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How will the CGT Withholding Regime affect you?
With the new foreign CGT withholding tax regime to come into force from 1 July 2016, the question is not “Will the changes affect you?” but “How will the changes affect you?”. Under the new regime, any person accepting a transfer of certain Australian assets from a relevant "foreign resident" is required to withhold and remit 10% of the total consideration to the Commissioner of Taxation (Commissioner). Whilst these changes are aimed at foreign residents, the regime will affect transactions regardless of the residency of the vendor or whether any consideration is in fact paid for the relevant asset.
It is important to note that whilst the withholding amount is paid to the Commissioner, affected vendors will be able to claim a credit for the withholding amount when lodging their tax return. This is to ensure that foreign residents comply with their existing obligations to lodge tax returns and pay any assessable capital gains tax (CGT) (subject to limits on CGT under Division 855 of the Income Tax Assessment Act 1997 (ITAA 1997). In addition to ensuring compliance the measures will also aid the Commissioner in the collection of CGT.
Assets to which the regime applies
The obligation to withhold the amount will apply to transactions which involve:
- taxable Australian real property (TARP), which includes vacant land, buildings, residential and commercial property, premiums paid for leases of real property, and mining, quarrying or prospecting rights where the material is situated in Australia;
- an indirect Australian real property interest (IARPI). An IARPI is generally a 10% or more interest in an entity whose assets comprise more than 50% taxable Australian real property by market value; or
- an option or right to acquire TARP or an IARPI.
Transactions to which the regime will apply
It is important to note that the withholding obligation will apply not just to sale transactions, but also to any transaction which would trigger any one of the CGT events listed in section 109.5 of the ITAA 1997. For example other transactions that may possibly be affected include:
- the creation of a trust over a TARP or an IARPI;
- the transfer of relevant assets to a Trust (including where a trustee retires and a new trustee is appointed);
- beneficiaries of a trust becoming absolutely entitled to a relevant asset;
- the granting of leases; and
- the transfer of a relevant asset to a beneficiary of a deceased’s estate.
How much is payable
The actual amount that must be withheld and paid to the ATO is equal to 10% of the first element of the CGT asset’s cost base (i.e. normally the purchase price), less any option fee paid by the purchaser in respect of the asset (including any renewal or extension fees) (CGT Amount). The CGT Amount must be paid on or before the date of settlement of the transaction. To ensure compliance, where a purchaser fails to withhold the CGT Amount, the ATO will impose penalties on the purchaser equal to the CGT Amount plus interest.
In addition to the above a purchaser, a foreign resident vendor or a secured creditor of the vendor may make an application to the ATO for the CGT Amount to be varied in respect of a particular transaction.
A purchaser’s obligation to withhold a CGT Amount from a vendor (whether a foreign or Australian resident) at settlement will not apply if:
- the transaction:
- was entered into prior to 1 July 2016 (however, note options granted before 1 July but exercised after 1 July are not excluded);
- involves a TARP or an IARPI has a market value of less than $2 million;
- is conducted via a stock exchange or crossing system;
- the arrangement is already subject to an existing withholding obligation;
- is a securities lending arrangement; or
- involves vendors who are subject to formal insolvency or bankruptcy proceedings (in Australia or elsewhere).
- a Commissioner clearance certificate is obtained from the ATO stating that the vendor is not a relevant foreign resident or the transaction is an excluded transaction; or
- For certain kinds of IARPI or options to purchase real property:
- the vendor provides the purchaser with a declaration that the vendor is not a foreign resident, and the purchaser knows this declaration not to be false; or
- the purchaser does not positively know and does not reasonably believe that the vendor is a foreign resident.
The relevant application forms can be downloaded from the ATO website here. It should be noted that the clearance certificates:
- will remain valid for 12 months from the date of issue;
- will generally be provided automatically but if there are any errors or irregularities may take anywhere between 14 to 28 days. It should be noted that high risk or unusual transactions, may take greater than 28 days due to the manual nature of processing such requests;
- can be provided at any time during the transaction but must be provided before completion;
- where a transaction concerns multiple vendors, each vendor must obtain their own clearance certificate; and
- Where the vendor is a trustee, the clearance certificate must be in the name of the trustee not the trust.
As noted above, in transactions involving IARPIs or options to purchase real property, a vendor may provide a declaration. The declaration must be in writing and state that for a specified period (no longer than six months after the declaration is made) they are and will be an Australian resident. The declaration may be included as a warranty or a separate declaration within a contract. Penalties will be imposed on vendors that make false or misleading declarations.
Claiming Credit for the CGT Amount
As noted above, CGT amounts paid to the Commissioner in respect of applicable transactions will be become a claimable credit when the vendor of the transaction lodges its tax return. The effect of this is that:
- Australian tax resident vendors, who have had CGT Amounts withheld from their sale proceeds, will be able to claim a credit for that amount when they lodge their tax return. This credit will be refunded subject to any deduction for capital gains tax payable on the sale of the property; and
- foreign resident vendors must lodge a tax return at the end of the financial year (or earlier if applicable) declaring their Australian assessable income, including any capital gain made from the disposal of the asset. The foreign resident will then be able to claim a credit for any withholding amount in their tax return.
Key impacts of the new requirements
Where the transaction being proposed does not fall within any of the exemptions listed above, Rostron Carlyle recommends that:
- Given the penalties that can be imposed, it will be prudent for the purchaser of a TARP or an IARPI to obtain either a clearance certificate or a vendor declaration (as appropriate) from the vendor.
- For any transaction involving an option to acquire either a TARP or an IARPI a clearance certificate or a declaration will need to be obtained.
- Applications for clearance certificates or any variations of the CGT Amount will need to be made as early as possible to ensure that the certificate is available either before or at settlement.
- Special conditions and warranties are inserted into the relevant contracts to ensure vendors and purchasers are protected from the penalties imposed under the regime and to ensure that the Purchaser is able to withhold the correct amount at settlement and preventing the amount payable from being grossed up to take into account the withholding tax amount.
- The purchaser’s due diligence investigations determine the residency of the vendor and the reliability of any declaration given by the vendor.
- Retiring trustees obtain clearance certificates when changing trustees of a trust which owns real estate or indirect interests in real estate.
- Creditors and vendors consider whether a variation of the CGT Amount will be required to ensure that the proceeds of a sale by the vendor will be sufficient to ensure a full release of the security over the property.
- Creditors identify how the regime will impact their ability to recover the amounts owing as whilst there is provision for the ATO to vary the CGT amount owing, there are no express protections granted for creditors.
- Holders of put and call options that will not be exercised prior to 1 July 2016 will need to ensure that they comply with the legislation.