Australian Tax Implications for U.S. Citizens Working in Australia

by Abigail Hogger, Mardi Heinrich, Adam Mendelsohn, and Andy Hutt, KPMG, Sydney
(KPMG in Australia is a KPMG International member firm)

Australia has been an attractive location for investment by multinational companies and for employee secondments for several years, and its attractiveness only continues to grow.¹ This makes it very important for international assignees and their employers to continue to focus on the various tax issues that may arise as a result of residing "abroad", and doing business, in Australia. Individuals should effectively and responsibly "manage" their Australian tax liabilities, especially considering the high marginal rate of tax generally incurred in Australia.

This article provides an in-depth look at Australian-specific tax laws that may impact an Australian resident, such as factors to consider in determining residency, social insurance coverage planning, and effectively structuring the sale of certain capital assets while in Australia.

General Tax Consequences in Australia – Employer Provided Benefits

A resident is defined as a person who resides in Australia and includes individuals who are domiciled in Australia, or who have been in Australia continuously or intermittently during more than one-half of the income year.

Generally, individuals who come to Australia with an intention of living in the country in a "routine" manner for six months or more would be treated as tax residents of Australia from the date of arrival.²

The residence article in the relevant income tax treaty may override Australian domestic law if the individual is resident in Australia and a foreign country at the same time. Generally, residency is deemed to begin on the first day during the year the individual is present in Australia.

An Australian resident is taxed on his or her worldwide income. Employment income is taxable when received or when the employee is entitled to receive it, if earlier. An Australian nonresident is an individual who is taxed only on Australian-source income.

Expatriate Concessions

International assignees who are residents of Australia for income tax purposes may receive favourable treatment for Fringe Benefits Tax ("FBT") purposes in relation to the various employer-provided benefits, such as the "Living Away From Home Allowance," employer contributions to rent, tuition for children, relocation assistance, and home leave. Foreign nationals who transfer to Australia on a permanent basis are not entitled to these concessions. Generally, these concessions only apply where the transfer does not exceed four years; however, this is only a guideline and employers should seek advice as to how to effectively structure their assignment contracts when determining the length of an employee's assignment to Australia.³

Fringe Benefits Tax (FBT)

FBT is a tax paid on certain benefits employers provide to their employees or their employees' "associates" (typically family members) in place of or in addition to salary or wages. FBT is separate from income tax and is based on the taxable value of the various fringe benefits provided. Examples of fringe benefits could include the following:

• Allowing an employee to use a work car for private purposes
• Giving an employee a below-market rate loan
• Paying an employee's private health insurance costs, or
• Providing cleaning services for an employee's private residence.

Please note, however, that FBT is not a creditable income tax for U.S. purposes, and, therefore, any FBT payable in respect of international assignees will increase the overall assignment cost for employers.

U.S. - Australia Social Security Agreement ("the Agreement")

Where an employee is transferred from the U.S. to work in Australia for a temporary period not exceeding five years and dual social insurance coverage would otherwise apply, the employee and employer will be subject only to the laws of the United States provided they apply for exemption from Australian coverage. This ensures that contributions are only required under the law of the country in which the person is most likely to retire.

Dual coverage would apply where an employer or employee is required to pay contributions under both the Australian and U.S. laws in respect of the same work undertaken by the employee. Where this occurs, the agreement regulates which country's laws will apply and which country's laws will not apply (that is, it eliminates dual coverage by exempting the employee or employer from one country's legislation).⁴

Where an employee from the U.S. is sent to work temporarily in Australia, and, as a result, the employee is exempted from Australia's legislation, (on the basis he or she remains subject to U.S. legislation), the U.S. Social Security Administration will issue a certificate of coverage.

Continuing U.S. Contributions While on Assignment in Australia

Generally, U.S. citizens on temporary assignments to Australia will want to maintain their U.S. FICA contributions as they intend to return to the U.S. after the conclusion of their assignments and to be exempt from paying Australian superannuation contributions so they are not liable to two separate retirement account contributions.

To obtain an exemption from superannuation contributions, employers should request a certificate of coverage prior to sending an employee to work temporarily in Australia. Regulatory authorities in Australia may request a copy of the certificate as evidence that the employee is eligible for an exemption from Australian social security laws. Please note employers do not need to provide a copy of a U.S.-issued certificate to the Australian Taxation Office ("ATO") or any other Australian government agency, though the ATO, from time to time, may request that employers provide copies of certificates as part of its ongoing compliance activities.

Where a U.S. citizen is transferred on a temporary tax-equalized contract, an exemption from superannuation would reduce the assignment costs to the employer.

Making Superannuation Contributions While on Assignment in Australia

Employers are generally required to contribute 9 percent of an employee's ordinary earnings into a complying superannuation fund or retirement savings account, unless a specific exemption applies or a bilateral Totalization Agreement is in place.

