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Focus: Withholding tax to capture exit profits

11 December 2015

In brief: Legislation introduced into Parliament will impose a 10 per cent non-final withholding tax on proceeds paid to foreign parties to acquire direct or indirect interests in Australian real property and mining rights from 1 July 2016. Partner Martin Fry (view CV) and Lawyer David Lewis discuss the proposed law.

How does it affect you?

  • From 1 July 2016, the sale and purchase of direct and indirect interests in real property (including leases) and mining rights will need to cater for the imposition of a 10 per cent non-final withholding tax where the vendor is a foreign party.
  • Vendors and purchasers will need to work together to agree satisfactory terms of sale. The sale agreement will either need to provide for the 10 per cent withholding from the sale price, or provide for the clearances or declarations that the purchaser will require before it will agree to not withhold and remit tax to the Commissioner of Taxation (the Commissioner).
  • Foreign vendors will need to make an early assessment of their liability for tax on selling direct or indirect interests in Australian real property or mining rights. Foreign vendors may wish to approach the Commissioner before sale to agree the Australian tax liability (if any) so that the agreed outcome can be reflected in a variation of the withholding obligation. Foreign vendors will generally need to file an Australian tax return in order to determine their final liability for tax on the sale (if any), taking into account any tax withheld by the purchaser.
  • Creditors of foreign vendors will need to ensure that the new withholding does not have the effect of creating a priority in favour of the Commissioner.
  • Subject to a purchaser relying on certain clearance certificates or declarations, a purchaser of direct or indirect interests in Australian real property or mining rights will need to withhold 10 per cent of purchase monies if:
    • the purchaser knows or reasonably believes that the vendor is a foreign resident;
    • the purchaser does not reasonably believe that the vendor is an Australian resident, and the purchaser knows the vendor to have a foreign address or is required to pay monies offshore; or
    • regardless of knowledge, the property to which the transaction relates is Australian real property, mining rights or certain interests in company title.

Background

The Commissioner has long had the legislative power to impose a withholding tax on the sale of Australian assets by foreign parties by issuing garnishee notices requiring purchasers to withhold and remit tax on account of the foreign vendor. However, over the years the Commissioner has encountered a range of difficulties in actually collecting tax under the garnishee notices.

The Federal Government previously released exposure draft legislation on the proposed 10 per cent non-final withholding tax (see our Focus: Withholding tax on the sale of Australian property by foreign residents exposure draft legislation released).

On 3 December 2015, a Bill based on the exposure draft was introduced into the House of Representatives. The most significant change from the exposure draft is that a vendor will be a relevant foreign resident if the property to which the transaction relates is Australian real property or mining rights, or certain interests in company title, regardless of the purchaser's knowledge or belief as to the residency of the vendor.

Structure of the new withholding tax

Unless an exclusion applies, a non-final withholding tax will apply where the following two elements are satisfied.

  1. A purchaser acquires a direct or indirect interest in Australian real property (including a lease) or mining rights, or an option or right to acquire such property or rights, from one or more entities.
  2. At least one of the vendors is a relevant foreign resident because one of the following criteria is satisfied.
    • The purchaser knows or reasonably believes that the vendor is a foreign resident.
    • The purchaser does not reasonably believe that the vendor is an Australian resident and either:
      • the vendor has an address outside of Australia; or
      • the purchaser is authorised to provide a financial benefit relating to the transaction to a place outside of Australia.
    • The vendor has a connection outside Australia of a kind specified in (yet to be issued) regulations.
    • The property to which the transaction relates is Australian real property or mining rights, or a membership interest of 10 per cent or more the holding of which causes a company title interest to arise. Put simply, the purchaser directly acquires Australian land or it acquires a membership interest of 10 per cent or more in a company entitling the purchaser to occupy land or a building or part of a land or a building. Note that when the transaction relates to this type of property the vendor will be a relevant foreign resident regardless of any knowledge or belief of the purchaser as to the vendor's residency, unless the vendor gives the purchaser a clearance certificate, discussed below.

However, even if one of these criteria is satisfied, a vendor will not be a relevant foreign resident if one of the following is satisfied.

