Details revealed for promised foreign resident CGT regime expansion

Treasury has released a Consultation Paper regarding a proposal to amend the foreign resident capital gains tax (CGT) regime. This was first announced by the federal government in the 2024-25 Federal Budget released in May 2024.

It has invited interested parties to comment on the implementation details. The closing date for submissions is 20 August 2024.

The current foreign resident CGT provisions are contained in Division 855 of the Income Tax Assessment Act 1997 (Cth) and have been a feature of the tax landscape since 2006. The rules govern Australia’s taxing rights over non-residents disposing of assets with a connection to Australia, mainly Australian real property (directly or indirectly).

Specifically, the proposed measures would apply to CGT events on or after 1 July 2025, to:

• clarify and broaden the types of assets that foreign residents are subject to tax on;
  
• amend the point-in-time principal asset test (PAT) to a 365 day testing period; and
  
• require foreign residents disposing of shares and other membership interests exceeding $20 million in value to notify the Australian Taxation Office (ATO) prior to executing the transaction.

Broadening the definition of ‘real property’

Division 855 allows a foreign resident to disregard a capital gain or loss arising from a CGT event (e.g. the disposal of an asset), unless that CGT event relates to an asset that is taxable Australian real property (TARP) or an indirect Australian real property interest (IARPI) (e.g. the sale of shares in a resident company where the majority of the company’s value is attributable TARP) or another specifically listed asset.

Relevantly, TARP is defined as real property located in Australia (including a lease of land) or mining, quarrying or prospecting right in respect of mining and petroleum reserves located in Australia. However, ‘real property’ is not defined. In our experience, there is often a divergence of opinions between taxpayers and the Australia Taxation Office (ATO) regarding what constitutes ‘real property’. This is because of the term’s meaning being derived primarily from state or territory property legislation, which apply varying definitions. It is particularly the case where a state or territory has adopted specific rules that apply to certain infrastructure that seek to sever assets from the underlying land. The ATO position has typically been that Division 855 should not give rise to different results for similar assets simply because they are located in different states or territories.

In that context, it is unsurprising that the list of assets that would fall within the TARP bucket will be expanded (not just clarified) if these measures are adopted. The Consultation Paper details that TARP may be broadened to include, amongst other things, leases or licences to use land and infrastructure (e.g. wind turbines, transmission towers, rail networks) and heavy machinery installed on land situated in Australia, as well as water entitlements in relation to Australian land. This will have a flow on impact to determining what constitutes IARPI. This seems to be more than clarification and could be viewed as being directed towards rectifying what may have been perceived to be a defect.

Principal asset test (PAT)

The PAT is used to determine, currently at a point in time (the time of the relevant CGT event), whether a company’s underlying value is principally attributable to Australian real property.

The proposal included in the Consultation Paper is to extend the PAT and require testing whether the market values of TARP exceed the threshold at any time during the preceding 365 days. The focus here is to ensure that taxpayers do not engage in transactions prior to a sale of an IARPI that would alter the composition of the underlying assets in anticipation of the sale. However, testing under the current PAT (i.e. a point in time) is already often a very onerous exercise for taxpayers. We expect that requiring testing at any point during the preceding year could be even more onerous, particularly in circumstances where a foreign resident does not have control over the company in which the interest is to be sold.

Increased reporting obligations to the ATO

The proposed changes would also introduce a new ATO notification requirement. This would apply to non-residents selling shares or other interests exceeding $20 million in value where the seller proposes to provide a vendor declaration that the sale is not an IARPI (which would usually result in a buyer not being required to withhold). Treasury proposes that the timing for notifying the ATO to be in advance of a set period (such as 28 days, or another period determined after consultation), before the relevant CGT event or settlement of the transaction – whichever is earlier. Given the relevant CGT event would typically be at the time of signing the transaction documentation, this new requirement is likely to have a significant impact on M&A transactions. Complications are likely to arise if notification is required before the terms of a transaction are settled (in anticipation of signing) or if there are multiple bidders. Such complications or delays could result in deals falling over and therefore have a material impact on M&A activity levels.

The Consultation Paper suggests that the ATO could intervene on the proposed transaction. This could be by recommending the declaration be withdrawn or taking alternative action such as issuing special assessments or applying for a freezing order over the purchase price and/or assets. The latter course has been chosen in some recent cases. However, the impact of this additional compliance burden on the already tight timeframes to execute commercial transactions remains to be seen. For example, it is not yet certain how long the ATO review period would be (this is part of the consultation). Also unknown is whether there will be any evidentiary requirements that need to be met by foreign residents to secure clearance from the ATO that the foreign resident CGT regime will not apply to the disposal as part of the ATO notification requirement. In addition to the impact on transaction timetables, the potential for intervention by the ATO could potentially reduce certainty for sellers and buyers.

Other changes to the rules

In addition to Consultation Paper, the government has also released draft legislation which, if enacted, would increase the foreign resident capital gains withholding rate for relevant disposals of TARP from 12.5% to 15%. It also removes the current $750,000 threshold before which withholding applies. These changes will apply from the later of 1 January 2025 and the commencement of the relevant legislation, and are subject to a separate exposure draft consultation process.

Interested parties can make submissions to Treasury on the contents of the Consultation Paper (including in respect of the length of a ATO review period (as described above)), with submissions to close on 20 August 2024.