2017 TAX EFFECTIVE SHARES & PROPERTY INVESTMENT BONUS ISSUE
WHAT’S NEW IN 2017?
Property Investors
- No deduction for travel/inspection expenses
- Changes to depreciation deductions
- -Temporary residents lose C.G.T. main residence exemption
- -Annual charge on foreign owners who leave properties unoccupied
- -Assisting first home buyers build a deposit inside superannuation
- -Expanding scope of C.G.T. withholding for foreign residents
- -Government to encourage investment in affordable rental accommodation
- -Purchasers of new properties or land subdivisions to remit G.S.T. directly to A.T.O.
- -Further commentary on land tax and stamp duty, primary production and the land tax exemption
In our last edition we covered the below property cases in some detail. These have been removed to our website.
- -Commissioner of Taxation V MBI Properties Pty Ltd (2014) HCA 49
- -Vidler V FCT: Residential Property
- -Vacant Land and G.S.T. – A Tap Is Not Enough
- –Corymbia Corporation Pty Ltd V Commissioner of Taxation (2010) AATA 401
- -Sunchen Pty Ltd V Commissioner of Taxation (2010) FCA 21
- -Commissioner of Taxation V Gloxinia Investments Ltd ATF Gloxinia Unit Trust
- -A F C Holdings Pty Ltd V Shiprock Holdings Pty Ltd (2010) NSWSC 985
- -Cyonara Snowfox Pty Ltd and Commissioner of Taxation (2011) AATA 124
- -Aurora Developments Pty Ltd V Commissioner of Taxation (2011) FCA 232 15 August 2011
- -ECC Southbank Pty Ltd As Trustee For Nest Southbank Unit Trust V Commissioner of Taxation (2012) FCA 795 31 July 2012
- -Craddon and Commissioner of Taxation (2011) AATA 790
NO DEDUCTION FOR TRAVEL EXPENSES
From 1 July 2017, the government will disallow deductions for travel expenses related to owning a residential investment property.
This is an integrity measure to address concerns that such deductions are being abused.
This will rein in a high growth deduction item and improve taxpayer confidence in the negative gearing system.
CHANGES TO DEPRECIATION ON SECOND HAND PROPERTIES
The Government will also confine plant and equipment depreciation deductions for items that can be easily removed, such as carpets and dishwashers and
only to those expenses actually incurred by investors.
Here the plan is to no longer allow subsequent owners of property to claim deductions on items purchased by the previous owners of the property.
There was some concern that such assets were being depreciated in excess of their actual values by successive investors. In effect this is an integrity
measure.
These changes are to apply on a prospective basis, with existing investments grandfathered. Plant and equipment forming part of residential investment
properties as of 09/05/2017 will continue to give rise to deductions for depreciation until either the investor no longer owns the asset, or the asset
reaches the end of its effective life.
Investors who purchase plant and equipment for their residential investment property after 09/05/2017 will be able to claim a deduction over the effective
life of the asset. However, subsequent owners of a property will be unable to claim deductions for plant and equipment purchased by a previous owner
of that property.
CHANGES TO C.G.T. RULES FOR NON RESIDENTS AND TEMPORARY RESIDENTS
The capital gains tax (C.G.T.) rules will been changed to reduce the risk that foreign investors avoid paying C.G.T. in Australia, including by no longer
allowing foreign or temporary tax residents to claim the main residence C.G.T. exemption, and by expanding the scope of the C.G.T. withholding system
for foreign residents;
Safeguarding the opportunity for Australian buyers to purchase in new developments by introducing a 50 per cent cap on pre-approved foreign ownership in
new developments;
CHANGE ON FOREIGN OWNERS
Foreign owners of residential real estate will be encouraged to rent their properties out by applying an annual charge of at least $5,000 (reflecting the
original application fee) to foreign owners who leave their properties unoccupied or not available for rent for 6 months or more each year.
FIRST HOME OWNER SAVINGS SCHEME
From 1 July 2017, individuals can make voluntary contributions of up to $15,000 per year and $30,000 in total, to their superannuation
account to purchase a first home.
