Proposed changes to Australia’s foreign resident capital gain tax regime

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Treasury has released a Consultation Paper on the Federal Government’s proposal to amend Australia’s foreign resident capital tax regime. Among other changes, the main change that will impact many investing in Australian infrastructure and energy will be the broadening of the types of assets for which foreign residents will be subject to capital gains tax.

25 July 2024

In Brief

Consultation has commenced on the Government’s proposals to amend the capital gains tax (CGT) rules which apply to foreign residents. This includes a consultation paper which addresses the 2024-25 Federal Budget proposal to strengthen the rules as well as draft law to give effect to the 2023-24 Mid-Year Economic and Fiscal Outlook proposal to increase the foreign resident capital gains withholding (FRCGW) tax rate and reduce the withholding threshold that currently applies to real property interests.

In Detail

The current foreign resident CGT regime broadly seeks to tax foreign residents on three types of assets - taxable Australian real property, indirect Australian real property interests (IARPI) (i.e. shares and other membership interests in entities that predominantly hold Australian real property) and assets used in an Australian permanent establishment. Furthermore, there is a form of withholding by the purchaser from the relevant proceeds relating to the disposal of relevant CGT assets.

Strengthening the foreign resident CGT regime

The consultation paper addresses the Budget proposal to strengthen the foreign resident CGT regime in relation to CGT events commencing on or after 1 July 2025 by way of:

clarifying and broadening the types of assets on which foreign residents are subject to CGT to ensure assets with a close economic connection to Australian land and/or natural resources are appropriately captured within the tax law
amending the point-in-time principal asset test to a 365-day testing period (applicable to IARPI) so as to address an integrity risk preventing a CGT-free sale of membership interests at a time when the underlying entity does not derive more than 50 per cent of its market value from taxable Australian real property, and
requiring foreign residents disposing of shares and other membership interests exceeding $20 million in value to notify the Australian Taxation Office (ATO) prior to the transaction being executed.

Comments can be made on the consultation paper by 20 August 2024.

The proposed measure to clarify and broaden the CGT base for foreign residents is said in the paper to be consistent with accepted international tax principles and appropriate since these assets derive their economic value from the use of Australian land and/or natural resources. This change will have a particular impact in determining whether shares or other membership interests in an Australian entity represent IARPI and potentially raise specific and complex valuation issues.

The consultation paper lists the following as examples of the sort of assets that would fall within the proposed broader foreign resident CGT base:

Leases or licenses to use land situated in Australia, including pastoral leases and licences, or a lease of 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 which includes land subject to a mining, quarrying or prospecting right of an entity. Some examples set out in the consultation paper include energy and telecommunications infrastructure such as wind turbines, solar panels, batteries, transmission towers, transmission lines and substations. Transport infrastructure has also been included which cover rail networks, ports and airports, and heavy machinery installed on land for use in mining operations (e.g. 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 per cent of the underlying entity’s market value is derived from the above assets.

Accordingly, any foreign investor in Australian infrastructure, transport, energy and resources sectors will be affected by this change.

No consultation questions have been asked in relation to this measure in the consultation paper. However, it is unclear as to the breadth of this proposal and the extent to which an asset may be considered to have a “close economic connection” to Australia. This may not always be clear. Note that the paper indicates that it is not proposed to extend the application to the disposal of livestock and equipment used in agriculture and forestry, even though arguably these assets have an economic connection to the land.

The amendments are proposed to apply to CGT events on a prospective basis. There is no mention in the consultation paper about a transitional rule so as to grandfather existing assets held by foreign residents that currently are not subject to CGT but which may now be brought into the Australian tax net under the broadened CGT base.

While this has not been previously announced, the consultation paper also flags views on the appropriateness of the policy principle to continue to exclude economic interests that derive their value from taxable Australian real property (such as by creating a ‘total return swap’ which may ultimately give rise to a future acquisition of the underlying asset) held by a foreign resident from Australian CGT. Although the general anti-avoidance rules, and other specific integrity rules, in the tax law will continue to apply, the prospect of additional integrity rules being considered is raised.

Principal asset test

In terms of the proposed amendment to the point-in-time principal asset test to a 365-day testing period (applicable to indirect real property interests), a practical question will arise as to how taxpayers will practically monitor valuations of their investments over a 12 month period and in particular will this add an additional compliance burden and cost for foreign investors that would not otherwise be relevant for Australian resident investors.

