As noted in our earlier article, foreign investors in Australian entities may be unaware that in some circumstances the Australian Taxation Office can assess them for tax on gains made from the disposal of their Australian investments.
In particular, a foreign investor will be liable to Australian tax where they make a gain on the disposal of taxable Australian property. Taxable Australian property includes direct holdings of Australian real estate and (for example) mining rights (referred to as taxable Australian real property). Importantly, it also includes interests in companies and trusts where, broadly:
- the foreign investor (together with associates) holds 10% or more in the company or trust; and
- the market value of the taxable Australian real property assets of the company or trust exceeds the market value of its assets that are not taxable Australian real property.
On 31 October 2014, the Australian Government issued a Discussion Paper which proposes to introduce law changes applicable from 1 July 2016. If passed, the law changes would, in certain circumstances, require purchasers to withhold 10% of the purchase price paid to a foreign resident for taxable Australian property and pay that amount to the Australian Taxation Office.
This proposal follows concern that foreign investors are not meeting their Australian tax obligations. At this stage the proposal is not law in Australia, but it was proposed initially some time ago, and we predict it is likely to become law in Australia.
What the proposed 10% withholding tax would mean for foreign vendors
If enacted, the withholding tax would apply to all disposals by foreign investors of taxable Australian property other than residential property transactions under $A2.5m. The definition of 'residential property' is yet to be confirmed, however it is likely to mean Australian land that has a building on it that is suitable as a place of residence. This means that a foreign investor selling their Australian investment (foreign vendor), may not receive the entire purchase price agreed, as some of the purchase price could be diverted to the Australian Taxation Office.
The 10% purchase price withholding tax is a non-final tax. This means that a foreign vendor will receive a tax credit in Australia for the amount withheld by the purchaser. However it also means that a foreign vendor would need to be aware of this issue, would be required to file an Australian tax return in respect of the gain, and would need to pay additional tax if their Australian tax liability exceeds the amount withheld. In circumstances where the foreign vendor's tax liability is less than the amount withheld (eg. where the foreign vendor has made a loss on disposal), the foreign vendor maybe eligible for a refund of the amount withheld.
What the proposed 10% withholding tax means for purchasers
In order to meet this new obligation, a purchaser (whether Australian resident or foreign resident) would need to make reasonable enquiries in order to determine whether:
- the foreign vendor is foreign resident; and
- the asset being purchased is taxable Australian property.
While establishing the status of the foreign vendor and the property may be straight forward in some cases, in other cases the purchaser may need to exercise appropriate due diligence in order to confirm their withholding obligations. Even after conducting due diligence, it may still be difficult for a purchaser to establish whether they have an obligation.
For example, there may be no freely available information in order for a purchaser to determine whether the market value of the taxable Australian real property assets of a target company or trust exceeds the market value of its assets that are not taxable Australian real property.
The Government is conscious of imposing an undue administrative burden on purchasers. Accordingly, the Discussion Paper suggests that it could be possible to adopt an approach similar to that in the United States, which would allow a purchaser to rely on a declaration by the foreign vendor which states their residency status and whether the asset to be sold is taxable Australian property.
Alternatively, the Government could adopt an approach similar to Canada, under which the seller could obtain a 'clearance certificate' from the Australian Taxation Office that could then be provided to the purchaser to advise them of whether there is a withholding obligation.
The Discussion Paper reaches no conclusion as yet as to what position could be taken by the Australian Government.
Issues to be clarified
The Discussion Paper seeks public input to assist in drafting the legislation for this new measure. The Discussion Paper notes particular areas which may require specific rules – for example where foreign residents use Australian resident custodians to hold taxable Australian property. The Discussion Paper also seeks feedback as to whether it would be feasible to establish a mechanism by which a foreign vendor could apply to the Australian Taxation Office for variation of the amount withheld (eg. where the foreign vendor can show they would make a loss on a sale and would not have an Australian tax liability). As stated above, the Discussion Paper also seeks feedback on how to reduce the administrative burden for purchasers.
The closing date for submissions on the Discussion Paper is 28 November 2014, after which the Government will proceed with drafting proposed legislation.