These contributions, which are taxed at 15 per cent along with deemed earnings, can be withdrawn for a deposit. Withdrawals will be taxed at marginal tax
rates less a 30 per cent offset and allowed from 1 July 2018.
While the measures are designed to help individuals save for a home, it may also have the unintended consequences of encouraging younger taxpayers to be
more engaged with their superannuation fund. Hopefully we’ll see focus on the investment return and fees charges, instead of the usual approach of
ignoring superannuation because the benefits are many decades away.
Also the change to superannuation to allow access to funds to buy housing will see changes to the sole purpose test and preservation rules in the Superannuation
Law. Close attention should be paid to how these changes are implemented.
Example: Louise earns $60,000 a year and wants to buy her first home.
Using salary sacrifice, she annually directs $10,000 of pre-tax income into her superannuation account, increasing her balance by $8,500 after the contributions
tax has been paid by her fund. After three years, she is able to withdraw $27,380 of contributions and the deemed earnings on those contributions,
after withdrawal tax, she has $25,760 that she can use for her deposit. By using this scheme, Louise has saved around $6,240 more for a deposit that
if she had saved in a standard deposit account.
SUPERANNUATION CONCESSION FOR DOWNSIZERS
From 1 July 2018, people aged 65 and over will be able to make a non-concessional (post-tax) contribution into their superannuation of
up to $300,000 from the proceeds of selling their home.
This measure will apply to a principal place of residence held for a minimum of 10 years. Both members of a couple will be able to take advantage of this
measure for the same home, meaning $600,000 per couple can be contributed to superannuation through the downsizing cap. These new contributions will
be in addition to any other voluntary contributions that people are able to make under the existing contribution rules and concessional and non –concessional
caps.
Example: George and Jane, both retired and aged 76 and 69, sell their home to move into more appropriate accommodation.
The proceeds of the sale are $1.2 million. They can both make a non-concessional contribution into superannuation of $300,000 from the sale proceeds ($600,000
in total); even though Jane no longer satisfies the standard contribution work test and George is over 75. They can make these special contributions
regardless of how much they already have in their superannuation accounts.
FOREIGN INVESTMENT REGIME CHANGES
The Budget includes measures that appear to be intent on increasing the supply of new residential housing available to Australian residents by:
- placing a 50 per cent cap on foreign ownership in new developments (applied through conditions imposed on New Dwelling Exemption Certificates); and
- charging foreign resident owners of residential properties an annual charge if the property is not occupied or available to rent for at least six months
each year.
The latter change has the benefit of either deriving revenue from the annual charge or revenue from income tax on forced rental of Australian investment
properties. A win-win for the revenue.
PROPOSED CHANGES TO IMPACT DEVELOPER CASH FLOW AND LENDER SECURITY
The May 2017 Federal Budget contained a proposal to shift the responsibility of remitting G.S.T. on new residential sales from property developers to purchasers.
From 1 July 2018 purchases will be liable to pay the G.S.T. on the sale directly to A.T.O.
It is obvious the change will have an adverse impact on developers’ cash flows. Depending on the date of settlement this could be felt for up to 50 days.
Lenders will be impacted as well
Current situation
- Developers claim G.S.T. input tax credits on expenses during the course of a development.
- They then pay G.S.T. on sales settled, under the Ordinary Method or the Margin Scheme (the most common method).
- The entity that completes the sale is responsible for remitting the G.S.T.
- A secured lender enforces its security on default as mortgagee in possession or through a Receiver; it then has the liability for G.S.T. payable on
sales.
Currently, where developers have financial difficulties, the lenders preferred position is to maintain a watching brief. This leaves the developer to settle
as many sales as possible while the lender insists on full net proceeds of sales in reduction of the secured debt. Payment of the G.S.T. liability
is deferred and a secured lender will then reduce the loan to value ratio (LVR) to the full extent possible.
If the secured lender is repaid, the distressed developer still has an incentive to defer the payment of G.S.T. on sales preferring other unsecured creditors.
For example, the directors of the development entity may have personal guarantees to some creditors or they may prioritise repayments on related party
loans, or pay builders and consultants rather than the A.T.O.
