Background
On 25 February 2016 the Tax and Superannuation Laws Amendment (2015 Measures No 6) Act 2015 (Cth) (Act) received Royal Assent and became law.
The Act introduced a new foreign resident capital gains tax (CGT) withholding regime in an effort to address the low levels of compliance with the obligation for foreign residents to lodge an income tax return and pay tax in respect of Australian assessable capital gain.
Under the new regime, a purchaser (whether they are an Australian resident or not) of certain taxable Australian property from a relevant ‘foreign resident’ is required to withhold and remit to the Commissioner of Taxation (Commissioner) 10% of the first element of the cost base (the ‘first element of the cost base’ is usually the purchase price or consideration paid where the dealings are at arm’s length).
Subject to certain exclusions, the obligation applies to the acquisition of:
The regimes applies to sales contracts and option agreements entered into on or after 1 July 2016 however the focus of this update will be the treatment of option agreements and the acquisition of TARP or an indirect ARP interest as a result of exercising an option under the new regime.
Who is a foreign resident for the purposes of the regime
The withholding regime applies if the vendor is a relevant ‘foreign resident’.
A ‘foreign resident’ is generally a person or entity that is not an Australian resident for tax purposes.
Under the Act a vendor is a relevant ‘foreign resident’ if, at the time the particular transaction is entered into:
Peculiarly, the definition of ‘foreign resident’ under the Act appears to have the effect of capturing all transactions for the acquisition of, or the granting of an option to acquire, TARP or a Company Title Interest even where the seller is clearly an Australian resident.
This has resulted in, and will continue to cause, an additional compliance burden for parties to transactions involving TARP or a Company Title Interest.
The treatment of options
An option to acquire property is a CGT asset of the option holder.[3]
If a foreign resident grants an option over TARP or an indirect ARP interest the granting of the option may trigger a withholding obligation for the grantee of the option (Purchaser).
The withholding obligation requires the Purchaser to withhold from the grantor of the option (Vendor) an amount equal to 10% of the first element of the option’s cost base, which is generally 10% of the amount paid for the granting of the option (Option Fee).
The 10% of the Option Fee must be withheld and paid to the Commissioner on or before the day the Purchaser becomes the owner of the option.
A Purchaser becomes the owner of an option on the date the option is granted.[4] As such care must be taken when dealing with option agreements that:
It is common for option agreements to grant the Purchaser a right to assign or novate the option. Upon the assignment or novation of the option, the assignee or party to whom the option is novated becomes the ‘owner’ of the option and the assignment or novation will also be subject to the withholding obligation if consideration is paid.
Threshold test
In an effort to ensure that the vast majority of residential house sales will be unaffected by the regime, any transactions involving the following are exempt from the regime:
However as options are not commonly used for the acquisition of residential property, being more commonly used in a commercial sense by sophisticated purchasers, options are not subject to the $2 million threshold test.
The withholding regime applies to all option agreements notwithstanding the value of the consideration paid for the option or the value of the TARP, Company Title Interest or indirect ARP interest (other than Company Title Interests) the subject of the option.
Therefore, the Purchaser of an option must withhold and pay to the Commissioner 10% of the Option Fee unless the exceptions set out below apply.
Vendor declarations
The withholding obligation in respect of options is subject to certain exceptions.
Logically, the Purchaser does not have to withhold part of the Option Fee if the Vendor is not a relevant ‘foreign resident’ at the time the option is granted.
The Vendor is not a relevant ‘foreign resident’ if:
The Explanatory Memorandum (EM) for the Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015 (Cth) (Bill) at paragraph 2.83 provides that a Purchaser will only know that a Vendor declaration is false if they have specific knowledge of the fact. That is, the Purchaser must be either a party to the fraud along with the Vendor or know that the declaration is completely implausible.
Given that the withholding obligation falls on the Purchaser, if a Purchaser has doubts as to the truth of a declaration the Purchaser should insist on withholding and remit the amount withheld to the Commissioner to avoid the penalties for failing to withhold.
Given that the regime applies to any agreement for the granting of an option to acquire TARP, Company Title Interests and an indirect ARP interest (as outlined above), the declaration can be inserted as a standard clause contractual warranty in any option agreement where the seller is clearly an Australian resident for tax purposes.
It is important to note that Vendor declarations are entity specific, so if a transaction involves multiple Vendors, each Vendor would need to provide their own separate declaration.
The Vendor’s declaration only applies for a specified period of up to 6 months and there are penalties for a Vendor who makes a false declaration or is reckless or takes no reasonable care in making the declaration.
Withholding upon exercise of option
A Purchaser has an obligation to withhold and remit to the Commissioner 10% of the purchase price (the first element of the cost base is usually the purchase price where the dealing is at arm’s length) payable under a contract entered into as a result of the exercise of the option (subject to any relevant exceptions).
However when TARP or an indirect ARP interest is acquired as a result of exercising an option, section 14-200(3)(a)(ii) of Schedule 1 of the Taxation Administration Act 1953 (Cth) (as amended by the Act) (Section 14-200(3)(a)(ii)) ensures the withholding obligation does not apply to the Option Fee twice.
Were it not for Section 14-200(3)(a)(ii), the obligation to withhold, which arises both when the option is granted and again when the option is exercised, would result in the Purchaser effectively being required to withhold twice on the Option Fee due to the operation of the existing legislation.[6]
Section 14-200(3)(a)(ii) avoids double counting of the option fee by reducing the amount to which the 10% withholding is applied by any payments the Purchaser made, and the market value of any property the Purchaser gave, for the option (or for its renewal or extension).[7]
For example if a Purchaser enters into an option agreement for an option fee of $100,000 to acquire TARP for a purchase price of $2 million and the withholding regime applies:
The regime applies to contracts for the acquisition of TARP or an indirect ARP interest that are entered into after 1 July 2016 as a result of exercising an option, even if the option was granted prior to 1 July 2016.
Therefore, in limited circumstances, Section 14-200(3)(a)(ii) can operate to reduce the amount of withholding even where there was no withholding on the granting of the option. This may occur in circumstances where the option was entered into prior to 1 July 2016 or the Vendor becomes a relevant ‘foreign resident’ after the date of the option agreement but before the option is exercised.
No further withholding
Whilst the $2 million threshold does not apply to options, if the asset acquired as a result of exercising the option is either TARP or a Company Title Interest, and the market value falls under the $2 million threshold, the Purchaser does not have any further withholding obligation.
Further information
In order to assist the public the ATO has produced a law companion guideline (LCG 2016/7) which sets out how the Commissioner will apply the regime to options and CGT assets acquired as a result of exercising an option which can be found on the ATO website at:
If a party relies on the information in the guideline in good faith, the party will not have to pay any underpaid tax, penalties or interest if the guideline does not correctly state how a relevant provision of the regime applies.
[1] s 14-200(1) of Schedule 1 of the Taxation Administration Act 1953 (Cth)
[2] s 14-210(1) of Schedule 1 of the Taxation Administration Act 1953 (Cth).
[3] section 108-5 of the Income Tax Assessment Act 1997 (Cth).
[4] sections 109-5(1) and 109-5(2) of the Income Tax Assessment Act 1997 (Cth) which state respectively that a person/entity acquires a CGT asset when they become its owner and a person/entity acquires an option at the time the option is granted.
[5] s 14-210(3) and s14-225 of Schedule 1 of the Taxation Administration Act 1953 (Cth).
[6] s 134-1 of the Income Tax Assessment Act 1997 (Cth) provides for the option fee to form part of the first element of the asset’s costs base with the option is exercised.
[7] paragraphs 2.104 to 2.106 of the EM.
