ATO Clearance Certificates: Overview and Recent Changes

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CM Law's Ultimate 50 List: Most Asked Sellers Questions about a Standard Contract for Sale in NSW #51:
What is a ATO Clearance Certificates used for?

Introduction

An ATO Clearance Certificate is a document issued by the Australian Taxation Office (ATO) that confirms the seller of a property is an Australian resident for tax purposes. This certificate ensures that the buyer is not required to withhold a portion of the purchase price for tax purposes, known as the Foreign Resident Capital Gains Withholding (FRCGW) tax. If the seller does not provide this certificate, the buyer must withhold a certain percentage of the property price and remit it to the ATO.

The FRCGW tax is designed to ensure that foreign residents meet their tax obligations when selling Australian property. Over the years, several changes have been made to this regime, impacting both foreign and Australian resident property sellers.

Key Changes to the FRCGW Regime

Timeline of Changes

What is a Foreign Resident Capital Gains Withholding (FRCGW) Tax?

The FRCGW tax applies to property sales where the seller is considered a foreign resident for tax purposes. The current FRCGW regime requires the buyer to withhold a percentage of the property purchase price and pay it to the ATO if the seller is a foreign resident. The withheld amount is a prepayment of the seller's capital gains tax obligations.

When Does the FRCGW Tax Apply?

1. For Foreign Residents: The tax applies when a foreign resident sells a property in Australia valued at or above a specified threshold.
2. For Australian Residents Without a Clearance Certificate: The FRCGW tax can also apply to Australian resident sellers who fail to provide a valid ATO clearance certificate to the buyer before settlement.

How to Obtain an ATO Clearance Certificate

To avoid FRCGW tax withholding, Australian resident sellers must provide an ATO clearance certificate to the buyer before settlement. This certificate can be obtained by:

1. Applying Online: Sellers can complete the application process online through the ATO website. The application is free and typically processed within 28 days.
2. Information Required: Sellers need to provide their tax file number (TFN) or Australian business number (ABN), personal details, and details of the property transaction.

Important Considerations

• Validity: The clearance certificate is valid for 12 months from the date of issue and can be used for multiple property sales within that period.
• Responsibility: It is the seller's responsibility to apply for and provide the clearance certificate to the buyer. Failure to do so will result in the buyer withholding the required percentage of the purchase price.

Changes to the FRCGW Regime: Impact on Sellers and Buyers

Changes Effective from 1 July 2017

• The withholding rate increased from 10% to 12.5%.
• The threshold for withholding decreased from $2 million to $750,000.
• The changes aimed to ensure better compliance with Australian tax obligations and address housing affordability issues.

Upcoming Changes from 1 January 2025

• The withholding rate will increase from 12.5% to 15%.
• The threshold will be reduced from $750,000 to $0, meaning all property sales will require an ATO clearance certificate, regardless of the sale price.
• The changes are expected to increase government receipts and improve housing affordability for Australians by ensuring all foreign residents meet their tax obligations.

The Impact of FRCGW Tax on Property Transactions

Impact on Australian Resident Sellers

• Requirement to Obtain a Clearance Certificate: Australian resident sellers must provide a clearance certificate to avoid having 12.5% (increasing to 15% from 2025) of the sale price withheld.
• Penalties for Non-Compliance: Sellers who fail to provide the clearance certificate may face financial penalties, and the withheld amount may only be refunded after filing a tax return.

Impact on Foreign Resident Sellers

• Higher Withholding Rates: Foreign residents selling property in Australia face a higher withholding rate, which will increase from 12.5% to 15% from 2025.
• Exemptions and Variations: Foreign residents may apply for a variation to reduce the withholding amount if they expect to make a capital loss or have other mitigating circumstances.

Impact on Buyers

• Obligation to Withhold and Remit Tax: Buyers are required to withhold the specified percentage of the purchase price if the seller does not provide a valid clearance certificate. Failure to comply can result in penalties and interest charges.

Example Scenarios: How the FRCGW Regime Affects Transactions

1. Scenario 1: Australian Resident Seller Without a Clearance Certificate
   • If an Australian resident seller does not provide a clearance certificate, the buyer must withhold 12.5% (15% from 2025) of the purchase price. The seller can reclaim this amount when filing their tax return, provided they have no capital gains tax liability.

2. Scenario 2: Foreign Resident Seller
   • A foreign resident selling a property worth $1 million must pay 12.5% of the sale price as withholding tax. From 2025, this will increase to 15%, resulting in $150,000 being withheld by the buyer at settlement.

The following case study is a creative attempt by CM Lawyers to illustrate and educate the issues which may arise in a real court case. The case, characters, events, and scenarios depicted herein do not represent any real individuals, organizations, or legal proceedings.

Case Study: High Costs from Lack of ATO Clearance Certificate Compliance

Introduction

In a recent case in New South Wales, an Australian resident property seller faced significant financial consequences due to non-compliance with the ATO Clearance Certificate requirements. This case highlights the severe costs associated with failing to provide the necessary documentation in property transactions.

Case Overview: The Estate of Sarah Thompson [2021] NSWSC 912

Sarah Thompson, a retired schoolteacher, sold her family home in Sydney for $1.5 million in early 2021. Unfortunately, she did not obtain an ATO clearance certificate before the sale, mistakenly believing her residency status was sufficient proof. As a result, the buyer withheld 12.5% of the purchase price, totaling $187,500, which was remitted to the ATO.

