Proposed Amendments to Australia’s Foreign Resident CGT Regime Could Materially Prejudice Capital Allocation Decisions

Treasury recently concluded consultation on proposed amendments to Australia’s foreign resident capital gains tax (CGT) regime contained in Division 855 of the Income Tax Assessment Act 1997 (ITAA 1997), which are additional and complementary to recent exposure draft legislation to increase the integrity of the foreign resident capital gains withholding regime .

The proposed amendments, which were first announced in the Federal Budget on 14 May 2024, and are forecast to increase net receipts by approximately $592 million over the forward estimates period, comprise measures to:

• Clarify and broaden the types of assets on which foreign residents are subject to CGT;
• Shift the point-in-time principal asset test (PAT) to a 365-day testing period; and
•  Introduce a requirement for foreign residents disposing of prescribed interests to notify the Australian Taxation Office (ATO) in advance of such disposal being executed.

No grandfathering or transitional provisions have been announced in connection with the proposed amendments, which are slated to apply to CGT events on or after 1 July 2025.

In Detail

Key features of each of the three measures are described in detail below.

Types of Assets Subject to Foreign Resident CGT

Broadly, whereas Australia’s foreign resident CGT regime is largely restricted to CGT events referable to CGT assets that are direct and indirect interests in taxable Australian real property (TARP), Treasury has flagged its concern that the absence of a legislative definition of ‘real property’ gives rise to an impermissible imbalance in Australia’s tax system.

Specifically, in the absence of a legislative definition of ‘real property’, reliance on State and Territory statutory severance legislation has given rise to inconsistency in the tax treatment of assets depending on their situs, which does not arise for domestic residents and creates distortions that can affect competition and undermine Australia’s tax system. The consultation paper appears to reference the contrasting outcomes in the Victorian case of AWF Prop Co 2 Pty Ltd v Ararat Rural City Council [2020] VSC 853 and subsequent New South Wales case of SPIC Pacific Hydro Pty Ltd v Chief Commissioner of State Revenue [2021] NSWSC 3951 as an example of such inconsistency[1]. Treasury also expresses its view that the current concept of ‘real property’ does not adequately capture assets with a close connection with Australian land/or natural resources.

Although no consultation questions are posed in relation to this measure, and no legislative definitions are expressly proposed, the following assets are identified as having the requisite close economic connection to Australian land and/or natural resources:

• Leases or licenses 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; 
• 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 prospective right of an entity, 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;
  •  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); and
• A non-portfolio membership interest in an entity where more than 50% of the underlying entity’s market value is derived from the preceding assets.

Treasury do pose some questions regarding the appropriateness of reforms to capture the disposal of economic interests in or rights to future income over TARP (e.g., total return swaps).

Shift of the PAT

Also proposed is an extension of the testing period of the PAT for indirect Australian real property interests (IARPI), the broad intention of which is to define when an entity’s underlying value is principally derived from Australian real property. 

The PAT currently operates as a point-in-time test, which is arguably inconsistent with Article 13 of the OECD Model Tax Convention, as well as the Multilateral Instrument, which Australia has ratified. Accordingly, to address associated integrity risk associated with actions that may precede the sale of relevant interests, this measure will amend the testing period for the PAT to be the 365 days preceding the disposal of relevant interests. If the underlying entity derives more than 50 per cent of its market value from TARP at the time of testing or at any time during the preceding 365 days, it will satisfy the PAT.

ATO Notification Requirement

To address current information asymmetry through the provision of information regarding high-value transactions, it is also proposed that foreign resident vendors disposing of membership interests exceeding $20 million in value must notify the ATO of a vendor declaration made to the purchaser that the sale is not of IARPI. 

The notification must be made in an approved form before the relevant CGT event or settlement (whichever is earlier) and will trigger a prescribed ATO review period (subject to consultation outcomes, of between 28 days to 60 days). Treasury cite the recent Federal Court case of Deputy Commissioner of Taxation v State Grid International Australia Development Company Limited [2022] FCA 139 wherein the ATO obtained freezing orders against a foreign resident vendor who had provided a non-IARPI vendor declaration that the ATO contested, as an example of the compliance risks posed by the current system of vendor declarations. 

RSM View 
Whilst reform to improve the integrity of Australia’s tax system is always welcome, we have a number of concerns with the measures as currently described in Treasury’s consultation paper, including:

• The inherent tension between augmenting Australia’s base and deterring foreign investment, particularly with respect to clean and renewable energy projects, which despite being of critical importance to Australia’s clean energy transition, appear to be squarely within the crosshairs of the first measure. This is of particular concern, given the heavy reliance of these sectors on foreign capital investment; 
• The apparent lack of grandfathering or transitional provisions, which would subject existing foreign investors to tax liabilities that were not anticipated at the time of investment, bringing into question the level of tax stability in Australia, which compounds our first concern regarding the increased cost of doing business in Australia. In this regard, it is noted that it is not unprecedent for transitional relief to be provided in the context of Division 855 – see subsection 855-25(3), which afforded market value cost base (as at the date of the Treasurer’s announcement to introduce Division 855) to IARPI not previously taxable for foreign residents;
• The practical difficulty inherent in a 365-day test period for the PAT. The incorporation of sensible rules to account for temporary failures (similar to that provided by the note to subsection 152-40(3A) of the ITAA 1997), or a two-point test (i.e., start and end of period) would be welcome; and
• The accuracy of certain assumptions made regarding the alignment of the proposed amendments to international tax rules is uncertain (e.g., whether the assets enumerated in respect of the first measure would correspond to ‘immovable property’ or ‘property accessory’ thereto), which could have material ramifications in terms of the overlay of Australia’s double tax agreements. 

In summary, whilst the proposed amendments to Division 855 have the potential to prejudice capital allocation decisions by foreign resident investors, Treasury’s consultation on the proposed amendments is welcome, and we remain optimistic that the final legislation will appropriately counterbalance relevant considerations. 

FOR MORE INFORMATION

Please contact your local RSM advisor should you wish to discuss or seek advice on the potential application of the proposed amendments to your organisation.