We previously reported on the new foreign resident capital gains tax withholding regime (“CGT Regime”), which will affect contracts for the sale and purchase of Australian land entered after 1 July 2016 (to read our previous Alert, click here). From 1 July 2016, purchasers who acquire ”indirect interests” in Australian land from a foreign resident may be required to withhold an amount equivalent to 10% of the purchase price and remit it to the Australian Taxation Office (“ATO”).
The new laws are technical and may create uncertainty for buyers and sellers in property M&A transactions as to whether a CGT withholding obligation applies. These issues should be investigated fully as part of pre-sale due diligence and negotiations, and addressed in the contract or other documentation for the deal.
1. What assets will attract the new CGT regime?
Under the CGT Regime, taxable Australian real property (“TARP”) will be considered a relevant taxable Australian asset. TARP includes real property (including leasehold interests) and mining, quarry or prosecting rights. Indirect Australian real property interests and any options or rights to acquire TARP or indirect Australian real property interests will also be considered relevant taxable Australian assets.
We will focus on indirect Australian real property interests in this summary.
2. What is an indirect Australian real property interest?
An interest in an entity will be an indirect Australian real property interest if it meets both the non-portfolio interest and principal asset tests:
- the non-portfolio interest test will be met if, at the time of the transaction or across any 12 month period during the 24 months prior to the transaction, the vendor and its associates hold or held an interest in the entity of 10% or more; and
- an interest will meet the principal asset test if, at the time of the transaction, the market value of the entity’s TARP assets exceeds the market value of its non-TARP assets.
In determining whether an interest is an indirect Australian real property interest, it is the total interest held by the seller which is important, rather than the total interest being disposed of. For example, if the seller is disposing of 8% of its 15% membership interest in an entity, 75% of whose assets consist of TARP, the disposition will be considered to be an indirect Australian real property interest.
3. When is the seller a foreign resident?
A seller will be deemed to be a foreign resident for the purposes of the CGT Regime if:
- they are a foreign resident for tax purposes;
- the purchaser knows or reasonably believes they are a foreign resident;
- the purchaser does not reasonably believe the seller is an Australian resident and either the seller has an address outside of Australia or the purchaser is authorised to provide a related financial benefit to a place outside Australia;
- they have a connection outside Australia of the kind to be set out in the regulations (which have not yet been enacted); or
- the asset to which the transaction relates is TARP or an indirect Australian real property interest giving rise to a company title interest.
Please see our discussion of company title interests under ‘Clearance certificates’.
4. Excluding the regime by declaration
The CGT Regime may not apply to a transaction:
- where the seller provides the purchaser with a declaration (“Declaration”) that it is an Australian resident; and
- where the seller provides the purchaser with a Declaration that it holds a membership interest in an entity that does not amount to an indirect Australian real property interest (ie because either the non-portfolio interest or principal asset tests are not met).
Declarations must cover the time when the transaction is entered and must be provided to the purchaser prior to the date of the completion of the contract. Declarations are valid for a maximum of 6 months. Unless a purchaser knows a Declaration to be false, they are entitled to rely on it. The ATO may impose penalties for a false or misleading Declaration.
5. Clearance certificates
The CGT Regime may not apply to a transaction where the ATO provides the purchaser with a clearance certificate certifying that there is nothing to suggest an entity is or will be a foreign resident during a specific period. Clearance certificates may only be used where the asset to which the transaction relates is TARP or an indirect Australian real property interest giving rise to a company title interest. A company title interest in relation to land means a right of occupancy of land or of a building arising by virtue of holding a membership interest or an option to purchase a membership interest, in the company that owns the land or building.
Indirect Australian real property interests will sometimes, but not always, give rise to a company title interest.
6. Other excluded transactions
Other transactions to which the CGT Regime may not apply include, but are not limited to, transactions:
- on an approved stock exchange, such as the ASX;
- conducted using a crossing system; and
- involving the administration of bankrupt estates or insolvency.
7. What happens if the withholding obligation applies?
If the withholding obligation applies, the purchaser is required to withhold and remit to the ATO an amount equal to 10% of:
- the first element of the asset’s cost base just after the acquisition; less
- if the acquisition is the result of the exercise of an option – any payment made or market value of any property given, in return for the option.
If the purchaser pays the withholding amount to the ATO, the ATO will notify the seller of receipt of payment and the seller will become entitled to a tax credit. If the purchaser fails to pay the withholding amount to the ATO, the ATO will take action against the purchaser and the purchaser may be required to pay a general interest charge, as well as a penalty equivalent to the withholding amount. The seller will not become entitled to a tax credit and cannot claim the non-payment as a tax loss.
To read the ATO’s summary of the CGT Regime, click here.