Exposure draft legislation implementing the Federal Government's promise to introduce a 10 per cent non-final withholding tax on purchasers of certain types of 'taxable Australian property' from foreign residents has been released for review and comment. Partner Charles Armitage and Associate Scott Lang consider the exposure draft legislation and discuss the practical application of this reform.
How does it affect you?
- From 1 July 2016, purchasers of certain 'taxable Australian property' from foreign tax residents will be required to pay 10 per cent of the total consideration for the transaction to the Commissioner of Taxation (the Commissioner) in the form of a non-final withholding tax.
- Foreign resident vendors will be entitled to a credit for the amount of any such withholding tax paid by a purchaser, but will be required to lodge an income tax return with the Commissioner in order to claim that credit. The Commissioner will then issue the foreign resident with an assessment, which will either require the entity to pay for any capital gains tax (CGT) liabilities it has in excess of any credits to which it is entitled or entitle the entity to a refund of the amount by which its credits exceed its CGT liabilities (if any).
- A withholding obligation will only arise if the purchaser knows or reasonably believes the vendor is a foreign resident or reasonably believes the vendor is not an Australian resident. Furthermore, the purchaser is entitled to rely on any declaration by the vendor that it is not an Australian resident or that the asset being acquired is not 'taxable Australian property'.
- The Commissioner will be given the powers to vary the amount of any particular tax payment (including to nil) on application from an interested party, as well as vary classes of amounts payable by way of legislative instrument.
- Submissions on the exposure draft legislation are due by Friday, 7 August 2015.
Foreign residents disregard any capital gain or loss they make from a CGT event in relation to a CGT asset that is not 'taxable Australian property'. 1 Effectively, this means that foreign residents are only liable to pay CGT on dealings involving 'taxable Australian property'. Taxable Australian property is defined to mean:
- 'taxable Australian real property', meaning:
- real property situated in Australia (including a lease of Australian land); or
- mining, quarrying or prospecting rights for minerals, petroleum or quarry materials situated in Australia;
- an 'indirect Australian real property interest', meaning an interest of 10 per cent or more in an entity whose underlying value is primarily derived from taxable Australian real property;
- any asset that has been used in carrying on a business through a permanent establishment in Australia; and
- an option or right to acquire any of these types of assets or interests.
The Federal Government claims that voluntary compliance by foreign residents in paying their CGT liabilities is extremely low and that the powers of the Commissioner to enforce these liabilities, namely by issuing an assessment, obtaining a Mareva injunction (freezing order) or issuing a notice under section 255 of the Income Tax Assessment Act 1936 (Cth) to a third party to redirect money, are insufficient and ineffective. 2
For this reason, the Federal Government proposes to introduce a new non-final withholding tax on disposals of 'taxable Australian property' by foreign residents. Imposition of a such a tax was announced by the former Federal Government in 2012. The current Federal Government confirmed its intention to proceed with this reform in 2013. Treasury released a discussion paper for consultation in 2014. For more detail on that paper, please see our earlier Client Update: Withholding Tax on the Sale of Australian Property by Foreign Residents. The current exposure draft legislation and explanatory materials are the result of that consultation.
When does the tax apply?
In summary, the non-final withholding tax applies where three elements are satisfied:3
- A purchaser acquires 'taxable Australian real property', an 'indirect Australian real property interest' or an option or right to acquire such property or interest from one or more entities (ie 'taxable Australian property' described in bullet points one, two and four above, but not the 'taxable Australian property' described in bullet point three above). Put simply, a purchaser acquires an interest in Australian land either directly or indirectly.
- At least one of the vendors is deemed to be a foreign resident because one of the following criteria is satisfied:
- The purchaser knows or reasonably believes that the vendor is a foreign resident (eg the vendor discloses that it is a foreign resident or the purchaser learns that the vendor is likely to be living overseas).
- 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 about the transaction in the possession or kept or maintained on behalf of the purchaser; or
- the purchaser is authorised to provide a financial benefit relating to the transaction to a place outside Australia (whether to the vendor or to anyone else).
- The vendor has a connection outside of Australia that is prescribed in the regulations. At this stage, no such connections are proposed to be prescribed.
However, even if one of these criteria is satisfied, a vendor will not be a deemed foreign resident if the vendor has given the purchaser a declaration that:
- at the time of the acquisition the vendor is an Australian resident;
- just after that time, it will be carrying on a business through an Australian permanent establishment; or
- a membership interest being acquired is not an 'indirect Australian real property interest',
and the purchaser does not know the declaration to be false (ie they are not a party to any fraud committed by the vendor or know that the declaration is completely implausible).
