The misnamed ‘foreign resident capital gains withholding’ (FRCGW) regime not only affects Australian residents but requires them to comply with legal obligations, and can impose heavy penalties for non-compliance. Recent legislative changes extended the rules to many more taxpayers, so it has never been more critical for resident taxpayers to be aware of their tax obligations if they are planning on buying or selling Australian property.
Note: ‘foreign resident’ means a non-resident for Australian tax purposes.
The FRCGW rules, which commenced on 1 July 2016, impose a payment obligation on purchasers of certain taxable Australian property from foreign resident vendors. Broadly, the purchaser is required to withhold 12.5 per cent (note this rate has recently changed; the rate was previously 10 per cent) of the purchase price and send this to the ATO; the vendor then claims a credit for the withheld amount.
All types of Australian property are subject to the rules, but there is a carve-out for real property with a market value below the specified threshold (see below), including for residential, commercial and agricultural property, as well as vacant land. This threshold does not apply to certain other types of indirect Australian property interests.
The Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Act 2017 received Royal Assent on 22 June 2017 and implements two changes which were announced by the Government on 9 May 2017 as part of the 2017–18 Federal Budget:
- A reduction in the threshold for real property and company title interests from $2 million to $750,000
Previously, the former $2 million threshold (which applied only to contracts entered into from 1 July 2016 to 30 June 2017) ensured most family home sales were not affected by the FRCGW rules. However, the reduced threshold of $750,000 is below the current median house price in Sydney and Melbourne — and only just above the median price in Canberra: see our Australian house prices infographic. As ABS data reveals, a collective 9,706,059 million people lived in Sydney, Canberra and Melbourne on Census Night 2016. This means many more Australian families are now affected by these rules when they move house.
- An increase in the withholding rate from 10 per cent to 12.5 per cent
The higher withholding rate of 12.5 per cent means purchasers are liable for a larger payment than was previously the case — and this means larger penalties can be imposed if the purchaser does not comply with their tax obligations.
These two changes affect contracts entered into on or after 1 July 2017 and make the FRCGW rules more relevant to Australian taxpayers and their advisers than ever before.
Where the value of the property transferred is $750,000 or more, the purchaser (whether or not a resident) is obliged to withhold 12.5 per cent of the purchase price and pay this to the ATO by settlement, unless the vendor is an Australian resident or an exception applies.
Crucially, the legislation provides that all vendors of eligible taxable Australian property will be considered foreign residents for this purpose unless:
- in relation to real property and company title interests — the vendor obtains a valid clearance certificate from the ATO and provides it to the purchaser by settlement; or
- in relation to indirect Australian real property interests (i.e. certain shares and units in entities that hold the majority of their assets in Australian real property, and certain rights and options) — the vendor makes a vendor declaration and provides it to the purchaser by settlement. There is no minimum dollar threshold for sales of these assets.
A vendor who is a genuine non-resident will not be able to obtain a clearance certificate from the ATO, or make a vendor declaration that they are a resident, so the purchaser will need to withhold from payments made to these vendors.
However, the rules also extend to Australian resident vendors who fail to obtain a clearance certificate and give it to the purchaser by settlement, by treating them as if they also are a foreign resident for this purpose.
- The purchaser has no obligation to withhold an amount from the purchase price and pay this to the ATO, which also relieves them of the obligation to complete and lodge with the ATO a purchaser payment notification form.
- This means the vendor can receive their settlement proceeds in full, so there is no impact on the vendor’s cash flow.
The FRCGW rules do not impose a tax obligation on the vendor, so there is no penalty on the vendor for failing to obtain a clearance certificate from the ATO or for failing to provide it to the purchaser by settlement. However, if the purchaser is required to withhold 12.5 per cent of the sale proceeds because the vendor failed to provide the purchaser with a clearance certificate, the vendor will have a cash flow issue because they will only receive 87.5 per cent of their sale proceeds, and they will need to wait until they lodge their income tax return to claim a credit back for the withheld amount.
The amount required to be withheld on the sale of an $800,000 property is $100,000. An unnecessary withholding of this amount could significantly affect the vendor’s capacity to settle on their new home or apply the substantial sum to other uses. The vendor is unable to claim a credit for the $100,000 that is withheld until they lodge their income tax return for the income year in which the CGT event occurred. If the settlement occurs early in an income year, there could be a delay of over a year before the vendor could claim the withheld amount against any tax liability payable, or receive a refund in the event that there is no tax to pay on the sale (for example, if the main residence exemption applies or the withheld amount exceeds the tax payable on the sale of the property).
If the purchaser fails to withhold from the purchase price when they were obliged to, the ATO can impose a penalty of $2,100 for failing to remit the withheld amount, as well as — and much more significantly — a penalty equal to the amount they failed to withhold … plus the general interest charge (GIC). This penalty is on top of the withholding amount that has not been remitted. In the above example of the $800,000 property, the ATO could impose a total penalty on the purchaser of $202,100 plus GIC!
In practice, it will be very difficult — if not impossible — for the purchaser to recover an amount representing the original $100,000 withholding liability from the vendor post-settlement. And the purchaser would certainly have to fund the $100,000 penalty amount themselves. From another, non-pecuniary, perspective, the purchaser’s failure to withhold may be a black mark against their otherwise-unblemished ATO compliance history.
What should vendors do?
A resident vendor of a property that is sold for $750,000 or more should obtain a clearance certificate from the ATO as soon as they have entered into a sale contract. They can even apply for the clearance certificate when they are considering listing their property for sale. This can be easily done online via the ATO website. However the vendor should not simply file it away with their other tax records; for it to be effective in avoiding withholding, they must provide it to the purchaser before the date of settlement. Clearance certificates are valid for 12 months so they should be sought well ahead of settlement, and they cover all properties sold by the vendor in that 12-month period. ATO policy is not to issue retrospective clearance certificates to vendors.
What should purchasers do?
A purchaser should request a clearance certificate from the vendor well before settlement date. If the purchaser is required to withhold — because the vendor does not supply the purchaser with a clearance certificate — the purchaser needs to register with the ATO (using the purchaser payment notification form) and prepare their documentation in time for withholding and remittance to the ATO by settlement.
The conveyancers and real estate agents involved in the sale should play a significant role in ensuring sale contracts reflect a potential withholding and in ensuring their clients, both vendors and purchasers, are aware of these rules. However, the liability for withholding and responsibility for payment of the withheld amount to the ATO falls solely on the purchaser — the tax law imposes this statutory obligation on the purchaser not the conveyancer.
Tax agents can play an important role in ensuring their clients — whether vendor or purchaser — consider and comply with these rules by encouraging their clients to advise them of any intention to buy or sell Australian property before entering into a contract. Forewarned is forearmed.
The devil is in the detail
Recognising that a resident client buying or selling Australian property may be subject to the FRCGW rules is only the first step. Next, you need to decide whether a specific exemption applies; whether the rules apply in a special way; and/or whether the withholding rate could/should be less than 12.5 per cent. Practical issues addressed by the legislation and the ATO include:
- multiple vendors, multiple purchasers and/or multiple properties covered by a single contract;
- when vendors or third parties may apply to vary the withholding rate;
- settlement adjustments;
- the sale of a property on revenue account;
- the impact of GST on the $750,000 threshold and the withholding calculation;
- how the purchaser pays the withholding obligation to the ATO;
- how the vendor claims a credit for a withheld amount;
- exceptions — including marriage breakdown, deceased estates and income tax exempt entities; and
- how the rules apply to indirect Australian real property interests (i.e. certain shares, units, rights and options).
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