    • If the property to which the transaction relates is Australian real property or mining rights, or a more than 10 per cent indirect interest the holding of which causes a company title interest to arise, and the vendor gives to the purchaser a clearance certificate issued by the Commissioner for a period covering the time the transaction is entered into.

      A clearance certificate is issued by the Commissioner to certify that, based on the information available to the Commissioner, there is nothing to suggest that the vendor is or will be a foreign resident during a specified period.

      While the provisions in the Bill have their difficulties, the intention seems to be that where the transaction relates to this type of property, the provision of a clearance certificate will be the primary means for the purchaser to be comfortable that withholding is not required.
    • If the property to which the transaction relates is:
      • membership interests in an entity directly or indirectly holding Australian real property or mining rights; or
      • an option or right to acquire a direct interest in Australian real property or mining rights, or such a membership interest,

and the vendor gives to the purchaser a declaration that the vendor is an Australian resident or that the membership is not an 'indirect Australian real property interest' (ie it is not an interest of 10 per cent or more in an entity for which more than 50 per cent of the value is attributable to Australian real property or mining rights).

Exclusions

The withholding obligation does not arise where the transaction fits within one of the following exclusions:

  • The property to which the transaction relates is Australian real property or mining rights, or a membership interest the holding of which causes a company title interest to arise, and the market value of the property is less than $2 million.
  • The transaction is on an approved stock exchange or conducted on a crossing system.
  • An amount is already required to be withheld from a withholding payment relating to the transaction.
  • The transaction is the re-acquisition of borrowed securities or the acquisition of identical securities by the lender of securities under certain securities lending arrangements.
  • Any of the relevant foreign residents is being wound up, is under administration, has executed a deed of company arrangement, has had a managing controller or a receiver appointed to its property or is in a similar position under a foreign law, or the transaction arises from certain bankruptcy arrangements.

Payment of the tax

The non-final withholding tax must be paid by the purchaser to the Commissioner on or before the day on which the purchaser becomes the owner of the property. Failure to pay the non-final withholding tax will render the purchaser liable to penalties and interest.

The amount of tax payable is equal to 10 per cent of the first element of the property's cost base just after the acquisition (ie 10 per cent of the total consideration paid or required to be paid to acquire the property) less, in the case of property acquired on the exercise of an option, any payment made and the market value of property given for the acquisition of the option.

This is subject to the ability of a purchaser, a vendor or an entity owed a debt by a vendor to apply to the Commissioner to vary the amount of non-final withholding tax payable by the purchaser, including to reduce the amount to nil.

The vendor remains liable for the capital gains tax on the disposal of the property. 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.

Where an acquisition that is subject to the non-final withholding tax involves a 'look-through earnout right', the purchaser will also be required to pay to the Commissioner 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 person who is a relevant foreign resident at the time the purchaser provides the financial benefit.

The non-final withholding tax will apply to acquisitions made on or after 1 July 2016. As purchasers are generally taken to have acquired property for capital gains tax purposes on the date they enter into the acquisition agreement, the non-final withholding tax will apply to transfers that are made under contracts entered into on or after 1 July 2016.

Some practical implications

In relation to sale and purchase agreements in general:

  • Sale and purchase agreements will need to specifically provide for the purchaser to either withhold the tax or be able to rely on a clearance certificate or declaration to refrain from withholding.
  • Where the vendor seeks to avoid the withholding by providing the purchaser with a clearance certificate or declaration, the sale agreement will need to impose the obligation on the vendor to provide such certificate or declaration to the satisfaction of the purchaser as a condition to completion of the sale.
  • Foreign vendors will want to analyse their liability for Australian tax before they commence the sale process, so as to assess whether there will be benefits in approaching the Commissioner and determining the outcome before the sale.

In relation to the sale of real property with a value of over $2 million:

  • The provision of clearance certificates by the vendor will become a standard step in the sale process and conveyance.
  • The Australian Taxation Office has indicated that it will be implementing an 'automated process' for issuing clearance certificates. In straightforward cases where the ATO has all the required information, it anticipates providing clearance certificates within 14 days of application. Where there are irregularities or exceptions, the clearance certificate could be provided from 14 to 28 days, or perhaps longer in high risk or unusual cases.

For further information, please contact:

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