The Australian property market is red hot at a number of locations at present. Given the relatively stable historical performance of property as an asset class in Australia, it is not surprising that some foreign investors are snapping up Australian properties in their tireless quest for investment returns. To that end, any tax costs associated with the property should be understood and taken into account in evaluating its merits as an investment as tax directly erodes investment returns. Therefore, it is important for foreign investors to be aware of their Australian taxation obligations before they purchase any properties in Australia.
When a foreign investor buys and sells a property that is located in Australia, any income or capital gain derived on the property will generally always be taxable in Australia, regardless of whether the foreign investor is a resident, non-resident, or temporary resident for Australian tax purposes. Therefore, the property owner will be required to lodge annual Australian tax returns to report the income and capital gain.
It should be noted that the tax residency status of an individual is not solely determined by the person’s citizenship or immigration status. Whether you are a tax resident of Australia is a question of fact that is weighed up against a number of factors under an ‘on balance’ approach. Therefore, if you are unsure of your residency status for Australian tax purposes, you should seek professional advice as your residency status may materially affect your Australian tax liabilities and obligations in relation to your Australian property and other income and capital gains.
As a basic rule, if you are taken to be an Australian tax resident, your worldwide income and capital gain will be taxable in Australia. On the other hand, if you are a non-resident, only your Australian sourced incomeand capital gains on taxable Australian property will be taxed in Australia.
In that regard, bear in mind that if you are subject to Australian tax on your property that is physically located in Australia and you are a tax resident of a foreign country, you may also be subject to the domestic tax law of that country. Further, any Double Tax Agreement (DTA) between Australia and that country may override the domestic tax laws of both countries, which may add an additional layer of complexity to your tax position.
As a general proposition, the DTAs between Australia and other foreign countries usually provide Australia with a taxing right over any income or capital gain derived on property that is located in Australia. If you are also taxed on the same income and capital gain by the foreign country, you may be relieved from double taxation by claiming any Australian tax paid as a foreign tax credit to reduce \ the tax liability imposed by the foreign country.
In any case, taxation involving multiple jurisdictions is often complex, which is why professional advice is indispensable in these circumstances.
Income versus capital gain
Technically speaking, if a non-resident or temporary resident buys a property in Australia with the intention of reselling it for a profit, any gain derived on the property when it is eventually sold is revenue in nature. That is, the gain is treated as income for income tax purposes.
On the other hand, if the property is purchased for the purpose of deriving rental income, any gain derived on the eventual sale of the property will be a capital gain.
The income or capital gain derived by the individual, whichever the case may be, will need to be included in the person’s assessable income in Australia, which will be reduced by any allowable deductions to which the individual is entitled to claim. The remaining amount, which is the taxable income, will be taxed at the individual’s marginal tax rate, which can be as high as 49% for taxable incomes exceeding $180,000 inclusive of Medicare Levy and the Temporary Budget Repair Levy.
For completeness, a non-resident will always pay more income tax than a resident if they have the same income, as a non-resident is not eligible to apply the tax-free threshold or the lowest individual marginal tax rate to which a resident is entitled.
Capital gains tax discount
If income and capital gains are included in an individual’s taxable income in the same manner, there appears to be little point differentiating between the two. However, this is not always the case.
For an individual who is a tax resident of Australia, the amount of capital gain derived on a property (or any other CGT assets for that matter) may potentially qualify for the 50% CGT discount if the property has been held for at least 12 months before it is sold. In which case, only half of the capital gain will be included in the individual’s assessable income. Therefore, the Australian taxation system has an inherent bias that favours capital gains over income.
The same rule used to apply to a foreign or temporary resident of Australia – until 8 May 2012 when the 50% CGT discount was effectively removed from any capital gain accrued on a CGT asset from that day forward that was attributable to a foreign or temporary resident. To preserve the discount on any capital gain accrued on the asset up to 8 May 2012, the following rules now apply:
● If the foreign or temporary resident
originally acquired the asset before 8 May 2012 and chooses to obtain a market valuation of the asset as at that date, they may apportion the capital gain such that the 50% CGT discount will apply to the capital gain up to that market value, but no discount will be applicable to any capital gain accrued after 8 May 2012.
● If the foreign or temporary resident
originally acquired the asset before 8 May 2012 but does not choose to obtain a market valuation of the asset, then the capital gain derived on the asset will not qualify for any discount.
● If the foreign or temporary resident
originally acquired the asset after 8 May 2012, the capital gain derived on the asset will not qualify for any discount. There are also other modifications to these rules to account for situations where the foreign or temporary resident was a tax resident for a period or periods during the ownership of the asset. Again, these rules are less than straightforward and you should seek professional help if you think you may be eligible for a partial CGT discount.
If you are a non-resident and rent out your Australian property, any net income you derive, as mentioned above, will need to be included in your taxable income that is subject to Australian tax. However, if you incur a net loss, you may carry forward the losses on a cumulative basis indefi nitely until you are able to offset the losses against any future income or capital gain you derive.
If you sell the property and make a capital loss, the capital loss may also be carried forward indefinitely and can only be offset against your future capital gains in Australia.
If the loss was incurred by a company or trust, there are special rules in place for changes in ownership of the company or trust that may result in the loss being unavailable.
State and territory taxes
Apart from income tax, you will be liable to pay stamp duty upon the purchase of the Australian property. The stamp duty rates vary between the states and territories, depending on where the property is located.
The stamp duty paid will be included in the cost base of the property, which will be taken into account when the capital gain or loss on the property upon its sale is calculated. When you sell the property, the purchaser will pay the stamp duty at that time.
Further, land tax may apply if the aggregated unimproved value of all the land you own in a particular state or territory exceeds a certain threshold. Any land tax you incur will be an allowable income tax deduction, which may reduce your taxable income (or increase your tax loss) in the income year in which the land tax is incurred.
Foreign Investment Review Board
If you are a non-resident of Australia or hold a temporary visa, you may be required to obtain approval from the Foreign Investment Review Board (FIRB) if you wish to buy Australian property. Therefore, it is important that you understand and satisfy the relevant requirements before you sign any purchase contract.
Further, since 4 May 2015, the Australian Taxation Offi ce (ATO) has been responsible for the residential real estate functions of the foreign investment regulatory framework, which includes audit, compliance, and enforcement activities.
As the ATO employs sophisticated data-matching technology, the detection risk of any non-compliance with the FIRB rules has been heightened. Notwithstanding this latest development, the government has announced a ‘reduced penalty period’ until 30 November 2015, which provides some relief for foreigners who breached the foreign investment rules. Therefore, now is the time to come clean if you have any ‘skeletons in the closet’!
is Partner, tax & advisory, property & construction, at BDO (QLD) Pty.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.