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1 REAL ESTATE INVESTMENT in Australia2 3 Contents FOReWoRD 4 Overview of the Australian Legal System 6 Purchase and Sale of Real Estate 7 Forms of ownership 8 Regulation of foreign investment 8 Investing in Australian real estate 9 Foreign government-related investments 10 Process 10 The contract 11 The due diligence process 11 Title insurance 13 Closing and registration 13 Financing of commercial real estate 13 Taxation of Real Estate Investments 14 Overview of the Australian taxation system 15 Tax benefits of owning Australian real property 16 Types of entities 17 Importance of treaties 18 Investment through loans 18 Taxation of equity investments 18 Direct equity investment 19 Equity investment through an Australian corporation 19 Equity investment through a foreign corporation 20 Equity investment through an Australian partnership 20 Equity investment through an Australian Managed Investment Trust 20 Goods and services tax 20 State and local tax considerations 22 Investment Vehicles 24 Key selection considerations 25 Types of corporate entities 25 Leases 28 Understanding leases 29 Commercial leases 29 Residential leases 29 Registration 29 Basic terms of commercial leases 29 Additional concepts in commercial leases 30 Retail leases 31 Construction 32 Contracts 33 Infrastructure in Australia 33 Obligatory requirements 33 Liability 34 Insurance 35 Security of payment 35 Handling disputes 36 Environmental Regulation and Development Approval 37 Planning laws 38 Heritage 38 Environmental laws 38 Climate change policy and regulation 39 Energy efficiency and green buildings 39 Real Estate Financing 40 Financing terms 41 Security 41 Mezzanine finance 41 USEFUL SITES 434 4 DLA Piper5 foreword Real estate markets globally have been severely affected by ongoing unprecedented economic turmoil, particularly in Europe and the United States. This is expected to continue. The Australian real estate market has, in this time, emerged as a destination of choice for global real estate investors seeking a safe haven in a well-regulated and highly transparent growth-oriented market for doing business. Uniquely, across most sectors, Australia has performed well over this time and is widely viewed as a stable market offering discerning foreign investors historically favourable pricing. Compared to many of their home markets, Australia offers investors exposure to one of the few economies, globally, to be on a growth trajectory. This recognition has led to an increasing number of new foreign investors entering the Australian real estate market, to the point that foreign-sourced capital is now the dominant source for Australian real estate investment. As a well-regulated, stable and transparent market, Australia offers a platform that allows new foreign investors to embrace the globalisation of real estate capital with confidence. As global capital flows shift from low-growth markets and sectors, we at DLA Piper are where our clients want to be. This legal guide demonstrates our commitment to ensure international clients access the intellectual property, seamless service and local market knowledge of our unique global Real Estate Group. As with all markets, investors must have access to reliable and easy to understand sources of information. This guide is specifically designed to assist foreign investors in gaining a quick understanding of the laws and practices associated with investing in Australian real estate. Les Koltai Head of Real Estate, Australia DLA Piper Real Estate Investment in Australia 56 Overview of the Australian Legal System Australia s legal system is a common law system, similar to that of Britain. Federal Parliament may pass statutes and make regulations under statutes to deal with specific issues. This is subordinate legislation and must be tabled in parliament. A body of common law is developed and interpreted by a judiciary, which also has the role of interpreting statutes and regulations. Courts are operated at federal and state levels. Judges are appointed by federal and state governments and serve until retirement age unless removed for misconduct. A comprehensive appeals system exists at both levels. Australia s legal profession is modelled on the British system and most states distinguish between barristers, who mainly appear in court, and solicitors, who are professionals authorised to practice law, conduct lawsuits and give legal advice to the clients. 6 DLA Piper7 Purchase and Sale of Real Estate Purchase and Sale of Real Estate Real Estate Investment in Australia 78 FORMS OF OWNERSHIP Throughout Australia, there are two principal legal structures in which real estate is directly owned: freehold title and Crown leasehold title. Owners of freehold title benefit from the absolute ownership of their land for an indefinite period of time. A Crown leasehold title confers rights of exclusive possession and use, pursuant to specific legislation. Some Crown leasehold titles are perpetual in nature and others are granted for fixed periods of time. Both freehold title and Crown leasehold title are subject to government powers of resumption, applicable laws governing the manner of use of their property (such as building regulations and town planning laws) and contractual arrangements freely bargained for by the holder of the title. Owners of freehold title and Crown leasehold title are able to grant leases of the property to third parties. We examine the process of transferring title to real property in the rest of this chapter. The key features of leases are examined in the Leases chapter. REGULATION OF FOREIGN INVESTMENT While there are some restrictions on foreign investment generally, the Australian Government (Government) recognises that foreign real estate investment can enhance Australia economically and socially. Accordingly, Australia s foreign investment regime is premised on ensuring foreign investment is consistent with Australia s national interest. Foreign investment policy in Australia is regulated by the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA), the Foreign Acquisitions and Takeovers Regulations 1989 (Cth) and other requirements set out by Ministerial Statement. FATA and its related regulations allow the Government to scrutinise proposed purchases by foreign persons of shares in companies incorporated or having assets in Australia and Australian real estate. The FATA regime is administered by the Federal Treasurer and the Foreign Investment Review Board (FIRB). FIRB is a non-statutory advisory body that examines foreign investment proposals, advises the Treasurer on whether the proposals are compliant with Australia s foreign investment policy and assists foreign investors in ensuring their proposals comply with government policy. Foreign investment may also be regulated under other federal, state and territory laws. For instance, state or local government approvals may be required for development projects involving construction works. While these regulatory regimes vary depending on state and/or industry sensitivities, restrictions are normally applicable to the mining, gambling, insurance and liquor industries. Professional advice should be sought and any restrictions carefully considered before deciding to invest in these areas. Foreign persons A foreign person includes: A person not ordinarily resident in Australia A corporation in which a person not ordinarily resident in Australia (nonresident) or a foreign corporation holds a controlling interest (15% or more) A corporation in which two or more non-residents or a foreign corporation hold an aggregate controlling interest (40% or more) The trustee of a trust estate in which a non-resident or a foreign corporation holds a substantial interest The trustee of a trust estate in which two or more non-residents or a foreign corporation holds a substantial interest. A substantial interest in a trust estate arises when the trustee of the trust is empowered to distribute to a foreign person, either alone or together with associates, more than 15% of the income of the trust estate. A substantial foreign interest occurs when a single foreigner (and any associates) has 15% or more of the ownership or several foreigners (and any associates) have 40% or more in aggregate of the ownership of any corporation, business or trust. General requirements for foreign investment Under the FATA regime, the key criterion for approval is whether or not the investment is considered contrary to the national interest. The general presumption is that foreign investment proposals will serve the national interest. The Treasurer has wide powers to prohibit foreign investment proposals and to order divestiture or unwinding of foreign investment proposals or unwinding of foreign investment arrangements in Australian companies and businesses if they are considered to be contrary to national interest. The Treasurer determines what is contrary to national interest by considering the widely held community concerns of Australians. The Government policy is to balance these concerns against the strong economic benefits for Australia that arise from foreign investment. National interest implications are determined on a caseby-case basis. Notification of the proposal to FIRB requires the submission of certain information required under FATA regarding the acquirer and the proposal. FIRB issues guidelines to assist with clarifying obligations under FATA. Approval may be granted by the Treasurer subject to the acquirer and the proposal meeting certain conditions (for instance, timeframes for completion of development activities or environmental requirements). More recently, conditions are also increasingly imposed on acquisitions by state-owned enterprises and sovereign wealth funds. Broadly, reporting requirements associated with foreign investment proposals can be divided into two categories: firstly, those which are subject to compulsory notification; and secondly, proposals which are at or above the annually indexed monetary thresholds that exist for notifying FIRB of individual investment proposals. US investors US investors are defined as national or permanent residents of the US; a US enterprise (constituted or incorporated under US law); or a branch of an entity located in the US and carrying on business activities in the US. Separate monetary thresholds are applicable for investors from the US under the Australia-United States Free Trade Agreement (AUSFTA). Australia also signed an investment protocol with New Zealand on 16 February Once implemented, New Zealand investors will have the same monetary thresholds that apply to US investors. Importantly, the definition of US enterprise excludes an Australian entity (such as an Australian subsidiary established as an Australian vehicle) owned by a US enterprise. Proposed acquisitions by such entities therefore continue to be subject to the AU$244 million threshold applicable to non-us investors. 