Capital Gains Tax Treatment of Employee Share Schemes for Temporary Residents.

Who is classed as a temporary resident?

A temporary resident for tax purposes (according to s995-1(1) of the Income Tax Assessment Act (ITAA) 1997) is a person who satisfies the following three criteria:

• must hold a temporary visa granted under the Migration Act 1958;
• must not be an Australian resident within the meaning of the Social Security Act 1991; and
• must not have a spouse who is an Australian resident within the meaning of the Social Security Act 1991.

Based on the above, a temporary resident visa holder will not necessarily be treated as a temporary resident for tax purposes, they must meet all three criteria.

A person who is treated as an Australian ordinary resident for tax purposes after 6 April 2006 will not be able to be treated as a temporary resident subsequently, regardless of whether that person holds a temporary visa.

What is deemed a TAP?

• Taxable Australian Real Property (TARP), e.g. land and buildings situated in Australia.
• an asset used at any time, whilst doing business through a permanent establishment in Australia.
• indirect Australian real property interests, e.g. a shareholding of 10% or more in a company where the assets of the company are principally (i.e. greater than 50%) made up of TARP.
• an option or right to acquire one of the above assets.

When a person holds shares in an Australian company, this does not necessarily mean that person has a TAP asset. That person will only be considered holding a TAP when the shares fall under one of the above definitions.

The TAP rule was introduced on 12 December 2006, and as a result, there are changes to the CGT exemption from this date onwards.

Timing and General Rules

Before 12 December 2006 a CGT exemption applied when a temporary resident sold their shares and had no necessary connection with Australia.

From 12 December 2006 onwards:

• a CGT exemption applies when a temporary resident sells a non-TAP or ceases being an Australian resident.

• any capital gain (or loss) will be considered as a non-assessable, non-exempt income and completely disregarded. However, the CGT on the sale of shares may be taxed to the extent of its connection to the person employed in Australia.

1. What happens when an ESS is a TAP?

When a CGT event happens on a TAP while the taxpayer is still a temporary resident, the taxpayer will only be taxed on the capital gain (or loss) that is related to their Australian employment.

Any capital gain (or loss) related to foreign employment will be disregarded. Thus, the taxable discount included in the taxpayer return will be used as a cost base in calculating the capital gain (or loss). 

For a former temporary resident who becomes an Australian permanent resident, there is no change to the CGT treatment of the ESS that has necessary connection with Australia (or TAP from 12 December 2006 onwards).

The whole capital gain (or loss) will be assessable in the income year when the CGT event occurred.

2. What happens when an ESS is a NTAP?

Two scenarios apply.

a) If an ESS is taxed on acquisition

When a CGT event happens on the NTAP while the taxpayer is still a temporary resident, a similar CGT treatment will apply.

The taxpayer will only be taxed on the capital gain (or loss) that is related to the Australian employment.  

However, the cost base used will be the market value at the time the shares were bought, instead of the discount taxable in the taxpayer’s tax return.  

If the CGT event happens when the taxpayer has become an Australian ordinary resident for tax purpose (for example the employee became a permanent resident), the capital gain or loss will be the total of the following: 

• the portion of capital gain (or loss) accrued during the time the person was a temporary resident (only to the portion that is related to their Australian employment income), and
• capital gain (or loss) accrued from the time the person became an Australian permanent resident, to the time the CGT event occurred.

b) If an ESS discount is deferred

When a CGT event happens on the NTAP while the taxpayer is still a temporary resident, any capital gain (or loss) from the sale of the shares will be disregarded.

However, when the taxpayer became an Australian permanent resident and the CGT event happens subsequently, the capital gain (or loss) will be accrued from the time the taxpayer became an Australian permanent resident till the CGT event happens.