The ATO's crackdown on investors

Australian Taxation Office Commissioner Chris Jordan makes no bones about tracking down tax evaders, and he's not just focused on recouping undeclared income from multinational corporations.

“Our efforts will be focussed on providing Australians with a service; helping people get things right, through prevention rather than correction, early engagement, advice and guidance, and alternative dispute resolution,” he said in April. “Importantly, we are also ready and able to deal with those who willingly step outside the tax system and hold them to account.”

As if to prove the point, in May the ATO announced it had exposed a $165 million alleged tax fraud it and other regulators had been attempting to crack for many months.

A massive investment in technology over recent years has dramatically increased the ATO's online surveillance capabilities, with linkages with a large range of external data sources enabling the tax regulator to capture more information than ever before.

And even investors with foreign assets are not immune from the ATO's revenue clutches. After giving Australian investors an amnesty on declaring their offshore assets several years ago, including cash holdings and hard assets such as property, the regulator was able to rake in more than $250 million in additional tax receipts levied against investors holding more than $2 billion in overseas interests.

What this means for smaller investors is that size of the ATO's tax capturing net is getting larger and larger, while the actual holes in the net are getting smaller and smaller. Anything bigger than financial plankton is unlikely to escape detection, and even investors committing seemingly tiny misdemeanours risk prosecution.

Having successfully identified scores of tax evaders in the latest financial year, including sophisticated Australian investors identified in the haul of documents known as the Panama Papers, the ATO is now making a concerted push to rein in all investment tax cheats.

High on the list are property investors, and the Federal Government announced several new measures in the May 9 Budget to close off loopholes that have enabled some to abuse allowable deductions on real estate fixtures and fittings, and to claim travel expenses purportedly incurred for inspecting their distant property holdings.

Below are the Government's latest measures, which come into effect from the start of the 2017-18 financial year.

Plant and equipment depreciation deductions

If you have purchased one or more established investment properties over time and have been depreciating the costs of the fixtures and fittings, the good news is you still can.

But Federal Treasurer Scott Morrison announced changes in the latest Budget that mean the depreciation goal posts relating to deductions on properties have been moved. In doing so, the Government hopes to capture an additional $40 million in tax revenue over the next financial year, and treble that tax take by 2020-21.

Revenue ($m)

From July 1, 2017, the Government will limit plant and equipment depreciation deductions to outlays actually incurred by investors in residential real estate properties. Plant and equipment items are usually mechanical fixtures or those which can be ‘easily' removed from a property such as dishwashers, carpet and ceiling fans.

The Government says this is an integrity measure to address its concerns that some plant and equipment items are being depreciated by successive investors in excess of their actual value. Acquisitions of existing plant and equipment items will be reflected in the cost base for capital gains tax purposes for subsequent investors.

These changes will apply on a prospective basis, with existing investments grandfathered.

The Government says that plant and equipment forming part of residential investment properties as of the Federal Budget on May 9 (including contracts already entered into at 7:30PM (AEST) on May 9 this year) will continue to give rise to deductions for depreciation until either the investor no longer owns the asset, or the asset reaches the end of its effective life.

Investors who purchase plant and equipment for their residential investment property after May 9, 2017 will be able to claim a deduction over the effective life of the asset. However, subsequent owners of a property will be unable to claim deductions for plant and equipment purchased by a previous owner of that property.

Disallowing travel expenses deduction for residential rental property

It also seems the Federal Government has cottoned on to some investors having claimed the cost of their travel costs to see interstate residential properties. The Gold Coast has been a favoured property purchasing destination for interstate investors, and many have claimed the cost of travelling to inspect their investments over time. The problem is, most of these properties are already managed by professional real estate agents.

Judging by the Government's calculations that it will net $540 million over its forward estimates from closing off this loophole, the practice of deducting travel costs (including airfares and accommodation) is obviously rampant.