If a developer then suffers an external appointment, the A.T.O. will rank equally with other unsecured creditors, for the developer’s G.S.T. liability.
Any ‘preferred’ creditors (i.e. those that received payment ahead of the A.T.O.) may be exposed to a preference recovery action by a subsequently appointed
liquidator.
The changes announced in the Budget prevent this, allowing the A.T.O. a super-priority above all other creditors, even those lenders that have security
over the development.
These changes will hurt developers’ cash flow placing increased pressure on struggling developers to enter into external administration.
The incentive for a secured lender to adopt a watching brief over a struggling developer will effectively disappear. As sponsor risk is such a key risk
in property development, lenders may choose to “appoint” earlier in the workout phase to avoid further risk.
Properly developers will need to be very circumspect in their dealings with lenders and will need to take specialist advice.
It is essential for developers to work closely with their secured lenders and resolve any questions of ongoing viability in a transparent manner.
And Government Affordable Housing
The Government will encourage private investment in affordable rental accommodation for low to moderate income households through a range of new incentives.
Private investors will be encouraged to invest in new and existing affordable housing. From 1/01/2018, investors, in qualifying for affordable housing,
will be entitled to a 60 per cent discount on capital gains if they hold the investment for a minimum of three years in aggregate. To qualify for the
discount, housing must be provided at below market rent, and made available for tenants on low to moderate incomes and be managed by a registered community
housing provider, From 1 July 2017, Managed Investment Trusts will be able to be set up to acquire, construct or redevelop property to hold as affordable
housing. This will incentivise foreign and domestic investors to invest in affordable housing.
A new National Housing Finance and Investment Corporation (NHFIC) will be established by 1 July next year to provide long term, low cost finance to community
housing providers for affordable housing projects. This will also assist in attracting large scale investors, including superannuation funds, into
the affordable rental sector.
The Government will enable direct deduction of rent from welfare payments of tenants in public and community housing of States and Territories, and will
provide greater income certainty for investors in this type of rental accommodation.
These measures will also support State, Territory and local governments imposing inclusionary zoning requirements on new development sites.
TOP EIGHT TIPS FOR INVESTMENT PROPERTIES
Start thinking about these issues now; not just prior to tax year end being 30 June.
The Importance of Good Records
Keep all documentation summaries of all your rental income and expenses.
This documentation should be kept for at least 5 years.
Depreciation
Generally only registered quantity surveyors are authorised to prepare eligible depreciation schedules for purchases of new property. Builders and cost
schedules are also allowable.
In the event you are doing a renovation a quantity surveyor can produce a scrapping schedule, which puts a value against all items to be discarded. Also
refer to our article on demolitions. This value is expensed in the year of expenditure. The new items are then depreciated in a new depreciation schedule.
Also note that each investor has their own depreciation cost limit – currently $300 – see our article on page 28
This is relevant where properties are owned by more than one person.
Interest Expenses
Only interest expenses on borrowed funds used to invest in an asset that produces assessable income can be deductible. This is known as the ‘use’ test
as consistently applied by the Courts.
A split line of credit should be considered when a loan is used for both investment and private purposes.
If capitalising interest on the investment line of credit, the A.T.O. may require evidence of correct documentation and intention.
In this area you will need to seek specialist advice. However, split loans have their place to avoid the merging of personal (non-deductible) and investment
(deductible) debt.
Pre-pay Expenses
If you have a geared investment consider pre-paying next year’s interest to gain an immediate tax deduction.
You could prepay insurance and bring forward expenditure.
Home Office
Consumables used as you work on your investment property may be a tax deduction. The A.T.O. provides an hourly rate for energy costs. Also you may claim
a modest percentage of internet costs along with printing and stationery costs. Telephone calls relating to these activities are also deductible.
Apply for a PAYG Variation
If you have purchased a negatively geared investment you may have your PAYG deductions reduced to allow for the losses being incurred.
You can request the A.T.O. to provide a PAYG variation certificate to give to your employer for reduced PAYG deductions. Alternatively, you will receive
the refund of the additional tax paid on lodgement of your income tax return.
Minimise Capital Gains
Taxable capital gains realised during a tax year may be minimised by an offset against capital losses or trading losses incurred during that same tax year.