8 DLA Piper9 The thresholds applicable to US investors are subject to annual indexation. Accordingly, the thresholds prevailing from year to year should be checked. Notification of proposals Non-real estate acquisitions of less than AU$244 million are generally exempt from compulsory notification. Proposals currently requiring approval include: Acquisitions of substantial interests in existing Australian businesses (including agribusinesses) whose gross assets exceed AU$244 million or where the proposal values the business at over AU$244 million. For US investors, the AUSFTA provides a notification threshold of AU$1,062 million, except for investments in prescribed sensitive sectors (including media, telecommunications, transport, human resources services and defence services or supplies), which are subject to the AU$244 million threshold All investments in the media of 5% or more, irrespective of value Takeovers of offshore companies whose Australian subsidiaries or gross assets are valued at AU$244 million or more, or the applicable US investor threshold of either A$1,062 million or AU$244 million for prescribed sensitive sectors Takeovers of offshore companies whose Australian subsidiaries or gross assets are valued at AU$244 million or more, or the applicable US investor threshold of either AU$1,062 million or AU$244 million for prescribed sensitive sectors Direct investments by foreign governments or their agencies, including sovereign wealth funds, irrespective of size. When considering whether a proposed investment is notifiable, funding arrangements (including debt instruments) having quasi-equity characteristics are treated as direct foreign investment. Investors in sensitive sectors such as banking, telecommunications, shipping, subject to more detailed examination, but are approved unless considered contrary to the national interest. The Government recommends that where any doubt exists as to whether a proposal is notifiable to FIRB, it should be notified. INVESTING IN AUSTRALIAN REAL ESTATE Australian urban land Australian urban land includes all land situated in Australia that is not used exclusively for carrying on a substantial business of primary production. Therefore, land that is not used for commercial farming or forestry purposes (accounting for detailed inclusions and exclusions if relevant) will generally be considered urban land. Proposals concerning urban land that require notification to FIRB include acquisitions of interest in urban land, including interests that arise through leases, financing and profit-sharing arrangements in which Australian urban land makes up more than 50% of the value of its total assets that involve the: Acquisition by a non-us investor of developed non-residential commercial real estate valued at AU$53 million or more, or if the property is subject to heritage listing, valued at AU$5 million or more Acquisition by a US investor of developed non-residential commercial real estate, where the property is valued at A$1,062 million or more. Proposed acquisitions of real estate for commercial development (not to be used for residential purposes) are generally approved subject to development conditions under FATA, being continuous construction commencing within five years and a minimum amount being spend on the development, which is equivalent to the higher of 50% of the acquisition cost or current market value of the land. Australian urban land corporations/trusts A corporation or trust is deemed to be an urban land corporation or trust if it holds more than 50% of its assets in Australian urban land. Notification to FIRB is required if the value of its (and its subsidiaries) total Australian urban land assets exceeds 50% of the value of its total assets, irrespective of the total value of the company, trust or the value of the proposal. Residential real estate In its regulation of foreign investment in residential real estate, the Government seeks to increase the supply of residential dwellings and ensure that investment is not speculative in nature. Residential real estate means all Australian urban land other than commercial real estate and rural properties used wholly and exclusively for carrying on a substantial business of primary production. Any acquisition of residential real estate regardless of value requires notification to and approval by FIRB, unless an exemption applies. Rural land Australian rural land includes all land that is used wholly and exclusively for carrying on a business of primary production. Proposed acquisitions of such a business that has assets where more than 50% of the value of those assets attributable to Australian rural land is $231 million or more (as at January 2010) (or the relevant threshold for US investors) must be notified to FIRB and require approval. Exemptions for real estate acquisitions Generally, foreign buyers intending to acquire real estate in Australia must seek prior approval from the Government, unless specifically exempted as follows: Acquisitions by Australian citizens living abroad or by New Zealand citizens purchasing residential property Acquisitions by foreign nationals who hold a permanent resident visa or who are buying property as joint tenants with their Australian citizen spouse Acquisition of a new dwelling bought from a developer who has pre-approval to sell them to foreign persons Acquisition of an interest in a time share scheme that allows four weeks use per year Acquisition of certain residential real estate in integrated tourism resorts Acquisition of an interest in developed commercial property where the property is to be used immediately and in its present state for industrial or commercial purposes, and the acquisition is wholly incidental to the purchaser s proposed or existing business activities Acquisition of an interest in developed commercial property valued below the relevant monetary thresholds discussed earlier Real Estate Investment in Australia 910 10 DLA Piper An interest acquired by will or by operation of law An interest acquired from a government in Australia (Commonwealth, state, territory or local) or a statutory corporation formed for a public purpose. Contractual arrangements FATA stipulates that agreements involving foreign persons must be made conditional on approval. Any contracts by foreign persons to acquire real estate in Australia must also be made conditional on FIRB approval (unless approval has already been granted). Contracts should provide for a minimum 40 days from the date of lodgement for a decision from FIRB. For real estate to be purchased at auction, prior FIRB approval must be obtained. Foreign government-related investments Proposed investments by foreign governments and their agencies irrespective of the size of the proposal must be notified to FIRB (subject to the thresholds applicable to US governments discussed above). In examining foreign investment proposals by foreign governments and their agencies, FIRB will consider whether or not an: Investor s operations are independent of the relevant foreign government Investor is subject to and adheres to the law and observes common standards of business behaviour Investment may hinder competition or lead to undue concentration or control in the industry or sectors concerned Investment may impact on Government revenue or other policies (for instance, investments by foreign government entities must be taxed on the same basis as other commercial entities) Investment may impact on Australia s national security Investment may impact on the operations and directions of an Australian business as well as its contribution to the Australian economy and broader community. Process FIRB s intention is to deal with proposals quickly and aims to provide a 30-day time frame for decisions. Once formally notified, the Federal Treasurer has 30 days to take action and a further 10 days to notify the parties concerned. Where FIRB is not able to meet the 30-day service standard, it has developed a practice of requesting a party to withdraw and resubmit their application to initiate a new 30-day review period. Approval of proposals may be subject to parties meeting certain conditions, and the applicant and their advisers will