The Tax Laws Amendment (2006 Measures No 4) Bill 2006 (Bill) proposes changes to Australian capital gains tax (CGT) for foreign residents, providing them with greater flexibility and efficiency in structuring their Australian investments and aligning Australia’s tax policy with current OECD practice.
The Bill was introduced into Parliament on Thursday 22 June 2006 and contains major reforms affecting the imposition of Australian CGT on foreign residents; mainly contained in new Division 855 of the Income Tax Assessment Act (1997). These changes seek to align Australian CGT law with prevailing OECD practice. Further, they implement a substantial shift in Australia’s tax policy as announced by the Treasurer in the 2006 federal budget and, to some extent, have relied on certain OECD and Canadian precedent.
Main changes proposed
Under the proposed legislation, foreign residents will only be subject to Australian CGT where either :
- They have a direct or indirect interest in Australian real property. An indirect interest includes an interest held through a non-portfolio interest, - that is, where an interest of 10% or more is held through an interposed entity. However, nonportfolio interests held by foreign residents in both Australian and foreign entities will only be subject to Australian CGT where at least 50% of the value of the entities' assets are attributable to underlying Australian real property; or
- The assets have been used in carrying on a business through an Australian permanent establishment.
Foreign residents will no longer be subject to CGT on Australian share or unit investments where the respective companies or trusts do not principally hold Australian real property; that is, companies or trusts involved in other trading or investment activities.
These changes, when enacted, should provide foreign residents with greater flexibility and efficiency in the structuring of their Australian investments.
Royal Assent of this Bill is expected in August or September this year. CGT events (that is, disposals and not acquisitions) occurring after that date will be subject to or benefit from these changes.
These changes raise significant tax issues for foreign resident investors in a wide range of sectors, particularly non-property owning trusts, venture capital, private equity, infrastructure vehicles, joint ventures, and several other sectors.
Key measures & concepts
The changes proposed by this Bill mean that a foreign resident or a trustee of a foreign trust will only be subject to Australian CGT where a CGT event happens in relation to a CGT asset that is taxable Australian property.
Taxable Australian property is defined to include the following:
- Taxable Australian real property.
- An indirect Australian real property interest (such as shares in a company or units in a unit trust which principally hold real property).
- A CGT asset used in carrying on a business through a permanent establishment.
- An option or right to acquire a CGT asset of the kind above.
- Certain CGT assets where entities choose to disregard gains or losses on ceasing to be an Australian resident.
Taxable Australian real property (TARP)
This is defined to include the following:
- Real property situated in Australia.
- A mining, quarrying or prospecting right (to the extent that the right is not real property), if the minerals, petroleum or quarry materials are situated in Australia. Real property, although not specifically defined in the Bill, is intended to be construed based on its common law meaning as well as by reference to relevant double tax treaty definitions in appropriate circumstances. For example, the UK/ Australia double tax treaty definition of real property includes ‘a lease of land or any other interest in or over land’.
Indirect Australian real property interest (IARPI)
A membership interest in an entity is a taxable IARPI where the following tests are satisfied:
- Non-portfolio interest test.
- Principal asset test.
The non-portfolio interest test requires that a foreign resident (together with its associates) hold 10% or more, direct or indirect interests (eg shares, units), in the relevant test entity. This test must be satisfied at the time of the disposal or throughout a 12 month period that commenced 24 months before the disposal and ended no later than the disposal.
The principal asset test will be met where more than 50% of the market value of an entity's gross assets is attributable to Australian real property. A 'lookthrough' approach is used to deem membership interests held by an entity in another entity to be either TARP assets or non-TARP assets. This is calculated in accordance with the percentage of interest held and the market value of that other entity's TARP assets and non-TARP assets. However, the 'look through' approach to find TARP assets is not necessary where the total participation in an entity is less than 10%.
One specific integrity measure is contained in the provisions: assets acquired by an entity to overcome the principal asset test will be disregarded in determining whether the test is met, unless the acquisition was done only for an incidental purpose of meeting the principal asset test. There is no ‘look back’ rule applicable to the principal asset test and there are no formal withholding tax or tax reporting obligations relating to CGT events of foreign residents.
The Bill rewrites the existing CGT rules for a foreign resident becoming an Australian resident and will amend the CGT rules for when Australian residency changes. There are other changes contained in the Bill which are not discussed in this paper.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.