Contributed by Tamara Cardan, Senior Associate, and Rebecca Bolton, Special Counsel, K&L Gates LLP, Melbourne
Under recent amendments to federal taxation laws, and stamp duty and land tax legislation in certain states, foreign vendors who acquire direct or indirect interests in Australian real estate will be under greater scrutiny, will have greater compliance obligations and are likely to have a greater degree of exposure to the Australian tax regime at both a state and federal level.
The 10% foreign resident withholding regime enables the Australian Tax Office (ATO) to capture capital gains made by non-resident vendors who may not have otherwise declared a gain on the disposal of Australian property interests. Several states are now seeking to impose additional duty and land tax surcharges in respect of land held by foreign residents.
These changes, in addition to new Commonwealth reporting requirements that will enable data-matching, may be seen as making Australia a more challenging jurisdiction in which to invest. It is essential that foreign vendors obtain tax advice as to the “tips and traps” in respect of these new measures, and carefully consider the way any investment into Australia is structured.
Foreign resident 10% withholding regime
From 1 July 2016, purchasers who acquire interests in Australian land valued at $2m or more from foreign resident vendors will be required to pay 10% of the first element of the asset’s cost base (usually, the purchase price) to the Commissioner of Taxation (Commissioner).
If the purchaser fails to pay this amount on or before settlement, they may be liable to an administrative penalty equal to the 10% they failed to withhold. The purchase price is taken to exclude any adjustments, but includes the market value of any non-monetary consideration provided and GST if the purchaser is not entitled to input tax credits. Depending upon the terms of the sale and purchase agreement, the purchaser may withhold the 10% from any payment which would otherwise be made to the vendor. The regime also extends to include certain indirect acquisitions in Australian real property.
Under the CGT provisions, purchasers are taken to acquire CGT assets on the date of entry into the contract. Consequently, the amendments do not apply to contracts entered into before 1 July 2016.
This new withholding regime is targeted to capture property transactions involving foreign vendors, due to the perceived low compliance in respect of declaring Australian property sales and paying the corresponding CGT. The regime aims to bring foreign vendors into the Australian tax net, by entitling foreign vendors to a credit for the amount paid by the purchaser. Vendors will only be eligible for the credit if the purchaser has actually paid the amount to the ATO; withholding alone is not sufficient. In order to claim the credit, foreign individuals and entities must lodge an income tax return, which will require vendors to hold an Australian tax file number.
Transactions subject to the regime
Under Div 855 of ITAA 1997, foreign residents who dispose of assets held on capital account are exempt from CGT unless the asset disposed of constitutes “taxable Australian property”, which broadly includes taxable Australian real property (TARP) comprising real property situated in Australia (including leaseholds), and mining, quarrying and prospecting rights. The definition also includes an indirect Australian real property interest, being a non-portfolio interest (10% or more) in an entity whose underlying value is principally attributable to Australian real property. All sales of TARP interests valued at $2m or more will be captured by the new regime, save for some limited exceptions. The measures are very wide and will apply to all purchasers, whether Australian or foreign residents.
The regime does not apply to the following transactions:
- transactions involving TARP valued at less than $2m
- transactions involving company title interests valued at less than $2m
- transactions conducted through a stock exchange or crossing system
- arrangements that are already subject to an existing withholding obligation
- a securities lending arrangement, or
- transactions where vendors are subject to formal insolvency or bankruptcy proceedings.
The purchaser will not be subject to the withholding requirement where the vendor obtains and produces a clearance certificate from the Commissioner in respect of transactions involving TARP or company title interests. The clearance certificate, which will be valid for 12 months, must be provided to the purchaser prior to settlement.
Vendors who are Australian tax residents may apply for a clearance certificate at any time they are considering the disposal of real property. The existence of a clearance certificate should be included in the completion checklist for real property transactions, acquisitions of shares in companies with substantial land holdings (subject to the comments below), company title interests, and business sales which include a real property component. Warranties should also be included in sale contracts outlining the parties’ obligations under this regime.
Knowledge condition and residency declarations
Where a vendor is disposing of an indirect real property interest (but not a company title interest), the purchaser may rely on the knowledge condition, or a residency declaration, to exclude the withholding requirement. Under the knowledge condition, the purchaser may have specific knowledge, or a reasonable belief, that the vendor is not a foreign resident. Purchasers not comfortable relying on the knowledge condition may alternatively seek a vendor declaration as to residency. Where the vendor makes a residency declaration that they are an Australian resident, no withholding obligation exists unless the purchaser knows the declaration to be false. Vendor declarations are valid for six months after the day the declaration is made.
It is envisaged that residency declarations will become a standard term in sale agreements that involve the sale of indirect property interests. This concessional treatment has a limited application, as it does not apply to sales of direct real property interests, where clearance certificates must be obtained.
