Wednesday 12 August 2015
CGT withholding tax proposal
Wednesday 12 August 2015
Draft legislation to implement a new withholding tax regime to assist in the collection of foreign residents' capital gains tax (CGT) liabilities has been released for consultation. If the draft legislation is enacted in its current form, it could impose additional responsibilities on purchasers of certain types of Australian property. We take a look at some of the potential obligations purchasers should be aware of.
Recap on CGT for foreign residents
Generally, Australian residents for tax purposes pay tax on their worldwide income, whereas foreign residents only pay Australian income tax on income sourced in Australia. For the purposes of CGT, Australian tax law disregards a capital gain or a capital loss from a CGT event for foreign residents, unless the asset is 'taxable Australian property'. This generally includes:
- a direct or indirect interest in taxable Australian real property (for example real estate or shares)
- an asset used in carrying on a business through a permanent establishment
It also includes rights and options with respect to these assets.
Examples of taxable Australian property:
|Direct taxable Australian real property||Residential real estate|
|Indirect taxable Australian real property||Shares in a company or units in a trust where:
|Asset used in carrying on a business||Business real property|
Under current rules, foreign residents are required to lodge a tax return if they have derived Australian sourced assessable income, including a capital gain on the disposal of such assets. However, compliance with the current regime is low, particularly in the case of foreign resident CGT liabilities.
Proposed withholding regime
Under the proposed regime, a purchaser of certain assets that are taxable Australian property will be obliged to pay 10 per cent of the asset's total purchase price (including the value of any non-monetary consideration paid) to the Australian Taxation Office (ATO) where the vendor is a foreign resident. Unlike other withholding tax regimes, which first impose the requirement to withhold and second to remit, this regime only imposes an obligation to remit the amount to the ATO.
It is proposed that the purchaser will have the option to withhold the amount from the payment made to the vendor. If they do not withhold from the payment, they will still be required to remit 10 per cent to the ATO. This will be a non-final withholding tax and foreign residents will need to lodge an Australian tax return, inclusive of any capital gains, to obtain a refund of any overpaid tax.
The new withholding obligations for foreign resident capital gains is proposed to apply to assets acquired on or after 1 July 2016.
When considering whether they will be required to remit to the ATO under the proposed regime, clients will need to consider two key questions:
- Is the asset being acquired subject to withholding?
- Is the vendor a foreign resident?
Which assets are subject to withholding?
The proposed withholding regime will apply to the acquisition of an asset that is:
- taxable Australian real property
- an indirect Australian real property interest, or
- an option or right to acquire such property or interest.
However, certain assets will be exempt, including:
- residential property with a market value less than $2.5 million
- transactions through a stock exchange
- arrangements already subject to existing withholding obligations.
Marty and Jennifer purchase a residential property, worth $1.25 million. Since the property's market value is less than $2.5 million, they will not have to consider any foreign resident withholding obligations.
Is the vendor a foreign resident?
A purchaser will only be obliged to pay an amount to the ATO where:
- they know the vendor is a foreign resident1,
- they have 'reason to believe' the vendor is a foreign resident
- they do not reasonably believe the vendor is an Australian resident, or
- the entity has the type of connection outside of Australia described in the (yet to be released) regulations.
This condition may be satisfied if the purchaser has no reasonable grounds to believe the vendor is an Australian resident and they are aware the vendor has an address outside Australia or they are required to pay a benefit to a place outside Australia, for example, a foreign bank account.
To provide purchasers with some certainty regarding their obligation to withhold, the draft legislation provides an exemption for the purchaser from the withholding regime where the vendor provides a signed declaration that they are an Australian tax resident, and the purchaser does not know the declaration is false. The explanatory material to the draft legislation suggests that such a declaration may be inserted into a sale contract as a standard clause.
Caleb enters into an off-market transaction to buy 100 per cent of the shares in a private company, of which more than 50% of its total assets are real property holdings in Australia. As the shares are an indirect interest in taxable Australian property, they will be included in the proposed regime.
As Caleb does not know the vendor, to ensure he meets any withholding obligations, he notifies the vendor that he requires a signed declaration confirming they are an Australian tax resident. If Caleb does not receive the declaration, he may need to pay 10 per cent of the purchase price to the ATO.
The vendor provides a signed declaration confirming they are an Australian tax resident. Caleb has no reason to believe the declaration is false and therefore will not have any withholding obligations, as the declaration negates any 'reasonable belief' the vendor may be a foreign tax resident.
Where the vendor is a foreign resident, the draft legislation also provides an exemption for certain assets that are membership interests (eg shares in a company). The exemption requires the vendor to provide a declaration to the acquirer that the interest is not an indirect Australian real property interest (and therefore not within the scope of the proposed regime). A purchaser is entitled to rely on this declaration, unless they have specific knowledge the declaration is false.
Considering the case of an SMSF
The application of the proposed regime extends to all 'entities', including individuals, trusts, companies, partnerships and superannuation funds acquiring non-exempt assets.
Given the increasing popularity of property investments in self managed superannuation funds (SMSFs), it is important for SMSF trustees to be aware of their new obligations when entering into transactions to acquire assets, such as business real property, residential property or shares in private companies where the underlying assets are taxable Australian property. This is highlighted in the following example.
George and Lorraine are the only members and individual trustees of their SMSF. They wish to purchase business real property within their SMSF from an unrelated third party. Without considering their potential withholding obligations, George and Lorraine go ahead with this purchase of property, which has a value of $500,000.
Subsequently, George and Lorraine discover the vendor was a foreign resident, and as such, they have a liability to remit 10 per cent of the purchase price (ie $50,000) to the ATO when, as SMSF trustees, they become the legal owner of the property. In this circumstance, they, in their capacity as trustees of their SMSF, will have paid $500,000 to the vendor. As trustees of the SMSF, George and Lorraine will need to remit a further $50,000 to the ATO.
The exposure draft states that existing administrative penalty provisions will apply for failures to withhold under the new withholding provisions, which means George and Lorraine may be liable for the unpaid amount and applicable penalties, as they are individual trustees of the SMSF. It is unclear from the draft legislation whether the liability may be discharged from the fund's assets, or whether it must be borne by the trustees.
If George and Lorraine had been aware of their obligation to withhold, they would have remitted $50,000 to the ATO and paid $450,000 to the vendor. In this case, the total paid would be equivalent to the purchase price of $500,000.
Meeting withholding obligations
Administratively, clients impacted by the new withholding regime that are required to remit an amount to the ATO, will need to:
- register with the ATO as a withholder
- pay the amount to the ATO on the day they become the owner of the asset (for real property, settlement date) using an electronic payment method (eg Electronic Funds Transfer or BPAY®)
- notify the ATO of the payment in the approved form
Where a purchaser fails to meet their obligations and does not pay the required amount to the ATO, administrative penalties and the General Interest Charge may apply.
The proposed amendments are still in draft form and may change as a result of industry consultation. The amendments are also subject to the successful passage of legislation through Parliament.
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