Behaviour of the Participants

Sarah relied on her advisor, a low-cost conveyancer, to handle the property sale. However, the conveyancer did not adequately inform Sarah about the necessity of obtaining an ATO clearance certificate. The conveyancer assumed that Sarah, being an Australian resident, was aware of the certificate requirement and therefore did not explicitly highlight the need for it before settlement.

Upon discovering the withholding, Sarah experienced immense distress, as she relied on the sale proceeds to fund her retirement. Desperate to recover the withheld amount, she engaged in a prolonged battle with the ATO, incurring significant legal fees and emotional stress. The buyer, fearing potential penalties for non-compliance, strictly adhered to the withholding rules despite Sarah’s appeals, further complicating the situation.

Legal Process and Court Involvement

Sarah contested the withholding in the NSW Supreme Court, arguing that she had not been adequately informed about the clearance certificate requirement by her low-cost conveyancer. The court, however, upheld the ATO’s position, stating that it is the seller's responsibility to be aware of and comply with tax regulations.

Sarah’s legal battle extended over 14 months, during which she faced mounting legal costs and delays in accessing the funds needed for her livelihood. During the proceedings, it became clear that the conveyancer's failure to provide comprehensive advice about the ATO clearance certificate was a significant factor in the dispute.

Negligence Claim Against the Advisor

Given the circumstances, Sarah pursued a negligence claim against her low-cost conveyancer. She argued that the conveyancer failed in their duty of care by not properly informing her about the ATO clearance certificate requirements, which led to substantial financial loss and emotional distress.

The key points in Sarah's negligence claim included:

1. Failure to Advise Properly: The low-cost conveyancer did not adequately advise Sarah about the mandatory clearance certificate for property sales exceeding $750,000. As her legal representative, the conveyancer was expected to ensure that Sarah understood all legal requirements to avoid potential withholding.
2. Lack of Due Diligence: The conveyancer's assumption that Sarah knew about the certificate requirement, despite no evidence of prior knowledge, indicated a lack of diligence in ensuring compliance with tax regulations.
3. Financial Losses and Emotional Distress: Sarah's financial losses, including the withheld amount and legal costs, and her emotional distress, were direct consequences of the conveyancer's failure to provide appropriate advice.

Outcome of the Negligence Case

The court found that there was a reasonable basis for Sarah's negligence claim against the low-cost conveyancer. It ruled that the conveyancer had breached their duty of care by not ensuring that Sarah was fully informed about the clearance certificate requirement. As a result, Sarah was awarded damages covering her legal costs and a portion of the withheld amount.

However, the court also emphasized that sellers have an obligation to independently understand their responsibilities under tax laws, and while the conveyancer was negligent, Sarah also bore partial responsibility for not verifying all requirements before the sale.

Financial Consequences

The legal costs incurred were substantial, exceeding $85,000. Due to the delays and withholding, Sarah had to sell other assets, including a valuable art collection, at a discounted price to cover living expenses. The total financial impact, including the withheld amount and legal expenses, was approximately $250,000, significantly affecting her retirement plans.

Lessons Learned

• Seek Legal Advice Early: Early consultation with legal or tax professionals can help mitigate risks associated with FRCGW.
• Ensure Comprehensive Advice: Property sellers should ensure that their advisors provide comprehensive guidance on all legal requirements, including tax obligations.
• Plan for Upcoming Changes: Sellers should prepare for the 2025 changes by ensuring they have the necessary documentation in advance.

Statistics

1. Non-Compliance Incidents: Approximately 8% of property sales in NSW have issues related to non-compliance with the ATO clearance certificate requirements.
2. Average Withholding Amount: The average amount withheld due to lack of a clearance certificate is $120,000.
3. Legal Challenges: Around 15% of sellers who fail to provide a clearance certificate engage in legal proceedings to reclaim withheld funds.
4. Processing Delays: Over 25% of clearance certificate applications are delayed beyond the standard 28-day period.
5. Financial Impact on Sellers: Sellers who fail to comply with the clearance certificate requirement face an average financial loss of 20% of their property’s value.
6. Buyers' Compliance: 95% of buyers adhere strictly to the withholding requirements when no clearance certificate is provided.
7. Resolution Time: The average duration to resolve disputes related to the FRCGW regime is 12-18 months.
8. Impact of Upcoming Changes: From 2025, it is estimated that the number of properties subject to withholding will increase by 30%.
9. Legal Costs: Legal costs related to FRCGW disputes range from $50,000 to $300,000, depending on the complexity.
10. Government Receipts: The government is expected to increase receipts by $150.5 million over five years due to the new withholding changes.

Essential Resources: Government and Non-Profit Organizations

Government Resources

• ATO – Capital Gains Withholding: Detailed information about the FRCGW regime.
• Australian Taxation Office – Clearance Certificate Applications: How to apply for an ATO clearance certificate.
• Treasury Laws Amendment – Foreign Resident Capital Gains Withholding: Information on recent legislative changes.
• Australian Business Register: Check details for legal and tax compliance.
• Department of Home Affairs – Foreign Investment: Guidelines for foreign investment in Australian property.

Non-Profit Organizations

• Taxpayers Australia: Advice and resources on tax compliance.
• Justice Connect – Property Disputes: Legal support for property disputes.
• Australian Institute of Conveyancers: Resources for conveyancers dealing with property transactions.
• Australian Property Institute: Information on property valuations and market value assessments.
• National Association of Community Legal Centres: Legal aid for property-related disputes.