Where the vendor is a foreign resident and therefore not entitled to a clearance certificate, but either party believes a withholding of 10% is inappropriate, the vendor or purchaser may apply for a variation of the amount to be withheld. A variation would most commonly arise where the vendor is of the view that it will not have an income tax liability, where the vendor is of the view that it will make a capital loss on the sale, or if the transaction involves multiple vendors with only one foreign resident.
The Commissioner’s power to issue a variation is discretionary and a variation is only effective if it is provided to the purchaser.
Stamp duty surcharge payable by foreign purchasers
In addition to the imposition at a federal level of a withholding tax on non-resident vendors, several jurisdictions have sought to introduce stamp duty and land tax surcharges on the acquisition of real estate by foreign investors.
In Victoria, the State Taxation and Other Acts Amendment Act 2016 received Royal Assent on 28 June 2016. The Act introduces a duty surcharge which is targeted at foreign purchasers of Victorian residential property, and non-residential land in certain circumstances. The Act also introduces a land tax surcharge. Where a dutiable transaction occurs, such that a land-related interest in residential property is transferred to a foreign purchaser, a 3% duty surcharge is imposed in addition to the normal duty rates.
The surcharge applies to the direct acquisition of land by foreign purchasers as well as to the indirect acquisition of land, through the acquisition of an interest in a landholder company or trust. “Residential property” is defined in the Duties Act 2000 (Vic) (Duties Act) to mean land on which a building is affixed, that is designed and constructed solely or primarily for residential purposes, and may lawfully be used as a place of residence. The definition also includes land on which a foreign purchaser intends to affix a building that is designed and constructed solely or primarily for residential purposes, and may lawfully be used as a place of residence. This broad definition would include not only houses and apartment blocks, but also vacant land that is zoned residential.
The surcharge may also apply to non-residential land, where the purchaser forms an “intention” to construct a residential dwelling on the land subsequent to its acquisition. There is no guidance on when such an intention may be formed, but it may be evidenced, for example, by the purchaser lodging an application for a planning certificate. Within 14 days of forming this intention, the purchaser must notify the Commissioner of State Revenue, with the additional 3% duty payable within 30 days of having formed the intention.
Again, while there is no guidance on this issue, the Explanatory Memorandum to the new Act suggests that if, say 12 months after acquisition of non-residential land, a foreign purchaser forms an intention to construct a residential dwelling on the land, the duty surcharge would subsequently be payable.
Who is a foreign purchaser?
A “foreign purchaser” is a foreign natural person, a “foreign corporation” or the trustee of a “foreign trust”. These definitions are widely drafted, and should be considered carefully to determine whether they apply in any specific circumstance.
Corporations and trusts may, in some circumstances, be eligible for an exemption from the additional 3% surcharge, pursuant to the State Treasurer’s general discretion. The exemption is intended to apply to those entities whose activities in the development or redevelopment of property add to the supply of housing stock in Victoria.
Foreign purchasers are not entitled to the duty concessions or concessional rates of duty otherwise provided for under Pt 5 of Ch 2 of the Duties Act, including the concessions that may be applicable where there is a change in trustee, and where property is transferred to beneficiaries of certain trusts.
Due to the absence of these concessions for purchases via foreign trusts, it will be particularly important to have ownership correctly structured prior to purchase to minimise the chance of a further round of duty being payable.
The stamp duty surcharge also applies to relevant acquisitions in a landholder that holds residential property. A landholder is any company or unit trust scheme (whether private or public) that has land holdings in Victoria with an unencumbered value of $1m or more.
Where a foreign purchaser acquires a “significant interest” or a further interest in a landholder, this will trigger a liability to the surcharge in addition to the normal duty rates. Foreign purchasers acquiring interests in landholders should obtain Australian tax advice to ensure they meet their tax obligations, as such entities may not be aware of this additional duty liability and any interest charges will be significant.
In the 2016/17 Budget, the Victorian Treasurer announced that the stamp duty surcharge will increase from 3% to 7%, for contracts signed on or after 1 July 2016. This would bring the total duty rate payable by foreign purchasers to 12.5% for properties with a purchase price of more than $960,000.
Land tax surcharge
Land tax is broadly payable by entities that own Victorian land, where the entity’s landholdings have a total site value of $250,000 or more. There are exemptions for primary production land, land used by charities, and land used as the owner’s principal place of residence.
From 1 January 2016, a land tax surcharge applies to “absentee persons”, at a rate of 0.5%, in addition to the general land tax rate of up to 2.25%. In the 2016/17 Budget, the Victorian Treasurer announced that the land tax surcharge on absentee owners will rise from 0.5% to 1.5% from the 2017 land tax year, taking the total rate to 3.75%.
New South Wales
As announced in the Budget on 21 June 2016, NSW introduced a foreign investor surcharge on stamp duty, and a land tax surcharge on the acquisition of interests in residential real estate (the State Revenue Legislation Amendment (Budget Measures) Bill 2016 which received assent on 28 June 2016). A stamp duty surcharge of 4% will apply to the acquisition of direct or indirect interests in residential real estate by foreign purchasers. For instance, the duty payable by a resident purchaser of NSW land for $2m would be $95,490, with foreign purchasers liable to duty of $175,490. The surcharge will apply to transactions that trigger a liability to transfer duty or landholder duty on or after 21 June 2016.
