Australia’s stable financial environment, well-regulated freehold land title system, consistent increase in population and lower deposits requirements are often the common factors that attract inbound property investors.
Based on experience, first time foreign investors tend to invest into the Australian property market in the traditional way by directly investing. This is primarily because of, for example, perceptions of “controlling” and “owning” the properties, perceived “efficient” profit repatriation mechanism, shortened statutory reporting timeframe (if multinational clients) etc.
However, there are a number of key issues associated with the traditional structure which we have discussed below.
Key issues with ‘traditional’ structure for inbound property investors
Distribution of profit
Generally speaking, foreign investors will be taxed on any income that is derived from the properties if there is a direct foreign ownership of the properties. That effectively means that the foreign investor will be liable for an Australia tax rate of between 30% to 45% on their share of the taxable income derived from the underlying properties, depending on the investment vehicle used.
To report their share of the taxable income, the foreign investor is required to apply for an Australian tax file number (TFN) and is required to lodge an Australian income tax return. Therefore, not only will foreign investors not be taxed at the top Australian tax rate without the benefit of the withholding tax regime, but also will be subject to extra compliance burdens.
Non-resident CGT withholding tax of 12.5%
When a foreign investor disposes of certain taxable Australian property, the purchaser is required to withhold an amount from the purchase price and pay that amount to the ATO. The foreign resident capital gains withholding threshold and rate for contracts entered into on or after 1 July 2017 are:
- for real property disposals where the contract price is $750,000 and above; and
- the withholding rate is 12.5%.
Effectively, that means the foreign investor (vendor) will only receive 87.5% of the sales proceeds instead of the full amount of the sales price, and they will need to wait until they lodge their income tax return, and claim a credit for the withholding amount paid to the ATO. Again, an Australian tax file number is required by the foreign investors.
The “preferred” structure for inbound property investors
Given the above comments, Australian inbound property investors may be advised to consider alternatives to the “traditional” structure. Unfortunately, there is no one universal structure that would be a perfect fit for all inbound investors because of their different tax profiles and commercial objects, however consideration will need to be given to balancing various objectives, such as profit repatriation, tax concessional treatment, asset protection and compliance burden.
One such example is using a 100% Australian special purpose company (i.e. New Co) controlled by the foreign investor. The incorporation of a local company not only makes it more efficient to set up and engage with local suppliers and financial institutions, there are also opportunities for tax efficiencies, which are discussed below.
“Better” tax rate for non-residents
Profits of the New Co may be repatriated back to overseas by a number of ways utilising the Australian imputation system and withholding tax system, which may reduce the effective tax rate below 30%. First, to the extent that the dividends paid/payable are fully franked, any profits from the New Co will be distributed to overseas with no withholding tax obligations Second, where dividends paid to overseas are not fully franked, dividend withholding tax will be applied based on double tax agreements that Australia has with the country where the ultimate shareholder is a tax resident there. The dividend withholding tax rate between Australia and some popular Asian countries is 15%, which is significantly lower than the Australian corporate tax rate of 30%.
The use of shareholder loan
Another way of repatriating profits back to overseas involves the use of shareholder loan. There should be no tax implications if the payment of the funds merely represents the payment of loan principal. For interest bearing loans, the interest withholding tax rate is at 10%, which is also significantly lower than the Australian corporate tax rate. However, it is important to ensure transfer pricing compliance issues and thin capitalisation are understood and planned for appropriately. One of the options is to access the simplified transfer pricing record-keeping for low-level inbound loans with a loan balance of less than $50m.
Less compliance burden for non-residents
As the withholding tax regime is the “last” tax in Australia, inbound property investors should have no Australian tax obligations.
There is no ideal structure. While the traditional property investment structure still offers merits for inbound property investors, it is perhaps timely to consider having a more efficient tax structure for properties to achieve better tax outcomes in Australia. For further guidance, download our Doing Business in Australia booklet.
This article was co-authored by Gloria Liang, HLB Mann Judd Melbourne