be informed of the conditions prior to the Treasurer making the decision. Approvals stand for one year. FIRB should be informed if the completion of a transaction will exceed this period. Additionally, a new application is expected where there are subsequent material departures from the existing approval. All proposals must specify the particular property to be acquired as a general or inprinciple approval is not available. Commercial-in-confidence information is respected and appropriate security given to proposals submitted to FIRB. If a third party takes action to obtain access to the information, it will not be made available unless a court so orders. The Government will normally defend confidentiality through the courts. THE CONTRACT There is no universally accepted form of real estate purchase agreement in Australia. Most states have pre-printed contracts endorsed by industry bodies and state law societies that can be useful for more straightforward transactions. However, in most transactions the parties negotiate a customised contract that reflects the specific transaction. The parties often record the deal points initially in a non-binding letter of intent or term sheet, before commencing negotiation of the formal contract. These arrangements usually include confidentiality provisions and exclusivity periods. The form of contract varies, depending in large part on whether the real property has buildings (known as improved ) or is vacant land (known as unimproved ); whether the real property is intended for residential, commercial, industrial or mixed use; and whether the purchase price will be payable in cash or in some form of vendor financing. Some important and typically contested issues in a contract include: Property The contract must properly describe the scope and nature of the property being transferred. The main asset is, of course, the real property and any related easements, lease rights or appurtenant rights (such as water or mineral rights), together with any improvements. Any registered encumbrances over the real property (such as easements and restrictive covenants) should be fully disclosed in the contract. Depending on factors such as whether the real property is improved or unimproved, the property being sold under the contract may also include personal property, trade names, intangible property and development agreements or other land use entitlements. Purchase price The purchase price is usually negotiated directly between the parties or their agents. Typically, any mortgages granted by the seller are discharged at closing. Goods and Services Tax (GST) consequences need to be considered by the parties up front and appropriate GST clauses included in the contract. Deposit The buyer normally pays a deposit of up to 10% of the purchase price upon formation of the contract. In the context of a contract that provides for a due diligence period in which the buyer may withdraw from the transaction, the deposit typically only becomes non-refundable to the buyer after the buyer has declined to terminate the contract at the end of the due diligence period. However, even after the due diligence period expiration, there are limited circumstances (such as the seller s default, destruction of the property or the failure of a condition precedent to closing) when the deposit will still be refunded to the buyer. The parties can provide for the deposit to be paid in instalments, often with one instalment payable at contract signing and a further instalment payable by the expiration of the due diligence period, or other significant conditions precedent to closing being satisfied. The deposit will be applied toward the purchase price due at the closing. The deposit is often used as an amount of liquidated damages that the seller is legally entitled to retain under the contract if the buyer fails to close the transaction in breach of its obligations. The deposit is usually held in the trust account of a licensed real estate agent, or in the trust account of the seller s11 lawyers (or the buyer s lawyers in some instances). The parties can agree that the deposit holder is authorised to invest the deposit until closing, and how any interest accruing on the investment is to be apportioned between the parties. Due diligence and title investigation For large value transactions or complicated assets, it is common for the buyer to be entitled to a period after signing the contract, known as a due diligence period, in which to conduct investigations of the property and during which the buyer may withdraw from the transaction. The contract should specify the length of the due diligence period (usually in the range of 30 to 90 days) and the scope of documents and information that must be provided by the seller to the buyer before or during this period to facilitate the buyer s due diligence enquiries. As part of the due diligence investigations, the buyer will have the right to review all leases, agreements and contracts concerning the operation of the property and the contract should specify which of these items must be terminated before the closing or will continue in effect after the closing. To preserve confidentiality and to protect the seller s interest in the property, the parties may need to negotiate the conditions under which the buyer is permitted to speak with the existing property manager, existing tenants, government agencies or other third parties about the property. The contract also should specify the conditions under which the buyer is entitled to conduct physical inspections of the real property. These conditions typically include the buyer s indemnification of the seller for any losses or damages and the buyer s obligation to restore the property to substantially the same as its original condition. The seller may insist on more stringent conditions or advance approval rights if the buyer seeks to conduct environmental assessments or any intrusive testing. Representations, warranties and covenants The parties must negotiate the scope of representations and warranties to be given by the seller to the buyer concerning the seller s ability to consummate the transaction, the condition of the property and any materially adverse issues affecting the property. Especially for improved property with tenants, the seller normally covenants to operate the property in a manner consistent with standard past practice until completion. The buyer usually will accept the property in its as is condition, subject to any express representations, warranties and covenants in the contract. Tenanted property In transactions that involve property occupied by tenants providing a significant amount of rental income to the owner, the buyer will generally undertake significant due diligence on the terms and conditions of the leases. The buyer will also require warranties from the seller in relation to the existence of, terms and conditions of, and enforceability of the leases. Damage to the property during the contract period The parties will negotiate provisions in the contract dealing with when risk in the property passes to the buyer, as well as the circumstances under which either party, or the buyer acting unilaterally, may terminate the contract after an event of damage to the property occurring after the contract is signed, but before closing. Concerns regarding contract parties It is not uncommon for sellers to require guarantees from directors and/or major shareholders of a buyer company in relation to the performance by the buyer of its obligations under the contract. Payment of a significant deposit by the buyer may soften the seller s requirements in that regard. It is not as common for buyers to require guarantees from directors and/or major shareholders of the seller. However, if the seller has obligations and potential liabilities that extend beyond closing, the buyer may require such guarantees where there are concerns about the weight of the seller s covenant. THE DUE DILIGENCE PROCESS The process by which buyers investigate and evaluate real property, known as the due diligence process, will be impacted by several preliminary considerations. First, the type of asset will help determine the level of due diligence that should be performed. For example, a buyer will probably wish to undertake a detailed due diligence and extract significant seller warranties when buying a commercial property with a single tenant. The buyer may not be as concerned in the case of a multi-tenanted residential property. Second, the purchase and sale agreement may impact the performance of due diligence. Both the time frame, where a period of around 30 days is typical (although often longer for complex assets such as hotels, large retail complexes or major commercial towers) and the scope (such as which third parties may be contacted and/or required to provide information) will typically be governed by the provisions of such an agreement, as discussed above. Finally, expense issues can play a factor in the level of due diligence performed by a buyer. For example, the involvement of third-party consultants and/or lawyers is advisable or even necessary for most of the due diligence items described below, but the overall project budget may not justify such expenses. The following is a general summary of the types of due diligence that can be performed for most asset types and under general circumstances. Title investigation The starting point for any due diligence investigation is to examine the title to the property being sold. Each Australian state and territory has its own separate legislative