The new Act also introduces a land tax surcharge of 0.75% on residential real estate owned by foreign persons commencing in the 2017 land tax year (ie calendar year). Additionally, foreign investors will no longer be entitled to the 12-month deferral for the payment of stamp duty for off-the-plan purchases of residential property, and will not be provided with a tax-free threshold for the land tax surcharge.
Under amendments introduced by the Duties and Other Legislation Amendment Act 2016 with effect from 1 October 2016, a 3% duty surcharge applies to direct and indirect acquisitions of specified residential property in Queensland by foreign acquirers (additional foreign acquirer duty or “AFAD”). This surcharge will apply in addition to transfer duty, landholder duty and corporate trustee duty. The AFAD will be imposed at a rate of 3% of the dutiable value of a relevant transaction, to the extent of the foreign person’s interest acquired through the transaction, and to the extent that interest relates to residential land. To the extent that the property has a value of more than $1,000,000, the transfer duty payable, including the AFAD, will be as high as 8.75%.
A concept of “foreign person” has been introduced into the Duties Act 2001 (Qld). A “foreign person” is a foreign individual, foreign corporation or the trustee of a foreign trust. A “foreign individual” is an individual other than an Australian citizen or permanent resident. A “foreign corporation” is a corporation that is incorporated outside Australia, or a corporation that is controlled by a foreign person or persons. Broadly, a “controlling interest” is an interest of at least 50% in the issued share capital of the corporation, or the ability to control 50% of the voting power, or potential voting power, of the corporation.
Due to this broad definition of “controlling interest” for corporations, the AFAD may apply to a company incorporated in Australia that has an ultimate foreign parent or is controlled by non-resident individuals.
A “foreign trust” is a trust in which at least 50% of the interests in the trust are held by a foreign person or persons.
AFAD residential land
The AFAD only applies to the acquisition of “AFAD residential land”. Generally, AFAD residential land refers to land in Queensland that is used, or will be used, solely or primarily for residential purposes. The definition encompasses several scenarios, including established houses and apartments, land for development for residential use, land on which a building will be refurbished for residential use, and vacant land upon which a house or apartment will be established.
The Act describes AFAD residential land as including land on which there is or will be a building designed or approved for “human habitation by a single family unit”. The Explanatory Memorandum does not clarify whether, for example, land on which a hotel, motel, serviced apartment or retirement village will constitute AFAD residential land.
The Queensland amendments do not contain a discretionary exemption as seen in the Victorian provisions. Some existing concessionary relief will continue to apply to AFAD liabilities, including corporate reconstruction relief and the change in trustee exemption.
The amendments apply if a liability to transfer duty, landholder duty or corporate trustee duty arises on or after 1 October 2016. Foreign purchasers should seek advice on the potential duty liability where they enter into contracts prior to 1 October 2016. Foreign purchasers should also be mindful of the surcharge if they have entered into an option contract to acquire AFAD residential land, and the exercise period commences on or after 1 October 2016.
Commonwealth reporting requirements
In November 2015, new Subdiv 396-B of Sch 1 to the Taxation Administration Act 1953 (Cth) was enacted. This amendment followed a decision of the Commonwealth, State and Territory Treasurers to establish a National Register of Foreign Ownership of Land Titles. Under the new provisions, the Commissioner can require certain entities to provide information about transactions that could reasonably be expected to have tax consequences for other entities. Entities required to report include states and territories where there is a transfer of freehold or leasehold interests in the real property situated in that state or territory. The information is proposed to be used by the ATO for information-matching purposes and ensuring compliance with Commonwealth tax requirements. The information will include details about the nationality and residency of vendors and purchasers. This new legislation again highlights the fact that the tax affairs of foreign residents will now come under greater scrutiny.
The result of the above measures is to ensure that non-resident investors in real estate are subject to Australian income tax, and also are treated differently to Australian investors in respect of state taxes. The combination of the foreign resident withholding tax and the state-based surcharges, effectively “book end” investment in Australian real estate for foreign residents. Foreign vendors who dispose of interests in taxable Australian property will now be brought within the Australian tax net, as they must lodge an income tax return to claim a credit for the tax paid by the purchaser. The need to lodge a tax return will give the Commissioner the opportunity to scrutinise the capital gain returned on the sale (if any) and possibly other gains or income that may be subject to Australian tax.
While the foreign resident withholding tax increases the ATO’s ability to capture capital gains made by non-residents on real estate transactions, the state-based surcharges operate to simply impose an additional liability on foreign purchasers when compared with resident investors. Whether the impact of these measures has any effect on the Australian real estate market is yet to be seen.