In Federal Budget 2017, the Government is clamping down on tax avoidance by foreign investors in real estate, by tightening the foreign resident capital gains tax withholding regime.
The new laws apply to both Australian resident and foreign resident vendors:
- Australian resident vendors of real property of $750,000 or more need to provide a Clearance Certificate issued by the Australian Taxation Office (the ATO) to a purchaser on settlement of the sale, to avoid the purchaser withholding 12.5% of the purchase price and remitting it as withholding tax to the ATO.
- Foreign resident vendors will see 12.5% of the purchase price being withheld and remitted to the ATO, unless the ATO approves a Variation.
The new laws will also remove the main residence exemption for capital gains tax on sales of the main residence by foreign and temporary tax residents and restrict it to Australian tax residents (for purchases after 9 May 2017 and for sales after 30 June 2019).
Do the new laws apply to all real property sales in Australia?
Yes: The new laws apply to all sales of taxable Australian real property: including vacant land, buildings, residential and commercial property, options, leases, as well as to mining rights in Australia. So long as the purchase price (market value) is $750,000 or more. It does not matter whether the property is sold by an Australian resident or a Foreign resident.
Reducing the price threshold from $2,000,000 (applicable until 30 June 2017) to $750,000 (applicable from 1 July 2017) will enable the ATO to capture more property transactions. In Sydney, there are 395 suburbs where at least half of the houses cost more than $750,000 and 126 suburbs with apartments in the same price range, according to the Domain Group.
What must an Australian resident vendor do to avoid the 12.5% withholding tax?
The vendor must obtain a Foreign resident capital gains withholding clearance certificate (a Clearance Certificate) from the ATO. If the Clearance Certificate is given to the purchaser on settlement of the sale, it releases the purchaser from the legal obligation to withhold and remit 12.5% of the purchase price to the ATO.
“settlement” means when the balance price is paid in exchange for the transfer of title.
Clearance Certificate applications can be lodged online, or in a paper form. Where there is more than one vendor, each vendor must lodge a separate application. It does not matter who the vendor is: individuals, companies, trusts and superannuation funds all lodge applications.
The application form is an information gathering exercise.
First, the applicant provides a Tax File Number or Australian Business Number for the title holder.
Then the applicant must answer these three questions:
1. Has your residency status changed since your last tax return or will it change before you sell the asset? If yes, further details are required to determine if Australian residency applies.
2. Have you lodged an Australian tax return for the last two years? If not, further details are required to determine if Australian residency applies.
3. Are you holding the property on behalf of a foreign resident or on behalf of other entities that include a foreign resident?
The applicant signs a declaration at the end that the information contained in this form is true and correct. Penalties apply for giving false or misleading statements.
The Clearance Certificate covers the period from the entry date of the Contract and is valid for 12 months from date of issue. It applies to any properties sold by the vendor in that period.
What can a foreign resident vendor do regarding the 12.5% withholding tax?
The Foreign resident vendor cannot provide a Clearance Certificate to the purchaser, and so faces the prospect of 12.5% of the sale price being deducted from the price and be paid to the ATO. The amount is withheld as against the actual capital gains tax liability which is determined when a tax return is lodged.
The Foreign resident vendor can reduce or eliminate the withholding tax if the prove to the ATO that they will make a capital loss on sale; or a CGT roll-over applies; or they have carried-forward losses or tax losses; or the proceeds of sale available at settlement are insufficient after repayment of the mortgage or other security interest; or they are selling their main residence (before 30 June 2019).
The procedure is to apply for a Variation. If approved, a Variation Notice issues and is given to the purchaser on settlement of the sale.
Some vendors, especially expatriates, may have allowed their Australian tax residency to lapse. The vendors may be able to restore their Australian tax residency before they sell. Note: tax residency has different rules to immigration residency – a person can be an Australian citizen or permanent resident without necessarily being an Australian tax resident.
The primary tax residency test is: If you reside in Australia, you are considered an Australian resident for tax purposes, even if you are away from Australia temporarily. Then there are the secondary residency tests: the domicile test - your permanent home is in Australia; the 183-day test - if you are actually present in Australia more than half the income year; and the superannuation test - for Australian government employees working at Australian posts overseas.
The declaration made on the latest Australian Income Tax Return is significant - if a person is an Australian tax resident they declare income earned anywhere in the world in their tax return. Also significant is whether or not an income tax return has been lodged within the last two years.
It's easy to see why the Government is cracking down on foreign resident capital gains tax avoidance - it stands to gain $570 million in revenue over the next four years.
Sellers of real estate who are Australian tax residents should apply for a Clearance Certificate when they enter into a Contract for Sale. Their tax affairs need to be in order. If their tax returns are lodged to date and they have no overdue tax, then the Clearance Certificate will issue in a day or two. Otherwise, there may be a delay and queries raised.
Contracts for Sale should include a condition which sets out a procedure for the Withholding Payments, covering Clearance Certificates, Variation Notices and remittances. This provides important protection for the purchaser because they are liable to withhold and remit the 12.5% of the price unless they receive a Clearance Certificate or Variation Notice.
For more, see the ATO webpage Capital gains withholding: Impacts on foreign and Australian residents