Tax net and compliance obligations expanded for foreign investors - Government unveils CGT changes

Expansion of taxable Australian property

Currently, non-residents are only subject to CGT in respect of assets that are ‘taxable Australian property’ (TAP). TAP assets include direct or indirect interests in ‘real property’ (land or similar interests and leases) and certain mining rights (Taxable Australian Real Property or TARP) and options and rights to acquire such assets.

‘Real property’ is not defined and its scope and meaning have been the subject of much conjecture, including, in particular, whether certain assets, such as wind turbines, are fixtures and, as such, are ‘real property’ and the role of statutory severance provisions in that context. To address these issues, certain assets that are considered to have a ‘close economic connection to Australian land and/or natural resources’ are now proposed to be treated in the same way as TARP. The relevant types of assets are set out in the table below:

The Consultation Paper is also seeking views on the adequacy of the current anti-avoidance rules in respect disposals of ‘economic interests’ in TARP assets and whether targeted integrity rules are required. The Consultation Paper observes that foreign residents may not be subjected to CGT by selling economic interests in TARP, or rights to future income over TARP, instead of selling the TARP asset directly (for example, by creating a ‘total return swap’ which may ultimately give rise to a future acquisition of a TARP asset).

Interaction with MIT rules

One issue that is not addressed in the Consultation Paper is how these changes will work with the existing managed investment trust (MIT) and trading trust rules. Under the MIT rules certain distributions made by a qualifying MIT will be entitled to concessional withholding tax treatment for most non-residents. One of the conditions is that the relevant MIT does not carry on or control a business other than an ‘eligible investment business'. While activities such as investing in land for the purpose or primarily for the purpose of deriving rent is an eligible activity, there is some uncertainty as to whether certain assets such as those used in wind farms and solar farms constitute an interest in land for these purposes. To achieve symmetry of treatment under the MIT and new CGT rules, it should be clarified that interests considered to be TARP under the new CGT rules should also be considered to constitute an interests in land for the purpose of the MIT and trading trust rules.

If this change is not made, it will result in many non-residents becoming subject to tax on an exit from Australian renewable investments where they would not have previously been subject to such tax as well as potentially not benefitting from the concessional MIT withholding tax rates on distributions from those assets that would have applied had those distributions been recognised as interests in land for MIT purposes.

Changing the test time for the principal asset test

When assessing whether non-residents hold ‘indirect’ interests in TARP (i.e., via a company or trust or a chain of such entities), the current principal asset test considers whether more than 50% of the value of the assets of an Australian entity is attributable TARP at a particular point in time, being the time of the disposal of the relevant shares or membership interests. The Consultation Paper explains that the point-in-time approach allows foreign residents to avoid CGT by planning the sale of their membership interests at a time when the underlying entity has more than 50% non-TARP assets. As part of expanding the scope of the application of the CGT rules to foreign residents, the principal asset test is to be applied over the 365-day period prior to the disposal of relevant interests.

ATO Notification of foreign resident sale of interests exceeding $20M

In conjunction with the above changes, a new compliance measure is proposed to be introduced which will require foreign resident vendors disposing of membership interests which have a value exceeding $20 million to notify the ATO if they will make a vendor declaration to a purchaser that the sale is ‘not [in respect of] an indirect Australian real property interest’.

This measure builds on the existing foreign resident CGT withholding tax regime, under which purchasers are broadly required to withhold and pay tax to the ATO (currently at the rate of 12.5%, to be increased to 15% from 1 January 2025) from consideration payable to non-resident sellers of TAP interests and stems from recent disputes in which the ATO has had different views from taxpayers as to which kinds of assets constitute TARP and whether this withholding obligation should have been complied with.

The Consultation Paper proposes the following process:

the vendor lodges a declaration with the ATO in the approved form within 28 days (or some other review period (eg. 45 or 60 days), which remains under consideration) before the relevant CGT event or settlement (whichever is earlier);
the ATO automatically issues a receipt to the vendor, and the vendor provides the declaration and receipt to the purchaser; and
the ATO can intervene before settlement to recommend that the vendor declaration be withdrawn and an amount be withheld from the purchase price.

This proposal raises a number of practical issues, particularly in respect of timing. For example, parties may not know until close to signing whether or not a sale will in fact go ahead and what the final price might be. Accordingly, the parties may not be in a position to approach the ATO with certainty within the relevant time frame.

This measure is also separate to any processes that may be driven by Australia’s Foreign Investment Review Board (FIRB) (if applicable). While the FIRB process will necessarily involve consideration of tax issues, the $20M threshold proposed here differs from the criteria that must be met under FIRB. Accordingly, if the proposal moves forward, foreign residents may need to consider both regimes as part of the transaction timetable.

Consultation

The consultation period for the proposed new measures ends on 20 August 2024.

Please reach out to the authors if you have any questions about the new measures.

Assets with ‘close economic connection to Australia’	Comparison to current position	Example uses 2
Leases or licenses Lease or licences to use land situated in Australia, including (but not limited to) pastoral leases and licences, for example: an agreement to lease land that is used in a manner that gives rise to the creation of emissions permits.	‘Leases of land’ are already included in the definition of ‘real property’. The inclusion of licences and agreements for lease is new and may apply to investments in entities with statutory licences granted by Government agencies which may otherwise have been outside the scope of the CGT rules.
Australian water entitlements	The ATO has previously expressed the view that water access rights are not real property on the basis that they are separately tradeable from land.
Fixtures and chattels Infrastructure and machinery installed on land situated in Australia, including land subject to a mining, quarrying or prospecting right, for example: 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	The inclusion of this subset of depreciable assets is intended to overcome the issue of when items of plant should be treated as fixtures and hence form part of the land upon which they rest and the related issue of how the common law position is affect by statutory severance provisions. These issues have been the subject of conflicting court decisions. The proposed changes are likely to have the effect that the terms of statutory severance provisions are no longer determinative of whether assets are TARP. It is hoped that the new provisions will only apply to the entity which has directly or indirectly incurred the costs of such assets and is treated as the holder (direct or indirect) of those assets under the capital allowance provisions such that the assets are not inadvertently treated as the property of the owner of the land upon which they are situated where the owner is not the relevant holder for depreciation purposes.
Options and other rights 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)	The reference to options and rights is consistent with the current definition of TAP. The reference to ‘similar asset types’ is vague and unhelpful and seemingly only applies in the context of options and rights to acquire such assets. It is hoped that the legislation will provide greater certainty for taxpayers so that taxpayers do not have to wait for ATO guidance as to what “similar types of assets” are in this context.
Agriculture and forestry assets NOT included	It is not proposed to tax foreign residents on capital gains from the direct or indirect disposal of livestock and equipment used in agriculture and forestry, except to the extent that those assets are installed on land, or are used in carrying on a business through a permanent establishment in Australia. This carve-out is intended to strike ‘a suitable balance between protecting Australia’s tax jurisdiction for immobile assets and encouraging foreign investment into Australia’.