Eddie Chung explains the tax implications of investing overseas and how to comply with the ATO
Investing in overseas investment properties is fast becoming a trend among Australians. Anecdotally, more and more Australian investors are turning to property markets in the US, New Zealand and other countries where the real estate markets have been battered by the global financial crisis. Many perceive that properties in these countries are now undervalued and represent good bargains for future growth.
However, the Australian taxation system is far reaching and overseas investment properties are caught by the Australian tax net by virtue of the general principle that the worldwide income of an Australian tax resident is subject to Australian tax, with limited exemptions. So, it is advisable to understand the Australian taxation implications of overseas property investment.
Here are some frequently askedquestions to help investors with their investment decisions:
1. Do I need to inform the tax office when I buy an overseas investment property?
No, but the self-assessment system requires you to disclose certain information regarding the property in your tax return, such as the rental income derived, rental expenses incurred, and capital gain or loss on the sale of the property.
Failure to disclose this information may give rise to hefty penalties and general interest charges if detected. Given the Australian Taxation Office’s growing sophistication in data matching and exchange agreements with foreign jurisdictions via the use of technology, there is a fair chance that your ownership in the overseas property may be detected at some stage. Therefore, it is better to be safe than sorry by fully disclosing your interest in the overseas investment property in your tax return as required.
2. What are the Australian implications of transferring large sums of money to buy the overseas property?
There are no Australian exchange controls in terms of transferring funds outside of Australia, but check with the local authorities in the jurisdiction to which the funds are being transferred to ensure that you are complying with the relevant country’s domestic exchange control requirements.
3. How will the rental income derived on my overseas property be taxed?
As an Australian individual tax resident, any worldwide income you derive will be assessable income in Australia, unless an exemption applies.
With respect to overseas property, you will need to ascertain, firstly, if Australia and the jurisdiction in which the property is located have a double tax agreement (DTA). The provisions of the DTA are important as they override if the DTA and domestic law contradict each other.
In many circumstances, both Australia and the country in which the property is located may have taxing rights over the rental income. However, double taxation is usually avoided under the foreign income tax offset (FITO) system in Australia. The FITO system commenced operation from 1 July 2008, replacing the previous foreign tax credit system.
Broadly, under the FITO system, Australia will provide a FITO to reduce the Australian tax payable on the rental income if tax has already been paid elsewhere on the same income. However, if the offset exceeds the Australian tax liability, the excess will not be refundable.
The amount of FITO available is generally subject to a limit. For simplicity, the law provides that if the total foreign tax paid does not exceed A$1,000, the offset amount is generally the amount of foreign tax paid. If the foreign tax paid exceeds A$1,000, you may choose to adopt a FITO amount of A$1,000, in which case, any excess offset that may otherwise be available under a full calculation will be disregarded. Alternatively, a full calculation may be performed to determine the maximum amount of your FITO entitlement.
Very broadly, the FITO amount is effectively the amount of Australian income tax that would have been attributable to the income that has given rise to the foreign income tax.
For completeness, it is important to note that the FITO amount is only available when the relevant foreign tax has actually been paid.
Further, under limited circumstances and depending on the country in which the property is located, the relevant DTA may grant that country the exclusive taxing right over the rental income, which means that the income is simply not assessable in Australia.
4. When I calculate the taxable income in relation to the overseas investment property, are tax deductions allowed to reduce the rental income?
In Australia, any expenditure or outgoing incurred that is productive of the rental income from the overseas investment property is tax-deductible, to the extent that the expenditure or outgoing is not of a capital or private/domestic nature.
For instance, the cost of repairing an investment property (but not initial repairs when the property was first purchased) to restore it back to its original state is generally deductible against the rental income derived.
On the other hand, the cost of improving something or replacing something in its entirety will generally not be tax-deductible because the cost will be capital in nature. Nevertheless,a depreciation or building allowanceclaim may be made in respect of such costs to reduce the assessable rental income derived.
Care should be taken when calculating the taxable income because what is deductible under Australian income tax may not necessarily be so in the foreign country and vice versa. Accordingly, it may be advisable to enlist the help of a local accountant to assist you in this area.
5. Can I negative gear the overseas investment property against my Australian income?
The short answer is yes.
Previously, any net foreign loss incurred by an Australian tax resident could only be offset against other foreign income of certain classes.
From 1 July 2008, any net foreign loss incurred may be offset against any Australian sourced income derived. If the foreign loss is not used, it may be carried forward indefinitely to offset any future income derived, regardless of whether the future income is sourced from Australia or otherwise.
There are transitional rules that govern how certain foreign losses incurred before 1 July 2008 may be converted to ordinary tax losses to be offset against Australian domestic income. These rules are complex and certain calculations are required to determine how much of the foreign losses may be converted to ordinary tax losses and utilised.
6. Will I have to pay CGT on the overseas investment property if it is sold at a gain in the future?
Similar to the treatment of rental income derived in respect of an overseas investment property, the taxation treatment of any capital gain derived upon the sale of the property will be determined by the DTA between Australia and the country in which the property is located.
The DTA may provide exclusive taxing rights to one country (usually the country in which the property is situated) or it may allow both countries to tax the capital gain. In other circumstances, the foreign jurisdiction may not have a capital gains tax regime at all.
Generally, unless the DTA specifically excludes Australia from being able to tax the capital gain, the normal CGT rules in Australia will apply. If foreign tax has also been paid on the capital gain, using the FITO system will avoid double taxation.
Notably, the CGT rules applicable to an overseas investment property will be the same as those applicable to properties located in Australia. If the overseas property has been held for at least 12 months before it is sold, the 50% CGT discount may apply, provided that it is held by an individual or a trust. If a capital loss is incurred, the capital loss may be carried forward into the future indefinitely to offset any future capital gain you derive.
The interaction between the taxation system of Australia and that of another country is very complex and specific. It is advisable to obtain advice from the start so that you are clear on the taxation implications associated with the overseas investment property to avoid future surprises. For the ATO, out of sight is no longer out of mind and investors should tread carefully.
Eddie Chung is a partner at BDO (Qld) Pty Ltd.