regime in relation to the ownership of land and the various available tenures. Each regime is fundamentally similar in its structure and implementation, however there are some differences between each jurisdiction. Australian real estate is regulated under a titling system, which operates on the principle of title by registration. This system effectively does away with the need for a chain of title (ie tracing titles through a series of instruments). Government land registers contain: Registered plans that define the location, size and dimensions of the property Details of the registered owner of the property Details of all registered leases over the property Details of registered encumbrances on the property, such as easements, restrictive covenants, mortgages, notices of resumption etc. Real Estate Investment in Australia 1112 A buyer can obtain a title search, as well as copies of each individual encumbrance noted on the title. Third-party reports Third-party consultants are typically retained to investigate all aspects of the physical condition and value of the property. These reports may include: 12 DLA Piper A Phase I environmental report (where public and other historical records of the property, surrounding property and present and former tenants are reviewed and a visual inspection of the property is performed), and, if recommended or prudent based on the results of a Phase I report, a Phase II environmental report (where soil samples are analysed for hazardous materials) A physical condition/structural report (based on a visual inspection of the property and its plans and specifications), which should specifically include an examination of the structure and all building services (such as air-conditioning systems, fire safety installations, elevators and all other relevant plant and equipment) A geo-technical/soils report (which is particularly important where future development is contemplated) A valuation of the property by a licensed valuer. The valuation will be particularly useful in circumstances where the buyer intends to obtain thirdparty financing for the acquisition of the property. Banks and lenders will only accept valuation reports from valuers approved by the bank and will require the valuer to endorse their valuation report so that the bank is entitled to rely on the report (unless the bank is commissioning its own valuation). Financial documents In order to verify that the financial assumptions made during negotiations are correct, the buyer will typically review and confirm historical and current financial records for the property, including, without limitation, statements of cash flow, balance sheets, statements of outgoings (including local government rates and charges and state land taxes), capital expenditure budgets and rental income. The buyer should ascertain the potential liability for state stamp duties as well as registration fees on registration of any title transfer. Plan and survey Architectural plans and specifications for all buildings should be reviewed by the buyer where available. In addition, the buyer should procure a survey of the property by a licensed surveyor, which will depict the boundary of the property, the location of any improvements (including identifying any encroachments) and restrictive easements or covenants affecting the property and other such information as negotiated between the surveyor and the buyer. A full survey report can also be used to confirm the accuracy of the plan of the property lodged on the government land register, which legally defines the boundaries of the property. Zoning Local governments have town planning regimes governing various aspects of the use and development of real property. There will typically be planning regulations governing various aspects of the property including its construction, use (ie retail, office, light/heavy industrial, hotel/leisure or residential), density, parking, appearance and permitted signage. In many circumstances, the planning regulations can be supplemented with planning maps, specific plans and/or particular regulations. Because the relevant information is not always straightforward or easily accessible, specialist qualified town planners are often retained to prepare a report on town planning issues, including compliance with the relevant planning scheme. Buyers can obtain town planning certificates from the local government, which provide relevant information to assess the site from a town planning and compliance perspective. Different levels of town planning certificates are available, ranging from limited certificates (which provide limited information on zoning and identifying applicable planning instruments), right though to a full town planning certificate (which will provide complete information on all relevant town planning matters, including details of compliance with any development approvals and conditions contained in any development agreements between the local government and the seller or a prior owner of the property). In addition, the local government will typically maintain records on each property, containing details of the various building permits, approvals, inspection records and other constructionrelated documents relating to the improvements located at a property. These documents will include the certificate of classification/certificate of occupancy (without which it may be unlawful to occupy a building). For a fee, the local government will provide a search report with details of all these matters. Finally, a property may be subject to agreements entered into by the seller or a prior owner and the local government, which govern aspects of its use or development. Typically, copies of and details of compliance with such development agreements are included in a full town planning certificate. Lease review Where particular tenants are important to the success of a project, the buyer should review the lease terms to confirm that the financial assumptions as to the property s income and expenses are correct, and that the terms and conditions of each lease are satisfactory and appropriate in the circumstances. In addition, the buyer should seek warranties from the seller in relation to the terms and conditions of each lease, the existence of any breaches or defaults and the enforceability of each relevant lease generally. Service contracts Sellers often stipulate that services contracts will be terminated with effect from closing. The buyer would need to put its own service contracts in place after closing. Where existing services contracts are to be assigned or novated to the buyer at closing, the buyer should review existing service contracts, including any property management and leasing/brokerage agreements, utility contracts and contracts for the maintenance, replacement or repair of the property. In particular, the buyer should confirm that it can terminate and replace those contracts that are unacceptable without the payment of substantial fees or unwanted delays. Insurance coverage Buyers will generally work with their own insurance brokers to arrange suitable insurance for the property. If the buyer is concerned about a property s insurability,13 the buyer should request copies of the seller s certificates of insurance coverage. Seller searches Claims and liens against the seller and/ or the insolvency of a seller can interfere with the consummation of the sale of real property. Although proper representations and warranties in a purchase and sale agreement can protect a buyer from the non-disclosure of such potential issues, buyers should perform their own due diligence in this regard. Searches of appropriate court registries can identify any litigation involving the seller. Company searches of corporate sellers will confirm whether or not the seller is subject to any external administration (due to the appointment of a liquidator, receiver or administrator). For natural persons, bankruptcy searches can be performed in order to ascertain whether the seller is an undischarged bankrupt. Property searches Buyers can conduct a range of searches and enquiries with all levels of government in order to determine whether a property is adversely affected by any government agency requirements. In addition to the title, town planning and building records searches referred to above, buyers are generally able to conduct searches and enquiries in relation to the property which will reveal whether: The land is registered on contaminated land or environmental management registers, and details of any site management plans affecting the property Any government agency has any proposed requirements or resumptive interests in the property The property is affected by any mining or exploration tenures Electricity is connected to the property and is available under normal tariff conditions There are any telecommunications installations (including underground cables) on the property Any native title claims relating to the property The property is affected by flooding There is any unpaid land tax or local government rates. Other more specific types of searches are available depending on the nature of the property (agricultural, coastal, environmentally significant properties etc). TITLE INSURANCE Australian real estate is regulated under legislative titling systems, which operate on the principle of title by registration. This system effectively does away with the need for a chain of title (ie tracing titles through a series of instruments). Title insurance is available in Australia, although it is rarely used as a substitute for the buyer s investigation