A Bill has been introduced into Parliament which proposes a non-final foreign resident withholding tax on transactions involving the disposal of certain ‘taxable Australian property’.
Although the changes, which are to apply to contracts entered into on or after 1 July 2016, are aimed at transactions involving a foreign resident vendor, they will have a practical impact on all transactions that involve “taxable Australian real property”, even where the vendor is an Australian resident.
Overview of the regime
Under the new regime, a person who acquires certain types of taxable Australian property from a foreign resident will, broadly, be required to remit 10 per cent of the purchase price to the Commissioner. A person that is required to provide a financial benefit under a qualifying (look-through) earnout right in relation to the acquisition of a relevant asset will also be required to remit 10 per cent of the market value of the financial benefit to the Commissioner. Upon payment to the Commissioner, the foreign resident vendor will be entitled to a credit for that amount against their Australian tax liability.
A failure to withhold may result in significant penalties for the purchaser.
New circumstances in which a withholding will be required
There are two “gateway” requirements that must be satisfied before a transaction will attract any withholding:
- the asset acquired must be:
- taxable Australian real property (TARP) – this covers, broadly, direct real property interests and certain mining rights;
- an indirect Australian real property interest (IARPI) – this covers, broadly, membership interests in entities whose taxable Australian real property assets represent 50% or more of their total asset value; or
- an option or right to acquire TARP or an IARPI; and
- at the time that the transaction is entered into:
- the purchaser knows, or reasonably believes, that the vendor is a foreign resident; or
- the purchaser does not reasonably believe the vendor to be an Australian resident, and the vendor has an address outside of Australia or the purchaser is authorised to provide a financial benefit to a place outside of Australia; or
- the asset being acquired is TARP (or an IARPI that gives rise to a company title interest).
Paragraph c) is a significant change to what was in the exposure draft legislation. It may result in the regime applying, even where both the vendor and purchaser are Australian tax residents, to any transaction involving the acquisition of TARP assets, unless a clearance certificate is obtained prior to completion or the transaction is otherwise exempt from withholding.
Exclusions from the regime: what has changed?
Expanded real property exemption
The exposure draft legislation included a specific exemption for transactions involving the acquisition of “residential premises” valued at less than $2.5 million.
This exemption has now been expanded to all TARP assets and IARPI that give rise to company title interests, which means that the exclusion now covers residential premises, commercial property, vacant land, leasehold, easements, covenants, mortgages and stratum title.
However, the threshold for the exemption has been reduced to $2 million.
A significant feature of the proposed regime is the ability for vendors to apply to the ATO for a “clearance certificate” to relieve a purchaser of their obligation to withhold and remit funds to the ATO. A clearance certificate will be mandatory for Australian resident vendors disposing of a TARP asset or a company title IARPI that is not excluded from the proposed regime. Without a valid certificate, the purchaser will be obliged to withhold. No certificate is required where the vendor is a foreign resident (such that the purchaser is already obliged to withhold).
ATO guidance (found here) provides that applications for a clearance certificate will be automated (at the first stage), may be made any time prior to the transaction and will be valid for 12 months.
Careful consideration will need to be given to the timing of obtaining a clearance certificate. Although in straightforward transactions the ATO should be able to provide the certificate in a short period of time (currently expected to be 1-14 days), applications for clearance certificates in more complicated scenarios may result in delays to the completion process.
The Bill retains the exemptions to the regime for:
- transactions on an approved stock exchange; and
- transactions involving shares or other similar interests (i.e. not direct real property) where the vendor provides the purchaser with a declaration that it is an Australian resident or that the interest being acquired is not an IARPI.
In addition, exemptions from the regime have been introduced in respect of external administration and bankruptcy, securities lending arrangements and transactions conducted on a broker operated crossing system.
Where the regime applies, the purchaser must remit the withheld amount to the Commissioner on or before completion. The Bill also contains a mechanism under which an application may be made to the Commissioner by the purchaser, a vendor or an entity that is owed a debt by a vendor, to vary the rate of withholding that is required (including to nil). In the majority of cases the ATO envisages that variations will be provided within 28 days. These factors may affect the settlement mechanics of a transaction.
In addition, a range of new provisions may need to be incorporated into even relatively standard sale contracts especially in transactions involving non-cash consideration, CGT rollovers, vendor financing and multiple vendor sales where only one vendor is a foreign resident.
Further, the regime is still based on an acquisition model, where the withholding obligation is enlivened by the acquisition of a CGT asset. This means, subject to an exemption or exception applying, that a purchaser may have a withholding obligation even where a tax liability does not arise for the foreign resident vendor. In such cases, it would appear that the intent is for the parties to apply for the withholding rate to be varied.
Foreign residents considering future sales, purchasers considering acquisitions from foreign resident vendors and any parties to transactions involving TARP assets or IARPI should consider how the changes will impact their transaction and how to build in the necessary mechanisms to manage their obligations under the new regime.