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Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018 [and] Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-New Dwelling Interests) Bill 2018



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BILLS DIGEST NO. 93, 2017-18 23 MARCH 2018

Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018 [and] Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 Helen Portillo-Castro Economics Section

Contents

Purpose of the Bills .................................................. 3

Background .............................................................. 3

Capital gains tax features: the main residence exemption and the discount ....................................... 3

Capital gains tax changes for foreign residents ........ 4 Change to the capital gains discount ........................ 4

Near-new dwelling interests certificates .................... 6 Committee consideration ......................................... 6

Senate Standing Committee for Selection of Bills ...... 6 Senate Standing Committee for the Scrutiny of Bills .............................................................................. 7

Policy position of non-government parties/independents ............................................... 7

The Labor Party ........................................................... 7

The Australian Greens ................................................. 8

Cross-bench senators .................................................. 8

Position of major interest groups ............................. 8

Financial implications ............................................... 8

Statement of Compatibility with Human Rights ........ 8 Parliamentary Joint Committee on Human Rights ..... 9

Date introduced: 8 February 2018

House: House of Representatives

Portfolio: Treasury

Commencement: Various dates as set out in the body of this Bills Digest Links: The links to the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page. The links to the Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018. Links to both can also be found through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at March 2018.

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Capital gains tax measures ....................................... 9

Changes for foreign residents ..................................... 9

Commencement ........................................................ 9

Financial impact ........................................................ 9

Key provisions and issues ........................................ 10

Absence rule adjustment ...................................... 11

Principal asset test application .............................. 12

Additional capital gains discount for affordable housing ...................................................................... 13

Commencement ...................................................... 13

Financial impact ...................................................... 13

Key provisions and issues ........................................ 13

Near-new Dwelling Interests .................................. 15

Reconciliation payment for near-new dwelling exemption certificates .............................................. 15

Commencement ...................................................... 15

Financial impact ...................................................... 15

Key provisions ......................................................... 15

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Purpose of the Bills This Bills Digest relates to two Bills.

The Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018 (the Principal Bill) will amend the Income Tax Assessment Act 1997 (ITAA 1997), the Income Tax (Transitional Provisions) Act 1997, the Foreign Acquisitions and Takeovers Act 1975 (FATA) and the Taxation Administration Act 1953 (TAA 1953). The provisions of the Principal Bill are designed to:

• restrict access to the capital gains tax (CGT) discount through the main residence exemption by precluding foreign residents from claiming the exemption (Schedule 1, Part 1)

• clarify the CGT regime (as it applies to foreign residents) by stipulating the basis for applying the principal asset test to enable a determination on whether an entity’s underlying value is principally derived from taxable Australian real property (TARP) (Schedule 1, Part 2)

• create a mechanism for developers to make a reconciliation payment when dwellings are sold to foreign persons under a near-new dwelling certificate (Schedule 2) and

• increase the CGT discount for investors when disposing of TARP that has been used to provide affordable housing (Schedule 3).

The purpose of the Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-New Dwelling Interests) Bill 2018 (Near-New Dwelling Interests Bill) is to modify the Foreign Acquisitions and Takeovers Fees Imposition Act 2015 (Fees Imposition Act) to impose the amount payable by developers, and frequency of fee payment, in respect of obligations under Schedule 2 of the Principal Bill.

Background

Capital gains tax features: the main residence exemption and the discount Prior to 1985, Australia had no general tax on capital gains. Tax applied to some capital gains on property held for less than a year.1 The introduction of a CGT was first recommended by the Asprey Committee report released in 1974, and later by the 1985 draft white paper on tax reform, on the basis that taxation at that time discriminated in favour of people who primarily earned income from capital gains.2

The draft white paper stated that the decision to exempt owner-occupied homes from the CGT was made by the Prime Minister and was consistent with overseas practices at the time.3 The CGT initially applied to realised gains or losses on assets acquired on or after 19 September 1985, adjusted for inflation so that taxation only applied to real (not nominal) capital gains.4

The main residence exemption has been a feature of CGT since the tax was introduced. While there have been a number of changes and clarifications to the specifics of the exemption since its introduction, the high-level principle has largely remained the same—namely that a dwelling used as a principal place of residence is ignored for CGT purposes.5

1. S Reinhardt and L Steel, ‘A brief history of Australia’s tax system’, Economic Round-up (Treasury), Winter 2006, pp. 1-26. 2. Australian Government, Reform of the Australian tax system: draft white paper, June 1985, p. 77. 3. Ibid., p. 81.

4. Reinhardt and Steel, ‘A brief history of Australia’s tax system’, op. cit., pp. 11-12. 5. For a statement of the policy rationale, see R Woellner et al., Australian Taxation Law 2017, 27th edn, Oxford University Press, 2017, p. 382.

