The new 10% foreign resident capital gains tax withholding regime applies more broadly than many will expect, and both vendors and purchasers, whether Australian resident or not, will need to consider whether or not their transactions are affected.
From 1 July 2016, purchasers of direct and some indirect interests in Australian land (including leases and mining rights), and grantees of options to acquire such interests will have to pay to the Australian Taxation Office (ATO) an amount equal to 10% of the purchaser's cost base in the relevant asset on or before completion of the sale.
This amount can be withheld from the purchase price, and any amounts paid to the ATO will discharge any liability of the vendor. The withholding applies unless either there is sufficient proof of the vendor's Australian tax residency or the transaction is otherwise exempted.
- This is not a final withholding tax, and the vendor can get a credit for the withholding amount when the vendor lodges its tax return (although this may not occur until well after the transaction settles).
- Purchasers will be out of pocket if they fail to withhold when required to do so, and may be penalised by interest costs.
- Some time is likely to be required in affected transactions to establish vendor residency, complete the compliance steps and apply to vary the withholding amount (if necessary). These need to be factored into settlement timeframes.
- Sale agreements should include appropriate clauses to address the withholding obligations and the timing of any compliance steps (e.g. obtaining Commissioner's certificates or withholding variations).
What transactions are affected?
The following transactions are affected, unless an 'exclusion' applies (see below).
- Sales of Australian land (including mining, quarrying and prospecting rights) and leases.
- Grants of leases of Australian land if a premium is charged.
- Transfers of interests in some Australian companies, partnerships and trusts where the vendor owns 10% or more of the entity and the entity is 'land rich' (that is, the value of the entity's Australian land interests is more than 50% of the entity's assets which are not Australian land interests).
- Grants of options to acquire the above.
The withholding regime applies to these transactions even if they will give rise to revenue gains.
What are the exclusions?
No withholding or payment to the ATO is required for these transactions:
- Transactions where sufficient 'proof' exists of the vendor's Australian tax residency;
- If the relevant agreement is formed prior to 1 July 2016, although any options granted prior to 1 July 2016 that are exercised after 1 July 2016 will be subject to the regime.
- Sale of land, leases or company title interests worth less than A$2m, or grants of leases with a premium of less than AU$2m. There is no such de minimis threshold for acquisitions of interests in land rich entities or for grants of options/rights.
- Transactions involving vendors who are in administration or subject to bankruptcy proceedings in Australia (this exemption extends to insolvency proceedings outside Australian in certain circumstances).
- Transaction conducted through an approved stock exchange or a broker operated crossing system.
- Certain securities lending arrangements.
- Transactions where another withholding tax applies, such as withholding from fund payments made by managed investment trusts to foreign resident taxpayers.
What 'proof' is required of the vendor's Australian tax residency?
Direct land transactions
For direct land transactions other than grants of rights or options, and for transfers of company title interests, no withholding is required if the vendor obtains and provides to the purchaser a ‘clearance certificate’ issued by the ATO.
If however, no clearance certificate is provided, the purchaser must withhold regardless of whether the vendor is, in fact, an Australian resident. This makes giving a clearance certificate to the purchaser an essential transaction step for every Australian and non-Australian vendor of Australian land, mineral rights or company title interests.
- Where there are multiple vendors, all vendors have to provide a clearance certificate. If even one vendor fails to do so, the obligation to withhold remains (although it may be possible to get the withholding amount reduced from 10% - see below).
- The ATO has indicated that once issued a clearance certificate remains valid for 12 months. The ATO has advised that the forms will be available prior to 30 June 2016 and has indicated that the timeframes for issuing clearance certificates will be 1 to 14 days if the information on the application conforms with that already on ATO systems, 14 to 28 days if any information needs to be checked, and over 28 days for 'high risk' or 'unusual' transactions.
Interests in land rich entities and grants of options or rights
For transactions involving sales of interests in land rich entities or grants of options or rights, vendors can make a declaration that they are Australian resident for tax purposes. Note that for interests in land rich entities, the vendor can instead declare that the membership interest held by the foreign vendor is not covered by the regime, because the foreign vendor's pre-sale interest is less than 10%, or that Australian real property accounts for 50% or less of the entity’s total value.
Either of these forms of vendor declaration can be relied upon by the purchaser unless the purchaser actually knows the declaration to be false. Vendor declarations can be relied upon for 6 months from the time they are made.
If no vendor declaration is given, or one is given but the purchaser knows it to be false, the purchaser has to apply the 'knowledge condition' test. Where this test applies, the purchaser will have to make the 10% withholding if the purchaser knows or has reasonable grounds to believe that at least one grantor is a foreign resident, or if the purchaser has a foreign address for a grantor or has been asked to make a payment to a place outside Australia in respect of a grantor and has no reasonable grounds to believe that grantor is an Australian resident.
How is the withholding amount calculated?
The amount to be paid is 10% of the total consideration paid or payable to acquire the asset in question (including any property given for the acquisition), reduced by any option fees paid to acquire the asset.
GST is excluded from total consideration provided the purchaser is registered for GST. Where there are multiple purchasers, the purchasers will 'split' the total withholding amount based on the respective interest in the asset acquired by each of the purchasers.
Can you apply to vary the withholding amount?
It is possible for a party with an interest in the transaction to apply to vary the withholding amount. Variation is at the Commissioner's discretion. A variation might be desirable, for example, where there are multiple vendors, only one of which is a foreign resident, where the transaction would not otherwise give rise to any income tax liability (for example, the vendors have tax or capital losses), or where the sale price is less than a debt owed to a secured creditor. Note that a secured creditor may be able to apply for a variation, not just the vendors and purchasers.
When must the purchaser pay the withholding amount to the ATO?
The purchaser must pay the amount on or before the day on which the purchaser becomes the owner of the property (usually settlement). The payment must be made to the ATO 'upfront' based on the total amount payable for the property (less any option fee), even if payments are to be paid by instalments post-settlement, for example under a terms contract. Before paying, the purchaser must notify the ATO about the payment.
If the contract falls through before the change of ownership occurs, the purchaser does not have to make any payment to the ATO.
There are also specific rules in relation to the treatment of look through earn outs, which broadly require withholding from each earn out payment.
The penalty for failing to pay the withholding amount to the ATO is equal to the amount that was required to be paid to the ATO. The ATO can seek recovery of the penalty plus interest from the purchaser.
- Consider whether or not your transaction will be caught to avoid surprises at settlement.
- You may need to include tailored clauses in the sale agreements including warranties, and clauses dealing with timing for the provision of clearance certificates, vendor declarations and any withholding variations. Vendors may also want to provide for remedies if purchasers fail to pay the withholding amount to the ATO as required, including providing for payment of interest by the purchaser for late payment or non-payment, as there is no legislative redress against the purchaser for amounts withheld in error.
- If you are an Australian resident vendor, obtain a compliance certificate as soon as possible.
- Factor in enough time for compliance, including purchaser tax registration if required, when deciding settlement timeframes.