On 3 December 2015 the Government introduced Tax and Superannuation Laws Amendment (2015 Measures No 6) Bill 2015 (“the Bill”) into Parliament. This Bill will enact into law a new foreign resident CGT withholding tax (WHT).
Broadly this WHT requires a purchaser of an Australian real estate asset to withhold and remit to the Australian Taxation Office (ATO) 10% of the purchase price paid to a foreign resident vendor. The WHT was introduced due to a concern that foreigners were not paying their fair share of tax when they disposed of Australian assets.
It is important to recognise this new WHT covers more than just Australian land – the WHT can apply to interests in companies and trusts which are “Australian land rich” and options covering such interests and Australian land. Additionally, Australian resident vendors of land or company title interests may be affected by the WHT if they do not obtain an ATO clearance certificate by settlement. This is so even though the WHT is aimed at foreign residents.
Professionals who deal with property, non-listed company shares and unit trust transactions need to take into account the impact of this WHT.
The foreign resident CGT WHT applies to sales contracts and option agreements entered into on or after 1 July 2016. Contracts entered into before this time (including off the plan sales contracts) will not be affected. However, a contract that arises out of an option agreement entered into before 1 July 2016 but exercised after 1 July 2016 will be affected. Ideally the contractual provisions discussed below to deal with this WHT should be included in any sales contract that may be annexed to an option agreement which can be exercised from 1 July 2016 onwards.
The new WHT applies to:
- taxable Australian real property (TARP) which covers:
- (i) Australian land (including a lease of land)
- (ii) mining, quarrying or prospecting right over minerals, petroleum or quarry materials situated in Australia
- an indirect Australian real property interest, or
- an option or right to acquire the property in paragraphs (a) and (b) above or an interest in such property. An indirect Australian real property interest captures shares and units in “Australian land rich” companies and trusts. Broadly, a foreign resident vendor holds an indirect Australian real property interest if, at the relevant time (being the time of settlement of the contract when the WHT has to be paid), they hold (either alone or with associates):
- a 10% or more direct interest in a company or trust whose majority of assets, by market value, comprise TARP at the relevant time; or
- in a 12 month period within 24 months before the relevant time, the interest formed part of a 10% or more direct interest in a company or trust and at the relevant time the company or trust had a majority of assets, by market value, comprising TARP.
Besides the purchase of Australian land the above discussion indicates that common transactions which may be affected by this WHT include the grant of options over TARP and also the purchase of shares and units in unlisted “Australian land rich” companies and trusts. The payment of a lease premium by a lessee to a foreign landlord may also be affected by this WHT.
The fact that a vendor may hold an asset as a revenue asset or trading stock on which ordinary income (as opposed to capital gains) will be derived, does not prevent this WHT. This is because CGT acts as a residuary tax, and all assets are CGT assets. It is just that the tax law may have certain provisions which provide for different income tax treatment for a particular type of asset apart from CGT treatment.
What transactions are excluded from this WHT?
Transactions which are excluded from the WHT include:
(a) transactions involving TARP or a company title interest in property which is less than $2 million;
(b) a transaction on an approved stock exchange or conducted using a crossing system (i.e. listed shares and units);
(c) an arrangement which is already subject to an existing withholding tax obligation;
(d) securities lending arrangements; and
(e) transactions involving vendors who are subject to formal insolvency or bankruptcy proceedings – whether in Australia or overseas.
Who is a foreign resident for these purposes?
Anyone who is not an Australian resident for income tax purposes is a “foreign resident” for these purposes. The income tax law has complicated Australian residency tests.
Broadly, an individual will be an Australian resident if:
(a) they ordinarily reside in Australia;
(b) have an Australian domicile unless the ATO is satisfied they have a permanent place of abode outside Australia;
(c) they are present in Australia for 183 days or more in a financial year unless the ATO is satisfied they have a usual place of abode outside Australia; or
(d) they are a member of a Australian government superannuation scheme or a spouse or child under 16 of such a member.
A company will be an Australian resident if:
(a) it is incorporated in Australia; or
(b) carries on a business in Australia and either has its central management and control in Australia or voting power controlled by Australian residents.
A trust will be an Australian resident if:
- the trustee is an Australian resident or the central management and control of the trust is in Australia; or
- in the case of a unit trust then one item in each column of the following table must be met:
One of these items:
- any property of the trust is in Australia
- trust carries on business in Australia
One of these items:
- central management and control is in Australia
- Australian residents hold more than 50% of the beneficial interests in the income or property of the trust
TARP and company title interests
A purchaser can treat a vendor as an Australian resident if they receive by settlement an ATO clearance certificate and no WHT will apply.