To reduce a capital gain generated on sale of property or other assets during the year, consider disposing assets which have lost value and have a bleak
future.
The 50% discount on capital gains is available where an asset is held for longer than 12 months so carefully consider the timing of any sale, noting that
relevant dates for calculating capital gains and eligibility for the discount is the contract date, not the settlement date.
Record those Capital Losses
Capital losses incurred in a given year may be indefinitely carried forward to future years if there are insufficient gains to absorb it in the current
year.
Note however, capital losses may not be offset against normal income such as salary or business trading income. In the event you have made a capital gain,
review your share and property portfolio to consider realising a capital loss to offset the gain.
Capital losses cannot be carried back to prior years. Refer to Issue #85 February 2017 tax tip #17 which outlines the importance of a C.G.T. Asset Register.
Trusts
The use of a trust improves asset protection, estate planning and allows increased flexibility for property investors – see Issue #088 August 2017 pages
19-25.
Ensure the Trust has been formed correctly to ensure you do not lose interest deductibility, normally fully allowable by the A.T.O. providing the requirements
are met.
G.S.T. “CHANGE OF USE” ADJUSTMENT RULES RELEVANT TO PROPERTY DEVELOPERS
An adjustment is a change that increases or decreased your net G.S.T. liability for a reporting period. There are two types of adjustments:
Increasing adjustments – these increase your net G.S.T. liability for a reporting period
Decreasing adjustments – these decrease your net G.S.T. liability for a reporting period
You may need to make an adjustment on your activity statement in relation to G.S.T. credits you have previously claimed if you use your property differently
from the way you originally planned – for example, if you have rented a residential premises that you planned to sell. You would need to make an adjustment
in these circumstances as the G.S.T. credits you have previously claimed in relation to the construction or development of the residential premises
you may have been too much based on your actual use. You will also have an adjustment if you originally planned to rent but have sold
residential premises that form part of your business or enterprise.
Information you need to work out change in use Adjustments
To be able to calculate change in use adjustments, you will need certain information including:
When you made your purchase
The G.S.T.-exclusive market value of each of your purchases
What G.S.T. credits you claimed when you made the purchases
The tax period in which you claimed the G.S.T. credits on your purchases
Any previous adjustments you have made relating to the purchases
Any details of you holding or marketing the property for sale (for example the listing agreement with your real estate agent or advertising material)
A reasonable estimation of the selling price (if the property has not sold)
What you have used the residential property for, including the period for which you have rented the premises or used the premises for private purposes
The amount of any rent you received (if they have been rented)
The date when you sold the property, and the amount you sold it for.
INCREASING A.T.O. FOCUS ON PROPERTY DEVELOPERS
Recently the A.T.O. has been using more ways of detecting goods and services tax (G.S.T.) avoidance on property sales, including property data matching
from the Office of State Revenue and Land Titles Data.
The A.T.O. is also using data matching and analysis to ensure property developers are correctly reporting G.S.T. on property sales.
The A.T.O. has made it clear that this activity will continue in 2017 with increased focus on their enhanced data matching capacities.
Property developers who try to avoid declaring G.S.T. on the sale of property are more likely than ever to be contacted by the A.T.O.
The A.T.O. has increased their focus on property developers who intentionally avoid their G.S.T. obligations, or claim G.S.T. credits on properties they
purchase and avoid lodging an activity statement after they later sell them.
In a recent case, a property developer purchased rural farmland and subdivided it into residential lots for the purpose of sale.
Through the data matching activities, the A.T.O. identified over 100 sales that were made by the same developer.
The main issues in this case were:
omitted G.S.T. income of approximately $1 million
default assessments (due to non-lodgement) of $5 million
overstated G.S.T. credits of $200,000.
The developer was found to have not reported the property sales and the A.T.O. charged the highest penalty applicable, amounting to approximately $4.5
million.
Every property transaction may have a tax consequence you need to report.
PROPERTY DEVELOPERS – THRESHOLD ISSUES
We have covered “the Accidental Developer” elsewhere in this edition. On the issue of isolated transactions, both accountants and business owners register
entities by overlooking section 188-25 of the G.S.T. Act i.e. transfer of capital assets and termination etc of an enterprise to be disregarded.