of title to the property and undertaking relevant searches and investigations. CLOSING AND REGISTRATION Closing Closing is the completion of the contractual process of selling and buying real estate. It is the event at which title to the property is legally transferred from seller to buyer. The transfer of title at closing is consummated by the delivery of any certificate of title for the property and signed transfer documents in the form required by the legislation establishing the land register. Closing occurs at a face-to-face meeting where representatives of the buyer, the seller, the seller s outgoing lender and the buyer s incoming lender will personally attend a meeting at which signed closing documents are delivered and the balance purchase price is paid. The contract will typically require other formalities to be fulfilled at closing beyond the mere delivery of transfer documents and discharge of seller securities. Commonly, the seller will be points to note required to turn over its property files and keys to the buyer and to provide documents conveying title to any personal property, leases and service contracts applicable to the property. Registration of transfer documents The buyer (or the buyer s lender where the buyer has given a mortgage over the property to raise acquisition finance) will lodge the signed transfer documents at the relevant government land registry office as soon as possible after closing. Registration gives public notice of the buyer s ownership interest in the property and provides the buyer with the benefits of an indefeasible title. FINANCING OF COMMERCIAL REAL ESTATE Commercial real estate lending in Australia is conducted by a wide variety of lenders, including major banks and financial institutions, managed investment funds, investment banks, credit companies and private equity lenders. The principal financial terms of real estate loans, such as the interest rate, fees, maturity dates, security requirements, key financial covenants and provisions for prepayment are normally negotiated at the time that the borrower applies for the loan. Such terms are set forth in a term sheet, loan application, or loan commitment, depending on the formalities of the lender. In Australia, direct ownership of real estate is held mostly under the state-based Torrens Title system of registration or under Crown Leasehold. The Commonwealth of Australia s policy supports foreign investment in the real estate sector where that is not inconsistent with the national interest. Most real estate transactions in Australia involve the parties negotiating a form of contract, taking into consideration issues specific to each transaction. It is strongly recommended investors undertake legal due diligence as part of the process of making the investment. On execution of contracts, the sellers and buyers are bound, subject to certain conditions. On completion or closing of the purchase and sale process the legal title of the property is legally transferred to the buyer in consideration for payment of the purchase price. Real Estate Investment in Australia 1314 Taxation of Real Estate Investments Taxation of Real Estate Investments 14 DLA Piper15 This chapter provides a high-level outline of the key Australian taxation considerations in relation to investment in Australian real estate or real property. Australia has a rigorous taxation regime covering income tax (including Capital Gains Tax (CGT)), Goods and Services Tax (GST) and stamp duties. Specifically, this chapter explores the implications of asset classification for capital gains tax purposes, the importance of carefully choosing the appropriate structure/ entity to hold real property investments and the planning considerations of which to be mindful when establishing financial or other transactional arrangements connected with real property holdings. The sections below describe the most common methods used by foreign individuals and foreign entities (foreign investors) to acquire and hold interests in Australian real estate or real property and briefly summarise the principal tax consequences of each method. However, this information is only a general overview and an investor should seek the advice of qualified tax advisors with respect to any particular transaction to determine the most appropriate method in each case. Overview of the Australian taxation system Taxation is spread between Australia s three levels of government. The Federal Government collects almost 80% of the tax paid in Australia and is the only level of government that levies income tax, its major form of revenue. In addition, it levies a GST and also levies tariffs on a number of imported items. Australian state and territory governments impose a large number of taxes, including stamp duty, land tax, mortgage duty, payroll tax and motor vehicle registration duty. Local governments also impose taxes in the form of rates payable by landowners. However, these make up less than 5% of taxes levied on the private sector. There is ongoing debate about tax reform in Australia. As with all decisions, businesses need to consider any proposed changes and factor them into business plans and activities. In particular, businesses should prepare before any tax change commences. Before dealing with the tax considerations of particular investment structures, it is helpful to summarise the different types of Australian tax that may be encountered by foreign investors. Federal individual income tax Australian resident individuals are liable for Australian income tax on all their income and capital gains (including gains from disposals of real property) from sources anywhere in the world. Temporary residents may be able to exclude certain foreign source income and capital gains. Income tax on individuals is computed at graduated rates depending on the amount of income. The maximum tax rate for Australian resident individuals is currently 46.5% (includes 1.5% Medicare Levy) for the year ended 30 June This tax rate applies for income greater than AU$180,000. The first AU$18,200 of income for an Australian resident individual is not subject to Australian tax and is referred to as the tax-free threshold. Foreign resident individuals do not obtain the benefit of the tax-free threshold but are generally not subject to the Medicare Levy. Foreign resident individuals are generally taxed on all income and capital gains from Australian sources, subject to specific exemptions. A network of Double Taxation Agreements (DTAs) operates to modify these rules. The maximum tax rate for foreign resident individuals is currently 45% for the year ended 30 June 2013 and this tax rate applies for income greater than AU$180,000. For capital gains, tax is payable only on 50% of capital gains arising from the disposal of Australian real property where certain residents (such as individuals and certain trusts) have held the real estate for more than 12 months. This is referred to as the CGT discount. Federal corporate income tax Similar to Australian resident individuals, Australian resident companies are taxed on all their income and capital gains (including gains from disposals of real property) from sources anywhere in the world. In contrast, foreign companies are generally taxed on income and capital gains from Australian sources. A tax rate of 30% applies to both Australian resident companies and foreign companies. However, companies (whether Australian resident or foreign) do not enjoy the benefit of the CGT concession that is available to individuals. Federal GST GST is a value-added tax of 10% that replaced wholesale sales tax and a range of state taxes in It is generally payable on supplies by businesses in Australia, including supplies of goods, services, real property, rights and obligations. It is generally applied at each stage of the production and distribution chain. The sale of real estate by GST-registered businesses is generally subject to GST at the ratxe of 10%. However, there are a number of exceptions, including: The sale of existing (not new) residential premises is input taxed (the equivalent of exempt in European VAT), that is, the vendor does not charge GST, but is not entitled to claim GST credits on its expenses associated with the sale. The sale of property can be GST-free (ie not subject to GST - the equivalent of zero-rated in European VAT) as a going concern where it is part of the sale of the assets of an enterprise or is sold subject to lease. The sale of new residential premises is taxable, however, there are special GST calculation rules (referred to as the margin scheme) under which the GST liability is normally calculated on the basis of the vendor s margin. Where the sale is subject to GST and the purchaser is also a registered business, the purchaser is ordinarily entitled to claim back the GST as a credit in its GST return (normally lodged monthly or quarterly, depending on turnover). Entities that are carrying on an enterprise must register for GST where their annual turnover in Australia is greater than AU$75,000 (AU$150,000 for non-profit organisations). Since there is no legislative ability for a supplier to recover an additional amount from a recipient on account of GST on a taxable transaction, it is important for suppliers to include a carefully worded GST clause in their contracts. Real Estate Investment in Australia 1516 Capital vs revenue asset The characterisation of whether the Australian real property is held on capital or revenue account is critical for a number of reasons. Firstly, the CGT discount is only available in respect of real