Expats and tax

PORTFOLIO POINT: Australians living overseas, foreign nationals working in Australia '¦ what’s their tax position?

Ayn Rand and WG Hill popularised the idea of the stateless perpetual traveller beholden to no country and paying little tax. That could be you, but it is more likely you are or will be one of the 5% of Australians who reside overseas or you are a foreign investor in Australia. In any case, you need to know more about how your investments are taxed here and what this means for managing your wealth.

Non-resident investors include Australian citizens who reside and often work overseas and are able to satisfy certain tax office conditions. They invest in Australia for various reasons including as a place to keep assets for their return, such as a home and superannuation, to hedge against Australian asset prices outperforming savings they hold in a different country and currency, or simply because it is a familiar market.

Non-resident investors also include foreign individuals, families, institutions, sovereign funds and other entities. They invest here for different reasons including hoping to profit from our historically high performing property and stock markets and to access our high interest savings and bond rates. They also do so to diversify assets and sometimes to protect themselves from sovereign risk in their country. Institutional funds invest here to support their current investment themes, such as developing market growth, interest rate arbitrage or to take a punt on commodity prices.

Non-resident investors pay little or no tax because: they aren’t using our public services; and we need to attract their money to fund our ravenous current account deficit.

Tax paid on income

The tax payable to the federal government on investment income earned in Australia from assets owned by non-residents varies, both by rate and how it is collected, as per the below table.

Some things to note:

• Non-residents investing in most things other than direct real property don’t usually need to file an Australian tax return (or include that income in it, if they do) because an institution will pay that tax for you through withholding. The bad news is that if you have used borrowed money to fund that, then you probably can’t get a deduction either.

• Foreign savers generally have 10% withheld from their interest income as tax. However, the federal government recently made lending money to it by foreign investors more attractive by eliminating withholding tax on government bond interest.

• Non-residents pay no tax on franked dividends they receive. The rate they pay on unfranked dividends from Australian companies differs, depending whether double tax agreements exist between Australia and the investor’s country of residence. Generally it is 15% if a treaty exists and 30% if not, but there are exceptions, such as 5% for US investors.

• The taxation of distributions from widely held Australian property trusts improved from July 1. Part should be tax-free and most of the balance taxed at 7.5%, which makes for an attractive pre and post-tax yield.

• Tax on rental income on directly held property is paid by the non-resident owner after completing an Australian tax return. Unlike other investments, deductions are allowed for expenses and any borrowing costs. Marginal tax rates (MTR) are similar to Australian’s personal tax rates, however there isn’t a low income threshold and rate. Also the Medicare charge doesn’t apply. Tax losses, say from negative gearing, can be accumulated and used to offset tax on future income potentially usable when an investor returns onshore to work.

• If an annuity is paid to an individual from one of the many countries Australia has a tax agreement with, then payments could be received tax-free, according to dominant provider Challenger, otherwise tax on the interest component will be withheld at non-resident tax rates. For some, annuities can provide a superior after-tax return to a lightly-taxed term deposit while also providing indexed income.

• Australian super funds don’t treat the taxation of income and capital gains earned by non-resident members differently. Instead tax rates vary mainly according to whether the member’s fund is in accumulation or pension phase. There are, however, important compliance issues that need dealing with regarding operating an SMSF and accepting contributions from non-resident members.

• These rates refer to what the federal government wants for its take. Other taxes to state and local governments may apply, but that is mainly for real property. The country in which the investor is resident may also wish to tax this income, although not all do. Also double tax agreements may allow Australian tax paid to be offset against local tax payable so the investor isn’t slugged twice.

Capital gains tax

Non-residents who invest in Australian shares and share funds don’t have to pay tax on any capital gain to the Australian government. Zip. Nil. I believe this is also the case for most investors in widely held public offer, property funds. However, if you own direct property and make a profit on sale, expect to pay capital gains tax as high as 45%. Note some investors might be able to get an exemption when selling the formerly rented-out family home if they move back in within six years. Gains in super funds are taxed as they are for resident Australian investors.

It gets more complicated if you are Australian and bought an appreciating asset before you moved offshore. Depending on whether you made good on any capital gains up to the date of departure, or instead elected to postpone dealing with that, you won’t or you will respectively have to pay tax on any further appreciation of the asset while you are offshore.

Offshore tax envy?

Before resident Australian readers develop tax envy and start thinking about moving offshore, it shouldn’t be forgotten that the taxation of Australian superannuation can be just as good and in some cases better. For instance, Australian superannuation funds in pension phase pay nil capital gains tax on share investments and direct property. When investing in companies that pay franked dividends, not only do they avoid paying further tax on franked dividends, like offshore investors, they also receive a rebate from the government of tax paid by the company. This arguably makes them negative, not nil, taxpayers. Incidentally, buried in the Henry report was a recommendation to change this by introducing a higher tax rate for pension investors. I don’t lament the failure of that particular tax reform.