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The CGT discount, legislated in 1999, was a significant change to the capital gains tax regime: it replaced the previous indexation method for assets acquired after 21 September 1999.6 Under the discount method, capital gains tax is paid on half of the capital gain on assets held for more than 12 months (or one-third for superannuation funds).7

Capital gains tax changes for foreign residents The pair of measures that affect foreign residents under the Principal Bill were announced in the 2017-18 Budget,8 along with related measures that have since been legislated to reform the CGT regime as it applies to ‘foreign investors’.9 The Government’s stated intent behind this pair of measures is to:

… stop foreign tax residents from claiming the main residence capital gains tax (CGT) exemption when they sell property in Australia from Budget night 2017. Foreign tax residents who hold property on Budget night can continue to claim the exemption until 30 June 2019. The legislation will also modify the CGT principal asset test to apply on an associate inclusive basis. This will ensure that foreign tax residents cannot avoid a CGT liability by disaggregating indirect interests in Australian real property.

10

However, some stakeholders have warned that the changes would apply to persons who were Australian residents for tax purposes (including Australian citizens and permanent residents) who have occupied their home for a period of time and happen to sell it while residing overseas (and hence whilst considered ‘foreign tax residents’).11

The Treasury released draft legislation for consultation on this measure on 21 July 2017, with submissions closing on 15 August 2017.12 Stakeholder views are discussed under the ‘Capital gains tax measures’ section below.

Change to the capital gains discount The proposed increase of the CGT discount under the Principal Bill was announced in the 2017-18 Budget: it too relates to other aspects of the Government’s housing affordability package—in particular the measure that aims to encourage investment in affordable housing supply through managed investment trusts (MITs).13

Taken together, these measures aim to create greater incentives for private investment in affordable housing supply that targets the rental market, whether through individual or

6. A Duncan et al., ‘The income tax treatment of housing assets: an assessment of proposed reform arrangements’, AHURI Final report, 295, Australian Housing and Urban Research Institute (AHURI), Melbourne, 7 March 2018, p. 16. 7. Reinhardt and Steel, ‘A brief history of Australia’s tax system’, op. cit., p. 12. 8. Australian Government, Budget measures: budget paper no. 2: 2017-18, pp. 27-8. 9. Specifically, measures under the Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Act 2017

are intended to enhance foreign residents’ compliance with CGT liabilities by introducing integrity measures that capture more property transactions through: increasing the CGT withholding rate when a dwelling is purchased from a foreign resident; and decreasing the market value threshold for such property transactions. See M Sukkar, ‘Second reading speech:

Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Bill 2017’, House of Representatives, Debates, 1 June 2017, p. 6026. 10. S Morrison (Treasurer) and M Sukkar (Assistant Minister to the Treasurer), Helping Australians realise their dream of home ownership, media release, 21 July 2017. 11. J Mather, ‘CGT: Expat property fire sale expected’, The Australian Financial Review Weekend, 24 February 2018, p. 3;

PricewaterhouseCoopers, Australia: Capital Gains Tax changes for foreign residents, Insights, PwC, 28 July 2017. 12. The Treasury, Housing tax integrity—Capital gains tax changes for foreign residents: exposure draft, Treasury website, 21 July 2017. 13. Australian Government, Budget measures: budget paper no. 2: 2017-18, pp. 26, 29. See also the updated policy surrounding

this related measure in Australian Government, Mid-year economic and fiscal outlook 2017-18, Appendix A, p. 116.

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institutional investment.14 Investors will realise a greater gain upon disposing of property that has been used to provide affordable housing for a minimum period of three years, by virtue of the CGT reduction at the time the property is sold.

Industry participants attribute decline in housing investment over the past year to prudential measures restricting investor lending since April 2017.15 The Australian Prudential Regulation Authority’s intervention stems from the 2014 Financial System Inquiry finding that ‘tax treatment of investor housing … tends to encourage leveraged and speculative investment in housing’.16 Yet investors play a critical role in the provision of housing to a significant percentage of housing market participants.

Research examining Australian Bureau of Statistics Survey of Income and Housing data for 2013-14 suggests that, at that time, 9.5 per cent of housing market participants were in an investor class that benefitted from renting TARP attracting the CGT discount. Ninety-point-five per cent of housing market participants did not own rental investment properties—and nearly half of this majority were renting.17

When exposure draft legislation for the CGT discount measure was announced on 14 September 2017, the Treasurer clarified that eligibility for the discount would differ—in terms of surrounding conditions and commencement date—by type of investor:

From 1 January 2018, residents investing in eligible affordable housing will be entitled to a capital gains discount of up to 60 per cent if they hold the investment for at least three years, rather than the standard 50 per cent discount.

From 1 July 2017, MITs can hold affordable housing for the purpose of deriving long-term rent. The same MIT will also be permitted to derive other eligible investment business income from investments including shares or commercial property. 18

[emphasis added]

A controversial announcement accompanied the release of the exposure draft legislation: that MITs would be prevented from acquiring ownership interests in dwellings other than residential property held for long-term rent as affordable housing.19

The controversy surrounding this announcement relates to the so-called ‘build-to-rent’ model that stakeholder groups argue represents an attractive proposition for investors;20 but that is said to be adversely affected if MITs are constrained to investing in residential real estate managed by an

14. The Treasury, Treasury Laws Amendment (Reducing Pressure on Housing Affordability No. 2) Bill 2017 [and] Income Tax (Managed Investment Trust Withholding) Amendment Bill 2017: exposure draft explanatory material, The Treasury, [14 September 2017], p. 3.

