From 1 July 2016, where a non-resident disposes of Australian real property, the purchaser will be required to withhold 10% of the purchase price (as a non-final withholding tax) and pay that amount to the Commissioner of Taxation. If you don't know much about the new laws, read Mark Friezer's overview first.
Here are nine common questions – and, more importantly, the answers too.
Question 1: When does the regime apply?
The regime applies to every contract entered into after 1 July 2016, subject to the three exemptions below.
The withholding tax applies where the following three elements are satisfied:
1. The purchaser acquires certain "taxable Australian property", including:
- real property in Australia – land, buildings, residential and commercial property;
- lease premiums paid for the grant of a lease over real property in Australia;
- mining, quarrying or prospecting rights;
- interests in Australian entities whose majority assets consist of the above such property or interests (is shares in a company or units in a trust); or
- options or rights to acquire the above property or interest.
2. The vendor, or at least one vendor in the case of multiple vendor transactions, is a non-resident (or is treated as being a non-resident by virtue of lacking an ATO certificate of clearance).
3. None of the following excluded transactions apply:
- real property transactions with a market value under $2 million;
- transactions listed on an approved stock exchange (ie. a sale of shares in a listed entity);
- the foreign resident vendor is under external administration or in bankruptcy.
The new withholding regime will apply to fresh options and contracts entered into on or after 1 July 2016 (including contracts entered into under a pre-existing option).
If it applies, Australian residents will need to obtain a clearance certificate from the ATO to prevent funds being withheld – in effect, Australian residents are deemed non-residents unless and until they have a certificate from the ATO.
Question 2: Freehold property is a CGT asset which is taxable Australian real property. What about leasehold interests? Does a lease for a long term (with or without options) get caught?
Yes, irrespective of the term of the lease or whether or not it is registered. Either a lease premium on grant or the transfer of a leasehold interest is caught.
This is because a lease relating to land situated in Australia is picked up by the definition of taxable Australian Real Property (see section 855-20 of the ITAA 1997).
An obligation will arise where:
- a lease is transferred for consideration; or
- in respect to lease premiums paid for the grant of the lease (but not for rent payable under a lease), as rent does not form part of the first element of the lessees cost base.
Accordingly, the acquisition of a lease asset by a lessee will be subject to CGT withholding tax where:
- the lessee has reason to believe the lessor is a foreign resident; and
- the premium or consideration for the transfer of the interest is $2 million or more.
The withholding tax will also apply where a purchaser acquires an asset as a result of exercising an option. The amount to which the withholding applies is reduced by any payments the purchaser made for the option, and by the market value of any property the purchaser gave for the option. Normally this should have little application to the chain of options to renew a lease but this cannot be ignored either.
Question 3: Is the 12 month validity period for clearance certificates prescribed by regulation? If a contract had a longer settlement period, could a Vendor ask for a longer validity period in an application for a clearance certificate, or would we need to get separate 12 month certificates to ensure we caught the day of sale and the date of completion, even if we did not catch the full period in between?
Where a valid clearance certificate is provided, the purchaser is not required to withhold an amount from the purchase price for the vendor. While the ATO has stated on its website that clearance certificates will be valid for 12 months, there is currently nothing in the Taxation Administration Regulations 1976 or the Taxation Administration Act 1953 which prescribed the 12 month period. The Explanatory Materials indicate that the Commissioner “may set a time period” for the validity of the certificates.
The legislation provides that an entity is not a foreign resident if the entity has a clearance certificate for a period covering the time the transaction is entered into (section 14-210(2) of Sch 1 to the TAA). The clearance certificate provision itself states that the Commissioner may certify that an entity is not a foreign resident during a “specified period”. Presumably this “specified period” will cover the execution and completion of the relevant transaction for which the application was made – but this is nowhere expressly stated in the Act.
However, it remains unclear whether the certificate is required to be valid at the time of settlement. As the ATO has indicated that the certificates will be valid for 12 months from the date of issue, there is potential for the certificate to not be valid at the time of settlement. This is particularly relevant for conditional contracts with long periods until completion.
The ATO had indicated that where a contract period exceeds the validity of the clearance certificate, "the purchaser may rely upon the clearance certificate as being valid as long as the date it is made available to the purchaser is within the clearance certificate period stated on the certificate." This suggests the certificate is not required to be valid at the time of settlement, provided it is valid at the time of entering the contract and the time of giving the certificate to the purchaser. The legislation remains silent on this issue. Perhaps this issue will be resolved in an administrative fashion when the regime takes effect.
Question 4: Where the purchaser needs to retain an amount and remit it to the ATO, is the 10% calculated by reference to the price excluding GST and excluding any adjustments (eg. for rent, rates and outgoings)?
The legislation specifies that the 10% withholding is calculated by reference to the first element of the cost base of the asset (s 14-200(3)(a)(i) of Sch 1 to the TAA). The first element of the cost base is the total of:
- the money paid or required to be paid, and
- the market value of any other property given or required to be given,
by the taxpayer in respect of acquiring the asset (s 110-25(2) of the ITAA 1997). The market value of any property is to be worked out at the time the asset is acquired.
