Summary of Key Practical Points:
- Many transactions that are outside the ambit of Foreign Resident Capital Gains Withholding Tax (in its current form) will fall within its scope from 1 July 2017, if the threshold change which was announced in the 2017–18 Federal Budget is enacted.
- For contracts made after 30 June 2017 and providing for acquisition of land, easements, leases other taxable Australian real property or company title interests – seek clearance certificates (or, if applicable, provide the required exemption evidence) where the market value of the relevant property equals or exceeds $750,000.
- For contracts made on or before 30 June 2017 and providing for acquisition of land, easements, leases other taxable Australian real property or company title interests – continue to adopt existing practices of obtaining clearance certificates (or, if applicable, providing the exemption evidence).
- For transfers (or other acquisitions) of land, easements, leases, other taxable Australian real property, or company title interests made after 30 June 2017 but not made pursuant to a contract – seek clearance certificates (or, if applicable, provide the required exemption evidence) where the market value of the relevant property equals or exceeds $750,000.
- Review standard agreements/documentation, office administration practices, and office administration manuals for Foreign Resident Capital Gains Withholding Tax compliance implications which arise due to the proposed changes.
- Monitor legislative action giving effect to the Budget Proposals.
- Ensure your external/internal professional advisers are aware of the proposals.
The Budget Proposals
The Federal Budget of 9 May 2017 proposes two changes to Foreign Resident Capital Gains Withholding (FRCGW) Tax. It contemplates the changes will take effect on 1 July 2017.
The proposed changes are:
- Most Importantly: The present withholding threshold of $2 million will be reduced to $750,000 for contracts entered into on or after 1 July 2017 and
- The tax rate will increase from 10% to 12.5%, with effect from 1 July 2017.
Significance of the Changes to the Threshold
Reminder of the nature of FRCGW
The term ‘foreign resident’ in the name of the tax is misleading. Basically, purchasers of:
- (i) taxable Australian real property;
- (ii) indirect Australian real property interests (e.g. certain interests in entities that directly/indirectly hold certain Australian real property), or
- (iii) rights/options in relation to such real property or such interests
are prima facie currently required to remit tax (10% of the purchase price) to the ATO, irrespective of whether the vendors are Australian residents or foreign residents. Although the tax has to be remitted by the purchaser, the purchaser is able to remit the tax out of the moneys payable to the vendor under the sale contract.
Taxable Australian real property incudes vacant or improved land in Australia, leases of land/buildings in Australia, easements, and certain mining/quarrying/prospecting rights.
For purposes of the threshold change, the only indirect Australian real property interest that needs to be considered is a company title interest. A company title interest exists where a company owns land or a building or part of a building erected on land and a right of occupancy of the land, building or part of a building arises from holding (or having a contract to purchase) shares in the company.
Currently, purchasers of taxable Australian real property or a company title interest with, in either case, a market value of at least $2 million have to remit 10% of the purchase price to the ATO, unless the Commissioner has issued a clearance certificate and this is held by the purchaser at the time of settlement (i.e. the time at which the transfer of title occurs).
While the above reflects the general relevance of the $2 million threshold, special rules define the value which is to be compared to the threshold in some situations. For instance, a special rule exists where the thing acquired is a joint ownership interest in real property or mining/quarrying/prospecting right.
It will be recalled that the $2 million threshold and clearance certificate exclusion mechanisms do not apply to some transfers of CGT assets. In particular, there is a different system for relieving purchasers of the obligation to remit FRCGW tax in relation to the purchase of CGT assets which are indirect Australian real property interests that are not company title interests and CGT assets which are rights/options to either such indirect interests or to Australian real property.
Implications of the change to the threshold
The Treasurer has proposed that the $2 million threshold will be reduced to $750,000 from 1 July 2017.
As a result, many more resident vendors will have to obtain a certificate of residency from the ATO and give this to their purchaser.
The ATO website clarifies the proposed transitional application of the changes. The proposed lower threshold of $750,000 will apply only to contracts entered into on or after 1 July 2017. By contrast, the $2 million threshold will continue to apply to pre-1 July 2017 contracts that are settled on or after that date.
The second proposed change is an increase in the rate of tax from the current 10% of the contract price to 12.5%. The ATO website states that this increased rate will apply to contracts entered into on or after 1 July 2017. According to the ATO website clarification, the existing 10% withholding rate will continue to apply to contracts entered into before 1 July 2017, ‘even if they are not due to settle until after 1 July 2017’.
In summary, where taxable Australian real property or a company title interest is sold with the transfer occurring on or after 1 July 2017, it is proposed:
- for contracts made prior to 1 July 2017, the purchaser will have to withhold tax of 10% of the contract price and remit this to the ATO, unless either:
- the market value of the relevant Australian real property/company title interest is less than $2 million; or
- where the market value is $2 million or more, the vendor gives the purchaser a clearance certificate issued by the Commissioner; and
- for contracts made on or after 1 July 2017, the purchaser will have to withhold tax of 12.5% of the contract price and remit this to the ATO, unless either:
- the market value of the relevant land is less than $750,000; or
- where the market value is $750,000 or more, the vendor gives the purchaser a clearance certificate issued by the Commissioner.