15. Housing Industry Association, Taxing investors not the answer to affordability, media release, 7 March 2018. 16. D Murray et al., Financial system inquiry: final report, The Treasury, November 2014, p. 17; W Byres (Chairman, Australian Prudential Regulation Authority), Address to the Australian Securitisation Forum 2017, Sydney, speech, 21 November 2017. 17. Duncan et al., ‘The income tax treatment of housing assets: an assessment of proposed reform arrangements’, op. cit.,

Table 7, p. 35. 18. S Morrison (Treasurer) and M Sukkar (Assistant Minister to the Treasurer), Increasing the supply of affordable housing, joint media release, 14 September 2017. 19. Ibid. See also C Bowen and D Cameron, Slomo's dangerous policy on the run, media release, 15 September 2017. 20. AHURI, ‘Could “Build to rent” create affordable rental housing?’, AHURI brief, AHURI website, last updated 5 December 2017.

See also Property Council of Australia (PCA), ‘Numbers stack up for build-to-rent’, Property Australia, PCA newsletter, 6 September 2017.

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authorised community housing provider.21 This issue, at the time of writing, is being considered by the Senate Economics Legislation Committee.22

Near-new dwelling interests certificates The 2017-18 Budget included a measure to restrict foreign ownership in new developments.23

Amendments came into effect in 2017 introducing a near-new dwelling exemption certificate under the Foreign Acquisitions and Takeovers Regulation 2015 (the Regulation).24 Prior to this, foreign buyers were required to go through a FATA application process in order to purchase dwellings that had never been lived in but that had been subject to a failed settlement (‘near-new dwellings’). A ‘near-new dwelling interest’ is defined in the Regulation.25

The amendments under Schedule 2 of the Principal Bill, combined with the Near-New Dwelling Interests Bill, propose that near-new dwelling interests sold to foreign persons will be subject to the imposition of a fee on the developer who enables the acquisition.26 This replaces the fee that was previously imposed on a foreign buyer through the FATA approval process, prior to the introduction of the near-new dwelling certificate last year.

The near-new dwelling exemption certificate creates a fee imposition mechanism, parallel to the new-dwelling exemption certificate available to developers under section 57 of the FATA. As for new dwellings sold to foreign persons under new-dwelling exemption certificates, sales will be

lawful where the developer holds a near-new dwelling exemption certificate.27

Committee consideration

Senate Standing Committee for Selection of Bills The Bills were referred on 15 February 2018 to the Senate Economics Legislation Committee for inquiry and report by 23 March 2018.28 Details of the inquiry are available via the inquiry homepage.

The Senate Standing Committee for Selection of Bills referred the Bills on the basis of potential stakeholder interest in the adjustments to CGT treatment of MITs involved in affordable housing supply.29

21. PCA, Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], 5 March 2018, p. 2.

22. Senate Standing Committees on Economics, Inquiry into the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions] homepage, Parliament of Australia website.

23. Australian Government, Budget measures: budget paper no. 2: 2017-18, ‘Reducing pressure on housing affordability—restrict foreign ownership in new developments to no more than 50 per cent’, p. 31. 24. Foreign Acquisitions and Takeovers Fees Imposition Amendment (Fee Streamlining) Regulations 2017, section 6A; Foreign Acquisitions and Takeovers Amendment (Exemptions and Other Measures) Regulations 2017, item 6 of Schedule 2, inserting

sections 43A and 43B into the Regulation. 25. Section 5 of the Foreign Acquisitions and Takeovers Regulation 2015 defines a near-new dwelling interest as an interest in a dwelling, if all of the following apply: (a) the dwelling is contained in a development; (b) an agreement to sell the interest in

the dwelling had become binding; (c) that agreement did not result in the transfer of title to the interest, and is no longer in force; (d) the interest is to be sold under another agreement; (e) the interest would be in a new dwelling, to be acquired under the other agreement, if there were no agreements to which paragraphs (b) and (c) applied. 26. Explanatory Memorandum, Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018 and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018, p. 34. 27. Foreign Investment Review Board (FIRB), Residential real estate—new (and near-new) dwelling exemption certificate, FIRB guidance note 8, 1 July 2017. 28. Senate Standing Committee for Selection of Bills, Report, 2, 2018, The Senate, Canberra, 15 February 2018. 29. Ibid., Appendix 6.

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Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills (Scrutiny of Bills Committee) considered the Principal Bill in its Scrutiny Digest, published on 14 February 2018.30

The Scrutiny of Bills Committee highlighted the retrospective application of the measures contained in the Bill, reiterating its concern that ‘“legislation by press release” […] challenges a basic value of the rule of law that, in general, laws should only operate prospectively’.31Amendments in:

• Schedule 1 are to apply to CGT events occurring at or any time after 7.30pm, by legal time in the ACT, on 9 May 2017 (items 31 and 34 of Schedule 1)

• Schedule 2 are to apply in relation to acquisitions of near-new dwellings occurring on or after 1 July 2017 (item 10 of Schedule 2) and

• Schedule 3 are to apply to CGT events happening on or after 1 January 2018 (item 7 of Schedule 3).

In relation to items 31 and 34 of Schedule 1 (the application provisions for that Schedule), the Scrutiny of Bills Committee noted:

… in the context of tax law, reliance on ministerial announcements, and the implicit requirement that persons arrange their affairs in accordance with such announcements rather than in accordance with the law, tends to undermine the principle that the law is made by Parliament, not by the executive.

… in fact, where taxation amendments are not brought before the Parliament within 6 months of being announced, the bill risks having the commencement date amended by resolution of the Senate (see Senate Resolution No. 44). 32

The Scrutiny of Bills Committee went on to flag sections of the Explanatory Memorandum for the Bill that explicated considerations given to the impact and reasons for retrospective application.33

Policy position of non-government parties/independents

The Labor Party The ALP supported the Bills through the House of Representatives noting, as has been the party position on related legislation, that the measures associated with the Government’s housing affordability package ‘don't deal with the core of the problem’.34

Despite providing grounds for not opposing the legislation, the ALP stated in the House that the Senate inquiry into the Principal Bill would provide clarification about the impact of:

• the modification to the main residence exemption on New Zealanders residing in Australia and

30. Senate Standing Committee for Scrutiny of Bills, Scrutiny digest, 2, 2018, The Senate, Canberra, 14 February 2018, p. 60. The Near-new Dwelling Interests Bill is considered on p. 18 of the Scrutiny Digest: it notes the retrospective application of provisions contained in this secondary Bill also, which are contingent on the Principal Bill becoming law.

31. Ibid., p. 61. The Committee raised the same concern regarding related legislation that was enacted last year, specifically the Treasury Laws Amendment (Housing Tax Integrity) Act 2017: see Senate Standing Committee for Scrutiny of Bills, Scrutiny digest, 11, 2017, The Senate, Canberra, 13 September 2017, pp. 21-2. 32. Senate Standing Committee for Scrutiny of Bills, Scrutiny digest, 2, 2018, op. cit., p. 61. 33. For Schedule 1, see Explanatory Memorandum, op. cit., pp. 29-31; for Schedule 2, see p. 37; for Schedule 3, see p. 62. 34. M Thistlethwaite, ‘Second reading speech: Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures

No. 2) Bill 2018, Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018’, House of Representatives, Debates, (proof), 1 March 2018, p. 81.

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• the increased CGT discount for MITs in particular, in light of Government policy to restrict investment through MITs to affordable housing developments.35

The Australian Greens The Greens appear not to have passed comment on the measures contained in these Bills specifically. However, the party took a policy to the 2016 election to phase out the CGT discount, reducing the concession by 10 per cent each year over five years.36 Immediately prior to the 2017- 18 Budget, Greens spokesperson for housing Senator Lee Rhiannon said ‘continuing to allow investor tax concessions to supercharge the housing market is profoundly irresponsible’.37

Cross-bench senators While no cross-bench senators have made specific comment about the Bills, some have expressed views on the subject of reducing ‘foreign’ ownership in Australian real estate in relation to addressing housing affordability—noting that, on the measure pertaining to foreign residents, the Bill in its current form does not differentiate between foreign investors and Australian citizens and permanent residents residing overseas who own real estate.

Senator Pauline Hanson has called for restricting foreign investment activity in the Australian housing market, stating ‘we should be making policies and building houses so Australians have homes for themselves and their families, not so foreign investors have a home for their investments’.38 It is not clear what position Senator Hanson may take in relation to Australians living abroad and the impacts the Bill will have on them.

Position of major interest groups The positions that major interest groups have taken are set out in ‘Key provisions and issues’ sections below, under the headings that relate to measures contained in the Principal Bill and Near-new Dwelling Interests Bill.

Financial implications Each Schedule of the Principal Bill has its own financial implications. The segmentation of the financial implications relates to the fact that each measure was announced separately in the 2017-18 Budget, despite forming part of the Government’s overall housing affordability package.

The parts of this digest examining each measure in detail contain information on the financial impact of respective measures.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Principal Bill’s compatibility with the human rights and freedoms

35. A Leigh, ‘Second reading speech: Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018, Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018’, House of Representatives, Debates, (proof), 1 March 2018, p. 87.

36. Australian Greens, The case for capital gains tax reform: a fairer tax system and housing market for all, Australian Greens political document, 14 May 2016. 37. L Rhiannon, Housing plans doomed if govt [sic] abandons negative gearing and CGT reform, media release, 3 May 2017. 38. P Hanson, Senator Hanson calls for non-resident home ownership crackdown, media release, 14 June 2017.

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recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.39

Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights deferred consideration of the Principal Bill on 13 February 2018.40

The Committee found that the Near-new Dwelling Interests Bill did not raise any human rights concerns.41

Capital gains tax measures The following outlines key elements of Schedules 1 and 3 of the Principal Bill, which contain the measures that affect CGT features described in the ‘Background’ section of this Bills Digest.