property held on capital account by certain trusts, individuals and complying superannuation funds. Secondly, losses generated in respect of real property held on capital account are capital losses. Capital losses can be carried forward and are only able to be offset against capital gains. However, losses generated in respect of real property held on revenue account are revenue losses and these losses can be offset against other assessable income (whether capital gains or income). Whether Australian real property is held on capital or revenue account is a question of fact depending on the particular circumstances. However, the Commissioner of Taxation provides guidance in Taxation Ruling TR 92/3, stating that if a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is ordinary income (rather than capital) if the transaction or operation: Is in the ordinary course of the taxpayer s business, or is in the course of the taxpayer s business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit Is not in the course of the taxpayer s business, but the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain The transaction or operation was entered into and the profit was made in carrying out a business operation or commercial transaction. Accordingly, in the Commissioner s view, profits derived from the sale of real property will be accounted for as revenue gains unless the above three tests do not apply. The Commissioner of Taxation recently released draft Tax Determination TD 2011/21, which discusses the capital vs revenue distinction in respect of trusts. This draft determination provides that whether a gain or loss realised by a trustee of a trust is on revenue or capital account is a question of fact dependent on the particular circumstances. Further, the draft determination details some of the factors that should be considered in making this distinction. A managed investment trust can elect to treat gains or losses from eligible assets (such as shares in companies or units in unit trusts) on capital account. This is discussed further below. Tax benefits of owning Australian real property In calculating taxable income from the ownership and operation of Australian real property, the owner is generally entitled to deduct interest expense on borrowings to acquire, own and operate the real property, as well as ordinary and necessary costs of ownership and operation. Further, an owner of real property may also be entitled to claim capital allowance and capital works deductions. Interest deductions Generally, interest is deductible if it is incurred in gaining or producing assessable income or in carrying on a business for that purpose and is not of a capital, private or domestic nature. On this basis, interest expenses incurred when acquiring Australian real property should generally be deductible against assessable income in the year in which they are incurred, where the real property is used to produce assessable income. To the extent that interest is capital in nature, deductions will not be allowed in respect of that interest. In a Full Federal Court decision, St George Bank Limited v Federal Commissioner of Taxation, it was held that interest payments made by an Australian bank to its US subsidiary were capital in nature on the basis that the overall benefit obtained by the bank was a capital benefit, being the satisfaction of regulatory capital requirements. Thus, the court held that the interest payments were not deductible. In addition, the amount of interest deductible will be subject to the operation of Australia s debt/equity rules, which classify instruments as either debt or equity-based on the economic substance rather than their legal form. Interest payments that are attributable to a loan or interest that is deemed to be equity will not be deductible and will generally be treated as a return on equity (ie a dividend) for Australian income tax purposes. Further, there are provisions in the debt/equity rules that will treat an interest as an equity interest where it arises from an arrangement to fund a return through connected entities. The interest deduction is also subject to the operation of the thin capitalisation rules. These rules operate when the amount of debt used to finance the Australian operations of multinational corporations exceeds specified limits. The rules disallow a proportion of the deductible finance expenses, for example interest attributable to the Australian operations. The thin capitalisation rules may apply to: Australian entities that are foreign-controlled, and foreign entities that either invest directly into Australia or operate a business through an Australian permanent establishment Australian entities that control foreign entities or operate a business through overseas permanent establishments and associated entities. There are two exemptions from thin capitalisation rules: Taxpayers and their associates claiming annual debt deductions of AU$250,000 (proposed to be increased to AU $2 million from 1 July 2014) or less Outward-investing Australian entities, if at least 90% of their assets are Australian. Interest deductions reduce when the amount of debt funding of Australian operations exceeds a specified maximum. This specified maximum varies according to whether the entity is inward or outward investing. 16 DLA Piper17 For foreign entities holding Australian real property as investments, the maximum amount of debt will be the greater amount determined under either the safe harbour debt test or the arm s length debt test. Under the safe harbour debt test, the maximum allowable debt will generally be equal to 75% of the value of its Australian assets (that is, a gearing ratio of 3:1). it is proposed this limit will be reduced from 75% to 60% of assets (effective debt to equity ratio of 1.5:1) from 1 July, The arm s length debt amount is determined by analysing an entity s activities and funding to deliver a notional amount that represents what would reasonably have been expected to be the entity s maximum arm s length debt funding during the period. Capital allowances and capital works deductions Under the capital allowance regime, the decline in value of income-producing assets is generally tax deductible over the asset s estimated useful life. Similarly, deductions are available under the capital works regime for certain capital expenditure on income-producing buildings and structures. However, there is a specific regime (referred to as Division 250) that denies or reduces certain capital allowance deductions that would otherwise be available for an asset. Division 250 applies if the asset is put to a tax-preferred use and the taxpayer has an insufficient economic interest in the asset. An asset is put to a taxpreferred use if the end user is a lessee of the asset and the asset is to be used by a tax-preferred end-user (eg government agencies), or the asset is to be used wholly or principally outside Australia by a non-resident. Types of entities The type of entity used to acquire the Australian real property will often determine the principal Australian tax implications. Commonly, entities or a combination of entities such as companies, trusts (either flow-through or taxed as companies), limited partnerships and joint ventures may be used to acquire Australian real property. Also, stapled structures (where investors hold interests in two or more entities and these securities cannot be bought or traded separately) are frequently used. Each of these entities, or a combination of entities, has distinctive tax characteristics that must be carefully examined to determine its appropriateness in carrying out the acquisition from an Australian tax perspective. There are several important tax reviews/reforms recently announced in Australia, such as the consideration of the possible reform of and expansion of the Collective Investment Vehicles, including whether a broader range of tax flow-though vehicles should be permitted. Further, the current review includes the consideration of changes to the limited partnership regime and the rewrite of existing trust law provisions. The general tax attributes of commonly used entities are summarised below. Companies Companies are treated as a separate legal entity. As discussed above, a tax rate of 30% currently applies to both Australian resident companies and foreign companies. Generally, losses generated by companies are carried forward, provided certain conditions are satisfied and offset against future income. Trusts Trusts are generally treated as flow-through entities. The trustee of the trust will not be taxed on the net income of the trust, provided that unitholders/beneficiaries are presently entitled to all the income of the trust. In this case, it is the unitholders/ beneficiaries that are subject to tax on the net income. The trustee is taxed at the highest marginal tax rate on the portion of net income of the trust to which no beneficiary/unitholder is presently entitled. Generally, losses generated by the trust will be quarantined at the trust level and cannot be distributed to unitholders/beneficiaries. These losses may be carried forward, provided certain conditions are satisfied and offset against future income. As noted above, the Federal Government has announced the rewrite of existing trust law provisions to address the major uncertainties that currently exist around trusts. For GST purposes, a trust is treated as a separate entity (technically, it is the trustee acting in its capacity as trustee of the trust that is treated as the entity). The trust is generally registered for