Requirements to notify the ATO

The proposed requirement for notifying the ATO in relation to CGT events from 1 July 2025 is that a foreign resident vendor disposing of membership interests exceeding $20 million in value must notify the ATO when they make a declaration to a purchaser that the sale is ‘not an indirect Australian real property interest’ (non-IARPI), i.e. that it is not subject to CGT. Treasury is interested in views on the appropriateness of the $20 million threshold.

The proposal is that the ATO notification be made by the vendor in an approved form at least 28 days before the earlier of relevant CGT event or settlement. The prospect of a longer period of time to notify the ATO is put forward in the consultation paper in the interests of enhancing the ATO’s ability to review the declaration and potentially disagree with the assertion and recommend that the transaction be subject to FRCG withholding.

There is no change for vendors who are of the view that a transaction is in respect of an IARPI and hence subject to CGT (and consequential FRCGW by the purchaser). In all other cases where declarations that the asset is non-IARPI are made, the vendor should be prepared for potential ATO scrutiny as the notification requirement will provide the ATO with information on high value transactions and in close to real time. This may create uncertainty as to the timing of transactions and in particular, whether it will impact completion and the flow of funds in a transaction.

Changes to FRCGW rate and threshold

Since 1 July 2016, the FRCGW regime has applied to impose an obligation on the purchaser of certain Australian real property and related interests to withhold an amount from the applicable proceeds and remit this amount to the ATO where the relevant property is acquired from a foreign resident vendor. The amount withheld is not a final tax in that the vendor is entitled to a credit for any amounts withheld following the lodgment of an income tax return on the making of an income tax assessment.

The draft law proposes the following changes:

increase the rate at which withholding applies for relevant CGT assets from 12.5 per cent to 15 per cent, and
removing the current $750,000 threshold before which withholding applies for transactions involving either taxable Australian real property or an indirect Australian real property interest that provides company title interests.

These changes will apply to acquisitions of relevant CGT assets (typically the date of contract) made on or after the later of 1 January 2025 and the commencement of this measure which will be 1 January, 1 April, 1 July or 1 October following enactment of the rules.

The Commissioner’s power to vary the rate of withholding by a purchaser will continue to apply and for some taxpayers this may become particularly important in light of the changes.

We previously have seen both the rate and the threshold change since the FRCGW rules first applied. The draft explanatory materials indicate that the planned increase in the current 12.5 per cent withholding rate is due to this rate increasingly resulting in a shortfall of assessed income tax payable on capital gains of foreign residents, particularly due to the upwards shift in the value of Australian real property.

Comments can be made on the draft law by 5 August 2024. It is expected that these amendments will progress quickly through Parliament so that they can be enacted well in time before a potential 1 January 2025 start date.

The Takeaway

The proposed amendments to broaden the foreign resident CGT base will have a significant impact on foreign investment into these new targeted Australian asset classes and in particular infrastructure and energy projects. An additional tax impost may add to the all-in cost associated with these projects and therefore may impact the type of investors who will likely invest in these assets.

Notwithstanding that the consultation paper states this proposed change will bring foreign residents’ CGT outcomes into closer alignment with the tax treatment for Australian residents, and with international tax best practice, there will be a significant Australian tax rate differential between foreign investors and complying Australian superannuation funds which have a 10 / 15 per cent CGT rate on exit for these types of investments.

Affected taxpayers will need to be aware of the consequences of these upcoming changes before entering into a transaction for the sale or purchase of any direct or indirect real property interest. There will still be uncertainty in the market as to the breadth of these measures so the consultation process and future legislation will be critical.

Contact us

If you would like to further discuss this alert, reach out to our team or your PwC adviser.

Christina Sahyoun

Infrastructure, Partner, Sydney, PwC Australia

+61 403 658 464

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Luke Bugden

Partner, NSW Tax Leader, Sydney, PwC Australia

+61 412 695 670

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Glenn O'Connell

Partner, Infrastructure and Deals Tax Lead Partner, Brisbane, PwC Australia

+61 409 000 370

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Mark Edmonds

Partner, Infrastructure, Sydney, PwC Australia

+61 2 8266 1339

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Kirsten Arblaster

Partner, Tax, Melbourne, PwC Australia

+61 3 8603 6120

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Steve Ford

Partner, Sydney, PwC Australia

+61 (2) 8266 3433

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Proposed changes to Australia’s foreign resident capital gain tax regime

Strengthening the foreign resident CGT regime

Principal asset test

Requirements to notify the ATO

Changes to FRCGW rate and threshold

Contact us

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