The Government announced several proposed capital gains tax (CGT) changes that are to the detriment of non-residents.
Under the current law all taxpayers (resident and foreign resident) are entitled to the CGT main residence exemption where they live in the property as their main place of residence.
Removal of the main residence exemption
The proposed new law will apply to all those who fail to meet the definition of ‘resident’ for Australian tax purposes.
The impact for these foreign residents is where they enter into a contract to sell their property they will no longer be entitled to the CGT main residence exemption (subject to certain transitional provisions).
The new law also applies to circumstances where an Australian citizen or permanent resident who leaves Australia for a period of time with the intention of returning. These people would also be considered a foreign resident for tax purposes.
CGT non-resident withholding rate and threshold changes
The Government also proposed to increase the CGT withholding rate for foreign tax residents from 10 percent to 12.5 percent to reduce the withholding threshold from $2 million to $750,000. These amendments apply in relation to acquisitions of property that occur on or after 1 July 2017.
That means, when a foreign investor sells certain Australian assets, the purchaser will be required to remit 12.5 percent of the first element of the cost base of the CGT asset (i.e. the purchase price) to the Commissioner.
In addition, under the changes the withholding obligation will not arise if the market value of taxable Australian real property is less than $750,000.
Principal asset test
To determine whether a foreign resident vendor is subject to 12.5 percent CGT withholding on the membership interests’ sale (indirect interest in Australian real property), it is important to understand whether the membership interests in an entity are indirect Australian Real Property and therefore Taxable Australian Property (TAP) for the purpose of Division 855 of Income Tax Assessment Act 1997 (ITAA 1997).
Membership interests will satisfy TAP status only if both of the following tests are passed:
- the non-portfolio interest test, and
- the Principal Asset Test. The
Principal Asset Test requires the market value of the taxable Australian Real Property (TARP) assets held by the Australian entity to be more than 50 percent of the total market value of the assets
(TARP and non-TARP assets) of that entity.
Under the existing rules, the Principal Asset Test is conducted on an entity’s standalone basis which makes it possible to disaggregate and have a number of small interests in Australian real property ultimately held by one foreign resident and therefore avoid a CGT liability.
However, the proposed test in Division 855 of the ITAA 1997 will be calculated on associates inclusive basis which means an ultimate foreign tax resident can no longer separate different indirect interests in Australian land to avoid being taxed on.
If you are likely to be affected by these changes it is important to check how the law applies to your personal circumstances.