligibility for the full 50% CGT discount;

5. whether they qualify as a UK-resident non-domiciliary (“Non-Dom”) such that they are only taxed in the UK on:
   1. UK-source income; and
   2. foreign (non-UK) source that is remitted to the UK (which has a particular definition in relation to which specific advice should be sought);

6. whether there are any pre-departure planning strategies to consider (from an Australian perspective);

7. whether there are any pre-arrival planning strategies to consider (from a UK perspective);

8. the operation of the Australia-UK Double Tax Agreement (“DTA”) in the event that:
   1. Australian source income (such as dividends, interest or royalties):
      1. is remitted to the UK (to be assessed in the UK); or
      2. is not remitted to the UK (and therefore, not subject to tax in the UK);
   2. Australian source capital gains from assets subject to an exit election are disposed of whilst remaining a Non-Dom and:
      1. is remitted to the UK (to be assessed in the UK); or
      2. is not remitted to the UK (and therefore, not subject to tax in the UK).

This article focuses on the interaction between the Australian domestic tax system and the provisions of the DTA in circumstances where the relevant Australian source is or is not remitted to the UK. It is assumed that the relevant individual ceases to be an Australian resident under Australian domestic tax law so as to trigger the Exit Tax or the making of an Exit Election.

Australia’s ‘Exit Tax’

CGT event I1 happens if an Australian-resident individual or company ceases to be a resident of Australia (s104-160(1) ITAA 1997). The timing of the event is when the individual or company ceases to be Australian tax-resident (s104-160(2) ITAA 1997).

A capital gain is derived if the market value of each relevant CGT asset is more than their respective cost base and a capital loss is incurred to the extent that the market value of each CGT asset is less than their respective cost base (s104-160(4) ITAA 1997).

Are all CGT assets subject to Exit Tax?

Not all CGT assets are subject to Exit Tax. That is, the class of CGT assets known as ‘taxable Australian property’ (“TAP”) (s855-15 ITAA 1997) are not subject to CGT event I1 (s104-160(3) ITAA 1997).

The most common form of TAP is Australian real property (s855-20 ITAA 1997) and indirect Australian real property interests (s855-25 ITAA 1997).

The policy driver of the Exit Tax is to prevent Australian-residents with unrealised capital gains ceasing to be Australian-residents and taking advantage of Australia’s CGT exemption for foreign-residents. That is, Australia only taxes foreign residents on Australian source capital gains from TAP assets, therefore, for example, if an Australian-resident individual with unrealised capital gains in shares in an Australian company (not being an indirect Australian real property interest) ceased to be an Australian resident then sold those shares the next day, but for the Exit Tax, they would not be taxed in Australia at all. The Exit Tax captures unrealised capital gains of Australian residents before those unrealised gains fall outside the Australian tax net altogether.

As TAP is always in the Australian tax net (even for foreigners that never step foot in the country), there is no need for an Exit Tax on these assets. Further, it is important to recognise that the Exit Tax:

1. applies to all CGT assets other than TAP, including foreign CGT assets of a departing Australian-resident individual (such as shares in foreign companies); and

2. only applies to CGT assets acquired after the introduction of Australia’s CGT regime on 20 September 1985 (s104-160(5) ITAA 1997).

Exception to Exit Tax: individuals may make Exit Election

Despite the Exit Tax rules above, individuals (but not companies) may choose to disregard any capital gain or loss on the deemed disposal of assets under CGT event I1 (s104-165(1) ITAA 1997) and the legislative mechanism by which this is achieved is to convert the previous non-TAP CGT assets into TAP assets going forward (item 5, s855-15 ITAA 1997).

To elect or not to elect: that is the question

Whether or not to make an Exit Election (which is an ‘all-or-nothing’ election in relation to all non-TAP assets rather than on an asset-by-asset basis) depends on variables, including:

1. the particular facts of the case (e.g. whether, on an overall basis, there would be a net capital gain);

2. the tax profile of the taxpayer (e.g. their income from other sources, the availability of tax and/or capital losses); and

3. the anticipated holding period and future performance of the asset.

In relation to the latter, it was previously more common for outbound Australian residents to make the Exit Election as Australia generally allowed both Australian and foreign-resident individuals to access the 50% CGT discount where, amongst other things, the relevant CGT asset was held for at least 12 months (Subdiv 115-A ITAA 1997)^.

However, as of 8 May 2012, foreign-residents are no longer entitled to the full 50% CGT discount (s115-105 ITAA 1997). Broadly, the maximum 50% CGT discount is reduced to the extent that the individual is foreign-resident over the holding period of the asset and therefore, whether or not to make an Exit Election now involves balancing the up-front tax cost versus the estimated future tax burden on actual disposal at (higher) foreign-resident tax rates of up to 45% and without the benefit of the full 50% CGT discount.

