Significant changes to capital gains tax for foreign residents – Treasury Consultation
Significant changes to capital gains tax for foreign residents – Treasury Consultation
Following the federal government’s announcement in 2024-25 Federal Budget regarding reforms in relation to capital gains tax (CGT) for foreign residents, Treasury released a consultation paper outlining the proposed reforms in further detail.
The three key proposed changes significantly increase the scope of Australian assets held by foreign residents subject to Australian CGT.
Treasury has asked for submissions with feedback on these proposals by 20 August 2024 to which BDO has responded.
Alongside these reforms, Treasury released exposure draft legislation to:
- Increase the withholding tax rate for the Foreign Resident CGT Regime from 12.5% to 15%
- Reduce the property value threshold down from $750,000 to nil.
This draft legislation was covered in our technical update on CGT withholding tax.
What you need to know
In the 2024-25 Federal Budget, the government announced its intention to strengthen the foreign resident capital gains tax regime “to provide greater integrity and certainty about the operation of the rules”.
Treasury’s consultation paper seeks input regarding proposed measures, with proposed application to CGT events occurring from 1 July 2025 onwards.
The three measures for consultation are set out below.
Broadening the asset base on which foreign residents are subject to CGT
Section 855 currently provides that a capital gain is disregarded for a foreign resident where the taxpayer is a foreign resident, and the asset is not taxable Australian property (TAP). TAP includes the following:
- Taxable Australian real property (TARP), which includes real property in Australia, leases and rights to use, and certain mining, quarrying or prospecting rights
- Indirect Australian real property interests (IARPIs), which are non-portfolio membership interests in other entities where more than 50% of the value of its assets are TARP (principal asset test)
- A CGT asset used in carrying on a business through a permanent establishment in Australia
- An option to acquire any of the above
- CGT assets of an individual under which a choice under section 104-165(3) has been made for their non-TAP assets to be treated as TAP assets following the individual ceasing to be an Australian tax resident.
Presently, the range of assets on which foreign residents are subject to tax is relatively confined compared to global standards. There are also inconsistencies created by virtue of there being no definition of ‘real property’ in the Australian tax law and it being subject to differing treatments under the various Australian state laws.
The proposed measures would expand/clarify the Australian capital gains tax net to specifically include the following:
- Leases or licences to use land situated in Australia, including pastoral leases and licences
- Water entitlements in relation to land situated in Australia
- Infrastructure and machinery installed on land situated in Australia, including wind turbines, solar panels, batteries, transmission towers/lines, transport infrastructure, and mining machinery
- An option or right to acquire any of the above
- A non-portfolio membership interest in an entity where more than 50% of the underlying market value of the entity is derived from any of the above.
The inclusion of these assets aims to align the assets on which foreign residents are subject to capital gains tax here in Australia with global tax principles. These principles include those in Articles 6 and 13 of the OECD Model Tax Convention, and a Multilateral Instrument to which Australia is a signatory.
Economic interests in TARP
The consultation paper also considers whether TAP should include economic interests in TARP such as ‘rights to future income from TARP’ and ‘total return swaps’ so they are taxed equivalently with membership interests in TARP. The consultation paper askes for feedback on whether it is appropriate to treat economic interests in TARP as TAP, and whether there would be any unintended consequences from including economic interests in TARP, so they are taxed equivalently with membership interests in TARP. This would represent a significant expansion of the scope of Australian CGT regime if enacted.
Alternatively, are additional integrity rules required to address these concerns or are the existing general anti-avoidance rules sufficient protection?
Amend the principal asset test (PAT) from a point-in-time test to a 365-day test
The ‘principal asset test’ ensures that foreign residents are taxed under the Australian capital gains tax regime when they dispose of IARPIs where the membership interests in the interposed entity is a ‘non-portfolio holding’ AND more than 50% of the underlying market value of the interposed entity is derived from assets that are TARP. The test is currently applied at the time of entering into a transaction.
The proposed changes modify the principal asset test to apply throughout a 365-day period prior to a transaction as opposed to the current point in time test.
Accordingly, the principal asset test will be failed where the market value of Australian real property of the interposed entity exceeds 50% of the market value of the CGT asset and at any time during the 365-day leading up to the transaction. Where failed, the asset will be considered an IARPI, and TAP, and therefore subject to capital gains tax in Australia.
ATO notification of non-IARPI vendor declarations required for foreign residents disposing of membership interests exceeding $20 million in value
Under the current law a Vendor non-IARPI declaration can be relied on by a purchaser that the sale is not in relation to a IARPI and therefore the purchaser does not have to withhold foreign resident CGT withholding tax from the purchase consideration.
The proposed measures tighten these rules by requiring foreign resident disposing of membership interests of exceeding AUD20 million to notify the ATO of a non-IARPI declaration made to the purchaser that the sale is not in relation to an Indirect Australian Real Property Interest (IARPI). The ATO would then auto-issue a receipt number for the notification to the purchaser with the non-IARPI declaration.
Where the CGT event is transacted in a foreign currency, the timing of the foreign exchange conversion to AUD will be important in determining whether the AUD20 million threshold has been breached. The Consultation Paper does not give any guidance on this.
The notification to the ATO must be made in advance of a predetermined review period before the CGT event or settlement of the transaction, whichever happens first. The consultation paper is not clear on exactly when this review period begins and ends because, for most CGT events, the CGT law provides for the time of a CGT event to be different to when the CGT event happens.
The consultation paper proposes possible review periods of 28, 45 or 60 days before the CGT event. The consultation paper recognises there is a trade-off between a shorter period reducing the vendor’s compliance impost and a longer review period to enhance the ATO’s ability to review the vendor declarations to better protect the integrity of the withholding tax regime.
The proposed ATO reporting requirements do not impact the rules on whether to withhold tax but rather provides the ATO with greater oversight over higher value transactions that are considered to be non-IARPI with an opportunity to intervene in circumstance where a declaration may have been made incorrectly. If the ATO does not intervene within the review period, it would leave the vendor and purchaser to finalise the transaction without any withholding tax implications.
The consultation paper includes some specific questions including on:
- The appropriateness of the AUD20 million value threshold
- The appropriate timeframe for foreign resident vendors to notify the ATO in advance of a transaction (e.g. 28 days, 45 days or 60 days)
- The information the purchaser should be required to consider in determining whether a declaration is false (and if so, to withhold)
- The appropriateness of the current administrative penalties for the failure to lodge an approved form and for providing a false and misleading vendor declaration.
BDO Comment
Taxation of international taxpayers and non-residents has been strong area of focus for the Federal Government, and these proposed measures add to this.
The non-IARPI reporting requirement will be of particular interest for foreign vendors especially given the uncertainty in relation to the finer details of the information to be declared, the precision required and time frame. The requirement for vendors of shares and other membership interests to provide the non-IARPI vendor declaration to the purchaser and report to the ATO 28 days (or possibly longer) before the earlier of the CGT event or settlement will cause unexpected delays in finalising many of these transactions.
Legislative or administrative guidance on the practicalities associated with complying with this new requirement in circumstances where commercial matters are still being negotiated (often outside of Australia) will need to be provided.
Once these new rules become law, both non-resident vendors and purchasers of TAP assets are encouraged to obtain advice on whether the assets may become subject to Australian CGT under the proposed rules and ensure they make the appropriate declarations and report to the ATO in the required timeframes in order to ensure transactions can be performed consistent with commercial timeframes.
Reach out to your BDO adviser from our tax services team if you would like further information regarding the proposed changes or our submission.