For ease of reference, we will refer to a vendor that satisfies one of these criteria and has not provided a declaration as a deemed foreign resident.
- None of the three exemptions applies:
- The asset acquired is real property (or an interest therein) with a market value of less than $2.5 million that is or contains residential premises.4
- The transaction is on an approved stock exchange and the asset is listed for quotation in the official list of that exchange.5
- An amount is already required to be withheld from a withholding payment relating to the transaction.
Who is the person liable to tax?
The purchaser is the person who is liable to pay the non-final withholding tax to the Commissioner through an approved electronic payment method (eg EFT or BPAY). Failure to pay the non-final withholding tax will render the purchaser liable to penalties and interest. The directors of any purchaser who fails to pay may also be liable to penalties.
Having said that, because the tax is only a non-final withholding tax, it is the vendor that remains liable for the CGT on the disposal of the asset. It must lodge an income tax return and pay any amount assessed by the Commissioner (but will be entitled to a credit for the amount of non-final withholding tax paid by the purchaser). To this end, the purchaser must also notify the Commissioner in the approved form of any payment of non-final withholding tax. The approved form contains information that allows the amount to be credited to the appropriate vendor and may include the vendor's tax file number.
What is the amount of tax payable?
The amount of tax payable is equal to 10 per cent of the first element of the relevant asset's cost base just after the acquisition (ie 10 per cent of the total consideration paid or required to be paid to acquire the asset).
The Commissioner is given the power to vary the amount of any particular tax payment (including to nil) on application in the approved form from:
- the purchaser;
- a vendor that is or 'could be' deemed to be a foreign resident; or
- a security holder exercising a power over a CGT asset.
The variation takes effect when the purchaser is made aware of it, even if the application is made by the vendor or a security holder.
The Commissioner is also given the power to vary classes of amounts payable by way of legislative instrument.
When is the tax payable?
The tax payable on acquisition must be paid to the Commissioner on or before the day on which the purchaser becomes the owner of the relevant asset.
What about earnout arrangements?
Where an acquisition that is subject to the non-final withholding involves a 'look through earnout right',6 the purchaser will also be required to pay an amount equal to 10 per cent of the market value of any financial benefit (ie 10 per cent of any earnout payment) provided to a deemed foreign resident vendor. Such an amount must be paid to the Commissioner on or before the day on which the financial benefit (ie earnout payment) is provided to the vendor.
However, no such additional amount is payable if it is provided to a person who is not (or is no longer) a deemed foreign resident (including a third party Australian resident or a vendor if they have subsequently provided the purchaser with a declaration that at the time of the provision of the financial benefit the vendor was an Australian resident or just after that time it will be carrying on a business through an Australian permanent establishment).
When will the tax commence?
The tax will apply in relation to acquisitions of assets made on or after 1 July 2016. Purchasers are generally taken to have acquired an asset for CGT purposes on the date they enter into a contract to acquire it.7 As such, the tax will apply to transfers that are made under a contract that was entered into on or after 1 July 2016.
Taxpayers should not underestimate the extremely wide application of the proposed non-final withholding tax. It will apply to purchasers regardless of whether they are Australian or foreign residents. It will apply to almost all transactions involving the acquisition of an interest in Australian land from a deemed foreign resident, either directly or indirectly, regardless of how minor the transaction and regardless of whether it will result in any CGT liability on the part of the vendor. Some submissions to the discussion paper suggested excluding foreign residents, the implementation of a de minimus asset value threshold and that the tax not be calculated on the 'gross' consideration value (but rather the CGT liability).
Indeed, whether or not a purchaser is required to pay withholding tax under the exposure draft legislation depends almost entirely on whether the vendor is a deemed foreign resident. This is the lynchpin of the tax. Tax residency is a complex legal and factual issue on which reasonable minds often differ. In many cases, a purchaser will not have sufficient information to establish whether the vendor is a tax resident. Providing purchasers with mechanisms to ascertain with certainty and in a timely manner whether a withholding obligation exists is fundamental to ensuring there is not a significant disruption to trade and commerce.
In seeking to address the issue, the exposure draft legislation creates two regimes: the declaration system and the Commissioner's variation power. Importantly, a purchaser is entitled to rely on a declaration without further enquiry, even if it is inaccurate, provided that they do not know it to be false. Further, there is no specific form of declaration; it may simply take the form of a contractual warranty. These are welcome developments.
