The CGT withholding regime and its impact on SMSFs
While many people are aware of the non-resident capital gains tax withholding obligations which arise for vendors disposing of certain taxable property, there are a number of traps for SMSFs that SMSF professionals should watch out for.
The non-resident capital gains tax withholding obligations (withholding regime) was introduced to allow the Federal Government to obtain tax in respect of foreign vendors. However, the Withholding Regime applies to most transfers of real estate in Australia unless an exception applies.
An aspect of the new Withholding Regime that has not gained much attention is its implications for SMSFs. This article discusses the relevant background and how the Withholding Regime impacts SMSFs.
What is the NR CGT Withholding regime?
The Withholding Regime applies to transactions entered into from 1 July 2016. Broadly, a purchaser is required to withhold 12.5 per cent of the value of taxable Australian real property, or an indirect Australian real property interest that provides company title interests, with a market value of $750,000 or more, unless the vendor shows the purchaser a clearance certificate that has been obtained from the ATO. Note that for contracts entered into between 1 July 2016 and 30 June 2017, the relevant market value threshold was $2 million, with the withholding rate being 10 per cent instead of the current 12.5 per cent rate. Further, the legislation focuses on who acquires an asset which, as discussed below, is broadly defined and applies to a range acquisitions and not just to purchases for monetary consideration (unless a relevant exception applies).
More specifically, s 14-200(1) of the Taxation Administration Act 1953 (Cth) ('TAA') provides that:
You must pay to the Commissioner an amount if:
(a) You become the owner of a CGT asset as a result of acquiring it from one or more entities under one or more transactions; and
(b) Subsection 14-210(1) (about foreign residents) applies to at least one of those entities at the time one of those transactions is entered into; and
(c) At that time, the CGT asset is:
(i) Taxable Australian real property; or
(ii) An indirect Australian real property interest; or
(iii) An option or right to acquire such property or such an interest;
unless a transaction referred to in paragraph (a) is excluded under section 14-215.
Note: You must pay the amount on account of income tax possibly payable by the entities on their capital proceeds resulting from your acquisition of the CGT asset.
The ATO confirm that taxable Australian real property includes:
· Vacant land, buildings, residential and commercial property in Australia;
· Mining, quarrying or prospecting rights where the material is situated in Australia; and
· A lease over real property in Australia if a lease premium has been paid for the grant of the lease.
For SMSFs, the Withholding Regime is likely to be relevant whenever an acquisition or transaction occurs with regard to real estate in Australia. Typically, the property lawyers handling the conveyancing aspects related to the transfer will assist with complying with the Withholding Regime. However, there are a number of transfers discussed below that SMSFs and their advisers need to be on top of to ensure they comply with the law.
Section 14-210 of the TAA sets out the test on whether an entity is a relevant foreign resident at the time of the transaction. As is common for tax residency issues, the relevant provisions involve a complex and multifaceted test and expert advice should therefore be sought.
Section 14-215 of the TAA lists a number of other exclusions, including where an amount is already required to be withheld from a withholding payment relating to the transaction.
Key impact of the Withholding Regime
The key impact of the Withholding Regime is that it will require an SMSF trustee purchasing or otherwise acquiring property in Australia to withhold 12.5% of the purchase price or the market value of the property (more particularly defined as the first element of the CGT asset’s cost base) just after the acquisition, unless a clearance certificate is obtained from the vendor or another exception under the TAA is satisfied.
The Australian resident entity or its representative (eg, the SMSF trustee or its tax agent) can complete an online application for a clearance certificate via the ATO’s website. It is the vendor’s responsibility to obtain the clearance certificate and to provide it to the purchaser at or before settlement. Where a valid clearance certificate is provided, the purchaser is not required to withhold.
It is expected that, in many cases, a clearance certificate will be made available by the vendor in the usual conveyancing process and that no withholding will be required. However, if a clearance certificate is not provided, eg, the vendor is a non-resident, or another exception is not satisfied prior to settlement, then a withholding obligation falls on the purchaser of the property even where no capital gain arises in connect with the disposal.
Key exception –– $750,000 threshold
Where the market value of the property is less than $750,000, that transaction is an excluded transaction under s 14-215 of the TAA. The ATO view is that, in many cases, the market value of a property will be the purchase price. The ATO state on their website (QC 48972) that ‘…where the purchase price has been negotiated between the vendor and the purchaser, acting at arm’s length, we will accept the purchase price as a proxy for market value.’
