Government Targets Foreign Investors with New Tax Legislation

What do Google, Uber and foreign owners of Australian investment properties have in common? There is a widespread perception that they are failing to pay appropriate levels of tax.

As such, the Government’s response to foreign investors has been to introduce new tax legislation.
 
There has been a significant amount of press regarding the purchase of Australian residential property by foreign nationals. It is no surprise that the imposition of increasingly tight financing restrictions on these types of purchases has been equally well-publicised.
 
Much less well broadcast, however, has been the implementation of the new Foreign Resident CGT Withholding Regime (“the Regime”) on July 1, 2016, when the Tax Superannuation Laws Amendment (2015 Measures No. 6) Act 2016 (‘the Act”) came into effect. Preliminary estimates that indicate this initiative is expected to generate government revenue of $330 million over the next four years.

Key requirements of the CGT Withholding Regime (“the Regime”)

In accordance with the Act, where a Taxable Australian Property ("TAP") is sold for an amount greater than $2 million by a foreign resident vendor, the purchaser is required to withhold and subsequently remit 10% of the purchase price to the Commissioner of Taxation ("Commissioner").

A TAP is defined to include:

• Taxable Australian Real Property ("TARP") including leased land and mining, quarrying or prospecting rights over minerals, petroleum or quarry materials in Australia.
• An indirect Australian Real Property Asset (being an interest of 10% or more in an entity whose assets comprise of more than 50% Australian real property by value). 
• An option or right to acquire such a property or interest.

The foreign resident vendor is then entitled to a credit of the amount paid to the Commissioner. That credit can only be accessed if and when the vendor lodges an income tax return – thus encouraging foreign vendors to comply with Australian taxation requirements.

The Government has not provided any insight as to how the withholding amount of 10% has been determined – leading to speculation that this percentage is purely arbitrary.

Who is a foreign resident?

Broadly speaking, a foreign resident is defined as a person or entity who is not considered an Australian resident for taxation purposes.

However, pursuant to the Regime, a vendor is classified as a foreign resident if at the time of the purchase of property:

1. The purchaser is aware that the vendor is a foreign resident or reasonably believes that the entity is a foreign resident;
2. The purchaser does not reasonably believe that the vendor is an Australian resident and the vendor has an address outside Australia and is authorised to make payments outside Australia; or
3. The property asset being sold is a TARP or a company title arrangement where shares are held in a company that owns property (as opposed to a direct real property interest). 

Note that Point 3 above results in the application of the Regime even if the vendor is an Australian resident for other tax purposes.

Clearance certificates

In order to avoid 10% being withheld and paid by the purchaser to the Commissioner, an Australian resident vendor can obtain from the ATO a clearance certificate which states that there is nothing to suggest the vendor is or will be a foreign resident for a specific period.

If an Australian tax resident has had withholding tax taken from their sales proceeds (because they did not provide the purchaser with a clearance certificate) they will be entitled to a credit for that amount when they lodge their tax return.  Obviously the potential delays in securing a credit may result in significant cashflow issues for the vendor.

In order to avoid delaying settlements or transactions as a result of the clearance certificate requirement, the ATO has advised that for basic applications, it will issue clearance certificates within two (2) weeks or receipt of the application, although in the case of irregularities the certificates may take a month or longer to be processed.

All certificates will be valid for a period of 12 months.

Potential traps of the legislative requirements

Although the clearance certificate is now an important component of property transactions, it is not yet mandatory to attach it to a sale contract. Purchasers should ensure that transactions for more than $2 million are subject to the Law Society's 2016 sale contract, which is the only version which refers to the clearance certificate requirement.

If a purchaser does not withhold the 10% from the purchase price as required, the purchaser remains liable to make the payment, and will also be exposed to interest and other administrative penalties if the payment is not made at or before settlement.

If a vendor fails to take into account the 10% withholding from the purchase price, they are exposed to considerable loss and a potential impact on their ability to pay creditors or finance their next purchase.

What is not covered by the amendments?

In addition to properties falling under the $2 million value threshold and the residency declarations, the amendments also exclude the following situations:

• "On market" transactions conducted on an approved stock exchange (such as the sale of listed shares and units);
• A transaction subject to another withholding obligation;
• A securities lending agreement; and
• Vendors subject to formal insolvency or bankruptcy proceedings.

In certain circumstances, the amount payable can be reduced if either the vendor or the purchaser makes an application to the Commissioner.

This is possible in situations where:

• The vendor will make no taxable capital gain;
• The vendor will not otherwise have an income tax liability; and
• There are multiple vendors, only one of which is a foreign resident.

The ATO has stated that it does not intend to undermine the security held by creditors in the event of a default by the vendor and as such secured creditors can apply to the Commissioner for a variation.

It is important to bear in mind that this is not an automatic variation of the fee, and that it must be separately applied for. This may mean that secured creditors need to initiate formal insolvency appointments earlier in order to benefit from a formal exemption of the scheme, rather than potentially miss out on the available relief.
 
The Regime attempts to encourage foreign nationals to comply with Australian taxation laws. Although it may seem onerous on the face of it, avoiding the incorrect application of the Regime is a straight forward process. Any kinks and flaws will hopefully be identified and ironed out quickly as more transactions fall within the criteria set out in the Act.