Revenue ($m)

From July 1, 2017, the Government will disallow deductions for travel expenses related to inspecting, maintaining or collecting rent for a residential rental property.

The Government says this is another integrity measure to address concerns that many taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private travel purposes.

“As part of the Government's strategy to improve housing outcomes, this measure will provide confidence in the tax system by ensuring tax concessions are better targeted,” according to Treasurer Morrison.

“This measure will not prevent investors from engaging third parties such as real estate agents for property management services. These expenses will remain deductible.”

Further clarity on the measure will be required, including where an investor uses a tax agent or financial advisor based in the same location as their investment property, and where travel for direct meetings is required.

Improving the integrity of GST on property transactions

Another tax hole the ATO wants to plug is to stop the leakage of Goods and Services Tax payable by property developers.

Under the current law (where the GST is included in the purchase price and the developer remits the GST to the ATO), some property developers are failing to remit the GST to the ATO despite having claimed GST credits on their construction costs.

From July 1, 2018, the Government will strengthen compliance with the GST law by requiring purchasers of newly constructed residential properties or new subdivisions to remit the GST directly to the Australian Taxation Office (ATO) as part of settlement. As most purchasers use conveyancing services to complete their purchase, they should experience minimal impact from these changes.

The ATO is using its surveillance skills to track down offenders, and the Government has calculated this initiative will add $660 million to its tax revenue coffers over time.

Revenue ($m)

In effect, the Government is slowly but surely walling off as many property corridors as it can to stem tax evasion. But there are a number of new initiatives just announced that will give property investors a tax leg up, and they relate to the provision of investment funding for affordable housing initiatives.

Affordable housing through Managed Investment Trusts

Starting from July 1, 2017, the Government will encourage investment into affordable housing by enabling Managed Investment Trusts (MITs) to invest in affordable housing.

Investors through MITs will receive concessional taxation treatment, but to qualify the affordable housing being invested in must be available for rent for at least 10 years.

MITs allow investors to pool their funds to invest in primarily passive investments and have them managed by a professional manager. Under this new scheme, MITs will be able to acquire, construct or redevelop properties but must derive at least 80 per cent of their assessable income from affordable housing.

Qualifying housing must be provided to low to moderate income tenants, with rent charged at a discount below the private rental market rate.

The MIT scheme will also have benefits for foreign-based investors, who are already playing a key role in the Australian property market. Under the MIT withholding tax regime, non‑resident investors are generally subject to a reduced rate of tax if they are a resident of a country with which Australia has an effective exchange of information treaty. Non‑resident investors are generally subject to a 15 per cent final withholding tax rate on fund payments from the MIT.

Resident investors will be taxed at their marginal tax rates, with capital gains remaining eligible for the existing capital gains tax discount.

Up to 20 per cent of the income of the MIT may be derived from other eligible investment activities permitted under the existing MIT rules in the income tax law. If this is breached, or less than 80 per cent of the MIT's income is from affordable housing in an income year, the non‑resident investor will be liable to pay withholding tax at 30 per cent on investment returns for that income year.

Properties held for rent as affordable housing for less than 10 years will be subject to a 30 per cent withholding tax rate on the net capital gains arising from the disposal of those assets.

This measure is estimated to have an unquantifiable cost to revenue over the forward estimates period. The Government will provide $1.5 million to the ATO to implement the measure.

Expanding tax incentives for investments in affordable housing

Meanwhile, from January 1, 2018, the Government has announced it will provide an additional 10 percentage points capital gains tax discount, increasing the discount from 50 per cent to 60 per cent, to resident individuals who elect to invest in qualifying affordable housing.

To qualify for the higher discount, housing must be provided to low to moderate income tenants, with rent charged at a discount below the private rental market rate. The affordable housing must be managed through a registered community housing provider and the investment held for a minimum period of three years.

The higher discount would flow through to resident individuals investing in qualifying affordable housing Managed Investment Trusts.