By Paul Goldin on Thursday, March 22nd, 2018 in 2018-19.
AUSTRALIA’S FOREIGN INVESTMENT RULES – PROPERTY ACQUISITIONS IN COMPANIES AND TRUSTS
Acquisitions of real property in Australian companies and trusts, may, in some cases, be breaching Australia’s foreign investment rules.
In simple terms, the Australian foreign investment rules pertaining to property acquisitions are different from ordinary legal concepts and Australian income tax legislation.
For example, as set out in more detail in the attached paper, an Australian resident company or trust may still need to apply to the Foreign Investments Review Board (“FIRB”) in order to acquire property in Australia. In essence, this is because:
– in the case of Australian companies, where a non-resident has 20% or more of the share and/ or votes in the company, then the Australian company may be considered to be a foreign person for FIRB purposes; or – in in the case of an Australian unit trust, again, where a non-resident has 20% or more of the units (income and/ or capital units) or voting powers in the unit trust; or – in the case of an Australian discretionary trust, where the trustee has discretion to distribute income or property of the trust to one or more non-resident beneficiaries.
The relevant rules are complicated, but the attached paper seeks to broadly describe the situation for Australian resident entities where there is either a substantial interest in the company or unit trust held by a non-resident, or the relevant Australian discretionary trust has the ability to distribute to non-residents.
In either case, we would recommend that Australia’s foreign investment rules be considered, prior to any acquisition of real property, by the relevant Australian company or trust.
As always, we recommend that if these rules are applicable, readers obtain appropriate advice to their specific situation.
1. AUSTRALIA’S FOREIGN INVESTMENT RULES
Australia’s foreign investment legislation (FI Rules) impose strict rules around the purchase of residential and commercial real estate (Australian Property). The use of Australian corporations and Australian domiciled trusts (or trustees who are Australian citizens or Australian corporations), does not, of itself, allow foreign persons to avoid the FI Rules.
Rather, the FI Rules extend the meanings of a “Foreign Person” for the purposes of those rules such that Australian corporations and trustees of trusts that meet the definition of a Foreign Person1 are required to seek foreign investment approval from the Foreign Investments Review Board (FIRB) to acquire interests in Australian Property. For example, the FI Rules are not the same as those applied to determine Australian residency for Australian tax purposes (Australian Tax Resident).
Strict penalties (including civil and criminal penalties) may apply for breaches of the FI Rules.
For this reason it our view that Australian property acquisitions through an Australian company or trust may not meet the FI Rules in certain instances, and that some of these real property acquisitions may also require FIRB approval.
This Alert draws the reader’s attention to and summarises the potential need for FIRB approval by Australian companies and Australian domiciled trusts (including a unit trust) acquiring Australian Property. The need for FIRB approval may be required notwithstanding that the Australian company or trust is an Australian Tax Resident.
2. FOREIGN PERSONS AND AUSTRALIAN PROPERTY
Foreign Persons generally need to apply for and receive FIRB approval before purchasing Australian Property. However, Foreign Persons, regardless of citizenship or residency, do not require foreign investment approval to acquire an interest in Australian Property that is:
Purchased as joint tenants with their Australian citizen spouse, New Zealand citizen spouse, or Australian permanent resident spouse. This exemption does not include purchasing property as tenants in common;
A new dwelling purchased from a developer that holds a new dwelling exemption certificate that allows the developer to sell dwellings in the specified development to Foreign Persons;
A time share scheme where the Foreign Person’s total entitlement (including any associates) to access the land is no more than four weeks in any year;
Acquired by will or devolution of law;
Acquired directly from the Commonwealth, a State, a Territory, or local governing body, or an entity wholly owned by the Commonwealth, a State, a Territory or a local governing body; and
An interest in certain Australian Property in designated Integrated Tourism Resorts.
Other than the above, where Australian residential property is acquired by a Foreign Person, FIRB approval will be required.
3. AUSTRALIAN COMPANIES & TRUSTS WHICH MAY BE REGARDED AS FOREIGN PERSONS
Foreign Persons are broadly:
Individuals not ordinarily resident in Australia (with the exception of Australian citizens living abroad); and
A holder of a visa that permits the individual to remain in Australia for only a limited period. There are certain concessions available to certain temporary residents; but the consideration of these issues is beyond the scope of this Alert.
However, Australian companies and trusts (and general partners of a limited partnership) satisfying the definition of a Foreign Person for the purposes of the FI Rules, are subject to the same treatment when purchasing residential real estate i.e. FIRB approval is required.
3.1 Is your Australian Company or Trust a Foreign Person?
A company and/ or the trustee of a trust is considered to be a Foreign Person if:
An Australian non-resident individual, a foreign corporation or a foreign government holds a substantial interest in the company or the trust; or
Two or more persons, each of whom is an Australian non-resident individual, a foreign corporation or a foreign government, hold an aggregate substantial interest in the company or the trust.
3.2 Substantial Interest
A person holds a substantial interest if the person holds, alone or with one or more associates, an interest of at least 20% in the:
company (for example, voting or shares with income and/ or capital entitlements); or
the income or property of the trust.
A specific rule applies to discretionary trusts (Refer below).
3.3 Aggregate Substantial Interest
Two or more persons hold an aggregate substantial interest in a company and/ or a trust if the persons, alone or with one or more associates, hold an aggregate interest of at least 40% in the:
the income or property of the trust.
