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Foreign residents and the sale of land

Foreign residents and the sale of land

By David P Lloyd

Capital Gains Tax 

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Changes to the foreign resident capital gains withholding regime, including a drop in the price threshold from $2 million to $750,000 came into effect on 1 July 2017.

Snapshot

  • A purchaser of land from a “foreign resident” has to pay an “amount” to the Commissioner on becoming the owner of the land.
  • An amendment to the legislation which took effect on 1 July 2017 decreases the $2 million market value threshold to $750,000.
  • A sale price at or above the threshold sum attracts the operation of the foreign resident capital gains withholding regime.

The 2017 federal budget saw the announcement of two important changes to the foreign resident capital gains withholding regime from 1 July 2017. Legislation giving effect to the changes has been enacted and is now in force.1 Special condition 1B of the Contract of Sale of Real Estate co-published by the Law Institute of Victoria and the Real Estate Institute of Victoria 2 has been modified to reflect the changes.

The legislation

The foreign resident capital gains withholding regime was established in 2016 by legislation 3 which added Subdivision 14-D of Schedule 1 to the Taxation Administration Act 1953 (Cth) (TAA) headed “Capital proceeds involving foreign residents and taxable Australian property”.

In broad terms, by s14-200(1) of Schedule 1 to the TAA, a purchaser of land from a “foreign resident” is obliged to pay an “amount” to the Commissioner on becoming the owner of the land as a result of acquiring it, and s14-200(2) requires the payment to be made when the purchaser becomes the owner of the land. The regime does not impose a tax as such, but rather an obligation on the part of the purchaser to make a payment on account of the vendor’s potential liability for capital gains tax arising as a consequence of the sale of the land.

The legislation applies to the sale of all land, whether improved or not and whether it is used for residential, commercial or other purposes.

The payment obligation arises in respect of a contract of sale entered into on or after 1 July 2016. Section 43 of the Tax and Superannuation Laws Amendment (2015 Measures No.6) Act 2016 (Cth) provides for the new measures to apply to acquisitions on or after 1 July 2016. Section 109.5(2) of the Income Tax Assessment Act 1997 effectively provides that the time of acquisition for capital gains tax purposes is the date when a contract is entered into.

Section 14-215 of Schedule 1 to the TAA lists transactions which are excluded from the ambit of the foreign resident capital gains withholding regime. One of these is where the land has a market value of under $2 million. Effectively, where the purchase price of the land has been agreed on at arm's length and is under $2 million, no payment is required by the legislation. The amendment to the legislation, which took effect on 1 July 2017, decreases the $2 million limit to $750,000. Obviously, far more sale of land contracts will fall within the ambit of the regime after that date.

Concept of foreign resident

The concept of foreign resident is dealt with in s14-210 of Schedule 1 to the TAA in terms of a purchaser knowing or reasonably believing that a vendor is a foreign resident, or not reasonably believing that the vendor is an Australian resident. Section 14-210(2) supplies what might be described as a lifeline for purchasers in the form of a “clearance certificate” relating to the vendor under s14-220(1) of Schedule 1 to the TAA, on the provision of which the payment obligation under s14-200 does not arise.

The 'amount'

Section 14-200(3) of Schedule 1 to the TAA originally defined the “amount” as 10 per cent of the first element of an asset’s cost base just after acquisition by the purchaser less any option fee consideration that has been paid, subject to variation by the Commissioner of the amount in accordance with s14-235(2). The amendment which took effect on 1 July 2017 increases the percentage to 12.5 per cent.

The Commissioner advises4 purchasers who are required to pay an amount to apply the relevant percentage to the actual purchase price set out in the contract or alternatively to pay such other sum as is set out in a variation document issued by the Commissioner under s14-235(2) of Schedule 1 to the TAA.5 In practical terms, the payment will need to be made immediately after settlement of the contract of sale.

No payment by a purchaser is required when the Commissioner has issued a clearance certificate under s14-220(1) of Schedule 1 to the TAA, which is still current for the purposes of the legislation at the time of settlement of the contract.