That said, it must also be remembered that a declaration only covers the vendor that makes it; in circumstances where there are multiple vendors, a declaration will be required from each. In the absence of a declaration from all vendors, a purchaser will still face significant uncertainty that could lead to disputes between the parties. Vendors will need to ensure that any declaration that they do make is accurate, otherwise they will be liable for an administrative penalty if the declaration is false or misleading in a material particular (including by way of omission).8 For this reason, some vendors may be reluctant to issue declarations.
Further flexibility is provided by the Commissioner's variation power, which effectively allows for a purchaser's withholding obligations to be waived. The Explanatory Materials suggests that the Commissioner might issue a variation where:
- there are multiple vendors and only one of them is a foreign resident;
- the foreign resident will not make a capital gain (eg because they will make a capital loss or CGT roll-over relief applies);
- the income from the transaction is exempt from taxation (eg under the terms of a relevant double tax agreement);
- the foreign resident will not have an income tax liability (eg because of prior year tax losses or capital losses carried forward); or
- a secured creditor is exercising its power of sale and the proceeds from the transaction are insufficient to satisfy the withholding tax amount and discharge the debt secured.
Indeed, in exercising this power, the legislation specifically requires the Commissioner to protect the rights of secured creditors to realise or otherwise deal with their securities. This should provide some comfort that withholding tax should not apply to certain disposals of highly geared assets. However, the power remains discretionary and there is no guarantee that the Commissioner will exercise it in any particular circumstances. Further, the legislation does not contain a 'clearance certificate' process under which a purchaser can apply to the Commissioner before a transaction for a determination that no withholding (or reduced withholding) is required.
Another important issue is the time at which, and the means by which, the withholding tax amount must be paid. The exposure draft legislation requires the amount to be paid on or before the day on which the purchaser becomes the owner of the relevant asset by approved electronic methods. There are no special provisions to deal with vendor finance arrangements, instalment contracts, purchase price adjustments and non-cash transactions (in particular, payee guarantee or surety options in lieu of withholding). In all such cases, a purchaser will still be required to make a cash payment to the Commissioner equal to 10 per cent of the total consideration or apply for the Commissioner vary the amount required to be withheld.
There are no specific provisions dealing with vendors that are trustees and custodians. However, the Explanatory Materials contains a series of three examples that suggest that whether a withholding obligation will arise for a purchaser will depend upon the residence of the trustee or custodian, unless the beneficiary of the trust is absolutely entitled to the asset being transferred, in which case that beneficiary's residence will determine the issue. This may pose a significant problem for purchasers, as they may be unaware that the vendor is acting as a trustee or the nature of the trust (eg secret agent trustee arrangements). There are no provisions that suggest that the custodian, rather than the purchaser, should bear the withholding obligations.
Finally, the exemption for listed assets should be noted and welcomed as purchasers of such assets can have no idea of the identity (let alone tax residence) of the vendor(s).
Submissions on the exposure draft legislation are due by Friday, 7 August 2015.
- Income Tax Assessment Act 1997 (Cth) s855-10. For further detail, see Division 855.
- Exposure Draft Foreign Resident CGT Withholding Regime Explanatory Materials, Tax and Superannuation Laws Amendment (2015 Measures No. 5) Bill 2015 (Cth) 5.
- Exposure Draft Tax and Superannuation Laws Amendment (2015 Measures No. 5) Bill 2015 (Cth).
- The term 'residential premises' is defined in A New Tax System (Goods and Services Tax) Act 1999 (Cth) s195-1, the meaning of which is explained in detail in a public ruling: Australian Taxation Office, Goods and Services Tax: Residential Premises, GSTR 2012/5, 19 December 2012. Purely vacant land will not qualify for the exemption.
- The Explanatory Materials state that this exemption 'will apply to listed securities where the sale is conducted off-market': 11. At first blush, this statement is inconsistent with the wording of the exemption and is also inconsistent with the policy rationale underlying the exemption (namely, that it is impossible for a purchaser to identify the vendor in an on-market transaction).
- This term is defined in the Exposure Draft Tax and Superannuation Laws Amendment (2015 Measures No. 4) Bill 2015 (Cth) dealing with CGT treatment of earnout rights. The Explanatory Materials to the non-final withholding tax legislation states that it 'depends on' the amendments proposed in the legislation dealing with CGT treatment of earnout rights, but the legislation itself contains no provisions do deal with the possibility that the CGT treatment of earnout rights legislation fails to pass.
- Income Tax Assessment Act 1997 (Cth) Division 109.
- Taxation Administration Act 1953 (Cth) sch1 s284-75(4).