A specific rule applies to discretionary trusts (Refer below).
The substantial interest and aggregate substantial interest tests apply to individuals and their associates.
The definition of associate is very broad and includes persons such as:
Any relative, including a person’s spouse or de facto, parent, grandparent, brother, sister, child, uncle, aunt, nephew, niece, lineal descendent or adopted child;
Any entity of which a person is an officer (for example, a director or a person who is in a position to determine the investments or policy of the trustee). It also includes any entity whose officers are accustomed or under an obligation to act in accordance with the directions, instructions or wishes of the person;
If the person is a company—a person who holds a substantial interest in the company; or
The trustee of a trust in which a person holds a substantial interest.
FIRB Guidance Notes 3 and 5 (Guidance Note 3 and Guidance Note 5) provides the following examples of a company and trust which would be a Foreign Person and require FIRB approval
Guidance Note 3 provides:
Three brothers establish a company in Australia with the intention of redeveloping property. Each brother holds an equal share of the company. One brother is an Australian citizen, one is an Australian permanent resident, and one is not ordinarily resident in Australia and is not an Australian citizen. The company is a foreign person for the purposes of Australia’s foreign investment framework because an individual who is not ordinarily resident in Australia and who is not an Australian citizen holds a substantial interest in the company (that is, an interest of at least 20 per cent). The company therefore needs to apply for and receive approval for any proposed purchase of residential land.”
Guidance Note 5 sets out the following examples:
Margaret holds a 15 per cent interest in Abode Developments and is a director of the company. Although Margaret does not hold a substantial interest in Abode Developments (as she holds less than 20 per cent of the shares in the corporation), Margaret and Abode Developments are associates as Margaret is a senior officer as defined in the Act.
Nadia is a 15 year old foreign person residing in Australia for six months through a secondary school exchange program. Nadia’s parents, who live in a foreign country, are proposing to purchase an established dwelling for Nadia’s benefit by establishing a trust where Nadia is the sole beneficiary with an Australian citizen being appointed as the trustee. The trustee of the trust is considered to be a foreign person in their capacity as trustee (as an individual not ordinarily resident in Australia holds a beneficial interest in at least 20 per cent of the income or property of the trust). The trustee will be required to seek approval to purchase residential real estate such as new dwellings in Australia. However, an application to purchase an established dwelling would generally not be approved, as a trustee of a trust which is a foreign person would normally be ineligible to purchase an established dwelling to live in or rent out.”
The Guidance Note examples above highlight situations where a company or trust might be an Australian Resident for tax purpose, but still require FIRB approval to acquire Australian Property.
3.5 Discretionary trusts
Generally, the term “discretionary trust” is used to describe a trust where under the terms of the trust, a trustee has the power or discretion to distribute the income or property of the trust to one or more beneficiaries
Under the FI Rules, the trustee of a discretionary trust where one or more Foreign Persons hold any beneficial interest in the trust is considered to be a Foreign Person.
Under the FI Rules each discretionary beneficiary of a discretionary trust (i.e. that the trustee has discretion to distribute the income or property to) is deemed to have the maximum percentage interest in the income or property that the trustee may exercise discretion to distribute to them.2
This is because the trustee of a discretionary trust has the power to distribute the income or the property of the trust to one or more beneficiaries, such that one person, who may be a Foreign Person, can have all the income of the trust distributed to them or receive all the assets of the trust.
Guidance Notes 3 and 5 provide the following example:
“A discretionary trust is established in Australia and the trustee is an Australian citizen. Four individuals hold a beneficial interest in the trust, as potential beneficiaries of any of the income or property of the trust. One of those individuals is not ordinarily resident in Australia and is not an Australian citizen, and the others are Australian citizens. The individual who is not ordinarily resident in Australia is a foreign person and taken to have a 100 per cent interest in the trust (irrespective of how the trustee may exercise his or her discretion in practice). The trustee of the trust is a foreign person for the purposes of Australia’s foreign investment framework. The trustee therefore needs to apply for and receive approval for any proposed purchase by the trust of residential land.”
The FI Rules also allows for the tracing of interests through multiple entities to help determine who the ultimate acquirer of the interest in the Australian Property is. The Treasurer, or his or her delegate, may issue a tracing notice to a person requiring further information about ownership of a dwelling. Failure to comply with a tracing notice may attract a penalty of imprisonment for up to six months or 30 penalty units (at the time of writing a penalty unit is $180), or both.
The Treasurer also has a wide range of powers to take action to penalise persons and their associates who are involved in a scheme for avoiding the Act. This includes the issuing of disposal orders requiring that an interest in Australian Property acquired by a person involved in a scheme, be sold to an eligible independent party.
The Treasurer also has the power to order that certain persons involved in a scheme to avoid the Act are taken to be associates for specified purposes.
We consider that a number of Australian Tax Resident companies and trusts will require FIRB approval, many of whom may not have obtained the necessary approvals. We further consider that there is likely to increasing focus on whether Australian companies and trusts acquiring real property have obtained the necessary approval with FIRB.
1 under the Foreign Acquisitions and Takeovers Act 1975 (Act)
2 Section 18 of the Act
The statements herein are not intended to amount to advice and should not be relied upon without first obtaining specific advice applicable to your situation.