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6 March, 2018
Australia's foreign investment landscape has undergone significant change over the course of 2017. Some of these changes provide greater transparency and flexibility for foreign investors and streamline the Australian foreign investment framework. In this article, we take a look at some of these changes and what they mean for foreign investors.
Increased scrutiny of stapled structures
Ever since their introduction in the late 1980s, stapled structures (investment vehicles in which two or more securities are contractually bound or "stapled" together, such that they cannot be bought or sold separately) have been a common feature of Australia's investment landscape. A typical stapled structure used in Australia involves a passive asset-owning trust (which is taxed on a "flow-through" basis rather than as a company) and a related active operating company, whose respective units and shares are stapled together.
Despite their common usage as an investment structure, the Australian Tax Office (ATO) announced in January 2017 that it would be targeting certain stapled structures which attempt to artificially re-characterise active trading income into concessionally taxed passive income. Following the ATO's announcement, the Treasury announced in March 2017 that the Government would re-examine the effectiveness of the taxation regime as it applies to stapled structures and consider measures to remove the tax advantages of stapled structures.
Which stapled structures are affected?
In the review of stapled structures, the ATO has made clear that it is not concerned with Australian real estate investment trusts (A-REITs), which derive all or most of their rental income from unrelated third party tenants and certain privatisations of land (or land improvements) based business (although the ATO has indicated that it will continue to engage with privatisations on a case-by-case basis). The passive rental income generated by A-REITs should continue to be taxed on a flow-through basis.
The types of stapled structures which are currently in the ATO's crosshairs include:
(a) rental staples, in which an asset trust holds land or fixtures that are leased to the operating entity to operate its business. The nature of this business may not be divisible in any commercially meaningful way and typically involves transactions which third parties acting at arm's length would not ordinarily enter into; and
(b) synthetic equity staples, in which an asset trust and operating entity enter into an arrangement under which the operating entity pays profit equivalent or turnover equivalent amounts (or amounts which in substance have a similar effect to such payments) to the asset trust.
Investors who implement such arrangements (particularly in sectors such as hotel, aged care and student accommodation) should expect and be prepared for increased scrutiny from, and engagement with, the ATO. Foreign investors seeking approval from the Foreign Investment Review Board (FIRB) should also expect early engagement with the ATO as it is likely that FIRB will refer such cases to the ATO as part of the approval process.
The future for stapled structures?
The increased scrutiny of the ATO and Government on stapled securities has made clear that changes in Australian income tax legislation that affect existing and contemplated stapled arrangements are on the horizon. Although the consultation process on the stapled structures review ended in September 2017, the recommendations are yet to be released and there has been no clear policy guidance from the Government at this stage on the future treatment of stapled structures. In light of this uncertainty, it will be important for foreign investors to closely monitor the ATO's position on stapled structures and any further developments in this space.
Emerging asset class: build-to-rent
Changing social attitudes toward housing and renting (which reveal a growing preference in younger generations for mobile living over home ownership), the affordability of housing in gateway cities and the current focus of Australian planning regimes on encouraging density and maximising existing infrastructure, have all contributed to an increased interest in Australia in build-to-rent (also known as "multi-family" in the US and the "private rental sector" in the UK).
Build-to-rent is an asset class involving the ownership of residential property which is built to be owned by a single private or institutional investor and held for the medium- to long-term for rental income. Since the release of the 2017-18 budget, in which the Government announced it would be providing tax incentives to increase private and institutional investment in affordable housing, investors have shown interest in investing in the build-to-rent sector in Australia, particularly through the use of managed investment trusts (MITs) which attract a concessional withholding tax rate of 15% on passive income distributions to foreign investors tax resident in "exchange information" countries.
In September 2017, the Treasury released draft legislation aimed at addressing issues of housing affordability by providing incentives for investors to invest in affordable housing in Australia. The draft legislation promotes direct investment in affordable housing; for example, by providing an extra 10% capital gains discount (i.e., a total discount of 60%) for Australian resident individuals investing in affordable housing and by enabling foreign investors investing in affordable housing through MITs to access the concessional 15% withholding rate. However, it also has the effect of disqualifying a trust from having MIT status if it invests in residential property (but not commercial residential premises) other than affordable housing (other than for certain incidental use). The consequence of the draft legislation is that a trust cannot qualify for MIT status if it invests in a build-to-rent asset other than affordable housing (and commercial residential premises). The response from commentators and stakeholders to the draft legislation has been understandably mixed.
Industry bodies and investors are engaged and working with State and Federal governments to consider drivers that will have an effect on investment in this sector. The outcome of these ongoing discussions will determine whether build-to-rent has the potential of becoming a significant and established asset class in Australia – so watch this space.
Clarity on property surcharges
Surcharge stamp duty rates apply in New South Wales, Victoria, Queensland and South Australia to foreign persons who purchase residential property. The Western Australian government has also announced its intention to introduce a similar surcharge at the rate of 4% with effect from 1 January 2019. The rate of the surcharge ranges from 3% to 8%, and the definition of foreign persons and residential property differs from State to State. The good news for investors is that these surcharges do not apply to various categories of commercial residential property, which may include hotels, retirement villages and student accommodation.
