This Legal Update provides an overview of the Australian tax issues for non-residents in respect of the sale of Australian real property interests following Australia's capital gains tax (CGT) reforms contained in Taxation Laws Amendment (2006 Measures No.4) Act 2006 (the CGT Reforms). The CGT Reforms will apply to gains made on or after 12 December 2006.
It also outlines some related stamp duty issues for non-residents on the sale of interests in 'land rich' entities.
For Australian income tax purposes, a non-resident is generally only assessable on income arising from sources in Australia. Gains arising from the sale of an interest in Australian real property is regarded as having a source in Australia. In addition, gains arising from the sale of interests in a company or trust that has assets being Australian real property interests is also regarded as having a source in Australia where those real property interests represent more than 50% of the market value of the underlying assets ('land rich' entities).
The CGT Reforms will also result in assessable Australian capital gains arising on the sale of non-resident entities being taxable in Australia where those entities (on a trace through basis) are land rich in Australia. Existing interests will transition into the Australian tax net with a cost base equal to market value on 10 May 2005.
Capital Gains Tax – Australian real property
Under Australia's domestic taxation laws, and in particular the relevant CGT provisions, the gain on the sale of Australian real property is subject to Australian income tax. Under Australia's double tax agreements ('DTAs'), Australia generally reserves the right to tax a gain on the sale of Australian real property - refer to the Alienation of Property Article (Article 13) of most DTAs. Therefore, where a non-resident makes a gain on the sale of Australian real property, the non-resident will be subject to Australian income tax on that gain.
Capital Gains Tax – land rich entities (before 12 December 2006)
Prior to Australia’s CGT Reforms, a non-resident was only subject to Australian income tax on gains made in respect of assets that had the 'necessary connection with Australia’. Shares in an Australian resident private company had a necessary connection with Australia as did shares in an Australian listed company where the non-resident (on an associate inclusive basis) owned at least 10 percent of the company at any time during the five years prior to the relevant disposal. Similarly, units in an Australian resident unit trust had the necessary connection with Australia where the non-resident (on an associate inclusive basis) owned at least 10 percent of the unit trust at any time during the five years prior to the relevant disposal. This was regardless of the underlying assets of the Australian company or trust.
Interests held by non-residents in non-resident entities did not have the necessary connection with Australia and were not generally subject to Australian income tax.
Australia's double tax agreements
As noted above, Australia will generally reserve the right to tax a gain made on the sale of shares or interests in entities whose assets consist wholly or principally of Australian real property under Australia's DTAs (refer to the Alienation of Property Article (Article 13) of most DTAs).
Australia amended its domestic legislation following the Full Federal Court decision in Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597 to maintain its taxing right over the alienation of Australian real property in situations where real property was owned through a chain of interposed Australian entities and the interposed Australian entity that was sold did not directly hold the real property interests.
In Lamesa the Full Federal Court held that the relevant provisions of the Alienation of Property Article in the Australia/Netherlands DTA did not extend to an effective alienation of Australian real property held by a Dutch resident through a chain of Australian companies.
The amendment to the domestic legislation effectively extends the Alienation of Property Article in Australia’s DTAs to cover the alienation or disposition of shares where directly or indirectly the underlying assets are wholly or principally attributable to Australian real property. Treaties entered into by Australia subsequent to the Lamesa decision generally mirror this approach in the express wording of the Alienation of Property Article. For example, see Article 13(4) of the Australia/United Kingdom DTA.
CGT Reforms for non-residents (on or after 12 December 2006)
The Federal Government recently passed the CGT Reforms to reduce the Australian CGT base as it applies to non-residents who hold a direct interest in Australian entities. The CGT Reforms will also broaden the Australian CGT base as it applies to non-residents who dispose of interests in resident or non-resident entities whose "underlying" value is principally attributable to Australian real property.
