New ATO rule on property deals over $2 million will hurt Chinese buyers even more

As if the negative gearing debate wasn't enough before the election, on July 1, there is another shocker waiting for real estate agents and property owners around Australia trying to transact in property exceeding $2 million.

According to a new ATO rule that comes into effect July 1, all Australian sellers of $2 million-plus properties will be classified as overseas investors unless they get a special tax clearance. That means that all buyers of $2 million-plus properties must deduct 10 per cent from the purchase price and pay that amount to the Australian Taxation Office (ATO) unless the seller can furnish a tax clearance, according to a recent report in The Australian. 

While the move will affect everyone, including Australians, Chinese investors will be impacted more, especially when taken together with steps taken to squeeze Chinese buying in residential property. 

Chinese and Asian buying of Sydney apartments has already fallen 50 per cent in recent weeks and the trend is spreading to other markets, particularly Melbourne. 

The current measure can be traced back to the days when former treasurer Joe Hockey caved into pressures to curb Chinese investment in Australian residential property in 2015. In the process, the treasurer was convinced by the Australian Taxation Office to widen the net to cover local residents, says the report in The Australian.

According to an ATO fact sheet, in May 2013, the government announced that it would introduce a 10% non-final withholding tax on payments made to foreign residents who dispose of certain taxable Australian property with a market value above a specified threshold. The new legislation for this measure became law in February 2016.

The $2 million rule applies to vacant land, buildings, residential and commercial property, leaseholds and strata title schemes.

The ATO website says, "The government is strengthening our foreign resident capital gains tax (CGT) regime to assist in the collection of foreign residents' liabilities."

The definition of property is very wide and includes leaseholds but does not include stock exchange investments. A purchaser who does not receive a “clearance certificate” from the vendor and does not send 10 per cent of the purchase price off to the ATO will still be liable to pay that 10 per cent to the ATO plus, almost certainly, will have to pay severe additional penalties and interest. The economics of buying the property will be severely damaged, says the media report.

It suggests that real estate agents selling $2 million plus properties should study how this new tax regime would impact their business.

For example, banks and other financiers may be affected where their secured debt exceeds 90 per cent of the value of the selling price. In a situation where the owner is being forced to sell, the banks will be better to take possession and sell themselves rather than being caught in the “tax clearance” delays.

In the majority of cases, local resident vendors will have no problem obtaining a clearance certificate, but it might increase the risk of a tax audit for property sellers who:

• Have not filed tax returns for many years;
• Have filed tax returns, which would indicate they could not afford such a property;
• Are selling their residential house at the same time as their neighbours to a single developer, which may give rise to a profit making scheme (such that the principal residence capital gains tax exemption may not apply to the value uplift generated by selling the properties together); or
• Where the ATO has gathered information that indicates the vendor is in the business of developing property, which means that the principal residence capital gains tax exemption may not apply.

The post by Robert Gottliebsen says this might lead to a rush to sell before July 1 and might create some property bargains for buyers.

Another implication is that as property prices rise, more vendors will fall into the $2 million plus category. Over time, the ATO may shift their audit target identification processes to $2 million-plus property vendors and away from other areas.

Additionally, if the vendor has a tax debt, the application for a “clearance certificate” may in some circumstances involve the ATO seeking to recover some or all of that tax debt from the purchaser by way of a garnishee notice. 

While the report argues that the ATO's new rule will only help recover tax legitimately owed, the danger is in the complexity. 

The legislation is yet another blow for Asian investors in Australian property. Banks have already imposed a credit squeeze on Chinese property buyers.

On July 1, the Victorian state government is set to raise the levy on foreign purchases of apartments from 3 percent to 7 percent 

For a Chinese investor, getting a tax clearance would be tough, or else they would have to give off 10 percent off the transaction price.