Changes for foreign residents

Commencement The amendments in Schedule 1 of the Principal Bill commence on the first 1 January, 1 April, 1 July or 1 October to occur after the Bill receives Royal Assent.42

Schedule 1 amendments are intended to apply to relevant CGT events occurring at or any time after 7.30 pm, by legal time in the ACT, on 9 May 2017.43 However, foreign residents holding property at that time may continue to claim the CGT exemption until 30 June 2019.44

Financial impact The estimate for the out-year in the forward estimates (2020-21) has been revised downwards— from $200 million to $170 million—since figures were published for the measure in the 2017-18 Budget.45

The financial implications are, however, identical to the projections published in the Explanatory Memorandum for the Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Act 2017—legislation that, together with the provisions of this Schedule, implement associated Budget measures affecting CGT as it applies to foreign residents.46

39. The Statements of Compatibility with Human Rights for each Schedule of the Principal Bill can be found at pages 31, 38 and 62 of the Explanatory Memorandum to the Bill. A separate Statement of Compatibility has not been provided for the Near-new Dwelling Interests Bill, but it may be considered to be covered by the Statement in relation to Schedule 2 of the Principal Bill. 40. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 2, 13 February 2018, p. 119. 41. Ibid., p. 42. 42. Proposed section 2, Reducing Pressure on Housing Affordability No. 2 Bill. 43. Item 31 and item 34 of Schedule 1 to the Reducing Pressure on Housing Affordability No. 2 Bill. Note that the Scrutiny of Bills

Committee has drawn the retrospective operation of this Schedule to the attention of the Senate. 44. S Morrison, ‘Second reading speech: Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017’, House of Representatives, Debates, 8 February 2018, p. 710; Income Tax (Transitional Provisions) Act 1997, proposed section 118-110, inserted by item 30 of Schedule 1 to the Principal Bill. 45. Australian Government, Budget measures: budget paper no. 2: 2017-18, p. 27; Explanatory Memorandum, op. cit., p. 7. 46. Australian Government, Budget measures: budget paper no. 2: 2017-18, op. cit., pp. 27-8. Specifically, the ‘Reducing Pressure

on Housing Affordability—capital gains tax changes for foreign investors’ measure.

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Table 1: Financial impact of CGT changes for foreign investors

2016-17 2017-18 2018-19 2019-20 2020-21

* $150m $100m $150m $170m

*Unquantifiable

Source: Explanatory Memorandum, op. cit., p. 7.

The Explanatory Memorandum for the Principal Bill explains that the revision to the Budget figures is due to ‘a minor policy change that will ensure only Australian residents for tax purposes can access the main residence exemption’.47

Treasury’s estimate for the 2017-18 tax expenditure on the existing main residence exemption was in the order of $33.5 billion.48 This figure is relative to the 50 per cent CGT discount that would apply in the absence of the main residence exemption.

Key provisions and issues The type of CGT events envisaged by Schedule 1 are those that occur when a person sells or otherwise disposes of taxable Australian real property (TARP) in the form of a dwelling, and that person makes a capital gain or loss.49

The amendments in Schedule 1 are designed to affect this kind of CGT event in two ways:

1. to preclude ‘foreign residents’ (including Australian citizens and permanent residents residing overseas) from claiming the main residence exemption in relation to the CGT event (contingent on the time it occurs) and

2. to clarify that the ‘principal asset test’ applies on an associate-inclusive basis when determining whether an entity’s underlying value is derived from TARP in relation to a CGT event.

The disposal of a CGT asset in the form of TARP is a CGT event under the ITAA 1997.50 Part 1 of Schedule 1 to the Principal Bill specifically targets dwellings, including the land on which the dwelling is located, for the purposes of defining whether the CGT asset may be subject to an exemption from CGT treatment.51

The current law provides an entitlement to claim an exemption in relation to CGT subject to certain conditions around the owner’s use of the dwelling as a main residence; the circumstances by which they acquired their ownership interest; and if the disposal of that asset would otherwise be treated as a CGT event.52 This is the case for:

• Australian residents for tax purposes

• temporary residents—such as those on temporary visas—and

• foreign residents for tax purposes.53

Items 3 and 4 of Schedule 1 to the Principal Bill insert proposed modifications to section 118-110 of the ITAA 1997. The amendments have the effect of excluding any person from claiming the exemption if, at the time the CGT event occurs, that person fits the definition of a foreign resident

47. Explanatory Memorandum, op. cit., p. 7. 48. [The Treasury], Tax expenditures statement 2017, The Treasury, Canberra, 25 January 2018, pp. 102: table E5. 49. Explanatory memorandum, op. cit., p. 16. See also ATO, ‘Types of CGT events’, ATO website, last modified 17 July 2017. 50. ITAA 1997, sub-division 104-A. 51. Explanatory memorandum, op. cit., p. 16. 52. ITAA 1997, sub-division 118-B. 53. Explanatory memorandum, op. cit., pp. 13 and 16-17; see also ATO, ‘Foreign residents and temporary residents’, ATO

website, last modified 17 July 2017.