Generally (and more technically), the tax amount is calculated using the first element of the acquirer’s CGT cost base of the thing acquired – a point which will assist understanding the discussion under the next heading. However, the ATO accepts that the contract price (in the case of sales of vacant/improved land, exclusive of settlement adjustments for rates etc.) is a proxy for the first element amount.
Brief reference should also be made to the situation where the transfer of title is not made pursuant to contract of sale.
Transfers made without consideration and Transfers made without antecedent Contract
In some situations, an entity will transfer taxable Australian real property or a company title interest either without consideration (e.g. a gift) or for consideration but without previously entering into a contract. It should be remembered that FRCGW will apply in these scenarios. In relation to the first scenario, although the recipient of the transfer (transferee) of the property does not receive any consideration from which it can withhold tax, the transferee must still remit the tax.
In these situations, the transferor and the transferee will need to be mindful that in relation to a transfer occurring on or after 1 July 2017, it is envisaged that the transferee will automatically not incur a liability only where the market value of the Australian real property/company title interest being transferred (or other value applicable in the particular circumstances) is below $750,000. Where the relevant value is at or above the $750,000 threshold, a clearance certificate will normally be required.
More generally, FRCGW applies to acquisitions (for CGT purposes) of taxable Australian real property under certain transactions. These can also occur by means other than transfers of title to property. For instance, grants of easements or grants of leases. It is expected that the $750,000 threshold will also be relevant to such grants made on or after 1 July 2017.
Due to constraints of length, further elaboration is not possible. However, you may find the ATO’s discussion of leases helpful. The following ATO comment in relation to the present legislation is especially pertinent in the present context:
‘The purchaser is required to withhold and pay to … [the ATO] 10% of the first element of the CGT asset’s cost base.
The obligation to withhold will only arise if a lease premium is paid for the grant of a lease, as the premium forms part of the first element of the cost base. Even where a premium is paid, withholding is only required if the market value of the lease is $2 million or more. …
Any assignment of a lease that doesn’t involve the payment of a premium will not give rise to a withholding liability.’ (underlining added)
A Brief Note concerning Certain Not-for-Profit Transferors/Grantors
As a general addendum to the foregoing, it is timely to also recollect that the Commissioner has issued determinations which reduce withholding tax to nil in some situations.
The PAYG Withholding variation for foreign resident capital gains withholding payments – income tax entities determination (issued in March 2017) is a recent instance of this. Where relevant income tax exempt entities provide the specified evidence of their income exempt character (the required exemption evidence) to a purchaser/grant recipient, the purchaser/recipient is relieved from the need to remit FRCGW tax. The determination was discussed in last month’s newsletter.
The required exemption evidence may not necessarily be easier to obtain than a clearance certificate. It is either:
- evidence of a private binding ruling issued by the ATO confirming that the entity is income tax exempt that is valid for the year in which the transaction is occurring; or
- documentation showing that the entity is endorsed for income tax exemption as a registered charity under item 1.1 of section 50-5 of the ITAA 1997.
It is important to note that the relief only applies to transfers/grants made by an income tax exempt entity and does not provide relief in relation to transfers/grants made to such an entity.
Further Comment on the change in tax rate
In addition to the application of the change in tax rate as described in the discussion above, you should be mindful that the new tax rate will apply to:
- acquisitions (for CGT purposes) of all indirect Australian real property interests, not just to company title interests; and
- acquisitions (for CGT purposes) of rights and options to acquire taxable Australian property or indirect Australian real property interests.
Practical Action
While amending legislation will be needed to give effect to the changes noted above, you should consider immediately updating your organisation’s practices as follows:
- for contracts made after 30 June 2017 and providing for acquisition of land, easements, leases other taxable Australian real property or company title interests – seek clearance certificates (or, if applicable, provide the required exemption evidence) where the market value of the relevant property equals or exceeds $750,000;
- for contracts made on or before 30 June 2017 and providing for acquisition of land, easements, leases other taxable Australian real property or company title interests – continue to adopt existing practices of obtaining clearance certificates (or, if applicable, providing the exemption evidence); and
- for transfers (or other acquisitions) of land, easements, leases, other taxable Australian real property, or company title interests made after 30 June 2017 but not made pursuant to a contract – seek clearance certificates (or, if applicable, provide the required exemption evidence) where the market value of the relevant property equals or exceeds $750,000.
For most NFPs, transactions involving FRCGW tax will be handled by legal and accounting professionals. However, NFPs should be alert to the proposals for change and ensure these have come to the attention of their advisers.
More conceivably, transactions which will not receive such specialist attention would include those involving acquisitions of:
- indirect Australian real property interests; or
- acquisitions of rights/options to acquire taxable Australian real property or such indirect interests;
- acquisitions of taxable Australian real property by way of gift/otherwise without consideration.
Corporate re-structures and the detailed components of standard form agreements can be especially problematic.
You may like to review the following documents and adjust these for any implications of the proposed changes to FRCGW (noting, the need to check for the changes to be given legislative effect):
- standard agreements/documentation used by your organisation; and
- office administration manuals.
The legislative process needed to give effect to the changes should be monitored.