Section 16-20 of Schedule 1 to the TAA effectively entitles the purchaser to deduct the relevant amount from the contract consideration by providing that the purchaser is discharged from any liability to pay the amount to any person other than the Commissioner. However, the legislation does not oblige the purchaser to withhold the amount from the contract consideration.

Special condition 1B

Special condition 1B of the standard contract is designed not to replicate but to complement the legislation, and at the same time to provide some measure of protection to both vendor and purchaser. For instance, under the special condition:

the vendor has an obligation to supply to the purchaser before settlement such information as is necessary to enable the purchaser to complete the purchaser payment notification form which is required to accompany payment of the amount to the Commissioner after settlement; and

there are mechanisms which are designed to ensure that any amount withheld from the settlement sum is paid to the Commissioner following settlement.Special condition 1B as originally drawn was stated to apply6 only if the purchaser is required to pay the Commissioner an amount in accordance with s14-200(3) or s14-235 of Schedule 1 to the TAA because one or more of the vendors is a foreign resident, the property has or will have a market value of $2 million or more just after the transaction, and the transaction is not excluded under s14-215(1) of Schedule 1 to the TAA. As already mentioned, the threshold market value has decreased to $750,000 from 1 July 2017.

Special condition 1B.2 provides that every vendor under the contract is a foreign resident for the purposes of special condition 1B unless the vendor gives the purchaser a clearance certificate under s14-220(1) of Schedule 1 to the TAA.

The legislation allows the purchaser to deduct the relevant amount from the contract consideration, and special condition 1B.4 gives the purchaser an entitlement to do so under the contract. The time for deduction of the amount from the purchase money will logically be at settlement of the contract, because this is when the purchaser’s payment obligation arises under the legislation. Usually, 90 per cent of the price will be payable at that time where the deposit was 10 per cent. There may be a difficulty if the full percentage amount to be paid to the Commissioner is to be deducted at settlement and there is a mortgagee seeking payment of more than whatever sum is available at settlement. In that scenario settlement may fail, but this would not be the fault of the purchaser.

The amount to be deducted will generally be the relevant percentage of the sale price set out in the contract or such other sum as is set out in a variation document issued by the Commissioner under s14-235(2) of Schedule 1 to the TAA. No deduction is warranted if a clearance certificate under s14-220(1) of Schedule 1 to the TAA has been supplied to the purchaser before settlement.

Special conditions 1B.5 and 1B.6 are intended to protect the vendor by ensuring, as far as possible, that any amount withheld at settlement is in fact paid over to the Commissioner. The Commissioner will not be attending settlement to collect a cheque for any amount payable. A failure on the part of the purchaser to pay the necessary amount to the Commissioner results in the purchaser being liable to pay a penalty to the Commissioner,7 but withholding of the amount from the settlement proceeds does not discharge any liability of the vendor for capital gains tax arising as a result of the transaction.

Responsible third party

Special condition 1B.5 requires the purchaser to engage either a legal practitioner or conveyancer, who is described as a “representative”, to conduct all the legal aspects of settlement including the performance of the purchaser’s obligations under the legislation and special condition 1B, and further obliges the purchaser to ensure that the person so appointed actually does so. The objective is to make sure that a responsible third party8 rather than the purchaser has control over the funds.

Special condition 1B.6 provides that the terms of the representative’s engagement are taken to include instructions to have regard to the vendor’s interests; instructions that the representative must pay or ensure payment of the relevant amount to the Commissioner as soon as reasonably and practicably possible from money under the control or direction of the representative; and instructions that the representative must promptly provide the vendor with proof of payment. For the sake of completeness, it is spelt out that the instructions are taken to require the representative to otherwise comply, or ensure compliance with, special condition 1B. Special condition 1B.6 goes on to provide that the terms of the representative’s engagement are taken to include such instructions despite any express contrary instruction except one emanating from both vendor and purchaser, and despite any other provision to the contrary elsewhere in the contract.

Special condition 1B.7 provides for the representative to be taken to have complied with special condition 1B.6 if settlement is conducted electronically through the electronic conveyancing system operated by Property Exchange Australia Ltd (PEXA) or any other electronic conveyancing system agreed by the parties and the amount is included in the settlement statement with a requirement as to payment being made to the Commissioner.

Special condition 1B.8 provides that a clearance certificate under s14-220(1) of Schedule 1 to the TAA or a document evidencing variation of the amount in accordance with s14-235(2) of Schedule 1 to the TAA must be given to the purchaser at least five business days before the due date for settlement. This is designed to allow the purchaser enough time to prepare a settlement statement9 setting out how the funds due to the vendor at settlement of the contract are to be disbursed.

There is nothing preventing the vendor providing a clearance certificate or variation document to the purchaser before that time. It could be provided at the time the contract of sale is entered into, or included in the section 32 statement as additional information if desired.

What has changed?

The significant change to special condition 1B is that the reference to the sum of $2 million has been replaced with a reference to the relevant section of Schedule 1 to the TAA. This serves the dual purpose of accommodating any future changes to the threshold market value sum and allowing the revised special condition to be used in all contracts of sale, whether entered into before or after 1 July 2017. Apart from that, some minor improvements have been made to the wording of the special condition.

What action needs to be taken?

The obligation on the part of a purchaser to pay 12.5 per cent of the sale price to the Commissioner will apply to settlement of a contract of sale of land which is entered into on or after 1 July 2017, and not to settlement of a contract of sale of land entered into on or after 1 July 2016 and before 1 July 2017 which takes place after that date,10 for which the appropriate percentage is still 10 per cent.

In a similar vein, the new threshold sale price of $750,000 is applicable to a contract of sale of land entered into on or after 1 July 2017, whereas the original threshold of $2 million remains applicable to a contract entered into on or after 1 July 2016 and before 1 July 2017.11 In both cases, it is a sale price at or above the threshold sum that attracts the operation of the foreign resident capital gains withholding regime.

In terms of mechanics, a separate sheet containing the new special condition 1B (together with the existing special condition 1A) has been printed for solicitors and estate agents, and the online version of the standard contract has been amended. The new special condition 1B is primarily designed for use in contracts entered into on or after 1 July 2017, but is compatible with contracts entered into before that date.

Postscript

At the time of writing, new special conditions for the standard contract were being prepared in anticipation of publication in September 2017. Special condition 5 will add a new general condition 15A which is in substantially the same terms as the existing special condition 1B.

 

David P Lloyd is a barrister with more than 37 years experience in property law. He co-authors the contract of sale of real estate co-published by the LIV and the REIV and is the lead author of Sale of Land Act Victoria and the forthcoming Victorian Land Contracts. He has been a member of the LIV Property Committee for more than 25 years.

 

1. Treasury Laws Amendment (Foreign Resident Capital Gains Withholding Payments) Act 2017 (Cth), which commenced on 1 July 2017.

2. Referred to in this article by the shorthand “standard contract”.

3. Tax and Superannuation Laws Amendment (2015 Measures No.6) Act 2016 (Cth).

4. The advice appears on the ATO’s website.

5. Which might be as low as zero.

6. Special condition 1B.3.

7. Equal to the amount that should have been paid.

8. Meaning someone required to have professional indemnity insurance.

9. In accordance with usual conveyancing practice.

10. The legislation referred to in footnote 1 provides for the amendments made by it to apply to acquisitions on or after 1 July 2017, in the same way that the Tax and Superannuation Laws Amendment (2015 Measures No.6) Act 2016 (Cth) provided for the new foreign resident capital gains withholding regime to apply to acquisitions on or after 1 July 2016. As previously noted, s109.5 (2) of the Income Tax Assessment Act 1997 effectively provides that the time of acquisition for capital gains tax purposes is the date when a contract is entered into.

11. Note 10 above.


Disclaimer: Views expressed by commentators are not necessarily endorsed by the Law Institute of Victoria Ltd (LIV). No responsibility is accepted by the LIV for the accuracy of information contained in the comments and the LIV expressly disclaims any liability for, with respect to or arising from any such views.

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