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for tax purposes.54 (The Government clarified in the 2017-18 MYEFO that temporary tax residents who count as Australian tax residents will be unaffected by the change.55)

Item 11 proposes a new subsection 118-185(3) to the ITAA 1997 so that, if at the time the CGT event occurs the dwelling owner is a foreign resident, a person is not entitled to a partial exemption where the dwelling has been used as a main residence during part of the ownership period only. Proposed subsection 118-245(3) at item 28 of Schedule 1 will provide that a partial exemption cannot be claimed if the person’s ownership interest is affected in part through compulsory acquisition (for example to land adjacent to the dwelling that was used as a main residence) and at the time of the compulsory acquisition the person is a foreign resident.56

Absence rule adjustment Under the ITAA 1997, an ‘absence rule’ allows owners to continue to treat a dwelling as their main residence even if they are absent from their main residence (for example, to travel, work or move into a retirement village). If the dwelling is used for income producing purposes, this absence is limited to six years. If not, there is no time limit for absence.57

Item 5 of Schedule 1 adjusts the example of the operation of the absence rule under subsection 118-145(4) (example) to provide that a person who vacates their main residence whilst living overseas may continue to treat it as a main residence, which serves to guide interpretation of the operative provisions that restrict the application of the absence rule.

The combined effect of the proposed amendments removes entitlement to the exemption—in part or in full—for all Australian citizens and permanent residents who are not residents for tax purposes at the time the contract of sale is signed.58 This includes Australians living and working overseas at the time they sell their property, who are counted as foreign residents for tax purposes. Advisory firms and the Australian expat community have expressed reservations about this adjustment to the absence rule.59

The table below demonstrates the impact of the proposed changes on different types of property owners, using the same transaction as an example.

Table 2: Impact of proposed adjustment to the absence rule on Australian taxpayers Type of property owner Material use of property/transactions Current tax treatment

upon disposal

Position under the Principal Bill

Australian resident owner-occupier • Purchased house for $250,000 in 2004.

• Resides in the house until it is sold in December 2020 for $500,000

The $250,000 capital gain is not included in the taxpayer’s assessable income.

Unchanged.

Australian resident • Purchased house for Due to the operation of Unchanged.

54. Foreign residents are defined in section 995-1 of ITAA 1997 as ‘a person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936 [ITAA 1936]’. See ITAA 1936, section 6. 55. Australian Government, Mid-year economic and fiscal outlook 2017-18, Appendix A, p. 109. 56. Explanatory memorandum, op. cit., pp. 19-21. 57. ITAA 1997, section 118-145. 58. M Heinrich and S Kneale, ‘Removal of CGT main resident exemption for foreign residents’, Insights, KPMG Australia,

28 July 2017. 59. CST Tax Advisors, Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], 26 February 2018. See also Tax Institute,

Submission to Treasury consultation Housing tax integrity - Capital gains tax changes for foreign residents, 15 August 2017; PwC, Australia: Capital Gains Tax changes for foreign residents, op. cit.

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Type of property owner Material use of property/transactions Current tax treatment upon disposal

Position under the Principal Bill

landlord $250,000 in 2004.

• Resides in the house until December 2016. • Rents the house from December 2016 until it is

sold in December 2020 for $500,000

the ‘absence rule’, the $250,000 capital gain is not included in the taxpayer’s assessable income.

Australian citizen/permanent resident expatriate landlord

• Purchased house for $250,000 in 2004. • Resides in the house until December 2016. • Moves overseas in

December 2016 and rents the house from December 2016 until it is sold in December 2020 for $500,000

Due to the operation of the ‘absence rule’, the $250,000 capital gain is not included in the taxpayer’s assessable income.

The entire capital gain of $250,000 must be included in the taxpayer’s assessable income, and taxed at their marginal rate (as a non-resident, they will not have the benefit of the tax-free threshold).

Source: ITAA 1997; Principal Bill.

The table above illustrates stakeholder concerns that the Bill will impose CGT on Australian citizens and permanent residents residing overseas, while taxpayers residing in Australia will continue to enjoy the CGT exemptions.60 It is not clear whether the Government intended Australian expatriates to be treated in the same way as bona fide foreign investors.

Principal asset test application Division 855 of the ITAA 1997 allows foreign residents to disregard a capital gain or loss against a direct or indirect asset, unless that asset is TARP. Paragraph 855-5(2)(b) states that this law is in place to ensure interests in an entity remain subject to Australia’s CGT laws if the entity’s underlying value is principally derived from Australian real property.

The amendments in Part 2 of Schedule 1 to the Bill are relevant where a foreign resident has an indirect interest in TARP, for example because they have shares in a company that holds TARP or they are a beneficiary or unitholder of a trust that holds TARP. These types of interests are referred to as membership interests.

A capital gain or capital loss made by a foreign resident in respect of a membership interest is disregarded unless both the following tests are satisfied:

• the non-portfolio interest test in section 960-195 of the ITAA 1997 and

• the principal asset test in section 855-30 of the ITAA 1997.

