Example Of Tax Consequences Of An Australian Tax Resident Selling An Asset
Given the result of Burton’s case [Burton v Commissioner of Taxation [2019] FCAFC 141], an Australian resident investing in the USA is only able to apply the foreign tax credits in so far as they apply to the taxable portion of the capital gain being taxed in Australia. The Australia-US DTA provides not further relief.
Let’s consider how this would look in a situation that compares the sale of a long term capital asset held in the US, NZ and Australia.
Example
Let’s assume that Amy is an Australian tax resident who has two property investments, one in the USA and one in New Zealand. Assume also that:
- There is no cost base on any of these assets;
- Amy has owned a $1,000,000 investment property in NZ for more than 12 months. NZ does not tax domestic capital gains;
- Amy has also owned a $1,000,000 investment property in the US for more than 12 months. The US does tax capital gains, however it taxes capital gains on assets that have been held for more than a year at a concessional rate. For ease of calculations we will assume the top income rate of 20% applies;
- Amy also owns a $1,000,000 investment in Australia, which she has also held for over 12 months. This means she will only be taxed on half of the capital gain in Australia. For ease of calculations we will assume the flat top marginal rate and medicare levy applies, 47%;
- Amy sells all 3 investments in the same financial year for AUD$1,000,000 each;
- For ease of calculations Amy has no capital losses to apply and she is able to apply the 50% CGT discount in full when preparing her Australian tax return.
As you can see from this example, Amy ends up paying more tax on the US asset.
This is because the US has taxed the full gain. The ATO’s approach is only to allow the foreign tax paid on 50% of the gain to be offset against the Australian tax payable on the discounted capital gain.
In Burton the contention made by the taxpayer, and the point that the dissenting judge, Logan J, agreed with, is that the DTA between Australia and the US should be interpreted as treating the capital gain in its entirety when applying the foreign tax paid as an offset against the gain being declared in the Australian return.
In our example if Amy were able to apply the foreign tax offset in full then she would only have to pay $235,000 total tax on the capital gain, just like she is assessed on the assets owned in NZ and Australia.
It should further be noted that the impact of the decision in Burton is not the same as the ATO clawing back the 50% discount on foreign held capital assets. If this were the case then Amy would be assessed on the full $1,000,000 of the foreign gains and be required to pay total taxes of $470,000 against each of the foreign capital gains.
In our example Amy is paying the full amount of Australian tax plus any taxes that the foreign country charges on the discounted portion of the capital gain.
Since Australia does not tax anything on this portion of the capital gain, the net impact of the total tax payable will depend on the local tax laws and tax rates in the foreign country who do tax the full capital gain.
Conclusion
Since the High Court has refused to hear an appeal – the effect is now that long term US sourced capital gains of an Australian resident – will be taxed in the USA at a rate which is much higher than 23.5% – closer to 33.5% – because Australia will not provide a full FITO.
It should now be very clear to all clients who are considering making US investments that the US-Australian DTA does not actually provide relief from what clients would see as double taxation. In effect the US-Australia DTA provides not assistance beyond what the basic FITO rules would ordinarily provide to the client.