The use of a certificate process is drawn from the Canadian and US tax systems. Currently the ATO indicates that it will implement an automated online process for issuing an ATO clearance certificate. The vendor (or their agent) would complete an online form and the ATO would automatically check the information on the form with the information it holds. The ATO expects that clearance certificates will be provided within 1 – 14 days of an application. Where there are data irregularities and manual clearance is required the wait could be up to 14 – 28 days or longer.
Significantly if a vendor fails to obtain an ATO clearance certificate by the settlement date, the purchaser must treat the vendor as a foreign resident and WHT will apply. This is so even if the vendor is in fact an Australian resident!
This consequence means that it will become standard practice for all conveyances that an ATO clearance certificate be obtained as part of the settlement process. However, given the ATO delays that can happen one would be prudent to list this task as one of the first tasks any solicitor acting for a vendor would do as part of drawing up the sales contract. The ATO indicates that it will issue ATO clearance certificates even before a property is listed for sale and its certificates will be valid for 12 months.
When acting for a vendor, it may prudent that a special condition be added to the sales contract that delays completion until the later of the agreed completion date or the time when the vendor obtains an ATO clearance certificate. It is not a final additional tax cost if WHT mistakenly applies because an affected Australian resident vendor may apply to the ATO for a refund of the WHT. However, this is an unnecessary compliance cost that can be avoided by making sure to obtain an ATO clearance certificate on a timely basis and including the relevant special condition in the sales contract.
Indirect Australian real property interests and options
For indirect Australian real property interests (apart from company title interests) and options the test for when WHT applies depends on the knowledge of the purchaser. WHT will apply if:
(a) the purchaser knows or reasonably believes the vendor is a foreign resident; or
(b) the purchaser does not reasonably believe that the vendor is an Australian resident and either:
(i) the purchaser has a record that the vendor has an overseas address; or
(ii) the purchaser is authorised to provide a related financial benefit to a place overseas.
There is provision in the legislation for a vendor to declare that either:
(a) the vendor is not a foreign resident; or
(b) the interest being sold is not an indirect Australian real property interest.
A purchaser can rely on a vendor declaration unless they know that the declaration is false. The Explanatory Memorandum (EM) to the Bill (see para 2.83) provides that a purchaser will only know that a vendor declaration is false if they have specific knowledge of the fact. That is, the purchaser must be either a party to the fraud along with the vendor or know that the declaration is completely implausible. The EM also states that the fact that a purchaser may have reasonable doubts as to the accuracy of the declaration does not, of itself, prevent the purchaser from relying on the declaration. Conservatively, since the WHT falls on the purchaser where the purchaser has real doubts as to the veracity of a declaration it would be likely that they would insist on withholding to avoid the penalties for failing to withhold and remit the WHT.
A vendor declaration is entity specific, so if a transaction involves multiple vendors each vendor would need to provide their own separate declaration.
It would be expected that such a declaration would form part of the standard warranties included in a sale contract. A vendor’s declaration can apply for a specified period up to 6 months. In a situation where completion of the sales contract will occur after 6 months from the date of contract, it should be part of the standard settlement procedure for a vendor to provide an updated vendor declaration a day before settlement occurs – noting that the purchaser’s obligation to pay the WHT is by or at settlement.
Where a sales contract has an earn out arrangement a purchaser’s WHT obligation is staggered to reflect the fact that the purchaser pays the purchase price in earn out instalments (this is discussed in detail below). To prevent the WHT applying a vendor would need to seek to ensure that they provide a vendor declaration a day before each earn out payment is made by the purchaser.
There are penalties of up to $21,600 for a vendor who makes a false declaration or is recklessness or takes no reasonable care in making the declaration.
How much WHT does a purchaser have to pay?
The amount which a purchaser must withhold is equal to 10% of the first element of the CGT cost base which they will have in the asset being bought. Practically this will be 10% of the purchase price.
Where a purchaser buys an asset as a consequence of exercising an option, then the WHT is 10% of the purchase price less any option fees paid by the purchaser to acquire the option (or to renew or extend the option). This prevents double counting since the purchaser would have been required to pay WHT on the option already.
There are special WHT rules for earn out arrangements. An earn out arrangement generally arises where a business is sold and the vendor and purchaser cannot agree on a set dollar sale price because of uncertainties related to business performance. In such a situation the parties may agree that the purchaser pay a set dollar figure and then make subsequent payments based on the future economic performance of the business. Where an earn out arrangement falls within the concept of a “look-through earn out right” for tax purposes then payment of the WHT is modified such that the purchaser pays the 10% WHT on the amount paid at settlement and then at the future times when further earn out payments are made.
