Foreign resident capital gains tax withholding regime
On 3 December 2015, Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015 was introduced into Federal Parliament and includes legislation to implement the proposed new 10 per cent non-final withholding tax on the acquisition of certain taxable Australian property from foreign residents. This measure will apply in relation to acquisitions occurring on or after 1 July 2016.
The obligation will apply to a transaction involving the acquisition of an asset that is taxable Australian real property (TARP), an indirect Australian real property interest or an option or right to acquire such property or such an interest, unless:
- the transaction is an excluded transaction (eg. transaction valued under $2 million or is an onmarket transaction); or
- in the case of a transaction involving TARP, the vendor provides a clearance certificate issued by the Australian Taxation Office (ATO) that confirms the vendor is not a foreign resident. A vendor will need to apply electronically for a clearance certificate which is valid for 12 months; or
- in the case of a transaction that does not involve TARP, the vendor provides a residency declaration or a declaration that the capital gains tax (CGT) asset is not an indirect Australian real property interest, or the purchaser has sufficient knowledge that the vendor is an Australian resident.
If an exception above does not apply, then the purchaser is required to pay 10 per cent of the first element of the cost base (usually, the purchase price) to the Commissioner on settlement of the transaction.
This amount may be withheld from the payment the purchaser makes to the vendor and the foreign resident vendor will be entitled to a credit for that amount paid. Note that the purchase price includes the market value of any property given in respect of the acquisition of the asset, so in a transaction where the consideration does not comprise at least 10 per cent in cash, the purchaser would have an obligation to fund this liability.
Investors looking to buy or sell Australian real estate assets will need to carefully consider the proposed withholding rules which apply from 1 July 2016.
The rules are drafted very widely, in particular in relation to acquisition involving TARP, where, to avoid withholding, a clearance certificate from the ATO will be required, regardless of the identity of the vendor. This will affect all off market real estate transactions above the $2 million threshold even if the asset is acquired from, for example, an Australian government authority, which is clearly an Australian resident.
US changes to the Foreign Investment in Real Property Tax Act (FIRPTA)
On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act that, in part, modifies the application of FIRPTA. Foreign investors should be aware of the new qualified shareholder exception, the increase from 5 per cent to 10 per cent for interests in publicly traded real estate investment trusts (REITs), the increased rate of withholding on dispositions and the new exception for qualified foreign pension funds.
Prior to the introduction of this law, in general, a gain or loss from the disposition of a US real property interest (USRPI) by a foreign person is treated as if the gain or loss were effectively connected with the conduct of a US trade or business and, accordingly, is subject to US net income taxation at a rate of 35 per cent. Additionally, a withholding tax obligation of 10 per cent exists of the amount realised on the disposition in the case of a disposition of a USRPI by a foreign person.
There are a number of modifications to FIRPTA under the PATH Act, including:
- an exemption from FIRPTA may apply to any USRPI held directly or indirectly through one or more partnerships, or to any distribution received from a REIT, by a qualified foreign pension fund or any entity, all of the interests of which, are held by a qualified foreign pension fund.
- adding a new USRPI exception for stock held in a REIT by ‘qualified shareholders’ – broadly owning less than 10 per cent of a REIT.
- increasing the FIRPTA withholding tax from 10 per cent to 15 per cent.
Australian investors with either current or proposed investments in the US, and in particular via US REIT structures, should be aware of the changes.
The most beneficial change is the exemption from FIRPTA for foreign pension funds. This is a significant benefit and should place foreign pension funds at a competitive pricing advantage. It will however be important to confirm that Australian superannuation funds can benefit from this exemption, i.e. that they qualify as ‘foreign pension funds’.