GST and enters into transactions for GST purposes. Partnerships Generally, partnerships that are not limited liability partnerships are also treated as flow-through entities. However, unlike trusts, partnerships facilitate the flow-through of both net income and net losses of the partnership to the partners. Unlimited partnerships bring with them practical difficulties, including the unlimited liability of the underlying partners. For GST purposes, a partnership is treated as a separate entity. The partnership is generally registered for GST and enters into transactions for GST purposes. Limited liability partnerships are generally taxed as companies and do not facilitate flow-through treatment. However, not all limited liability partnerships are taxed as companies. For example, Australia s venture capital provisions enable certain limited partnerships to be treated as flow-through entities. These provisions are restrictive and generally not available for property investments. As noted above, the Federal Government is reviewing the limited partnership regime, considering changes to the limited partnership regime and examining the treatment of venture capital limited partnership vehicles in a way that recognises its policy objectives. In addition, certain foreign limited partnerships or companies may be treated as flow-through entities under Australia s foreign-hybrid rules, provided that certain conditions are satisfied including that the entity has flow-through treatment in its country of residence/establishment. Importance of treaties In the event that cross-border transactions take place, DTAs should be considered when determining where (and to what extent) liability to taxation may arise. These treaties typically reduce the rate of withholding tax on passive income, as described below. Further, DTAs may be relied upon in certain circumstances to ensure that double taxation does not arise. The terms of Australia s DTAs take priority over domestic tax legislation. Real Estate Investment in Australia 1718 The decision in FCT v Lamesa Holdings BV 97 ATC 4752 (Lamesa) illustrates the effectiveness of the protection offered by DTAs. In Lamesa, a US-based group was entitled to treaty protection from Australian tax due to the favourable treaty between the Netherlands and Australia. The US group held its interests in Australian real property (otherwise subject to tax in Australia on disposal) through a Dutch holding company. In the aftermath of Lamesa, the International Agreements Act was amended to ensure that Australia s DTAs do not protect taxpayers from tax in circumstances where real property is held through interposed entities. However, contrary to the views of the ATO, there are strong grounds to argue that several of Australia s DTAs continue to protect non-residents from CGT on the disposal of assets with the necessary connection with Australia. Australia has introduced a general CGT exemption for foreign residents. Under these rules, foreign residents are generally exempt from Australian CGT, except where the capital gain is derived from interests (direct or indirect) in Australian real estate or assets used in carrying on a business in Australia through a permanent establishment. These rules align Australian CGT rules with the foreign resident CGT exemptions provided by other Organisation for Economic Cooperation and Development member countries. In two recent cases (Virgin Holdings [2008] FCA 1503; Undershaft [2009] FCA 41), it was held that Australia s pre- CGT treaties (ie those entered into prior to the introduction of capital gains tax) apply to capital gains and the taxing rights of the contracting states to tax capital gains. Australia s more recent DTAs specifically state that nothing in the DTA impacts upon Australia s rights to tax non-residents on the disposal of their CGT assets. However, in certain DTAs (eg the Australia/Netherlands DTA), where the non-resident does not have a taxable presence in Australia (eg a permanent establishment), only Australia is given the taxing rights in relation to the disposal of real property (or entities that wholly or principally hold real property assets). Also, a number of Australia s recent DTAs (such as Australia/ New Zealand DTA and Australia/Japan DTA) recognise managed investment trusts. Investment through loans A foreign investor may also invest in Australian real estate by making a loan to the owner of the property. In general, interest income from a real estate loan will be subject to 10% withholding tax, as described below. The withholding tax can be reduced or eliminated by applicable tax treaties. In addition, certain types of foreign investors may be exempt from interest withholding tax (eg certain foreign pension funds). Further, there are exemptions from interest withholding tax for interest paid to foreign residents on certain public debentures and debt interests issued by companies. Care needs to be taken in structuring the loan so that it is not treated for Australian income tax purposes as if it were in substance equity. If the loan is treated as equity, the interest paid on the loan will be taxed as dividends. Foreign investors may wish to secure the repayment of their loans by taking a mortgage over the property as security. Mortgage duty will be payable if the mortgage is taken over property in the state of New South Wales, until 1 July 2013 when mortgage duty will be abolished. Taxation of equity investments Income from property Generally, income derived from the property (eg rental income) will be treated as assessable income and be taxable in the hands of the owner at the owner s tax rate, as described above. Tax on gain from dispositions The taxation of the gain arising on the disposal, or other disposition, of Australian real property will depend on whether the property is held on capital or revenue account, as outlined above. If the property is held on revenue account, the gain will be included in the assessable income of the owner and taxed at the owner s tax rate. If the property is held on capital account, the net capital gain will also be included in the assessable income of the owner. However, there are a number of concessions and exemptions that can apply in respect of capital gains. One such concession is available to investors who are non-residents of Australia for tax purposes. Generally, a foreign investor will only make a capital gain or loss on disposal of a capital asset if either: They have a direct or indirect interest in Australian real property. An indirect interest includes an interest held through a non-portfolio interest, that is, when an interest of 10% or more is held through an interposed entity. However, nonportfolio interests held by foreign residents in both Australian and foreign entities will only be subject to Australian CGT when at least 50% of the value of the entity s assets are attributable to underlying Australian real property; or The assets have been used in carrying on a business through an Australian permanent establishment. Accordingly, any gain arising from a disposal of a direct interest in real property will not be exempt from CGT. However, disposal of indirect interests may be exempt from CGT in certain circumstances, depending on the percentage of Australian real estate held as compared to the other assets. Withholding tax In Australia, withholding tax is payable in respect of certain passive income paid to foreign investors. In particular: 30% withholding tax for dividends paid out of untaxed profits. Dividends paid from taxed profits are exempt from withholding tax 10% withholding tax for interest. These rates may be reduced or eliminated pursuant to an applicable tax treaty. In addition, certain exemptions from withholding tax are available for certain types of payments to certain foreign investors (eg interest paid to a foreign pension fund). Further, there are exemptions from interest withholding tax for interest paid to foreign residents on certain public debentures and debt interests issued by companies. 18 DLA Piper19 Direct equity investment The following briefly summarises the tax consequences to a foreign investor of a direct equity investment in Australian real estate. By a foreign individual A foreign individual who holds Australian real estate directly in his or her name will be subject to Australian income tax on the net income from owning and operating the property (eg rental income less operating expenses, depreciation, interest and other related expenses) at the tax rates outlined above. Regardless of whether the interest in the real estate is held by the foreign individual on revenue or capital account, gains on the sale of property will be included in the assessable income of the foreign individual and taxed at the rates outlined above. By a foreign corporation A foreign corporation that holds Australian real estate directly in its own name will be subject to Australian income tax on the net income from owning and operating the property (eg rental income less operating expenses, depreciation, interest and other related expenses) at the corporate tax rate of 30%. Regardless of whether the interest in the real estate is held by the foreign corporation on revenue or capital account, gains on the sale of property will be included in the assessable income of the foreign corporation and taxed at the corporate rate above. Equity investment through an Australian corporation The following briefly summarises the tax consequences to a foreign investor of investing in Australian real estate indirectly through an Australian corporation. By a