This update provides an overview of the key Australian taxation developments in 2020 that impact on foreign investment in Australian real estate. While the Australian Federal and State Governments have focussed on expenditure measures to stimulate the economy this year, due to the significant impact of COVID-19, there are still a number of important tax developments that foreign investors and managers should be aware of in relation to their existing and future investments in Australia. We are optimistic that 2021 will see growing interest and foreign investment into the Australian real estate sector as the global economy gradually recovers from COVD-19.
Federal Income Tax Developments
Inbound investment and funding structures
Debt and equity structuring – Taxpayer Alerts
- In May 2020, ATO released Taxpayer Alert TA 2020/2 in relation to the use of debt instruments with equity-like returns by foreign investors in Australian assets. The ATO raised concerns with the transfer pricing and withholding tax benefits (as well as FIRB approval avoidance) sought under such arrangements, which attempt to “mischaracterise” the structure used by foreign investors. The ATO has increased its scrutiny of and audit activity for such structures.
- In August 2020, ATO released Taxpayer Alert TA 2020/3 in relation to the use of interposed entities between an Australian trust and a foreign investor, where the interposition and relevant features are not supported by commercial rationale. The ATO raised concerns with such arrangements giving rise to withholding tax and/or income tax avoidance, transfer pricing, thin capitalisation and other tax concerns. The ATO has increased its scrutiny of and audit activity for such structures.
Hybrid mismatch rules
- In August 2020, Australia’s hybrid mismatch rules were amended, including mostly retrospective clarifications relating to the application to trusts and partnerships, deducting hybrids, dual inclusion income rule, corresponding foreign hybrid mismatch rules, foreign income tax, MEC groups, and integrity rule for financing arrangements.
- By way of background, from 1 January 2019, Australia’s hybrid mismatch rules came into effect. From a funding/financing perspective, these rules incorporate the OECD’s BEPS Action 2 with additional integrity rules (such as the targeted integrity rule addressing the interposition of low-tax jurisdiction entities in a financing structure).
Gearing level – thin capitalisation
- In March 2020, ATO finalised Taxation Determination TD 2020/2, which concerns the requirement that an entity needs to comply with accounting standards in calculating the value of its liabilities (including debt capital). ATO provides its views that an entity’s debt capital must be valued in its entirety in the manner required by the accounting standards regardless of whether it comprises debt interests that are classified as financial liabilities, equity instruments or compound financial instruments under the accounting standards.
- In August 2020, ATO finalised its guidance on the arm’s length debt test (ALDT), which is an alternative test to the safe harbour debt amount of 60% LVR, for the thin capitalisation rules – Taxation Ruling TR 2020/4 and Practical Compliance Guideline PCG 2020/7. In these guidelines, the ATO provides its view that the ALDT is generally only available in limited circumstances, so taxpayers will need to provide stronger economic and financial support where it seeks to rely on the ALDT.
Tax aspects of foreign investment approval reforms
Proposed reforms to foreign investment regime
- New foreign investment approval rules will be implemented in Australia from 1 January 2021. The new legislation implements substantial reforms to Australia’s foreign investment review board (FIRB) approval regime, including new national security tests, ‘call in’ and other review/enforcement powers, and a new register of foreign ownership. Importantly, the financial value thresholds for foreign investment approval (which were temporarily removed due to COVID-19) will be reinstated.
- Some of the key tax considerations for the proposed foreign investment approval regime include:
- How the “foreign control or influence” tests in the FIRB regime will impact on the Australian tax implications arising from such influence, control or participation – (e.g. certain withholding tax exemptions, capital gains tax (CGT) on exit).
- How information provided for the proposed register of foreign ownership and ownership tracing for unincorporated limited partnerships could be used by the ATO for assessing partners up the ownership chain for Australian tax.
- The proposed amendments will allow protected information to be disclosed to the Commissioner of Taxation (including for purposes of advising the Treasurer about FATA administration), Ministers for tax policy purposes and foreign governments and authorities where certain requirements are satisfied.
Tax conditions to FIRB approvals
- FIRB updated its Guidance Note 47 – Tax Guidance, which provides FIRB’s guidance on tax conditions typically attached to FIRB’s approval of a foreign investment into Australia. The key changes to the Guidance Note include the insertion of additional tax conditions requiring an applicant to provide FIRB and the Australian Taxation Office detailed information relating to structures, investors and expected tax outcomes, a non-legally binding tax risk notification mechanism, and updated required wording for an applicant’s compliance report on tax conditions.
MIT related changes
Stapled structure and related reforms
- ATO finalised Law Companion Ruling LCR 2020/2 to clarify the application of the non-concessional MIT income rules. The LCR also includes the ATO’s views on the factors – including a trustee’s intention, both at acquisition and whilst the land is held – relevant in determining whether a trust acquired land primarily for the purposes of deriving rent.
- By way of background, the non-concessional MIT income rules provide that: from 1 July 2019 (subject to certain transitional rules for existing structures), certain income derived by MITs will no longer be eligible for the 15% MIT tax rate; rather, withholding tax will apply at 30% in respect of the following types of income:
- MIT cross staple arrangement income;
- MIT trading trust income;
- MIT agricultural income; and
- MIT residential housing income.
