Withholding the truth – the secrets of the foreign resident CGT withholding regime

We’re sure you’re tired of reading about the rapidly approaching commencement of the foreign resident CGT withholding regime. But there are some facts and issues we thought you should know about.

While the new regime has its heart in the right place, the breadth of its application will result in compliance costs and risks for many unsuspecting parties. It could also put a stop, or at least a deferral, on many purely domestic transfers occurring, particularly where time is of the essence.

It’s been a long time coming

For many years the ATO and Treasury have been justifiably concerned by the relatively low levels of compliance by foreign taxpayers selling Australian assets resulting in capital gains that should be subject to Australian tax.

As far back as July 1999, the Ralph Review of Business Taxation recommended that a withholding tax regime be introduced to capture the tax payable by non-residents on sales of assets subject to Australian taxation. The Ralph Review recommended a non-final withholding tax of 10% with a final rate of tax on assessment set at the company tax rate for all non-resident taxpayers!

17 years later we are finally seeing the introduction of a withholding regime.

While the idea is sound, the cost of compliance will be borne very widely indeed.

What are the requirements of the regime?

If triggered, the withholding regime requires the acquirer of an asset to pay to the ATO an amount equal to 10% of the first element of their cost base for the asset acquired.

When is it triggered?

The new regime applies to acquisitions occurring on or after 1 July 2016.

It is limited to acquisitions of:

• taxable Australian real property
• indirect Australian real property interests
• options or rights to acquire such property or interests

The requirement to withhold is triggered where the acquirer knows or reasonably believes the entity they acquire the asset from is a foreign resident. It is also triggered where the acquirer does not reasonably believes the entity is an Australian resident and either the entity has a foreign address (according to the acquirer’s records) or the acquirer is required to provide financial benefits to a foreign address.

These triggers seem entirely reasonable. However, that’s not the end of it.

It is also triggered if the CGT asset is taxable Australian real property or certain indirect Australian real property interests. And this is what triggers the very broad application of the regime and will lead to a widely felt compliance burden. The definition of taxable Australian real property means:

• real property (including leases) situated in Australia
• mining, quarrying and prospecting rights over resources in Australia

So, the starting point is a transfer of Australian real property will enliven the withholding provisions.

Excluded transactions

There is a list of several transactions that are excluded from the regime.

Of significance, a transaction will be excluded where an asset is taxable Australian real property (or certain indirect interests) with a market value less than $2 million.

So, fortunately many sales of residential property will be unaffected by the regime. But with Australia’s apparently ever-increasing property values, with time more transactions will be dragged into the net; kind of like the dreaded ‘bracket creep’ we are hearing so much about!

The exceptions

There are some important exceptions from the regime.

The first exception is where, prior to payment to the ATO, the vendor entity provides the acquirer with a certificate issued by the ATO, to the effect that the entity is not a foreign resident during the period in which the CGT event occurs. This exception only applies to acquisitions of taxable Australian real property and certain indirect Australian real property interests.

The second exception is where, prior to payment to the ATO, the vendor provides the acquirer with a declaration to the effect it is an Australian resident and the acquirer does not believe the declaration to be false. However, this exception is unavailable where the relevant asset is taxable Australian real property (or certain indirect interests).

Common related party transactions will be caught

The inclusion of transactions involving taxable Australian real property worth $2m or more, means that many relatively common, related party transactions will trigger the withholding regime, unless the vendor party obtains a clearance certificate from the ATO prior to settlement.

Examples include:

• the transfer of the family home from a higher risk partner to their lower risk spouse, for natural love and affection, as part of an asset protection strategy
• in specie distributions of real property from a trust to its beneficiaries; which may be followed by an in specie contribution into a superannuation fund
• the transfer of real property pursuant to a family law dispute
• the transfer of real property within a consolidated group or as part of a roll-over
• the transfer of real property to the executors of an estate or to the beneficiaries of the estate
• the transfer of real property to a surviving joint tenant.

In many instances, these transactions can be time critical. The need to obtain a clearance certificate, which will understandably take time, may mean the relevant time constraints cannot be met and the transaction cannot proceed or will need to be deferred.

What if the transaction is for no consideration?

The amount to be paid to the ATO is 10% of the first element of the acquirer’s cost base of the acquired asset; not the amount payable by the acquirer to the vendor.

This means the acquirer is required to pay an amount to the ATO even if the transfer did not involve consideration. It also means the payment will be based on 10% of the market value of the asset if the parties are not at arm’s length and less than market value consideration was provided.

So, referring back to the common related party transactions, many of these will be for no or inadequate consideration, however, the amount to be paid to the ATO will be 10% of the market value of the transferred asset.

What about deemed acquisitions?

The relevant legislation provides that the regime is triggered where the acquirer ‘becomes the owner of a CGT asset as a result of acquiring it from one or more entities under one or more transactions’.

There are several scenarios where the CGT provisions effectively deem someone to acquire an asset from them-self. Examples include:

• Division 149 which deems a company or trust to have acquired a pre-CGT asset at the time when there is a change in majority underlying ownership.
• CGT event K4 and section 70-30 which deem a taxpayer to have sold and acquired an asset for market value where they start to hold it as trading stock.
• Section 855-45 which deals with a non-resident becoming an Australian tax resident.

Guidance will be needed as to whether these deemed acquisitions actually trigger the regime and give rise to a need to obtain a clearance certificate.

How does the regime apply to options?

An acquisition of an option to acquire taxable Australian real property or an indirect Australian real property interest is subject to the regime.

However, unlike with actual taxable Australian real property (and certain indirect interests), the obligation to withhold for an option is only triggered where:

• the acquirer knows or reasonably believes the vendor is a non-resident
• where they do not reasonably believe they are an Australian resident and the entity has a foreign address (according to the acquirer’s records) or financial benefits are to be provided to a foreign address.

But, again, unlike with actual taxable Australian real property (and certain indirect interests), the exclusion for transactions of less than $2 million does not apply to options.