Where the parties are not dealing at arm's length, it is likely the market value substitution rule will apply (section 112-20 of the ITAA 1997).
The 10% calculation will include adjustments, if under the terms of the contract, those adjustments alter the purchase price (which we understand to be the usual position in respect of most if not all adjustments).
Whether GST is included will depend upon whether the purchaser is registered for GST, and whether the purchase is a taxable supply.
Where the purchaser is registered for GST and the transaction is a taxable supply, and the purchaser is entitled to an input tax credit, the GST inclusive purchase price less the input tax credit may be used as by the purchaser in determining how much withholding is required.
However, where a purchaser is not registered for GST or the supply of the asset is not a taxable supply (eg. because the vendor is not registered for GST or the supply is input taxed), or the purchaser is not entitled to any input tax credit, the first element of the cost base of the asset will include the GST charged on the supply.
Question 5: Can a vendor refuse to settle if the purchaser withholds the 10% withholding tax from the settlement payment?
In short, no. The legislation protects the purchaser from having to discharge its liability to pay the amount equivalent to the withholding tax to the vendor (section 16-20 of Sch 1 to the TAA).
Under the new regime, where a transaction to which the regime applies occurs, the purchaser has the obligation to withhold the 10% calculation from the vendor and pay that amount to the Commissioner. Purchasers will be exposed to penalties and interest charges if they fail to pay the Commissioner (sections 16-30 and 16-35 of Sch 1 to the TAA).
As with existing withholding taxes (eg. the Tax File Number withholding tax and PAYG withholding tax), the withholding entity, in this case the purchaser, is discharged from all liability to pay so much of the total amount payable in acquiring the CGT asset as is equal to the amount the purchaser is required to pay the Commissioner in relation to the acquisition. To suggest that a purchaser could refuse to settle due to the withholding is similar to claiming an employee could sue their employer for the entirety of their paycheck.
Question 6: When is the tax payable? What if the date the purchaser becomes entitled to be registered as proprietor of the interest and payment occur at different times?
The required amount must be paid to the Commissioner on or before the day the purchaser becomes the owner of the property. The Explanatory Material provides that this is to be distinguished from the time the purchaser is taken to have acquired the asset for CGT purposes. Under CGT Event B1, a tax event occurs where the purchaser enters possession and enjoyment of the land prior to becoming the registered owner.
Ordinarily, in following CGT Event B1, the amount would become payable when the purchaser takes possession prior to settlement. However, the Explanatory Material provides that the time for payment is distinguished from the time of acquisition for CGT purposes, and therefore, it can be inferred that the tax is payable by the settlement date.
Question 7: The legislation refers to an application to the Commissioner in the approved form. At this juncture, has the approved form, and the fee, been prescribed?
The Clearance Certificate Application Form for Australian residents is available on the ATO website.
The ATO has recently publically stated that there is no fee for obtaining a Clearance Certificate.
Question 8: How can a taxpayer apply for a variation?
Where the vendor is clearly a non-resident vendor, and thus, is not entitled to a clearance certificate, the vendor can apply for a variation in particular cases as discussed below.
A variation to the 10% withholding tax is available where:
- The vendor will not make a capital gain on the transaction (because they will make a capital loss or a CGT rollover applies).
- The vendor will otherwise not have an income tax liability (because of carried-forward capital losses or tax losses).
- A creditor of the vendor has a mortgage or other security interest over the property and the proceeds of sale available at settlement will be insufficient to cover the amount to be withheld and to discharge the property secured.
- A creditor acquires legal title to the property as a result of an order for foreclosure and its security would be further diminished as a result of having to comply with the withholding obligations.
The ATO has indicated that variation decisions will be provided within 28 days of the application being made.
If the Commissioner grants the variation request, the vendor will receive a notice of variation stating the revised amount that is to be withheld. In appropriate circumstances, the withholding tax can be reduced to nil (section 14-235(6) of Sch 1 to the TAA).
The variation can be granted on a conditional basis (eg. that the purchase price for the property does not exceed a certain amount). An example is where a vendor's cost base for a property is $3 million, and the vendor does not expect to be able to sell the property for $3 million or more. In this instance, the vendor can apply for a variation, requesting the withholding tax be reduced to nil on the basis that the vendor will make a capital loss on the sale of the asset. The Commissioner has the power to grant the variation on the condition that the purchase price of the asset does not exceed $3 million.
Once granted, the variation notice takes effect when received by the purchaser.
Where the Commissioner rejects a variation application, the vendor can object in the usual manner.
The application form is available on the ATO website.
Question 9: The 10% retention amount seems a completely arbitrary percentage. Why is 10% to be withheld?
This is nothing in the Explanatory Material or commentary that indicates why 10% was chosen. Completely arbitrary is as good a description as any other, especially since non-residents can no longer access the 50% CGT discount (although this is subject to some grandfathering rules for assets held at 8 May 2012).
As a general note, the new 10% withholding tax is designed to assist the Commissioner in enforcing foreign resident tax liabilities. Whether it will prove effective in this role remains to be seen, especially when the impact on commercial activity is kept in mind.
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