Australia’s real estate market is attracting a large number of foreign investors looking to get into this lucrative sector. Eddie Chung explains the tax considerations foreign investors need to take into account when investing in Australia
The Australian property market has remained a relatively stable and attractive option for investors, particularly when compared with other property markets around the world. Unlike the property market in the US, for instance, the Australian property market held up reasonably well during the global financial crisis. While property prices in many developed countries have plummeted dramatically during times of volatility, Australian property prices have performed much better overall in comparison. For these reasons, many foreign investors have opted to invest in Australian properties.
Tax considerations for foreign investors
1. While this may not be a tax issue per se, as a foreign national in Australia you are subject to certain restrictions imposed by the Foreign Investment Review Board (FIRB) that regulate your ability to buy Australian property.
Under the current rules, unless a specific exemption applies, the acquisition of both residential and commercial properties in Australia by foreigners will need clearance from FIRB by default, regardless of the value of the property and nationality of the purchaser.
Some common examples of exempt acquisitions that do not require FIRB approval include:
a New Zealand citizen buying residential property in Australia;
a foreign national buying residential property as a joint tenant with their spouse who is an Australian citizen;
a new dwelling sold by a developer who has obtained prior approvalto sell the property to a foreign national; and
a foreigner buying an interest in developed commercial property where the property is to be used immediately and in its present state for industrial or non-residential
commercial purposes, etc.
It is important to note that these restrictions extend to the indirect acquisition of property through Australian-incorporated company and trust structures. It is therefore very important for you to understand these rules before signing a purchase contract to buy property in Australia.
2. If you are permitted to buy Australian property as a foreign national, you need to determine your tax residency status in Australia. However, the tax residency rules are not straightforward and are not the same as your residency status for immigration purposes. For example, you may not be an Australian permanent resident or citizen under the immigration rules,but you may be treated as a tax resident of Australia for income tax purposes.
Under Australian tax law, if you are a tax resident of Australia, your worldwide income and capital gains are generally subject to Australian tax. Otherwise, only your Australia-sourced income (and foreign employment income earned while you are a temporary resident) and capital gains on ‘taxable Australian property’ (which includes Australian real estate) are taxable in Australia.
Further, the Australian tax law contains a special set of ‘temporary resident’ rules, which may also treat a tax resident or non-resident as a temporary resident. Broadly, you may be a temporary resident for Australian tax purposes if you:
hold a temporary visa for immigration purposes;
are not an Australian resident for social security purposes, and
do not have a spouse who is an Australian resident for social security purposes.
Special rules may apply in some circumstances (eg if you hold a special category visa), so advice is recommended if you potentially come under these rules.
As a temporary resident, most of your foreign income is not taxed in Australia, but you will be subject to Australian income tax on income sourced in Australia and capital gains tax (CGT) derived on any taxable Australian property you own.
To complicate things further, the domestic law in Australia will need to be applied in conjunction with any Double Tax Agreement (DTA) Australia has with your country of residence. The DTA may grant taxing rightsoncertain types of income exclusively to one country or, alternatively, it may allow both countries to tax the same income and require one of the countries to reduce the tax liability on the income by the tax already paid on the same income in the other country. If the DTA and domestic tax law contradict each other, the DTA will prevail.
These rules are very complex and professional advice is highly recommended.
3. Although Australian tax residents are taxed on their worldwide income and capital gains (subject to the provisions in any applicable DTA), they are also entitled to the tax-free threshold and lower marginal tax rates. As a tax resident of Australia, up to $18,200 of your taxable income in the year ending 30 June 2013 is currently tax-free. In contrast, non-residents are not eligible for the tax-free threshold, which means they are subject to Australian tax on every dollar
they earn that is sourced in Australia.
Notwithstanding the above, non-residents are generally not subject to the Medicare Levy (currently 1.5% of taxable income),while residents pay Medicare Levy by default unless a specific exemption applies (eg if the resident is in receipt of a war veteran’spension).
As mentioned above, a tax resident or non-resident may also be treated as a temporary resident. There are no special tax rates applicable to temporary residents – if an individual is a tax resident and also a temporary resident, they will pay tax at resident rates; if an individual is a non-resident but also a temporary resident, they will pay tax at non-resident rates.
4. Irrespective of tax residency status, any investor who has derived a capital gain on their Australian property that is not their main residence will be subject to CGTin Australia if the property was acquired after 19 September 1985.
If you are a tax resident of Australia and have derived a capital gain, you will qualify for the 50% CGT discount if you owned the property for at least 12 months before it was sold. The same applies to a resident trust. Meanwhile, the CGT discount is 33.33% for a complying resident superannuation fund,but a company is not entitled to a CGT discount.
Before 8 May 2012, the CGT discount was also available to non-residents and temporary residents under the same set of rules that are applicable to residents. However, the Australian Government announced in the 2012 Federal Budget that the CGT discount was no longer available to individuals and beneficiaries of trusts who are non-residents or temporary residents in respect of taxable capital gains accrued after 8 May 2012. These rules are currently in draft form and are subject to change,but they will apply retrospectively from 8 May 2012 when they are passed as law.
Under the draft legislation, if you are a non-resident or temporary resident and you acquired a property in Australia after 8 May 2012, you will not be eligible for the 50% CGT discount if you make a capital gain upon the sale of the property.
If you bought the property before 8 May 2012 and sell it after that date, you may elect to use the ‘market value approach’ – that is, you choose to apply the 50% CGT discount to the accrued capital gain up to 8 May 2012,based on the market value of the property on that date,and pay full CGT without the discount on any capital gain accrued from that point. If you do not choose this approach, you will not be eligible for the CGT discount on the entire capital gain.
Under the draft law, there is no specific requirement for you to obtain a formal valuation of the property by a qualified valuer. However, you will need to be able to defend the market value adopted, so it is probably worthwhile to obtain a formal valuation to satisfy the CGT record-keeping requirements.
For completeness, there are other CGT discount apportionment rules in the draft law to deal with situations in which you change your tax residency status during the ownership period of your Australian property.
There is no change to the rules on the offset of capital losses against capital gains. A capital loss must first be applied against the full capital gain before any discount, before the residual gain is reduced by the CGT discount.
The Australian tax law is already complex when it is applied to domestic transactions,but the complexity increases significantly when multiple jurisdictions and foreigner taxpayers are involved. When evaluating Australian property as an investment, a foreign investor needs to fully understand their taxation obligations in both Australia and their own country of residence, which often requires the engagement of tax specialists in both countries. The additional costs for professional advice must therefore be factored into the overall decision-making process.