The new foreign resident capital gains withholding tax will apply to certain transactions entered into from 1 July 2016. The type of transactions that may potentially be caught by the new requirements is quite broad, but may be even broader than initially anticipated.
Partner Justin Byrne and Associate Janelle Metcalf look at some issues relating to the measure, including:
- The ATO releasing the clearance certificate application form
- Things you need to know about the $2 million threshold
- Application of the rules to options to acquire
- How the measure applies to family law and matrimonial transactions
What transactions are caught by the requirements?
The new foreign resident capital gains withholding tax will apply to transactions entered into from 1 July 2016 where:
- an entity becomes the owner of a particular asset or interest by acquiring it from a vendor under a transaction, including under a contract entered into on or after 1 July 2016;
- at least one of the vendors is a relevant foreign resident at the time the transaction is entered into;
- the asset or interest is a certain type of Australian property, being:
- taxable Australian real property, including:
- real property situated in Australia;
- a lease of land in Australia if a lease premium has been paid for the grant of the lease;
- a mining, quarrying or prospecting right, if the minerals, petroleum or quarry materials are situated in Australia, including an authority, licence, permit or right to undertake those activities, a lease of land permitting those activities to be undertaken on the land if a premium has been paid for the lease, or an interest in such an authority, licence, permit, right or lease;
- an indirect Australian real property interest (i.e. a membership interest of 10% or more in an entity whose underlying value is principally derived from Australian real property) such as shares in a company that owns land; or
- an option or right to acquire any of the above; and
- there are no exceptions applicable (note that there are a number of exceptions, including where the market value of the asset or interest is less than $2 million).
- Clearance certificate application form
The ATO has now issued a pdf version of the clearance certificate application form which sellers are able to download and complete. Once completed, the form may be faxed or posted to the ATO for processing.
It is anticipated that:
- an automated application processing system will be implemented in the near future (replacing the manual system initially implemented); and
- online lodgement capabilities will be released a few days prior to 30 June 2016.
Together, these measures should assist in minimising application processing times. It should be noted that once obtained, the clearance certificate is valid for 12 months.
- Market value and $2 million threshold
Transactions relating to assets or interests with a market value of less than $2 million are not caught by the requirements.
A number of factors need to be considered when determining whether the $2 million threshold is met:
- Purchase price vs market value
- Where a purchase price has been negotiated between a vendor and purchaser acting at arm's length, the market value of an asset or interest will most likely be the purchase price. However, where the parties are related or they did not act at arm's length, it may be prudent for a purchaser to obtain an independent valuation to verify the market value.
- If the purchase price is adopted as the market value, no regard is had to adjustments for disbursements at settlement (e.g. rates, water, body corporate levies etc).
- If the supply of the asset or interest is a taxable supply, and the purchaser is registered for GST, the market value is reduced by any input tax credit the purchaser is entitled to.
Where a purchaser is registered for GST and the transaction is a taxable supply, the GST-inclusive purchase price less the input tax credit may be adopted as the market value (subject to the exceptions noted above for arm's length transactions). For example:
- If the market value of the asset or interest is $1.9 million and the purchaser is required to pay GST but is entitled to an input tax credit, the market value remains $1.9 million and therefore under the $2 million threshold.
- If the market value of the asset or interest is $1.9 million and the purchaser is required to pay GST but is not entitled to an input tax credit, the market value becomes $2.09 million and therefore is above the threshold. Therefore withholding may be required if a clearance certificate has not been provided by the vendor.
- If the supply of the asset or interest is not a taxable supply (e.g. if the supply is input taxed), the purchaser is not registered for GST, or the purchaser is not entitled to an input tax credit, the GST-inclusive purchase price may be adopted as the market value (subject to the exceptions noted above for arm's length transactions). For example:
- If the purchase price is $1.9 million and the purchaser is not required to pay GST, the market value remains $1.9 million and therefore under the threshold.
- If the purchase price is $1.9 million and the purchaser is required to pay GST but is either not registered for GST or not entitled to an input tax credit, the market value becomes $2.09 million and therefore above the threshold.
In some transactions, it may be difficult to determine at the outset whether the $2 million threshold will be met. In those circumstances, where the market value is close to the threshold, it would be prudent for a purchaser to require the funds to be withheld unless the vendor is able to provide a clearance certificate.
- Application to options to acquire
The applicability of the withholding requirement needs to be considered in all options to acquire taxable Australian real property or an indirect Australian real property interest, regardless of:
- the value of the option fee paid under the option; and
- the market value of the asset or interest, or the purchase price in any contract attached to the option agreement.
In these circumstances, the $2 million threshold is not relevant and the following applies:
- If the vendor of the asset or interest is not a foreign resident:
- The option agreement must include a declaration by the vendor to that effect. No prescribed wording for the declaration has been issued by the ATO but templates will be available from the ATO website from 1 July 2016.
- Any contract attached to the option agreement must be considered separately – it may be that the vendor will need to provide the purchaser with a clearance certificate.
- If the vendor of the asset or interest is a foreign resident:
- The option agreement should be drafted to provide for the purchaser to withhold and remit to the ATO 10% of the option fee payable under the option agreement. If a security deposit has been paid under the option agreement, the characteristics of the security deposit will need to be considered to determine whether it is in the nature of an option fee. If so, the withholding requirement will also apply to the security deposit.
- The contract attached to the option agreement must also include a requirement for the purchaser to withhold and remit to the ATO 10% of the market value of the asset less any payments already remitted by the purchaser to the ATO under the option agreement, if the market value of the property is $2 million or more.
- Family law and matrimonial transactions
The requirements are broad enough to capture not only sales, but any conveyance or gift of certain assets and interests.
This will include transfers and gifts between parties to matrimonial or family law proceedings where the relevant criteria are met. In these circumstances, the following matters should be considered:
- Valuations – due to the existing relationship between the parties, in most instances, an independent valuation will be required to verify the market value of the asset or interest. Where multiple assets or interests are being transferred between the parties, multiple valuations may be required to determine whether the $2 million threshold for each asset or interest is met. This is likely to involve considerable cost, and should be factored into negotiations between the parties.
- Compliance – If the criteria are met and the market value of an asset or interest is above the $2 million threshold, the withholding requirements will prima facie apply and the relevant obligations need to be appropriately documented and implemented by the parties.
These matters should be carefully considered by parties to matrimonial or family law proceedings where property assets or interests are being transferred to ensure the requirements are met.
As noted above, the types of transactions that are potentially captured by the withholding requirement may be broader than originally anticipated. As a result, we strongly recommend that potentially affected parties seek expert advice as to how to satisfy the requirements and appropriately protect their interests.
We have prepared clauses which can be utilised by vendors and purchasers to address and protect their respective interests if the withholding requirement is relevant (or potentially relevant) to their transaction. HopgoodGanim Lawyers is also able to provide advice generally in relation to the application of the withholding requirements to specific transactions.
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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.