Broadly, the non-portfolio interests test will be satisfied where the foreign resident has an interest of 10 per cent or more in the entity in which it holds a membership interest.61 The principal asset test will be satisfied where ‘more than 50% of the market value of the entity's assets is attributable to Australian real property’.62

60. SMATS Group, Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], 5 March 2018.

61. Thomson Reuters, Australian Income Tax 1997 Commentary, [855.1000]. 62. Ibid.

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Section 855-30 provides that where the foreign resident entity’s interest in the entity that holds the Australian property interest is less than 10 per cent, the market value of the TARP assets will be treated as zero and therefore the principal asset test will not be met.

Part 2 of Schedule 1 to the Principal Bill proposes to amend section 855-30 to ensure that, when determining the foreign entity’s interest in the entity that holds the Australian property, both the interests held directly by the foreign entity and the interests held by any of its associates are counted.

This amendment will mean that the principal asset test is to be applied on an ‘associate inclusive basis’, and is designed to ensure that the use of related entities and persons cannot be utilised to evade CGT liabilities. Some stakeholders have suggested that this anti-avoidance measure will be ineffective, in that ‘foreign residents can simply swap the membership interests in associates with direct interests in TARP assets’.63

Additional capital gains discount for affordable housing

Commencement The amendments in Schedule 3 of the Principal Bill commence on the first 1 January, 1 April, 1 July or 1 October to occur after the Bill receives Royal Assent.64

Schedule 3 amendments affect TARP leased to provide affordable housing (as defined in the Bill)65 on or after 1 January 2018 for at least three years (1095 days).

Financial impact The financial impact of the increase to the CGT discount is anticipated to have a $15 million cost to revenue, commencing in the 2019-20 year of the forward estimates.

Table 3: Financial impact of the additional CGT discount

2016-17 2017-18 2018-19 2019-20 2020-21

- - * -$5m -$10m

*Unquantifiable

- Nil

Source: Explanatory Memorandum, op. cit., p. 8.

Treasury’s estimate for the 2017-18 tax expenditure on the existing CGT discount for individuals and trusts was in the order of $10.2 billion.66

Key provisions and issues Item 2 proposes a new section 115-125 of the ITAA 1997, inserting the object of the measure and the conditions under which an increased CGT discount may be calculated for disposal of TARP assets. These conditions amend existing law to introduce specifications regarding:

• the entities that may qualify

63. National Affordable Housing Consortium (NAHC), Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], 7 March 2018, [Summary]. 64. Proposed section 2, Reducing Pressure on Housing Affordability Measures No. 2 Bill. 65. ITAA 1997, proposed division 980, at item 3 of Schedule 3. 66. [The Treasury], Tax expenditures statement 2017, op. cit., p. 105.

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• the types and uses of TARP assets that may qualify and

• the period(s) of time that ownership interests in TARP assets must be held

before the additional CGT discount formula can apply.

Individuals will qualify for an additional discount of up to 10 per cent more than the standard 50 per cent CGT discount,67 if:

• they directly own TARP,68 or have invested in TARP through a trust69 and

• the TARP is a dwelling that has demonstrably been used to provide affordable housing on at least 1095 days before the CGT event and during the person’s ownership period of the dwelling70 and

• the tenancy of the dwelling is exclusively managed by a community housing provider, who has issued the owner a valid affordable housing certificate concerning their ownership interest.71

The minimum three-year period during which the dwelling must be used to provide affordable housing may accumulate through multiple, shorter tenancies that count as affordable housing days;72 and the dwelling must be leased through an eligible community housing provider.73

Item 3 inserts a division at the end of ITAA 1997 Part 6-1 that stipulates that entities that manage the tenancy of dwellings must be providers of community housing services registered under an Australian law or by an Australian government agency.74

Items 5-6 amend the Taxation Administration Act 1953 to allow the ATO to disclose information to an agency that regulates community housing service providers and to require community housing providers to advise the ATO Commissioner of any affordable housing certificates they

issue each financial year.

Industry has welcomed the introduction of the additional CGT discount formula, but has argued that the implementation of this measure alone provides insufficient incentive to increase supply to the rental market.75

Given the current downturn in the housing construction cycle and the limitations the conditions in the Bill represent, institutional investors may not perceive the incentive alluring enough to fund the amount of construction activity required to develop sufficient additional affordable housing supply. Some related barriers for institutional investment in the sector include:

1. the need for opportunity at a sufficient scale to generate shareholder returns

2. the profile of residential property as a higher-risk investment class and

67. ITAA 1997, proposed subsections 115-125(4) and (5) at item 2 of Schedule 3. 68. Proposed subsections 115-125(4) and (5) complement the proposed amendments to the main residence exemption under Schedule 1 of the Reducing Pressure on Housing Affordability Measures No. 2 Bill: the ownership period on which the extra CGT discount is based will exclude days after 8 May 2012 during which individuals were a foreign or temporary resident. 69. ITAA 1997, proposed sections 115-125(2) and (3). Note that proposed paragraph 115-125(3)(a) excludes capital gains made

by trusts that are superannuation funds or public units trusts as defined in ITAA 1936, section 102P. 70. ITAA 1997, proposed paragraph 115-125(2)(d) at item 2 of Schedule 3 and proposed sections 980-1 and 980-5 at item 3 of Schedule 3. 71. ITAA 1997, proposed section 980-15 and proposed paragraph 980-5(c). 72. Explanatory memorandum, op. cit., p. 47. ITAA 1997, proposed subsections 115-125(2)(d) and 115-125(5). 73. ITAA 1997, proposed section 980-10. 74. ITAA 1997, proposed section 980-10. 75. PCA, Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure

on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], op. cit., p. 1.