Note, however, that the $750,000 threshold does not apply in the case of an option or right to acquire property: see s 14-200(1)(c)(iii) of the TAA. Thus, acquisitions of options and rights to acquire property are covered by the Withholding Regime unless a relevant exception applies (other than being below the $750,000 threshold).
Properties equal or above $750,000
A clearance certificate will generally be required where the property has a market value equal to or more than $750,000 — that is, the Withholding Regime is deemed to apply until the vendor issues the purchaser with a clearance certificate. Broadly, while the regime was introduced to tax non-residents, the Withholding Regime applies to everyone, including Australian residents, unless the vendor obtains a clearance certificate or otherwise satisfies another exception.
Furthermore, it is the vendor’s responsibility to obtain the clearance certificate and to provide it to the purchaser/transferee prior to or at settlement. Without being presented with a valid clearance certificate, the purchaser/transferee will be required to withhold and remit 12.5% to the ATO if no other exception applies. On the other hand, where a valid clearance certificate is provided, the purchaser/transferee is not required to withhold.
Given the current values of property, particularly in most Australian capital cities, it is clear that many transactions involving real property will be covered by the Withholding Regime.
Traps –– how might SMSFs otherwise be covered?
Australian real estate remains a popular investment choice for SMSFs and where an SMSF trustee acquires real estate in any manner, the SMSF trustee must be mindful of the potential application of the Withholding Regime.
In particular, the meaning of ‘acquiring a CGT asset’ is broadly defined and covers any type of acquisition covered by s 109‑5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), subject to a relevant exception applying. Thus, the Withholding Regime applies to more than just a standard purchase/sale arrangement for monetary or other valuable consideration. The following types of transactions are covered by the Withholding Regime (assuming the relevant property has a market value above $750,000):
· A transfer in-kind/in specie of business real property by a member to an SMSF trustee (eg, pursuant to a relevant contribution cap) whereby the SMSF trustee becomes the owner of the property at this time. Even though this kind of transfer does not involve valuable consideration, the Withholding Regime is still applicable and the member must provide a clearance certificate to the SMSF trustee.
· A lump sum payment in-kind/in specie of residential property from an SMSF trustee to a member whereby the member becomes the owner of the property at this time. As noted above, the Withholding Regime must be managed in this circumstance, and a clearance certificate must be provided to the member by the SMSF trustee.
· The transfer of property from a retiring SMSF trustee to a new individual or corporate trustee or to the continuing individual trustee(s). Note that one of the real hassles of having individual trustees is the possibility of multiple retirements and appointments occurring during an SMSF’s lifetime. For example, if an individual trustee dies, the assets of the SMSF must generally be transferred to the surviving trustees (which may require a new individual trustee or a corporate trustee to be appointed). On each change of trustee, the title to fund assets must be transferred, and thus, the Withholding Regime needs to be managed on an ongoing basis. There may, however, be certain exceptions available where an asset passes to a legal personal representative on the death of an individual or where an individual acquires the asset upon the death of an individual as the surviving joint tenant(s). Naturally, expert advice should be obtained.
What amount must be withheld and paid to the ATO?
If a withholding obligation arises and a clearance certificate cannot be obtained (for whatever reason), a further analysis must be undertaken by the purchaser to determine what constitutes the first element of the asset’s cost base. The first element is the amount paid for the asset and the market value of any other property you gave, or are required to give, in respect of acquiring it under s 110-25(2) of the ITAA 1997.
Note that this amount (ie, the first element of the CGT asset’s cost base) may, in some cases, differ significantly to the asset’s market value. Thus, where a withholding obligation arises, care is required to ensure that the correct amount is withheld. Moreover, further complexities may arise if the transaction is subject to goods and services tax. Accordingly, expert advice should be obtained.
The relevant withholding amount is due for payment to the ATO on or before the day you become the owner of the asset, which is typically settlement in the context of a sale transaction.
Various penalties apply for non-compliance with the Withholding Regime. These include administrative penalties in relation to clearance certificates where a person makes a false or misleading statement to the Commissioner, and penalties for failing to withhold. The offence of failing to withhold is one of strict liability, meaning that a potential withholder will be liable for the offence even if his or her failure to meet a withholding payment obligation is unintentional.
SMSF trustees, members and advisers should ensure they are aware of their obligations under the Withholding Regime and should take appropriate action to ensure that these obligations are appropriately satisfied. Expert advice should be sought where there is any doubt.