If you are an Australian resident, don’t forget you pay tax on your worldwide income including that earned from investments offshore. Some exemptions apply, such as earnings you make in an employer super plan you may have retained. The tax you have paid to another country can sometimes be offset against tax you pay here.

Let’s try to now answer what all this means to you if you are a non-resident investor, you may become one or are on your way back.

Non-resident investors welcome!

If you are a non-resident investor with no ties to Australia, investing in our stockmarket helps you access the returns from a mature market that has been operating since the mid 1800s. Today it is one of the highest yielding in the world and on a total return basis has outperformed all other developed markets since 1900. It is dominated by two sectors: resource companies and banks. It can provide exposure to other industries and some world champions.

The small size and openness of our stockmarket make it and our currency a bit of a plaything of professional investors. When resource investment themes run hot and while interest and dividend rates are high, foreign money, including low-cost money borrowed from elsewhere, fire up returns and our dollar. When these themes abate, you may wish you had a currency hedging strategy in place. In the late 2008 the Australian dollar fell from US97¢ to US64¢ in just eight weeks.

Today our savings and bond interest rates are far more attractive than those on offer in the major markets of the US, UK, Japan and most of Europe. Lending money to our governments, both federal and state, is probably more sound than lending to more highly indebted countries. Our banks need you to. Westpac and Commonwealth were recently reported as the fourth and seventh largest corporate bond borrowers in the world. Depending on your point of view, Australia’s is still a growing economy or we are living beyond our means.

Commercial real estate bought through widely held property trusts yield even more and are an easier and potentially more tax efficient way to invest in Australian property. Don’t worry about gearing up, since our funds have done too good job of that already. Funds listed on the stock exchange are highly liquid but their price is more volatile than for direct or unlisted property.

Foreign ownership rules relating to the purchase of direct property have been retightened recently. If you miss out, don’t worry because investors in residential and low-priced commercial property need continuing high levels of capital growth to justify earning some of the lowest rental yields in the world. This is especially true after taxes (land, income, capital gains, stamp duty, municipal rates) and the high cost of debt if you don’t bring your own money with you.

Offshore Australian investors

If you are an Australian non-resident you have more reasons to invest here, including in the property market, if you are worried prices will leave you behind while you are away. Investing in our stockmarket may be as attractive as investing in overseas markets if you don’t have to pay tax on franked dividends and capital gains. Research carefully any offshore investment schemes to ensure they are compatible for if you return to Australia and, more importantly, are a sound and low-fee investment. Investing in some countries is like going back in a time machine to when we had high-fee and complex life insurance savings plans; or worse, means investing in highly structured products which failed to perform in the mid-2000s.

If you are a very high income earner, rather than contributing to a tax haven you could consider contributing to an Australian super fund while away. You’ll find limits for bringing back foreign super fund monies modest and the opportunities to later transition large amounts of capital into super are long gone. Note it may be possible also to reduce the tax on rental income by making a deductible contribution to super.

Considerations for Australians moving offshore

If you may be moving offshore you may need to think about '¦

Asset allocation. After you work out what you can afford to, have to and want to leave here, you’ll need to work out your overall global balance of assets and currencies and how you’ll transition assets.

How you structure debt. Deductible debt funding a share portfolio might no longer be so when you move offshore, while your non-deductible mortgage could become deductible. Using an offset account might help you earn a greater deduction later.

Your SMSF. Can you keep it going and contribute to it while away? You’ll need to research options to change control of your fund and/or temporarily become a member of larger public fund. Family trusts are similarly complex but different issues apply.

Capital gains. Deciding to pay capital gains tax on non-property and non-super investments after you leave or whether to elect to defer that. Speak to your accountant or another specialist about this including if you are a member of an employee share plan.

Considerations for returning Australians

Coming back to Australian raises other questions, such as:

• When is the right time to bring money back from an exchange rate point of view? The answer is probably not all in one day, and your default position should be to stagger the repatriation of your wealth. This applies to anyone exchanging large sums of money.

• Should you repatriate your foreign superannuation? While your answer could be different, it may be “yes” if you came from the UK, but perhaps “maybe” if you are returning from the US.

Temporary residents in Australia

You’re different once again. In short, expect to pay tax on income earned while here temporarily, but not necessarily from investments left offshore.

If it is not clear by now, crossing borders with your money is complicated and it is something you need to research carefully and discuss with your advisors. If you are not an Australian resident, there are many reasons to suggest you’re money should reside here instead.

Doug Turek is the principal adviser of personal wealth advisory and money management firm Professional Wealth. Since interpretations and your circumstances will vary, rules differ between countries and change frequently, you need to undertake your own research and seek professional advice before investing.