Example 3 in GSTR 2001/7 (Goods and Services Tax: Meaning of G.S.T. Turnover, including the effect of Section 188-25 on projected G.S.T. Turnover) explains
this.
Example 3: Sample calculation of current G.S.T. turnover and projected G.S.T. turnover
Alan, a retiree, owns all three shops located next to a suburban railway station. Each of the shops is rented to tenants whose weekly tenancies are to
terminate on 14 December 2001. The rent payable for each of the three shops is $200 per week. The railway department is planning an expansion of the
station. Alan sells the shops with vacant possession to the railway department for $200,000. Alan’s only enterprise is renting the shops. He is not
registered for G.S.T. He is not intending to carry on any other enterprise in the next 12 months. Settlement is to take place on 20 December 2001.
Alan’s current G.S.T. turnover as calculated in December 2001 is the sum of the values of all the supplies that he has made or is likely to make during
the 12 months ending on 31 December 2001. Alan has no supplies that are excluded under section 188-15 or 188-20 (such as input taxed supplies).
Alan’s current G.S.T. turnover is 50 weeks rent of $600 per week (up to 14 December 2001) plus the $200,000 from the sale of the shops. That is, a total
of $230,000. Alan’s current G.S.T. turnover is above the registration turnover threshold.
Alan’s projected G.S.T. turnover is the sum of the values of all the supplies that Alan has made or is likely to make in December 2001 and up to 30 November
2002. Alan has made or will make supplies of 2 weeks rent of $600 per week (up to 14 December 2001) plus the $200,000 from the sale of the shops. His
projected G.S.T. turnover calculated under section 188-20 is $201,200.
In selling the shops, Alan will dispose of a capital asset in addition to ceasing to carry on his enterprise. Although the supply satisfies the conditions
under both paragraph 188-25(a) and 188-25(b), those proceeds are excluded only once when calculating projected G.S.T. turnover. (Refer to paragraph
30.) Alan can disregard the $200,000 from the sale of the shops. Alan calculates his projected G.S.T. turnover as $1,200. As Alan has calculated his
projected G.S.T. turnover on a reasonable basis to be below the registration turnover threshold, his G.S.T. turnover does not meet that particular
turnover threshold. He is not required to register for G.S.T.
However, we are still seeing accountants making registrations which are not necessary.
COMMON G.S.T. ERRORS FOR DEVELOPERS
In a typical development where full input tax credits are claimed we see four common mistakes.
A Failure to Adjust for a change in ‘Creditable Purpose’ from Selling to Renting
This is not an uncommon situation where the developer is not able to dispose of stock units at the desired price. A choice may be made to rent out some
units.
Note I.T.Cs have been claimed on the basis the units were to be sold, refer to Division 129 of the Act.
The fundamental question Division 129 asks is ‘was the G.S.T. position applied to earlier transactions reflective of how the acquisition was put to use.’
Clearly adjustments will be required for premises that have for a period of time derived rent. A.T.O. data matching techniques are increasingly identifying
these situations.
In the event an adjustment is made there is failure to consider a potential dual use application
Where Division 129 adjustments are made by the Taxpayer there is sometimes a failure to consider a dual use application. We refer you to GSTR 2009/4 and
the formula outlined in Paragraph 83.
This could result in substantial savings.
In order to sustain a dual use intention a taxpayer must on an objective assessment of the facts and circumstances demonstrate that there was and still
is a genuine intention that relevant properties be sold.
Paragraph 45 of GST 2009/4 outlines some relevant factors.
Incorrect Interpretation of the 5 year ‘Residential Accommodation’ use ‘Carve Out’ from the definition of New Residential Premises
If you have taken advantage of a dual use application to minimise the input tax credits clawed back, then you cannot expect to have your cake and eat it
too.
Refer to section 40-75 (2) ‘Meaning of New Residential Premises for the 5 year rule.’ Once again GSTR 2009/4 provides guidance on the Commissioner’s view
which is where dual use premises are involved, then the premises will have been used for a purpose other than input taxed residential premises. The
A.T.O. view is that where the dual use of the premises continues, then the 5 year rule cannot apply.