The Australian government introduced laws, effective from July 1, 2002, that allowed an individual who had entered Australia on an eligible temporary resident visa, and who had permanently departed Australia, access to his or her accumulated superannuation entitlements at the time of departing Australia (less withholding tax), rather than requiring that individual to wait until retirement age, which in Australia is at least 55 years.⁵ This law does not apply to Australian permanent residents or citizens as, though they may leave Australia, they always retain the option of returning to and retiring in Australia.

Where a U.S. citizen is seconded on a temporary tax-equalized contract and superannuation contributions are paid on his or her behalf, the employee will have the opportunity to access the contributions from the funds upon permanent departure from Australia. Please note where totalization agreements are not in place, employers should consider the terms of their current assignment policies if superannuation contributions are made on behalf of an employee in addition to U.S. contributions where the employee has the opportunity to withdraw the funds upon departure.

Capital Gain Tax Considerations

U.S. citizens entering into Australia and establishing residency for Australian tax purposes need to be aware that the Australian capital gains tax ("CGT") regime operates differently to that in the United States.⁶

Deemed Acquisition

The Australian CGT provisions will not apply to assets acquired before September 20, 1985. A CGT asset acquired on or after this date that already has the 'necessary connection' with Australia, such as Australian property, will generally have the amount paid on acquisition as its cost base. However, a CGT asset acquired on or after this date that does not already have the necessary connection with Australia, such as shares or options to acquire shares in companies that are not Australian resident companies, will effectively be deemed to have been acquired at the time that the U.S. citizen becomes an Australian tax resident, with its cost base being the market value at that time.

Consequently, U.S. citizens entering Australia and establishing residency for Australian tax purposes need to consider the impact that the above deemed acquisition rules will have when they dispose of CGT assets while tax residents of Australia. For example, where a U.S. citizen disposes of a share in a U.S. company while Australian tax resident, and the market value of the share on disposal is less than the amount paid to acquire the share but is higher than the market value at the time he or she became an Australian tax resident, a capital loss may arise in the U.S. while a taxable capital gain arises in Australia. U.S. citizens should note, however, that any capital gain arising in Australia may be discounted by 50 percent where the CGT asset giving rise to the gain has been held for at least 12 months.

Deemed Disposal

In light of the above deemed acquisition rules, some U.S. citizens may consider delaying disposal of CGT assets that lack the necessary connection with Australia until after they have departed Australia and broken Australian tax residency. This is particularly relevant to individuals that were Australian tax residents for less than five years during the 10 years before breaking Australian tax residency, as capital gains (and losses) arising in these circumstances from CGT assets lacking the necessary connection with Australia and owned before becoming an Australian tax resident will be disregarded.

However, where this rule does not apply, for example, due to the U.S. citizen being an Australian tax resident for more than five out of the 10 years prior to breaking Australian tax residency, and/or the U.S. citizen acquired CGT assets lacking the necessary connection with Australia while an Australian tax resident, deemed disposal rules will apply when Australian tax residency is broken. That is, a capital gain will arise where the market value of the CGT asset at the time of breaking Australian tax residency is greater than the CGT asset's cost base, which may be a deemed acquisition cost base if acquired prior to becoming an Australian tax resident. Capital gains (and losses) arising as a result of deemed disposal can be disregarded, but if the decision to disregard is made, it applies to capital gains (and losses) resulting from all CGT assets that were prima facie deemed to have been disposed; and all of these assets will be taken to have the necessary connection with Australia until the earlier of their actual disposal or again becoming Australian tax resident.

According to Article 13 of the U.S.-Australia income tax treaty, where an individual elects to treat the assets as having a necessary connection with Australia upon ceasing to be resident of Australia (i.e., and therefore, not subject to Australian tax under the "deemed sale" rule), as described above, only the U.S. will tax the subsequent sale of the asset upon return to the United States.⁷

Treatment of Employee Share Options

U.S. citizens should be aware that the Australian tax treatment of their employee share options will depend on whether the options were granted before or after establishing Australian tax residency and when the options are exercised and subsequently sold.⁸

Options Granted and Exercised While Australian Tax Resident

U.S. citizens will be required to include the discount in their assessable income for the year that the employee share options are exercised, unless an election is made to be taxed on the options in the year of grant. Where an election to be taxed up-front is not made, the calculation of the discount depends on whether or not the shares are subsequently sold within 30 days of exercise. Where they are sold within 30 days of exercise, the discount is calculated as the sales proceeds received on disposal of the shares, less the exercise price. No further capital gains tax consequences will arise in these circumstances.