Not all earn out arrangements will give rise to a “look-through earn out right”, it has a very specific tax definition. For instance, a look-through earn out right cannot last for more than 5 financial years after the date when the contract was entered into. One should seek expert tax advice in structuring an arrangement to give rise to a look-through earn out right because if the arrangement does not fall within that concept a purchaser’s calculation of the WHT on the look-through earn out right becomes complex since it would involve assessing the market value of that right.
Where the purchase price is paid in instalments, the purchaser will still have to pay the WHT on the whole purchase price on settlement. There are no special rules for instalments purchases like the earn out rules. Practically this means that a purchaser would need to ensure that they pay at least a 10% instalment to cover the WHT.
Many contracts relating to shares and units may include adjustments to purchase price after settlement depending on different variables. The legislation does not expressly outline what happens if the purchase price is adjusted after settlement. It requires WHT to be paid on 10% of the purchase price at settlement. Given that it is possible for the vendor to ask for a refund of excess WHT paid, it may be that WHT must be paid on the higher initial purchase price, even though eventually the purchase price may be reduced. This is because the purchaser would be unlikely to agree to remit a lower amount of WHT because the penalties for failing to remit the right amount of WHT fall on the purchaser.
The ATO has the power to reduce the amount of WHT that must be paid (this can be to nil) by issuing a variation notice. This would be in situations where the vendor can show that either:
(a) they will not make a taxable capital gain (eg capital loss or CGT rollover); or
(b) they will not otherwise have an income tax liability (eg prior year losses).
Either a vendor or purchaser can apply for a variation notice, but it would be most likely that a vendor would apply for such a notice since they have the relevant information. Currently the ATO envisages that it will issue variation notices within 28 days of an application. The ATO indicates it will provide a form to make a variation request on its website once the Bill becomes law. Given the time delay that could occur in obtaining a variation notice, this request should be done early on in the sale process.
Once obtained, the vendor would provide the variation notice to the purchaser at settlement to prevent the WHT from applying.
Importantly, secured creditors can also request a variation notice to reduce the WHT – this reflects the policy that the interests of secured creditors should not be undermined by tax. However, it should be noted that transactions arising from the formal insolvency or bankruptcy processes are excluded from the WHT. The EM provides an example of a bank exercising its power of sale as a situation where no formal insolvency proceedings have been instituted and the bank as a secured creditor seeks a variation notice.
A variation notice does not solve the issues that can be caused by the purchase price being paid in instalments or being adjusted. This is because the ATO only has the power under a variation notice to reduce the amount of WHT paid and not its timing.
When does a purchaser have to pay the WHT?
A purchaser has to pay WHT by settlement. The EM indicates that it would be expected that this be by electronics funds transfer (EFT) or BPAY.
At the same time as paying the WHT a purchaser is required to lodge a Purchaser Remittance Form with the ATO – this would provide details of the vendor, purchaser and the asset acquired. The ATO has not yet released this form.
Given that the purchaser has to pay the WHT by settlement, where intermediaries are used to complete the purchase transaction it will be necessary for the purchaser to make arrangements with their intermediary to ensure that the WHT is paid by settlement. This approach of imposing the WHT obligation on the purchaser differs from the managed investment trust withholding tax rules where the withholding tax obligation is imposed on intermediaries.
Importantly the WHT is not a final tax and the foreign resident vendor is required to lodge an Australian tax return in relation to the capital gain they make on the sale. The foreign resident vendor gets a credit for the WHT already paid.
Significantly, a foreign resident vendor only gets a credit for the WHT paid, if the purchaser has actually remitted the WHT to the ATO. If the purchaser withholds but does not remit the WHT, no credit arises for the foreign resident vendor. Consequently, if one were acting as a solicitor for the vendor it is likely that the sales contract would include provisions requiring the purchaser to provide evidence at settlement that the WHT has been paid. Obtaining a copy of the EFT or BPAY and the Purchaser Remittance Form that will be lodged with the ATO would be a start in obtaining such evidence. However, because the vendor really needs an assurance of payment, it may be that the vendor may ask for it to control the process of payment at settlement.
What are the penalties for a purchaser for failing to withhold?
The penalties for a purchaser who fails to withhold are not insignificant. Such a purchaser will be liable to pay an administrative penalty equal to the amount of WHT they should have remitted to the ATO. Additionally, a general interest charge is payable from the date of settlement until the date when the WHT is paid.
At the time of writing, the Bill is still before the Senate.
Please note that this article will be published in the March 2016 edition of the inTAX magazine.