A failure to take into account the Application of Division 135 to an Acquisition
Division 135 is an integrity measure which provides for an adjustment to ensure a proper accounting for G.S.T. that is in proportion to the private or
input taxed use of the property that is acquired.
This may happen when a bundle of residential premises are acquired such as residential complex (refer to MBI Properties).
Another example would be the acquisition of a retirement village.
The message here when claiming input tax credits on making adjustments is that big dollars equals big risk particularly where the accountant or the business
owner enters unchartered waters – seek professional advice.
NEW RESIDENTIAL PREMISES AND G.S.T.
The A.T.O. have advised that if you are registered for G.S.T. and have constructed new residential premises that you originally intended to sell but have
since rented out, you may need to make an adjustment in your next Business Activity Statement.
If you constructed new residential premises which you intended to sell as part of your business, then the premises have been constructed for a creditable
purpose – G.S.T. credits can generally be claimed on things which are acquired for a creditable purpose.
If your use of the property changes – for example, you rent instead of sell – so does the creditable purpose. The renting of the premises is input taxed
and is not for a creditable purpose.
If you have a change in creditable purpose, you will need to make an adjustment to the amount of G.S.T. credits originally claimed. An increasing adjustment
will increase your G.S.T. liability for the tax period, while a decreasing adjustment will reduce your G.S.T. liability.
Adjustments for the change in creditable purpose are often made over a number of years and are generally recorded in June activity statements.
If you find you have creditable purpose adjustment for property transactions that you didn’t report, you should complete a Voluntary disclosure.
If you review your activity statements and report any mistakes voluntarily, you won’t have to pay any shortfall penalties, and any general interest charges
(GIC) will be reduced to the base rate.
VALUATIONS AND THE G.S.T. MARGIN SCHEME
In January 2012 the A.T.O. published a “Valuation Issues Paper” in collaboration with the Australian Property Institute and the Australian Valuation Office.
The current requirements for approved valuations for G.S.T. margin scheme calculations should be considered in the light of this issues paper.
There are several situations in which calculations of G.S.T. payable under the margin scheme for supplies of real property under Division 75 of the GST
Act 1999 require an “approved valuation” of a property interest as a 1 July, 2000 or some a later date when a particular event occurs (e.g. the date
of G.S.T. registration).
Section 75-35 allows the Commissioner to determine in writing the requirements for making such a valuation and has issued a number of legislative determinations
in this regard – see MSV 2009/1 applying to sales or real property from 1 March, 2010. Typically a taxpayer will adopt Method 1 of engaging a professional
valuer.
Paragraph 13 of MSV 2009/1 lists various requirements for a valuation by a professional valuer to be an approved valuation for the purposes of Division
75.
The decision of the Federal Court in the Brady King case is authority for the Commissioner being able to challenge margin scheme valuations (i.e. where
the Commissioner considers the valuation is too high so the G.S.T. payable is too low) where the terms of the applicable legislative determination
have not been complied with.
The message here is clear – if you are applying the margin scheme seek specialist advice which carefully considers the “valuation issues paper.”
FOREIGN RESIDENT CAPITAL GAINS TAX WITHHOLDING
Since 1 July 2016, the foreign resident capital gains tax withholding regime has been in force.
From 1 July 2017, the withholding rate that a buyer must pay to the Australian Tax Office on purchase of real estate assets from a foreign resident seller
increased from 10 percent to 12.5 percent. The threshold values at which the laws apply have also reduced from $2 million to $750,000.
This regime impacts not only upon purchasers of real property but also purchasers of shares in non-listed property rich companies and purchases of units
in unlisted property trusts.
The definition of property includes both residential and commercial real property, leasehold interests and mining, quarrying and prospecting rights.
Property acquisitions
If you are a purchaser of property for more than $750,000 then you must withhold unless the vendor shows you a clearance certificate or a variation certificate. An exemption is available where the vendor is in financial distress as defined (e.g. administration) but
in such cases specialist advice should be sought.
The legislation makes it clear that the clearance certificate should be valid