As we approach the first anniversary of Foreign Resident Capital Gains Withholding (FRCGW) Tax, the Federal Treasurer has provided an impetus to the “infant” FRCGW regime to extend its reach. As announced in the 2017–18 Budget Paper No. 2, it is expected that the longer arm of FRCGW will commence on 1 July 2017 and has two aspects.
The Two changes foreshadowed in the 2017–18 Federal Budget
For contracts entered into after 1 July 2017, the present threshold of $2m will be lowered to $750,000. As a result, many more resident vendors will have to obtain FRCGW clearance certificates from the ATO in order to avoid having the tax withheld. For instance, it appears that currently more than half of Melbourne (metropolitan median price $ 826,000) and Sydney (median price $1m) house sales will be affected.
Readers who looked at the ATO website in the immediate aftermath of the 2017–18 budget announcement that changes would be made to FRCGW, should note that the website has been updated. The proposed lower threshold of $750,000 will apply only to contracts entered into on or after 1 July 2017. By contrast, the $2m threshold will continue to apply to pre -1 July 2017 contracts that are settled on or after that date. Amending legislation was introduced into Parliament on 1 June.
The second aspect of extended reach is an increase in the rate of tax from the current 10% of the contract price to 12.5%. The ATO website states that this increased rate will apply to contracts entered into on or after 1 July 2017. The existing 10% withholding rate will continue to apply to contracts entered into before 1 July 2017, “even if they are not due to settle until after 1 July 2017”.
In order to appreciate the significance of the first change, a quick basic refresher on the role of the $2m (soon to be $750,000) threshold may help.
A basic refresher on FRCGW and identification of practical ramifications of the changes
Basically, where there is a transfer of CGT asset that is either taxable Australian real property (e.g. vacant or improved land in Australia, lease of land/buildings in Australia, and certain mining/quarrying/prospecting rights) or company title which has a market value of less than $2m (soon to be $750,000), the FRCGW regime does not apply. However, where taxable Australian real property or company title has a market value of $2m (soon to be $750,000) or more, FRCGW will apply, unless the Commissioner has issued a clearance certificate and this is held by the purchaser at the time of settlement (i.e. the time at which transfer of title occurs).
It will be recalled that the $2m threshold and clearance certificate exclusion mechanisms do not apply to transfers of certain CGT assets. In particular, there is a different system for removing the need for purchasers to remit FRCGW tax in relation to purchase of CGT assets which are indirect Australian real property interests that are not company title and CGT assets which are rights/options to either such indirect interests or to Australian real property.
Where taxable Australian real property or company title is sold with the transfer occurring on or after 1 July 2017:
- for contracts made prior to 1 July 2017, the purchaser will have to withhold tax of 10% of the contract price and remit this to the ATO, unless either:
- the market value of the relevant Australian real property/company title is less than $2m; or ○ where the market value is $2m or more, the vendor gives to the purchaser a clearance certificate issued by the Commissioner; and
- for contracts made on or after 1 July 2017, the purchaser will have to withhold tax of 12.5% of the contract price and remit this to the ATO, unless either: ○ the market value of the relevant land is less than $750,000; or ○ where the market value is $750,000 or more, the vendor gives to the purchaser a clearance certificate issued by the Commissioner.
Generally, the tax is calculated on the first limb of the acquirer’s cost base of the thing acquired and the ATO accepts that the contract price is a proxy for the first limb amount.
While the above reflects the general relevance of the $2m (soon to be $750,000) threshold, special rules define the value which is to be compared to the threshold in some cases. For instance, a special rule exists where the thing acquired is a joint ownership interest in real property or mining/quarrying/prospecting right.
Brief reference should also be made to the situation where a transfer is not made pursuant to a contract.
Transfers made without consideration and Transfers made without a prior contract
In some situations, an entity will transfer Australian real property or company title either (i) without consideration (e.g. a gift) or (ii) for consideration but not pursuant to a contract. It should be remembered that FRCGW will apply in these two scenarios. In relation to the first scenario, although the recipient of the transfer (transferee) of the property does not receive any consideration from which it can withhold tax, the transferee must still remit the tax.
We suggest that these situations are more likely than conventional contract sales to come to the attention of accountants before they occur. In particular, such transfers are likely to occur in the course of an accountant advising a client on business restructuring or family investment asset planning.
In these situations, the transferee will need to be mindful that in relation to a transfer occurring on or after 1 July 2017, it will automatically only be relieved from liability where the market value of the Australian real property/company title being transferred (or other value applicable in the particular circumstances) is below $750,000. Where the relevant value is at or above the $750,000 threshold, a clearance certificate will normally be required.
More generally, FRCGW applies to acquisitions (for CGT purposes) of taxable Australian real property under certain transactions. These can also occur by means other than transfers of title to property, such as grants of a lease at a premium. It is expected that the $750,000 threshold will also be relevant to such grants made on or after 1 July 2017.
Moving tax beyond the infant’s grasp
As a general addendum to the foregoing, it is timely to also recollect that the Commissioner has issued determinations which reduce withholding tax to nil in some situations.
The PAYG Withholding variation for foreign resident capital gains withholding payments – income tax entities determination (issued in March 2017) is a recent instance of this. Where relevant income tax exempt entities provide the specified evidence of their income exempt character (which might in some cases be as cumbersome as providing a clearance certificate) to a purchaser, the purchaser is relieved from the need to remit FRCGW tax.
An unwanted present …
The purpose of this note is to alert you to the imminent likelihood of material legislative change being made to the FRCGW. It would be prudent to consider the proposed legislation and to review office practices dealing with FRCGW in anticipation of its enactment, so that you are not “burnt” when the first birthday candle is lit.
Anyway, many happy returns FRCGW for 1 July 2017!