The foreign resident capital gains withholding (FRCGW) regime has widespread implications for buyers and sellers of real estate in Australian, irrespective of whether you are resident of Australia for taxation purposes. Not fulfilling legal obligations in relation to a property transaction can result in heavy penalties for non-compliance.
Recent legislative changes extended the rules that now impacts arguably most real estate sales, so it has never been more critical for resident and non-resident taxpayers to be aware of their tax obligations if they are planning on buying or selling Australian property.
The FRCGW rules, which commenced on 1 July 2016 and significantly altered on 1 July 2017, impose a payment obligation on purchasers of certain taxable Australian property from foreign resident vendors.
Broadly, the purchaser is required to withhold 12.5% (previously 10%) 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 a $750,000 threshold, 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.
How did the FRCGW rules change on 1 July 2017
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 — hence likely to impact most real estate transactions now in those cities which means many more Australians impacted by these rules when they move house or purchase an investment property. - An increase in the withholding rate from 10 per cent to 12.5 per cent
The higher withholding rate of 12.5% means purchasers are liable for a larger payment than was previously the case — and larger penalties for non-compliance.
Why are Australian residents affected by the FRCGW rules?
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% 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 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.
What are the benefits of a resident vendor supplying a clearance certificate?
- 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% 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% of the 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 potential capital gains tax (CGT) event occurred
What are the penalties for non-compliance?
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.
What actions should be taken going forward?
By Vendors
A resident vendor/seller 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 done online via the ATO website or by us as your tax agent.
This certificate must be provided 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. Be warned that the current ATO policy is not to issue retrospective clearance certificates to vendors.
By Purchasers
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 conveyancer and real estate agent 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 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%. 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).
If unsure about any potential real estate acquisition or sale, please address the FRCGW rules with your solicitor/conveyancer in the first instance and definitely do not assume that the vendor is an Australian resident as the potential penalty can be enormous.