Where the shares are sold after 30 days of exercising the options, the discount is calculated as the market value of the shares at the time the share is acquired, less the exercise price paid for the shares. The market value of the share is determined by taking the weighted average of the prices at which those shares were traded on the stock exchange during the one-week period up to and including the day the shares were acquired. The subsequent sale of the shares gives rise to a capital gains tax event. The capital gain or loss will be calculated as the sales proceeds (net of brokerage costs) less the market value of the shares on the day acquired. As mentioned above, the capital gain will be reduced by 50 percent where the shares are held for at least 12 months from the date of exercise.

Options Granted While Australian Tax Resident but Exercised after Breaking Australian Tax Residency

Where a U.S. citizen is granted employee share options while an Australian tax resident, but exercises them after returning to the U.S., a portion of the discount (as calculated above) will relate to employment undertaken in Australia. Consequently, Australia will have a source-country right under the U.S.-Australia income tax treaty to tax that portion of the discount that relates to Australian service. The ATO has indicated an allocation method that may be appropriate in certain circumstances, as follows: "the portion that relates to Australian service is calculated by the number of days that the U.S. citizen was employed in Australia between grant date and vesting date to the total number of days employed between grant date and vesting date."⁹ Reference to the income tax treaty should be made to ensure that amounts taxed in Australia as Australian source would be accepted as "foreign" for U.S. purposes in claiming foreign tax credit relief.

Options Granted Prior to Establishing Australian Tax Residency

When a U.S. citizen exercises employee share options while an Australian tax resident, that were granted to him or her prior to establishing Australian tax residency, a taxing point does not arise. However, a taxing point will arise when the shares are disposed of while Australian tax resident. This will be a capital gains tax event.

For Australian tax purposes, the options will be deemed to have been acquired on the day Australian tax residency is established. Any capital gain or loss made on the disposal of the underlying shares will be calculated in accordance with the Australian capital gains tax regime.

Where the options are exercised and shares sold within 12 months of the date of exercise, the capital gain or loss will be calculated as follows:

Capital gain / (capital loss) = net proceeds from sale of shares minus cost base of shares

where cost base of shares = market value of options on date Australian tax residency established plus exercise price.

The capital gain is then taxed at one's marginal tax rate.

Where the options are exercised and the shares are sold at least 12 months after the date of exercise, any capital gain made on the sale of the underlying shares would be reduced by 50 percent.

How to determine the market value of an unlisted option is not specifically addressed in the Australian CGT provisions. The market value of the options on the date Australian tax residency is established should be at least equal to the difference between the exercise price and the share price on the date Australian tax residency is established. A professional valuation of unlisted options should be considered which would take into account all factors relevant to the options at the time Australian tax residency is established.

Conclusion

With the growing number of long-term international assignees to Australia, it is becoming ever more important that companies and their emplyees working "abroad" in Australia be cognizant of the applicable tax rules and practices. A casual approach to managing one's tax exposure in Australia is imprudent and can be costly, to both the assignee and the employer. There are a number of aspects of Australia's tax laws—governing, for example, capital gains, employer-provided benefits, superannuation, and employee share options—that can catch assignees and their employers unaware, and leave them exposed to non-compliance penalties and unwanted tax liabilities. Careful planning, maximizing available opportunities, and informed decision-making, should go a long way to mitigating such risks.

Footnotes:

1 For further information, see A. Deshpande, "Weighing the Pros and Cons of Taking Up Permanent Residency in Australia," Country Supplement, The Expatriate Administrator 2003-03, Autumn 2003. ; also see "Australia: A Wealth of Opportunity," Australia's Department of Communications, Information Technology and the Arts, 2003; and, also see the "Invest Australia" Web site at: http://investaustralia.hyperlink.net.au/.

2 Australian Taxation Office Taxation Ruling TR98/17 Residency status of individuals entering Australia.

3 Miscellaneous Tax Ruling MT 2030.

4 Article 2.1 of U.S.-Australian Social Security Agreement.

5 For further analysis, see V. Curl and A. Lampkin, "Australia Moves on Superannuation for Departing Nonresidents," Flash International Executive Alert 2002-22 (January 29, 2002). Also see, D. Aravamis and T. Collard, "Australia Makes Changes to Tax Treatment of Overseas Superannuation Retirement Benefits," Flash International Executive Alert 2003-239 (December 9, 2003).

6 For an earlier article on the capital gains tax, see A. Lampkin "Capital Gains Tax in Australia Can Catch Assignees Unaware," The Expatriate Administrator 2001-2, Summer 2001.

7 For a related article, see "Further Analysis on Protocol to U.S.-Australia Income Tax Treaty," Flash International Executive Alert 2001-156 (October 26, 2001).

8 For a related article, see R. Garnon, A. Payne, and D. Morris, "Australian Implications for International Share Plans," The Expatriate Administrator 2001-1, Spring 2001.

9 Australian Taxation Office Interpretative Decision ATO ID 2003/1084.