The Australian Government is moving forward with its plans to introduce a new withholding tax regime to apply to the disposal of certain Australian real property (and indirect interests in Australian real property) by foreign residents from 1 July 2016. The regime is intended to ensure that capital gains of foreign residents do not escape the Australian tax net by introducing a collection mechanism that imposes a withholding tax obligation on the purchaser of certain property from a foreign resident vendor.
Whilst there are a number of excluded transactions (including residential property valued less than $2.5m), because the obligation to withhold rests with the purchaser, purchasers will need to consider additional due diligence and/or require a declaration of residence from a vendor to protect against penalties for failing to withhold, which can be significant.
On 8 July 2015, the Government released draft legislation which proposes a new withholding tax regime to apply to the disposal of certain Australian real property (or indirect interests in Australian real property) by foreign residents.
Under these proposed measures, a withholding tax obligation prima facie will arise where, from 1 July 2016, an entity (the purchaser) acquires a capital gains tax (CGT) asset:
- from a vendor that is known to be, or reasonably believed to be, a foreign resident, or where the vendor is not reasonably believed to be an Australian resident and either has an address outside Australia or the purchaser is authorised to provide a financial benefit relating to the transaction to a place outside Australia, and
- that is “taxable Australian real property”, an “indirect Australian real property interest” or an option or right to acquire such property or such an interest.
Taxable Australian real property refers to real property situated in Australia (including a lease of land) or a mining, quarrying or prospecting right if the minerals, petroleum or quarrying materials are situated in Australia. An indirect Australian real property interest is an interest of 10% or more in another entity (for example, shares in a company or units in a trust), where, broadly, more than 50% of the assets of that entity, by market value, comprises taxable Australian real property.
The following are excluded transactions that do not attract a withholding obligation:
- transactions involving residential property where the value of the real property is less than $2.5 million, and
- transactions on an approved stock exchange where the CGT asset is an interest listed for quotation on that exchange.
Additionally, withholding will not apply where the vendor gives the purchaser a declaration that it is an Australian resident, or that it carries on a business through an Australian permanent establishment, or, where the CGT asset is a membership interest, that the asset is not an indirect Australian real property interest.
Where the withholding obligation arises, the purchaser of the relevant CGT asset will be required to remit an amount equal to 10% of the first element of the CGT asset’s cost base just after the acquisition time (which generally will be the total purchase price, regardless of when the total purchase price is actually paid) to the Commissioner of Taxation on or before the day the purchaser becomes the owner of the CGT asset (which generally will be the date of settlement of the transaction). The Commissioner has the ability to vary the amount payable, where, for example, it can be shown that the vendor will not make a capital gain on the sale, or to protect the rights of a secured creditor to realise or otherwise deal with an asset that was security for a liability of the vendor.
Practical implications for purchasers and vendors
The proposed new withholding tax regime is based on an assumption that the purchaser has a basic level of knowledge of the residency status of the vendor and/or the relevant CGT asset. Historically, there would be many cases where this has not been the case. As such, from 1 July 2016, purchasers of real property assets, or interests in real property assets, may need to do additional due diligence to satisfy themselves as to the identity of the vendor, and the nature of the assets, particularly in the case of shares in companies or units in trusts which may be “indirect Australian real property interests”. Alternatively, it may become common practice in contract negotiations to require the vendor to make certain declarations regarding their residency and/or the nature of the asset. In most cases, a purchaser will be able to rely on these declarations, unless they are known to be false. Limited guidance has been provided to date as to how this may play out where the purchaser and vendor disagree on whether an asset is an “indirect Australian real property interest”. In such cases, the purchaser may which to seek an indemnity from the vendor, as failure by the purchaser to withhold will attract a penalty of 100% of the amount that should have been withheld, plus the general interest charge.
In cases where a foreign resident holds their investments in Australia via an Australian trust, the draft explanatory materials confirm that the new withholding tax regime should not ordinarily apply when the Australian resident trust disposes of its Australian real property.
The withholding obligation applies to any purchaser, regardless of whether they are an Australian or foreign resident – and so the withholding can apply to transactions wholly outside Australia between foreign entities. This means that some foreign residents that are not currently identified within the Australian tax system may be required to withhold and remit amounts to the Commissioner, which will require them to register to withhold. Although it is proposed that a purchaser will be able to notify the Commissioner of an amount and register to withhold on a single approved form, this may mean some entities will be brought within the Australian tax net as a result of having purchased certain real property interests from a foreign vendor (even if the purchaser themselves would not be subject to Australian tax on a subsequent sale of the asset).
The implications of withholding for any transactions that include a non-cash component as consideration (for example, payment by way of scrip rather than cash) should be carefully considered. If the purchase price does not include a cash component of at least 10% of the purchase price, the purchaser will be required to fund the withholding tax obligation from other cash flow sources.
Because the withholding is a non-final withholding tax, the foreign resident vendor remains obliged to lodge an Australian tax return disclosing any resulting capital gain (or loss) which might arise from the transaction and pay any resulting income tax (if any). In working out the final income tax liability the vendor will be entitled to a credit for the amount withheld from disposal of the relevant CGT asset.
There will be a number of situations where a vendor will want to request a variation in the amount to be withheld held, including where the vendor will not make a capital gain from the sale, or is able to take advantage of a CGT rollover as part of a corporate reorganisation. Timing the variation from the Commissioner will become critical as the purchaser will need to be aware of the varied amount by the time they are otherwise obliged to withhold and remit on becoming the asset’s owner. Implications for security and debt arrangements will also need to be considered carefully.
The proposed new withholding tax regime is intended to enhance the integrity of the Australian tax system as it applies to foreign residents, and will likely result in greater scrutiny by the Australian Taxation Office of transactions involving foreign residents.
Whilst the commencement date from this proposed new withholding tax regime is still almost 12 months away, both vendors and purchasers should be considering the cash flow implications for any contracts they may be considering entering into from 1 July 2016. Purchasers of real property or interest in entities that may comprise an indirect Australian real property interest should take care to understand their obligations to minimise the likelihood of penalties.