Foreign resident withholding tax – anyone can be a foreign resident
Australia has always been the beneficiary of foreign investment particularly in relation to our agricultural assets. With our clean green environment, and a skilled population with in depth ‘know how’ of the agricultural sector, we are an ideal place for food and commodity based investments. Whilst Australia’s agricultural sector continues to attract foreign investors there have been some key changes in the world of tax that should be front and centre in the minds of all agribusiness stakeholders.
A recent and significant change is the new foreign resident withholding tax regime which commenced on 1 July 2016. This regime imposes a non-final 10% withholding obligation on a purchaser who acquires taxable Australian property (including indirect interests in and options or rights to acquire such property) from a foreign resident.
The policy basis for this regime is to ensure greater compliance by foreign residents with their capital gains tax (CGT) obligations. However, as this article illustrates, Australian resident vendors are also captured by this measure.
First up, certain assets are specifically excluded from this regime. The key ones include:
- Real property that has a market value of less than $2 million
- The sale of shares or units conducted through an approved stock exchange or a broker-operated crossing system.
The context of this article is the sale of direct and indirect interests in agricultural real property. However, these rules apply to a wider range of assets including options and other rights over real property. Therefore, appropriate advice should always be sought about the sale or purchase of any interests in or over real property, as these rules could affect you.
In terms of navigating these rules, it’s important to understand that the rules differ depending on whether the asset being sold or acquired is a ‘direct’ or ‘indirect’ interest in Australian real property.
Direct real property interests
Real property is defined very broadly for the purposes of these rules. Relevantly, for the agricultural sector, real property includes land or a lease of land situated in Australia. However, real property includes a much broader range of assets, so care should be taken.
A ‘direct’ interest in real property is typically one that is held directly by you, as opposed to one held indirectly through a company or trust.
Significantly, where someone sells a direct interest in real property, the rules treat the vendor as a foreign resident, unless the vendor provides the purchaser with a clearance certificate issued by the Australian Tax Office (ATO). A purchaser is therefore liable to pay the ATO 10% of the sale proceeds (note this is the first element of cost base not solely the cash proceeds), unless the vendor has given the purchaser one of the following documents before settlement of the property:
- A valid clearance certificate
- A notice confirming that the ATO has varied the withholding rate of 10% to nil.
In practice, we expect that Australian resident vendors will generally apply for a clearance certificate. Currently the process for obtaining a clearance certificate involves completing the ‘Foreign resident capital gains withholding clearance certificate application’ and lodging it with the ATO. This can be done online.
So, if you are selling agricultural land that has a market value of $2 million or more, the clearance certificate rules will apply to the sale regardless of Australian residency. Alternatively, expect to only receive 90% of the total sale proceeds from the purchaser on settlement.
Indirect real property interests
As mentioned above, the rules for indirect interests in real property are different to those for direct interests.
An indirect interest in real property is, broadly, a share or unit in a land rich company or trust. Generally, an entity will be land rich where more than 50% of the market value of that entity’s assets is attributable to Australian real property. However, these rules should only apply if the vendor is a foreign resident who holds 10% or more of the shares or units in a land rich entity.
Notably, clearance certificates are not relevant for indirect interests. Instead, the vendor’s options will depend on their residency status:
- An Australian resident vendor can provide a ‘residency declaration’ to the purchaser (before settlement) confirming that they are an Australian resident
- A foreign vendor can provide an ’interest declaration’ to the purchaser confirming that, broadly, the interest being disposed of is not an indirect Australian real property interest.
As with a clearance certificate, a purchaser is entitled to rely on a valid residency or interest declaration. Take the following example:
Frank, an Australian resident, owns a company (Santa Gertrudis FarmCo) which runs a cattle farm. The company is land rich. Frank recently accepted an offer from a stranger to sell his shares in Santa Gertrudis FarmCo for $10 million.
Frank is selling shares in a land rich company so the rules for indirect interests apply. To avoid the risk of the purchaser withholding 10% (i.e. $1 million), from the total purchase price, Frank can give the purchaser a residency declaration before settlement. If this is the case, the purchaser will no longer be required to pay the ATO 10% of the purchase price.
Where a vendor does not provide a residency or interest declaration, the purchaser of an indirect interest has to work through a series of questions to determine whether the vendor is a foreign resident. This process is called the ‘knowledge condition’. This will not be a difficult process where the purchaser knows the vendor. However, in all other cases, the process may be complex, so it is best to get advice about the knowledge condition if and when needed.
In practice, however, we expect that most purchasers will ask the vendor to provide a residency or interest declaration; otherwise a purchaser may simply withhold 10% of the sale proceeds given the risks involved with non-compliance of this regime are with the purchaser. For example, if a purchaser fails to withhold at a time they should withhold, they may have to pay 10% of the proceeds to the ATO out of their own pocket (as a penalty).
One only has to do a quick online search of rural properties for sale to see the breadth of the potential application of these rules. The fact that they can apply to sales of property between two Australian residents is likely to catch vendors and purchasers off guard so care should be taken to ensure that all parties involved are aware of their rights and obligations under this measure.