- Broadly, these types of income are considered “active” business income and thus should not be eligible for the MIT rate. Rental income from commercial and industrial real estate continues to be eligible for the 15% WHT.
ATO audit activity in 2021
- The ATO had previously announced that it had planned to conduct increased tax audit and reviews of MIT eligibility in Q3 2020, but has postponed these to 2021 due to COVID. Thus, operators of MIT structures in Australia should ensure they have sufficient evidence to support their annual satisfaction of the MIT requirements.
Expansion of exchange of information countries
- Announced as part of Australia’s 2020/21 Federal Budget, the list of Exchange of Information countries (which qualify for the 15% MIT rate) will be expanded from 1 July 2021 to include Dominican Republic, Ecuador, El Salvador, Hong Kong, Jamaica, Kuwait, Morocco, North Macedonia and Serbia. Kenya will be removed from the list.
Deferred start date of removal of CGT discount for MITs
- Legislation remains to be developed that would (as first announced in the 2017-2018 Federal Budget) prevent MITs and attribution MITs (AMITs) from applying the 50% CGT discount at the trust level. Rather, any eligible investors (e.g. Australian resident individuals) will claim the discount in their own tax returns.
- The Australian Federal Government announced a revised start date for this proposal. The original start date was 1 July 2020. The revised start date is such that the measure would apply to income years commencing on or after 3 months after Royal Assent of the enabling legislation.
Other international taxation changes
Corporate collective investment vehicles
- Legislation remains to be developed, further to exposure draft legislation for the corporate collective investment vehicles (CCIV) including draft tax rules, as originally announced by the Australian Federal Government in January and February 2019. In summary, the corporate CCIV is intended to be a corporate vehicle that has the equivalent tax treatment to Attribution MITs.
Significant global entity (SGE)
- The definition of SGE has been expanded to include large multinational groups headed by certain investment entities, private companies, trusts and partnerships. This applies to income years commencing on or after 1 July 2019.
- For background, SGEs (with global revenue of over AUD1 billion) are subject to specific anti-avoidance rules (e.g. the Diverted Profits Tax), increased penalties and enhanced transfer pricing documentation obligations in Australia.
ATO Infrastructure Framework
- The ATO’s updated Infrastructure Framework remains to be released. ATO had previously confirmed that it will update and publish its Infrastructure Framework (draft from 2017) in early 2020. This framework includes key guidelines that the ATO will apply to the infrastructure sector as well as other investment sectors, include in respect of the meaning of “control” for Division 6C public trading trust purposes (which is relevant for MIT status).
Taxation of trustees of non-fixed trust
- There has been a number of tax cases concerning the taxation of non-fixed trusts. This includes Peter Greensill Family Co Pty Ltd (trustee) v Commissioner of Taxation (2020) FCA 559, in which the Federal Court held that a trustee of a non-fixed trust was liable to Australian income tax on the trust’s capital gains made from its sale of shares by the trust, even though those shares were not “taxable Australian property” and all capital gains had been distributed to a foreign resident. Mostly all Australian property trusts are structured as fixed trusts (e.g. unit trusts), but these cases will be relevant for any non-fixed trust structures used in Australia.
Australian tax residency for foreign incorporated companies
- The Australian Government has announced legislative amendments to clarify the corporate residency test to foreign companies.
- The law will be amended to provide that a company that is incorporated offshore will only be treated as an Australian tax resident if it has a “significant economic connection to Australia”. This test will be satisfied where both the company’s core commercial activities are undertaken in Australia and its central management and control is in Australia.
Australian TP rules incorporated latest OECD Guidelines
- Australia’s transfer pricing legislation has been updated to incorporate the latest 2017 version of the OECD’s Transfer Pricing Guidelines.
State Taxes Developments
New South Wales
- November 2020: Started public consultation process to abolish stamp duty and land tax, and replace with broader annual property tax.
- 2020 tax year: Land tax reduction of 25% for landlords with commercial tenants, where savings are passed on to tenants affected by COVID.
- 2021 tax year: Land tax relief will be limited in relation to small retail tenants only (less than AUD5 million annual turnover).
- 50% land tax reduction and foreign owner surcharge exemption for build-to-rent developments, up to the year 2040.
Queensland
- Land tax reductions (of up to 25%) for 2020 and 2021 years for eligible landlords, where savings are passed on to tenants affected by COVID.
- 2021 tax year: Land tax surcharge of 2% for foreign owners takes effect (deferred 1 year due to COVID)
South Australia
- Land tax deferral (up to 6 months) and 25% reduction for periods up to 30 April 2021 for eligible landlords.
Tasmania
- 2021 tax year: Land tax exemption available for owners of commercial property adversely financially impacted by COVID.
Victoria
- 50% land tax reduction and foreign owner surcharge exemption for build-to-rent developments, up to the year 2040.
- 50% stamp duty reduction for commercial and industrial property purchased in rural/regional Victoria from 1 January 2021.
- Land tax reductions (of up to 50%) for 2020 and 2021 tax years for eligible landlords, where savings are passed on to tenants affected by COVID.
Western Australia
- Land tax rebate for 2020 tax year. Eligible landlords can receive cash payments equal to up to 25% of their land tax liability in relation to small business tenants.