As outlined above, a non-resident was previously only subject to Australian CGT on gains made in respect of assets that had the necessary connection with Australia. Such assets included land and buildings situated in Australia, shares or units in Australian companies or trusts (but excluding holdings of less than 10% in listed companies and unit trusts) and assets used at any time in carrying on a business through a permanent establishment in Australia.
Under the CGT Reforms, a non-resident will only be subject to Australian CGT in respect of Taxable Australian Property ('TAP'). The five categories of CGT assets that are TAP are:
(a) Taxable Australian real property
(b) a CGT asset that:
- is an indirect Australian real property interest, and
- is not covered by (e)
(c) a CGT asset that:
- has been used at any time in carrying on a business through a permanent establishment and
- is not covered by (a), (b) or (e)
(d) An option or right to acquire a CGT asset covered by item (a), (b) or (c), and
(e) A CGT asset that is covered by subsection 104-165(3) of the Income Tax Assessment Act 1997 (choosing to disregard a gain or loss on ceasing to be an Australian resident).
Taxable Australian real property is defined as real property situated in Australia, and also includes a mining, quarrying or prospecting right, if the minerals, petroleum or quarry materials are situated in Australia.
Indirect Australian Real Property Interests
An 'indirect Australian real property interest' is defined as essentially a membership interest of at least 10 percent (on an associate inclusive basis) in a resident or non-resident entity where the market value of the entity's assets that are taxable Australian real property is more than 50 percent of the entity’s total assets. Assets of subsidiary members are therefore also taken into account.
In particular, a membership interest in an entity will be an indirect Australian real property interest where:
- it passes the non-portfolio interest test (that is, a membership interest of at least 10%) at that time, or throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time, and
- the interest passes the principal asset test (that is, the market value of taxable Australian real property represents more than 50 percent of the total assets).
Stamp Duty Implications
Each Australian State and Territory imposes 'land rich' duty on dealings in certain entities irrespective of where those entities are resident or incorporated. The entities are private companies and private unit trust schemes but in some limited circumstances can include other listed entities.
Land rich duty is only payable on certain dealings in entities which are 'land rich'. In most jurisdictions a company or a private unit trust scheme is 'land rich' if:
- its land holdings in all places, whether within or outside Australia, comprise 60 percent or more of the unencumbered value of its total assets (not counting excluded assets), and
- it has land holdings in the relevant Australian State or Territory with an unencumbered value of at least $1 million to $2 million (depending on the relevant Australian State or Territory).
In determining whether a private company or a unit trust scheme is taken to be land rich it is necessary to include land or and other property held by a 'linked entity' (of the private company or unit trust scheme). In most jurisdictions, an entity will be a linked entity of a target if 20 percent or more of the equity interests in that entity are held by the target.
For example, if company A held 30 percent of the issued capital of company B which directly held land, then company A would be deemed to be entitled to 30 percent of the land and other property of company B for the purposes of determining whether company A is itself 'land rich'.
A liability to pay duty under the land rich provisions arises when a 'relevant acquisition' is made. Generally, a relevant acquisition occurs when a person acquires a significant interest in the landholder. A significant interest is an interest of 20 percent or more in a private unit trust scheme or 50 percent or more in a wholesale unit trust scheme or a private company arising under one arrangement and calculated on an associate inclusive basis.
A person acquires an interest in a land rich landholder if the person obtains an interest in the landholder, or the person's interest in the landholder increases, regardless of how it is obtained or increased.
In Queensland and Western Australia, the land rich provisions relate only to companies. However, other provisions impose duty on dispositions of interests in private unit trust schemes effectively on a look-through basis as if an interest in the underlying land had been acquired.
Depending on the relevant jurisdiction, duty must be paid within 30 days to six months after the date on which a liability to pay duty arises. Generally duty is payable by the person who makes the relevant acquisition or relevant disposal and is chargeable at the rate applicable to a transfer of land. The top transfer duty rate is 5.5 percent in most jurisdictions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.