Australia – New 10% Witholding Tax

Certain disposals of Australian real estate will no longer be self-assessable by non-residents in historic move by the Australian Tax Office (ATO).  

Disposal proceeds from the sale of certain Australian real property may attract a 10 per cent withholding tax (WHT) for contracts exchanged on or after 1 July 2016, and penalties for purchasers in the event that it is not withheld. While aimed at non-residents, the rules may also catch those residents without the correct paper work in place.

Why have these changes been brought in?

These measures are said to have been initiated on the back of the ATO’s concerns that the self-assessment regime is, to a material extent, ineffectual. Our view is that this change has most likely come about because there have been a number of high-profile incidents where non-residents have sold arguably taxable Australian investments just ahead of unsuccessful ATO attempts to tax the sales proceeds. It is therefore the absence of any viable compliance mechanism, along with continued growth in the scale and range of foreign investments in Australian real property, that has prompted the Australian Government to make this significant change.

What will the WHT apply to?

The WHT will apply to disposal proceeds from the sale of both "direct" and "indirect" interests in Australian real property by Australian non-residents whether these are brought into account as income or as capital.

Direct interests in Australian real property consist of:

• Australian situs land, buildings, residential property, commercial property, or lease premiums paid for the grant of a lease;

• Australian mining, quarrying or prospecting rights;

•  "company title" real property interests (e.g. apartment buildings where ownership of the apartment is conveyed through the sale of shares in the company which owns the apartment); and

• options or rights to acquire any of the above.

Indirect Australian real property interests consist of:

1. shares or units or other interests in entities the majority of the assets of which ultimately (tracing through all interposed entities) consist of any of the above types of Australian real property (N.B. this is not the same as "company title" real property interests); and
2. options or rights to acquire any of the above.

Exclusions from WHT

In relation to the disposal of direct interests, only sales with a market value of AUD 2,000,000 or more attract WHT.

In relation to the sale of indirect interests, the following are excluded:

• "on market" transactions undertaken on Australian or approved foreign stock exchanges;
• transactions undertaken using private broker-operated crossing systems (e.g. dark pools);
• certain securities lending transactions; and
• sellers under external administration or bankruptcy.

Who will the WHT apply to?

While the intention of the legislation is for the WHT to only apply to non-residents, it may also apply to Australian residents without the correct paperwork in place at the time of settlement.

Practicalities

Different criteria need to be met depending on whether the property being disposed of is a direct or indirect real property interest.

In relation to sales of direct interests, a purchaser must levy WHT unless the seller provides a valid Commissioner clearance certificate (a CCC) on or before settlement. In the event that the purchaser does not receive a valid CCC on or before settlement, even if the purchaser is clearly an Australian resident and can prove this, the purchaser must withhold. This process means that a purchaser will not need to undertake any timely due diligence on, or bear any risk in relation to, whether a seller is an Australian resident. It also means that the WHT on payments to non-Australian residents is automatic. Standard transaction documentation has been amended to incorporate this compliance requirement.

In relation to sales of indirect interests in Australian real property, there is a requirement, with one exception as discussed below, for a purchaser to levy WHT where the purchaser:

• knows or reasonably believes the seller is a foreign resident; or
• does not reasonably believe the seller is an Australian resident and the seller has an address outside Australia (according to any record in the purchaser’s possession) or the payment is being made outside Australia.

The exception alluded to above is where, on or before settlement, the seller provides the purchaser with a valid declaration (probably in the form of a representation or warranty) that it is an Australian resident and/or the property is not an indirect Australian real property interest, provided the purchaser can show (having regard to any documents in his possession) that he has no grounds to believe that the declaration is false.

Process for obtaining CCC 

The Government has indicated that the process for obtaining a CCC will not result in any onerous or time – consuming obligations. An Australian resident must fill out an online "Clearance certificate application for Australian residents" form and the ATO says that it will respond "within days" owing to a new automated system. The CCC will be valid for 12 months once issued.

ATO personnel will no doubt be grateful for the additional data on Australian resident transactions this process provides and it remains to be seen whether this will generate ATO audits or related information - gathering processes for Australian sellers.

Payment obligations 

The purchaser must in effect remit an amount equal to 10 per cent of the purchase price to the ATO (but see below in relation to varying this amount) on or before the day of settlement of any transaction. Even where payments for purchases are made in instalments, an amount equal to 10 per cent of the total amount payable must be withheld and remitted upfront on the day of settlement.

The requirement to remit an amount on or prior to completion has introduced a material degree of additional complexity into the property settlement process – particularly in the early days of the new rules as parties familiarise themselves with new processes.

In the event that the seller’s tax is less than the amount withheld, the seller can obtain a refund by filing an income tax return.

Protecting the seller's creditors 

The ATO is given a largely unfettered right to vary the amount of tax that is required to be withheld, either up or down in amount. The only restriction on this is that the ATO "must have regard to the need to protect a creditor’s right to recover a debt". This is the only protection offered to secured and unsecured creditors of the seller and it appears potentially insufficient. As a result, some creditors could, depending on the particulars of their situation, find themselves permanently out of pocket by reason of the withholding.

In theory, this power of variation should allow withholdings to be eliminated where it is clear that the seller will suffer a taxable loss from the sale prior to any withholding being levied. However, it remains to be seen whether variations will be available in practice. At present, it would be prudent to assume that they will not, as the drafters of the legislation have been at pains to leave the power of variation unfettered by considerations such as the lack of any underlying tax being payable. Moreover, the power of variation does not preclude the ATO from increasing the amount it may demand, which may be of concern to those persons who would otherwise be minded to apply for a variation.