foreign individual Income from the investment will generally be subject to Australian tax at the corporate tax rate of 30%. The Australian corporation will be subject to Australian income tax on the net income from owning and operating the property (eg rental income less operating expenses, depreciation, interest and other related expenses) at the corporate tax rate of 30%. The tax paid by the Australian corporation will give rise to franking credits. These franking credits may be attached to dividends (referred to as franked dividends ) paid by the Australian corporation to the foreign individual. If so, no further Australian income tax or withholding tax will be paid in respect of the dividend. In contrast, dividends paid out of untaxed profits (known as unfranked dividends ) will be subject to Australian withholding tax at a rate of 30%. This rate may be reduced by any applicable tax treaties. Regardless of whether an Australian corporation holds the real estate on revenue or capital account, gains on the sale of property will be included in the assessable income of the corporation and taxed at the corporate rate above. Australian corporations are not eligible for any CGT concession. Any dividends or liquidation distributions paid by the corporation from the sale of the real estate will be subject to same tax treatment as the dividends described above. If the foreign individual holds his or her interest in an Australian corporation on revenue account, gains on the sale of their shares in the corporation will be included in the assessable income of the foreign individual and taxed at the tax rates outlined above. If the shares in the corporation are held on capital account, gains on the sale of shares may also be included in the assessable income of the foreign individual as a capital gain, depending on the following circumstances: If less than 50% of the value of the corporation s assets is attributable to underlying Australian real property, the capital gain will be disregarded. If at least 50% of the value of the corporation s assets is attributable to underlying Australian real property, but the foreign individual holds less than 10% of the total interests in the corporation, the capital gain will be disregarded. If at least 50% of the value of the corporation s assets is attributable to underlying Australian real property and the foreign individual holds at least 10% of the total shares in the corporation, the capital gain will be included in the assessable income of the foreign individual. By a foreign corporation The Australian income tax consequences of a foreign corporation investing in Australian real estate indirectly through an Australian corporation will generally follow the consequences outlined above for foreign individuals, except that foreign corporations pay tax at the corporate tax rate of 30% and are not eligible for the CGT concession. Equity investment through a foreign corporation The Australian income tax consequences for a foreign corporation have been outlined above. Dividends or other distributions paid by a foreign corporation to a foreign individual will not be subject to Australian income tax. Generally, disposals of interests in a foreign corporation should not be subject to Australian income tax. However, Australian CGT could potentially apply. If a foreign individual disposes of his or her interest in a foreign corporation, the Australian CGT consequences will generally follow the consequences of a foreign individual disposing of an interest in an Australian corporation, as outlined above. Equity investment through an Australian partnership The Australian tax consequences for a foreign investor investing in Australian real estate through an Australian partnership, foreign partnership or other entity treated as a partnership for Australian taxation purposes (eg certain foreign limited liability companies and partnerships) are similar to the results of a direct equity investment outlined above. Real Estate Investment in Australia 1920 As noted above, partnerships are generally treated as flowthrough entities, facilitating the flow-through of both net income and net losses of the partnership to the partners. Accordingly, a foreign investor who holds Australian real estate indirectly through a partnership will be subject to Australian income tax on their share of the net income of the partnership from owning and operating the property (eg rental income less operating expenses, depreciation, interest and other related expenses) at their respective tax rates. In addition, foreign investors will be subject to taxation on their share of any gain arising from a disposal of an interest in Australian real estate in the same manner as if they had held the interest in the real property directly, as outlined above. Equity investment through an Australian Managed Investment Trust Australian tax law provides favourable tax treatment for foreign investors in Australian unit trusts that qualify to be a Managed Investment Trust (MIT). In particular, there has been a significant reduction in withholding tax on certain distributions (predominantly rental income and certain capital gains) from Australian MITs to foreign investors. Essentially, the previous non-final 30% withholding tax rate has been reduced to a final withholding tax rate of 15% from 1 July Most importantly, to be eligible for this significant reduction in the Australian withholding tax for these distributions from Australian MITs (principally managed investment schemes ), the foreign investor must be resident in a country with which Australia has an effective Exchange of Information (EOI) arrangement on taxation matters. These countries are listed below. Anguilla Fiji Kiribati Singapore Antigua and Finland Malaysia Slovakia Barbuda Argentina France Malta South Africa Aruba Germany Mexico Spain Bahamas Gibraltar Monaco Sri Lanka Belgium Guernsey Netherlands St Christopher and Nevis Belize Hungary Netherlands Antilles St Vincent and Grenadines Bermuda India New Zealand Sweden British Virgin Indonesia Norway Taipei Islands Canada Ireland Papua New Guinea Thailand Cayman Islands Isle of Man Poland Turks and Caicos Islands China Italy Romania UK Czech Japan Russia USA Republic Denmark Jersey San Marino Vietnam From 1 July 2012, the Cook Islands, Macau, Mauritius and South Korea were added to the list of EOI countries above. Some countries with which Australia has EOI agreements or double tax treaties, including Switzerland and Austria, have not currently been included on the list. In addition, Australia has entered into tax information exchange agreements with a number of countries (such as Switzerland, Samoa and Vanuatu), however, there is a time lag between the entry into these agreements and the time which these countries are gazetted and added to the list above. The lower withholding tax rates apply to fund payments, ie distributions primarily of rental income and capital gains from Australian real property by Australian MITs. The lower withholding tax rates do not apply to dividend, interest and royalty income, which are subject to their own withholding tax rates. In addition, capital gains from non-taxable Australian property are not subject to withholding (since foreign investors will generally be exempt from CGT in respect of such capital gains). Only distributions of Australian source net income of these trusts to non-residents will benefit from the lower withholding tax rates. Distributions made by MITs to foreign investors that are resident in countries not on the list will generally be subject to a final withholding tax of 30%. In addition, distributions made by unit trusts that do not qualify as a MIT to foreign investors will be subject to a non-final withholding tax at the foreign investor s own tax rate, as outlined previously. GST GST is a value-added tax of 10% that replaced the previous Wholesale Sales Tax on goods and a range of state taxes in It is generally payable on a broad range of supplies by businesses in Australia, including supplies of goods, services, real property, rights and obligations, and is generally applied at each stage of the production and distribution chain. GST has a significant impact on the profitability of a real estate project, as well as the choice of financing, the purchaser s cash flow and the amount of stamp duty payable. It can also give rise to significant tax compliance costs. Accordingly, it is important that the investment and operational structure of a real estate project minimises GST inefficiencies/costs. GST must be considered prior to establishing a project structure. In particular, the special GST rules that apply to property, cross-border arrangements and financial services must be considered carefully in the early stages of a project. There are generally three types of supplies for GST purposes: Taxable supplies, where the supply attracts GST and the supplier is entitled to claim GST credits on its expenses associated with the supply Input taxed supplies, where the supply does not attract GST, however, the supplier is not entitled to claim GST credits on its expenses associated with the supply GST-free supplies, where the supply does not attract GST and the supplier is entitled to claim GST credits on its expenses associated with the supply. The GST implications of real estate transactions depend on the nature of the property and the availability of any GST concessions. The following table summarises the GST treatment of different types of real estate transactions. 20 DLA Piper View more
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