Exposure draft legislation to impose a non-final withholding tax on transactions involving the disposal of ‘taxable Australian property’ by foreign residents has been released for consultation.
The release of the draft legislation follows on from the discussion paper that was released in October 2014 seeking submissions on the design of the proposed regime. A link to our previous alert on the discussion paper may be found here.
If enacted, from 1 July 2016, a purchaser of taxable Australian property from a foreign resident may be required to remit 10% of the gross proceeds to the Commissioner of Taxation on account of the foreign resident’s Australian tax liability on the disposal.
While the draft legislation appears to have taken into account a number of issues raised during the initial consultation process, there are a number of practical difficulties associated with implementing the new regime which still need to be addressed to ensure that the regime is workable in practice.
Overview of the proposed regime
Foreign residents are subject to Australian capital gains tax (CGT) on gains they make from the disposal of what is termed “taxable Australian property”. However, the collection of such tax relies heavily on voluntary compliance through the lodgement of returns and issue of assessments in the normal course. The proposed new withholding regime is intended to address the apparently low levels of voluntary compliance by, and the high costs of taking enforcement action against, foreign residents.
Broadly, under the proposed regime, a person who acquires a relevant CGT asset from a person who they know, or reasonably believe to be, a foreign resident will be required to remit to the Commissioner an amount equal to 10 per cent of the purchase price.
Upon payment being made to the Commissioner, the foreign resident vendor will become entitled to a credit for the amount against their Australian tax liability.
Who will be affected by the regime?
The new regime will affect foreign residents wishing to dispose of certain types of taxable Australian property (see below) and purchasers of such assets.
Purchasers will be concerned to establish at an early stage of the transaction whether or not any withholding may be required (and ensure that they have adequate contractual protections to enable them to comply with their legal obligations). Even if no withholding is ultimately required, the parties will still need to undertake a level of due diligence to satisfy themselves of this.
Vendors will want to be certain whether or not the purchaser considers itself bound to withhold and to ensure that this is factored into the settlement mechanics (including, for example, release of securities etc).
When will a withholding be required?
There are two “gateway” requirements that must be satisfied before a transaction will attract any withholding:
- First requirement: The asset being acquired must be:
- taxable Australian real property – this covers direct real property interests (eg, freehold and leasehold) and certain mining rights;
- an indirect Australian real property interest – this covers non-portfolio interests in entities (including those not incorporated or tax resident in Australia) whose underlying value is principally (more than 50%) derived from taxable Australian real property; or
- an option or right to acquire taxable Australian real property or an indirect Australian real property interest.
- Second requirement: No withholding is required unless:
- the purchaser knows that the vendor is a foreign resident;
- the purchaser reasonably believes that the vendor is a foreign resident; or
- the purchaser does not reasonably believe that the vendor is an Australian resident and either:
- the vendor has an address outside Australia (according to any record in the purchaser’s possession or kept or maintained on the purchaser’s behalf); or
- the purchaser is authorised to provide a financial benefit relating to the transaction to a place outside Australia.
What isn’t caught?
There are specific exemptions where the regime will not apply:
- Residential premises: the regime will not apply to purchases of property consisting of, or containing, ‘residential premises’ where the market value of the property is less than $2.5 million. ‘Residential premises’ has the meaning given in section 195-1 of the A New Tax System (Goods and Services Tax) Act 1999. This exemption applies where the property being transacted consists of, or contains, residential premises, which may enable it to apply to transactions that also include non-residential property (provided that the total market value of the property falls under the $2.5 million threshold).
- Listed shares: Transactions conducted on an approved stock exchange are excluded from withholding. This simply reflects the practical reality that a purchaser in an on-market transaction has no means of determining the identity of the vendor, making it impossible to comply with any withholding obligation. Off-market transfers of quoted securities do not qualify for this exemption.
An important feature of the regime which is likely to be heavily relied on in practice, is the ability for a vendor to provide the purchaser with a declaration that the vendor is an Australian resident or carrying on business through an Australian permanent establishment. A purchaser is entitled to rely on such a declaration (such that no withholding is required), unless the purchaser knows the declaration to be false. In a similar vein, there is provision for a vendor to provide a declaration that an asset being disposed of is not an “indirect Australian real property interest”.
The ability for a vendor to provide these types of declarations recognises that tax residency and the characterisation of indirect Australian real property interests can often involve complex legal and factual questions, which the purchaser (with limited information) would have difficulty answering with confidence.
In cases where withholding is, prima facie, required, careful consideration will be needed to determine how that withholding will factor into the settlement mechanics of a transaction.
Examples of difficult (but not unusual) situations include: non-cash transactions, CGT rollovers, vendor financing and distressed asset sales. The draft legislation contains a mechanism under which it is possible to make an application to the Commissioner to vary the rate of withholding down from the standard 10 per cent of gross proceeds. It would appear that the variation procedure is intended to be used to deal with the types of situations already mentioned (and no doubt other situations not mentioned).
It is likely that the new regime will also require a range of new provisions to be incorporated into even relatively standard sale contracts, to give both the purchaser and vendor comfort as to the legal application of the regime and its practical operation in a particular case.
When will the changes come into effect?
The new regime is proposed to apply to acquisitions which occur on or after 1 July 2016.
Generally speaking, this means that the new regime should not apply to transfers that occur under a contract that is entered into before 1 July 2016.
Affected investors (being both foreign investors considering future divestments and investors considering future acquisitions from foreign investors) should consider the impact of the proposed measures on any contemplated transactions.