Impact of the DTA

As Australia and the UK have entered into the DTA, its provisions override those of domestic tax law to the extent of any inconsistency (other than in relation to Australia’s general anti-avoidance rules).

The purpose of the DTA is to allocate taxing rights so as to minimise the impact of double taxation (or double non-taxation).

Non-Doms and remittance-based taxation

Australian source dividends, interest and royalties

Under Australian tax law, the following Australian source income items are subject to Australian withholding tax at the relevant rates:

1. dividends – 30% (s128B(4) ITAA 1936 and s7 IT(DIRWT)A 1974);

2. interest – 10% (s128B(5) ITAA 1936 and s7 IT(DIRWT)A 1974); and

3. royalties – 30% (s128B(5A) ITAA 1936 and s7 IT(DIRWT)A 1974).

Of course, no withholding tax applies to the extent that the dividend is franked (s128B(3)(ga)(i) ITAA 1936).

Under the DTA (which again, overrides domestic Australian tax law to the extent of any inconsistency) these withholding tax rates are reduced as follows:

1. dividends – 0% – 15% (Article 10 DTA);

2. interest – max. 10% (Article 11 DTA);

3. royalties – max. 5% (Article 12 DTA).

However, the DTA limits relief in certain circumstances involving former Australian-residents that are Non-Doms. That is, Article 23(1) DTA states:

“Where under this Convention any income or gains are relieved from tax in a Contracting State [Australia] and, under the law in force in the other Contracting State [UK], a person in respect of that income or those gains is taxed by reference to the amount thereof which is remitted to or received in that other State [UK] and not by reference to the full amount thereof, then the relief to be allowed under this Convention in the first-mentioned State [Australia] shall apply only to so much of the income or gains as is taxed in the other State [UK].”

Based on the above, where a Non-Dom derives Australian source dividends, interest or royalties and:

1. does not fully remit any of that income to the UK – they will be subject to Australian domestic withholding tax rates (unless the relevant dividends is fully franked such that no dividend withholding tax arises and it does not make a difference from an interest perspective given the same 10% rate arises); and

2. remits some but not all of that income to the UK – they will be subject to a mixture of both:
   1. Australian domestic withholding tax rates; and
   2. the DTA rates (as apportioned).

Australian source capital gains

Article 13(5) DTA states:

“An individual who elects, under the taxation law of a Contracting State [Australia], to defer taxation on income or gains relating to property which would otherwise be taxed in that State [Australia] upon the individual ceasing to be a resident of that State [Australia] for the purposes of its tax, shall, if the individual is a resident of the other State [UK], be taxable on income or gains from the subsequent alienation of that property only in that other State [UK].”

In terms of the interaction between Australian domestic tax law and the DTA, where an Exit Election is made (to disregard the Exit Tax), even though Australian domestic tax law would continue to treat those assets as TAP and therefore, within the Australian CGT net on actual disposal, if the relevant individual remains a Non-Dom on actual disposal, the DTA will apply to override Australian domestic tax law such that, provided that the capital gain is fully remitted to the UK (Article 23(1) DTA), the  capital gain will be taxed solely in the UK (Article 13(5) DTA).

Conversely, if the capital gain is not remitted to the UK, despite Article 13(5) DTA the operation of Article 23(1) DTA will prevent its application leaving the capital gain to be assessed under Australian domestic tax law (at foreign-resident rates without the benefit of the full 50% CGT discount).

The operation of similar provisions under the UK-Canada Double Tax Agreement were recently confirmed by the Federal Court of Appeal of Canada in Conrad Black v The Queen, 2014 FCA 275 (FCA) November 26, 2014.

Conclusion

Whenever an Australian relocates overseas, there are myriad issues to consider.  For those heading to the UK and becoming a Non-Dom, it is important to understand the tax implications of that status insofar as the relief available under the DTA being dependent on whether or not, and if so, to what extent, they remit Australian source income to the UK.

As an adviser, clients should be made aware of the tax implications of various scenarios to enable them to make fully informed decisions prior to their departure. Of course, at that stage the actual tax implications of future disposals are purely hypothetical and the conversation is more structural, that is:

1. when will they be taxed;

2. where will they be taxed; and

3. how will they be taxed.

As to the interaction between Australian domestic tax law and the DTA with regards to a Non-Dom that made an Exit Election, the position may be summarised as follows:

* Fully franked dividends are not subject to dividend WHT in the first place so the DTA is not relevant in this context.

Finally, for a useful pre-departure planning tool for Australians heading to the UK – see our Flow Chart – Are you relocating to the UK? 

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Note – This paper was published in the August 2016 edition of inTAX Magazine (a Thomson Reuters publication).