On 3 December 2015, the Government tabled a Bill1 to introduce a withholding regime designed to facilitate the collection of capital gains tax (CGT) in relation to dealings with “taxable Australian assets” by foreign residents. Assuming the Bill is enacted, it will impose a 10% withholding obligation on buyers in relation to direct and indirect acquisitions of Australian real property occurring on or after 1 July 2016. The measure, which is complex and will impact on many transactions, is outlined below.
Background to and rationale for measure
The idea of a withholding tax in relation to the CGT obligations of foreign residents was first mooted in a review of the tax system conducted in 1999. As part of the 2013-14 Australian Federal Budget, the previous Labor government announced its intention to introduce a withholding regime in order to “improve the integrity of Australia’s foreign resident CGT regime to ensure gains on Australian real property are appropriately taxed”. The Explanatory Memorandum (EM) accompanying the Bill suggests that this is because “[v]oluntary compliance with [the CGT rules by foreign residents] is extremely low and compliance action, by the Australian Taxation Office, is difficult to undertake”. An exposure draft of the relevant measure was (finally) released for comment in July 2015. The final Bill has been modified to address a number of the concerns raised during the consultation process.
Outline of measure
The measure applies where, on or after 1 July 2016, a buyer acquires an asset from a “foreign resident” that is:
- taxable Australian real property (TARP), ie. Australian real property2, mining, quarrying and prospecting rights;
- an indirect Australian real property interest, ie. an interest of 10% or more in a company or unit trust whose underlying value is principally derived from TARP; or
- an option or right to acquire such property or interest.3
Unless an exemption applies, on or before the day of becoming the owner of the asset,4 the buyer is required to pay the Australian Commissioner of Taxation (Commissioner) an amount equal to 10%5 of the amount paid (or the market value of property given) to acquire the asset. The buyer must register for withholding with the Commissioner (if not already registered) and also provide a notification to the Commissioner in approved form when the amount is remitted.
The amount paid may be withheld from the payment the buyer is otherwise obliged to pay to the seller. The seller is generally entitled to claim a credit for the amount withheld against its Australian tax liability in its tax return for the relevant tax year.
Exceptions from withholding
No withholding is required if:
- in the case of TARP,6 the transaction value is less than $2 million;
- in the case of an indirect Australian real property interest,7 the dealing is conducted through a stock exchange (or broker operated crossing system) or it is a securities lending arrangement; or
- the seller is subject to formal insolvency or bankruptcy proceedings.
Further, no withholding is required if:
- in the case of TARP,6 the seller obtains and provides the buyer with a clearance certificate from the Commissioner (that there is nothing to suggest that the seller is or will be a foreign resident); or
- in the case of an indirect Australian real property interest,7 the seller provides the buyer with a declaration (which may be included in the sale agreement) that:
- the seller is an Australian tax resident; or
- the interest is not an indirect Australian real property interest,
provided the buyer does not know the declaration to be false.
The measure raises a number of practical issues for future transactions, as follows:
- The withholding obligation can be triggered even where a seller is, in fact, an Australian tax resident as a seller will be regarded as a foreign resident, and withholding will prima facie be required, if:
- in the case of TARP (and company title interests), the seller fails to provide a clearance certificate; or
- for other indirect Australian real property interests, the buyer either knows the seller is a foreign resident or does not have reasonable grounds to believe the seller is an Australian resident and has a foreign address for the seller, or is required to make payment to a place outside Australia.
- Where a buyer acquires property from multiple sellers, the obligation to pay may arise if any of the sellers is a relevant foreign resident. Accordingly, considerable care will be required by a buyer in any case where any part of the purchase price is to be paid or provided to a foreign party or location. In such cases, it will be in the interests of sellers to seek a variation from the Commissioner of the amount to be withheld, otherwise the buyer will presumably seek to withhold 10% of the entire purchase price.
- While a buyer can generally rely on a seller’s declaration as to residency or as to whether shares or units give rise to an indirect Australian real property interest, this will not apply if the buyer knows the declaration to be false. The EM suggests this is only the case if a buyer has specific knowledge of the matter (rather than merely doubts the accuracy of the declaration) but, in any event, care is needed if a buyer is put on notice that a seller is or may be a foreign resident.
- While the measure will only start to apply from 1 July 2016 (assuming the Bill is enacted), it can have implications for deals being negotiated now if, for example, a put or call option over a relevant asset provides for exercise after 1 July 2016. However, the measure will not apply to a simple contract that is entered into prior to that date, even if completion occurs subsequently.
- The calculation of the amount to be remitted to the Commissioner is based on the payments made or the value of other property provided by the buyer. In the latter case, the buyer will need to fund any payment to the Commissioner and so any non-cash consideration will need to be adjusted accordingly. Subject to any variation of the amount to be withheld, this may create cash flow issues in the case of an off-market scrip for scrip takeover, even if a CGT rollover is available to the seller(s).
- The obligation to remit amounts to the Commissioner applies at the time that the buyer becomes the owner of the relevant CGT asset (ie. generally on completion). This may cause complications in terms of any payments which are only to be made after completion, such as instalment payments. However, special timing rules apply for payments in respect of “look through earn-out rights”.8
- The obligation to remit amounts to the Commissioner only applies to the buyer and not to any intermediaries (eg. solicitor or escrow agent). Accordingly, to avoid being out of pocket, the buyer needs to make sure that it retains or receives from any intermediary the relevant amounts required to be paid to the Commissioner.
- There is an ability for a creditor to apply to the Commissioner for a variation of the amount to be withheld. The EM suggests that the Commissioner must take into account that the regime is not intended “to undermine the security of creditors in the event of a vendor’s default”. However, as the power is discretionary, it remains to be seen how this plays out in practice, particularly if the application is made by an unsecured creditor.
While the rationale for imposing withholding on foreign residents in respect of their CGT liabilities is understandable – and broadly consistent with similar regimes in other countries (eg. Canada, US) – we anticipate the new regime will add a layer of additional complexity for transactions involving Australian land or shares or units in entities which hold Australian land that take place on or after 1 July 2016.