Australia: New CGT withholding requirements affecting more than just foreign resident vendors

What you need to know

• From 1 July 2016, buyers of Australian property valued at over $2 million from foreign residents will be required to withhold 10% of the purchase price and pay it to the Australian Tax Office (ATO).
• The presumption is that a seller is a foreign resident unless it proves otherwise by providing a clearance certificate from the ATO, or for certain assets a declaration.
• Where a buyer fails to withhold and remit it will be liable to the ATO for an equal to the amount that it was required to withhold and pay.

The Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015 passed parliament and received Royal Assent on 25 February 2016 creating a new withholding regime. From 1 July 2016, buyers who enter into contracts with foreign resident sellers for the acquisition of Australian property assets valued at more than $2 million will be required to withhold 10% of the market value and remit it to the ATO.

The withholding tax will be imposed on the market value of the transaction, however if the parties have negotiated a purchase price on an arm's length basis, then the purchase price may be used as a proxy for market value. The purchase price excludes adjustments but includes the market value of any non-monetary consideration to be given to the seller, and GST, if the purchaser is not entitled to an input tax credit for GST paid.

The purpose of the new regime is to assist in the collection of capital gains tax (CGT) liabilities from foreign residents. Funds withheld from settlement proceeds will be applied by the ATO to foreign residents' CGT liabilities and tax liabilities arising where disposal of the property by the foreign resident generates gains on revenue account and, as a result, is taxable as ordinary income.

Property affected

The new regime applies to all relevant Australian assets – retail, commercial, industrial, residential agricultural etc. Relevant Australian assets will include taxable Australian real property (TARP), an indirect Australian real property interest, and options or rights to acquire TARP or indirect interests.

TARP includes real property in Australia (including leases), mining, quarrying or prospecting rights if the materials are located in Australia, and company title interests under which shareholders have rights of occupation of land owned by the company.

An indirect Australian real property interest is, generally speaking, a non-portfolio interest (ie 10% or more) in an entity whose assets comprise more than 50% Australian real property by market value.

Excluded transactions

The regime will not apply to transactions that are:

• TARP sales valued at less than $2 million (this exception is designed to exclude the majority of residential sales)
• conducted through a stock exchange
• already subject to a tax withholding obligations
• securities lending arrangements, or
• undertaken by entities that are subject to formal insolvency or bankruptcy proceedings.

How to identify relevant foreign residents

All sellers will be treated as relevant foreign residents for TARP transactions unless a clearance certificate is obtained from the ATO certifying that the seller is not a relevant foreign resident.

For assets other than TARP, a seller will be treated as a relevant foreign resident unless a declaration confirming that the seller is an Australian citizen for income tax purposes, or a declaration confirming that the interest is not an indirect Australian real property interest (eg because the relevant entity does not hold sufficient aggregate interests in Australian real property) is provided to the buyer. A buyer in entitled to rely on any such declaration unless it knows that the declaration is false.

If a buyer acquires an asset from multiple sellers, the obligation to withhold and remit may arise if any seller is a relevant foreign resident.

Key impacts for sellers

Sellers will need to ensure that they take into account the new regime before going to market.

To avoid funds being withheld from the sale proceeds Australian sellers of:

• TARP, will need to apply for a clearance certificate and provide it to the buyer before settlement, or
• assets other than TARP, will need to make a declaration and provide it to the buyer before settlement.

Foreign residents selling relevant Australian assets will need to factor in the negative adjustment of the sale proceeds especially when making application for releases of any securities over the relevant Australian assets.

Sellers can apply to the ATO for variation of the withholding amount where they believes that the 10% withholding is inappropriate. Variation applications may take some time and therefore a seller should make any such applications well in advance of a sale.

Key impacts for buyers

Buyers should ensure that there are appropriate conditions regarding clearance certificates, declarations and warranties in contracts addressing this new regime.

The 10% withholding obligation will apply to buyers unless:

• the transaction is an excluded transaction
• for transactions involving TARP, ATO clearance certificates are collected before settlement
• for transactions other than TARP, relevant declarations are collected before settlement, or
• a seller gives notice that it has made a variation request and provides the buyer with the ATO's acceptance of the request, in which case the buyer will need to ensure that it retains the amount stated in the ATO's acceptance and remits it to the tax office.

Ultimately, the buyer will be liable for the full withholding amount if it is required to withhold and remit and fails to do so.

Key impacts for creditors

A creditor of a seller that holds a security interest (eg a mortgage) over a relevant Australian asset will need to take into account the seller's obligation to permit a buyer to withhold 10% of the settlement proceeds for transactions other than excluded transactions.

This may create situations where the proceeds of sale are insufficient to discharge the creditor's debt. Creditors need to ensure that they implement processes and procedures to:

• identify transactions that may be subject to a withholding requirement
• facilitate the receipt of clearance certificates or ATO accepted variation requests in advance of settlement, and
• in the event a withholding is required, to ensure sufficient funds will be available after the withholding to discharge the debt secured by the mortgage.

The new regime does not include specific provisions that protect the rights of creditors in these circumstances. However, creditors will have similar rights as those held by sellers to apply to the ATO to vary the amount that a buyer is required to withhold.

Key takeaway

The new regime will apply to almost all transactions involving Australian land valued at $2 million or more, whether the sale or purchase is direct or indirect, and regardless of whether the transaction results in any CGT liability on the part of the seller.

All persons involved with property related transactions should familiarise themselves with the obligations imposed by the new regime as there are severe penalties, particularly for buyers, for failure to comply.

Sellers and their creditors will need to ensure that they are prepared for sales by obtaining clearance certificates, organising declarations, making variation applications or factoring in the negative adjustment of the sale proceeds as a result of the withholding regime.

Appropriate special conditions and warranties will need to be included in contracts, options, share sale agreements and all similar arrangements to deal with the new regime.

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories