Capital gains tax: is our Government being fair to non-residents

Foreign investors and residents have been on notice since the Federal Budget that the Australian Government was looking to expand their liability for capital gains tax. At the time, we analysed some of the practical uncertainty that could flow from these changes, but cautioned that much more detail was needed. That further detail has now arrived with the release of a consultation paper on this expansion of the types of assets that foreign residents are subject to capital gains tax on in Australia, along with proposed changes to the foreign resident capital gains tax withholding tax regime, and notification requirements changes to the principal asset test. The consultation period runs to 20 August 2024.

Expanding the Australian tax base may be appropriate, but subjecting those gains to what is globally a high rate of tax, without the benefit of transitional rules, is not and could harm local investors equally given the shrinking market participants.

Broadening the capital gains tax net for foreign residents

What’s proposed

Treasury has stated that this change is intended to align the types of assets in Australia's CGT net more closely with international tax practice, and the taxing rights of Australia as provided in its tax treaties network. However, it is likely that the effect of these rules will expand the definition of assets that are treated as real property for both domestic and tax treaty purposes. The rules will apply from 1 July 2025 with no transitional regime in respect of capital already deployed.

The aim is to capture assets which have a close economic connection to Australian land and/or natural resources. Examples of additional assets that could be brought into scope given in the paper include:

• Leases or licenses to use land situated in Australia including (but not limited to) pastoral leases and licences, such as an agreement to lease land that is used in a manner that gives rise to the creation of emissions permits;
• Australian water entitlements in relation to land situated in Australia;
• Infrastructure and machinery installed on land situated in Australia, including land subject to a mining, quarrying or prospecting right of an entity, including:
  • ­Energy and telecommunications infrastructure, such as wind turbines, solar panels, batteries, transmission towers, transmission lines and substations;
  • ­Transport infrastructure, such as rail networks, ports and airports; and
  • ­Heavy machinery installed on land for use in mining operations, such as mining drills and ore crushers;
• An option or right to acquire one of the above assets (or similar asset types with a close economic connection to Australian land and/or natural resources);
• A non-portfolio (ie. at least 10%) interest in an entity where more than 50% of the underlying entity’s market value is derived from the above assets; and
• Livestock and equipment used in agriculture and forestry will not be captured (unless installed on land, or are used in carrying on a business through a permanent establishment in Australia).

Treasury is also considering capturing assets that economically derive their value from Australian land assets (for example, total return swaps that may ultimately give rise to a future acquisition of relevant Australian land assets). One of the questions posed in the paper is whether current integrity rules sufficiently deal with this.

The impact

The broadening of the types of assets within the foreign investor CGT net is quite a significant change, particularly in relation to renewable energy investments which have historically been considered not taxable Australian real property.

There may be potential behavioural impacts as a result of the change, including an incentive for foreign residents to exit out of certain asset classes prior to 1 July 2025 to the extent the changes would otherwise bring these assets within the foreign investment CGT net. As the relevant tax will be triggered on signing, it is expected that a rush to ink deals will occur.

The consultation paper only addresses the broadening of the asset types for CGT purposes only and not for the purposes of determining the types of assets that a Managed Investment Trust may invest in. It is hoped that there will be symmetry between the two regimes and if so, this will go a long way to preserving the status of Australia as a net capital importer, without materially adversely impacting asset prices held by local funds.

Amend the point-in-time principal asset test (PAT) to a 365-day testing period

What’s proposed

The 2024-25 Budget measure amends the testing period for the PAT to be the previous 365 days before the time of disposal of the CGT asset.

The impact

The purpose of this amendment is to reduce the ability of taxpayers to manipulate the asset composition of the entity in anticipation of a sale to achieve a favourable tax outcome.

However, it will be practically impossible to have a third-party valuation of significant tangible and intangible assets to be undertaken at multiple times within the preceding 365 days, particularly where foreign investors may only have a minority interest in the Australian assets.

ATO notification requirements for disposes of membership interests exceeding A$20 million

What’s proposed

The notification requirement will only be required where the vendor proposes to make a CGT WHT Declaration that the membership interest is not an indirect Australian real property interest.

Treasury has proposed, subject to consultation, the notification process as follows:

• the vendor lodges a notification with the ATO in the approved form by a statutorily prescribed date (eg., 28 days, 45 days, or 60 days, subject to consultation) before the relevant CGT event or settlement (whichever is earlier); and
• the ATO will automatically issue a receipt to the vendor, which would be provided to the purchaser along with the CGT WHT declaration.

The impact

We query what level of detail will be required in the notification, noting, subject to the level of detail required, the ATO may have limited information to assess the appropriateness of the CGT WHT declaration in the context of a non-public transaction.

We assume that this notification process will trigger a review of some sort by the ATO if it considers the declaration to be incorrect or uncertain.

The notification process creates an additional step to be considered in the M&A transaction timeline prior to signing.

Foreign resident capital gains tax withholding regime

What’s proposed

An exposure draft was released to amend the application of Australia's capital gains tax withholding regime by:

• Increasing the rate from 12.5% to 15%; and
• Remove the A$750,000 threshold before which the regime applies.

As currently drafted, the amendments proposed by the exposure draft will apply from the later of 1 January 2025 and the commencement of the relevant legislation.

The impact

The ATO would receive a greater withholding tax amount upfront before the foreign resident either disputes the capital gains tax treatment, or lodges an income tax return receiving a refund or paying top up tax.