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3. reputational risk in the event recourse to assets provided as security is required (however low).76

This relates to so-called ‘build-to-rent’ developments, in that industry believes the viability of that model could rely on attracting investment in projects that combine both affordable rental housing and dwellings let at market rates.77 If investment in housing developments through MITs is constrained to affordable housing let through community housing providers, the argument is that the constraint will have an adverse impact on a model that otherwise holds promise to attract investment that would increase supply for participants in both the private and social housing rental markets.78

Near-new Dwelling Interests The provisions of the Near-new Dwelling Interests Bill amend the Fees Imposition Act; they are tied closely to provisions contained in Schedule 2 of the Principal Bill that amend the FATA.

The following outlines key elements of Schedule 2 of the Principal Bill and the provisions of the Near-new Dwelling Interests Bill. Taken together, these comprise measures that impose administrative and financial obligations on developers as described in the ‘Background’ section of this Bills Digest.

Reconciliation payment for near-new dwelling exemption certificates

Commencement The provisions of the Near-new Dwelling Interests Bill are contingent on, and are to commence simultaneously, with those under Schedule 2 of the Principal Bill—that is, commencement for these interrelated provisions will occur the day after the Principal Bill receives Royal Assent.

The application of the amendments to the FATA are proposed to affect acquisitions occurring on or after 1 July 2017. However, transitional arrangements affecting the timing of reconciliation payments are proposed to apply to acquisitions that occur on or after 1 July 2017 that are covered by a residential land (near-new dwelling interests) certificate issued to the developer at least six months before the provisions become law.79

Financial impact The financial impact of this measure is aggregated with others ‘aimed at streamlining the foreign investment regime with a cost of $20.4 million over the forward estimates’.80

Key provisions Items 1 and 9 of Schedule 2 to the Principal Bill propose to insert two definitions into the FATA, namely:

1. a near-new dwelling acquisition81 and

76. A Sharam et al., Understanding opportunities for social impact investment in the development of affordable housing, AHURI Final report, 294, AHURI, February 2018, p. 53. 77. Industry Super Australia (ISA), Assisting housing affordability, ISA discussion paper, November 2017, pp. 43-4. 78. NAHC, Submission to Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Reducing Pressure

on Housing Affordability Measures No. 2) Bill 2017 [provisions] and Foreign Acquisitions and Takeovers Fees Imposition Amendment (Near-new Dwelling Interests) Bill 2018 [provisions], op. cit., pp. 7-8. 79. Items 10 and 11 of Schedule 2 of the Reducing Pressure on Housing Affordability Bill; items 5 and 6 of the Near-new Dwelling Interests Bill. As noted in this Bills Digest, the Scrutiny of Bills Committee has drawn the retrospective operation of these

provisions to the attention of the Senate. 80. Explanatory Memorandum, op. cit., p. 8.

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2. a residential land (near-new dwelling interests) certificate.82

Section 113 of the FATA, which sets out when fees are payable under that Act, is amended by items 2 to 9 of Schedule 2 to the Principal Bill. The amendments create a reconciliation mechanism that requires developers to make payments in relation to sales to foreigners made under residential land (near-new dwelling interests) certificates. This will mirror the existing requirements in section 113 that apply to sales to foreigners under new dwelling exemption certificates issued under section 57 of the FATA.

Schedule 1 of the Near-new Dwelling Interests Bill proposes to amend the Fees Imposition Act with reference to the FATA amendments to impose the reconciliation payment. Item 4 of the Near-new Dwelling Interests Bill amends section 6 of the Fees Imposition Act, adding proposed sections 6(5) and 6(6) that stipulate how the quantum of the reconciliation payment for a residential land (near-new dwelling interests) certificate is to be derived.

The relevant Foreign Investment Review Board (FIRB) guidance note stipulates that liability for the fee may fall on the foreign purchaser where this is agreed by the developer and the foreign person.83 A foreign purchaser is not normally required to seek FIRB approval to acquire interests in a property that is already covered by an exemption certificate.84

81. FATA, amendments to section 4 and proposed subsection 113(4A). 82. FATA, amendments to section 4. Note that residential land (near-new dwelling interests) certificate is defined as in the Foreign Acquisitions and Takeovers Regulation 2015, which scheduled to sunset on 1 April 2026.

83. FIRB, Residential real estate—new (and near-new) dwelling exemption certificate, op. cit. 84. Ibid.

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