New South Wales, Victoria and Queensland also impose a land tax surcharge on foreign absentee owners of land. The rate of the surcharge is 2% in New South Wales and 1.5% in Victoria and Queensland. The definition of a foreign absentee owner differs from State to State. In New South Wales, the surcharge only applies to residential land.
Victoria also imposes a vacant residential land tax of 1% of the capital improved value of taxable land in certain areas of Melbourne for residential land which is left unoccupied for six months or more in a calendar year. If residential property is subject to the vacant residential land tax, notification must be made to the Victorian State Revenue Office via their online portal by 15 January each year. Exemptions may apply.
An annual vacancy charge is imposed by the Commonwealth Government for vacant residential property held by foreign owners. The annual vacancy charge is equal to the relevant foreign investment application fee paid by the foreign investor for obtaining approval to purchase the residential property and applies to all foreign investors who make a FIRB application (or would be required to do so in the absence of an exemption certificate).
Foreign owners of residential property must now also keep occupancy records for a period of up to five years and report annually to the ATO, by lodging a vacancy fee return in respect of each residential property owned. These obligations apply even if there is no liability to pay the annual vacancy charge, and failure to submit the vacancy return will result in a deemed vacancy.
There is no liability to pay the annual vacancy charge where a property is occupied or genuinely available on the rental market for at least six months in a 12-month period. Accordingly, the annual vacancy charge should have limited application to institutional investors who are looking to invest in commercial residential assets (such as build-to-rent). The annual vacancy charge will be of greater relevance to foreign developers of residential property seeking to sell rather than rent and should be taken into account at the FIRB approval stage for the development.
Streamlining the Australian foreign investment framework
Changes introduced to the Australian foreign investment framework in recent times aim to clarify requirements, reduce regulatory burdens and simplify procedures for foreign investments. Outlined below is a summary of some of the key changes which took effect from 1 July 2017.
New business exemption certificate to cover a programme of acquisitions of interests
A new exemption certificate has been introduced which allows the acquisition of interests in the assets of an Australian business and/or securities in an entity. The exemption certificate allows for a foreign investor to obtain pre-approval for a programme of acquisitions, rather than having to make separate notifications in respect of each proposed action.
The new exemption certificate will likely be useful for foreign investors who are interested in investing in multiple interests over a specified period of time and should reduce the regulatory burdens and costs involved in making these kinds of applications.
New residential exemption certificate
A new residential exemption certificate has also been introduced by FIRB which allows foreign investors to seek broad pre-approval from FIRB for the purchase of a new dwelling or vacant land out of multiple new dwellings. Given the current development cycle in Australia, which has seen sustained interest in the development of apartments and mixed-use assets with a residential component, this exemption certificate may be of particular assistance to foreign investors looking to invest in residential property.
Property developers and vendors can apply for a new dwelling exemption certificate (NDEC), allowing them to sell new dwellings in a development to foreign purchasers without such purchasers having to obtain their own FIRB approval, provided that the development:
(a) is comprised of one or more multi-storey buildings;
(b) consists of 50 or more dwellings; and
(c) has received development approval and FIRB approval (if required).
As an NDEC relieves foreign purchasers from having to obtain their own FIRB approvals, developments with an NDEC in place are likely to be viewed as more attractive by investors. However, developers should be aware of the restrictions that apply to all applications for NDECs received and approved from 9 May 2017, which prevent developers from selling more than 50% of the total dwellings in the development to foreign persons.
Clarification regarding the treatment of commercial residential land
Prior to 1 July 2017, there was uncertainty regarding whether residential premises that have a commercial use should be treated as residential or commercial land for the purposes of notification under the legislation. With the recent changes to the Australian foreign investment framework, this position has now been clarified. The definition of commercial residential premises has been amended to include residential property types which are commercial in nature, including student accommodation, aged care facilities and retirement villages.
This is good news for foreign investors who are interested in these asset classes, given that acquisitions of an interest in residential premises that have a commercial use are now subject to the higher monetary thresholds for developed commercial land (being A$55 million or A$252 million, depending on the nature of interest in the land being acquired).
Solar and wind farms
From 1 July 2017, land that contains a wind or solar power station will be treated as developed commercial land rather than vacant commercial land where the wind or solar power station is on the surface of the land.
Where the land is yet to be developed as a solar or wind farm, it may be considered to be either agricultural land or developed commercial premises depending on the status of approvals in place for its use as a solar or wind farm.
Reduced red tape for foreign government investors in a consortium
Prior to the amendments, consortia containing foreign government investors were required to make separate notifications to FIRB for the acquisition of interests in an investment vehicle to fund the subsequent acquisition of an asset (which is notifiable) through the investment vehicle (even where the funding by investors is for the acquisition).
In order to streamline the notification process and reduce costs and red tape for foreign government investors, FIRB has confirmed that the acquisition of a direct interest in a consortium vehicle to effect a notifiable acquisition does not separately need to be notified.
For further information, please contact:
David Wang, Ashurst
david.wang@ashurst.com
