The 'CGT' effect

The Tax Laws Amendment (2006 Measures No 4) Bill 2006 was introduced into Parliament on 22 June 2006, and one of the changes is to reform the Capital Gains Tax (CGT) treatment of Australian assets owned by foreign residents.

The bill is applicable to CGT events occurring on or after Royal Assent.

The changes will better align Australia’s taxation of foreign residents with Organisation for Economic Cooperation and Development (OECD) practice through narrowing the range of assets on which foreign residents will be subject to Australian CGT.

Under the current law, a foreign resident pays CGT on a broad range of assets having the necessary connection with Australia. When the new law comes into effect, a foreign resident will pay CGT only on taxable Australian property, held directly or indirectly.

‘Taxable Australian property’ is defined under the new S855-15 of the Income Tax Assessment Act 1997, and replaces the current nine categories of assets that are collectively referred to as assets ‘having the necessary connection with Australia’.

Taxable Australian property includes real property assets and the business assets of a foreign resident’s permanent establishment in Australia. Real properties include a mining, quarrying or prospecting right (to the extent that the right is not real property), where the minerals, petroleum or quarry materials are situated in Australia.

An ‘indirect interest’ in an Australian real property will only exist where a foreign resident has a membership interest in an entity, and that interest passes two tests: the non-portfolio interest (10%) test, and the principal asset (50%) test.

A foreign resident with an interest of less than 10% in Australian entities will not be subject to Australian CGT. Where a foreign resident holds more than 10% in an entity, more than 50% of the value of the entity’s assets must be attributable to Australian real property before there are Australian CGT consequences. Assets are measured at fair market value, i.e. the amount that a willing purchaser, acting at arm’s length to the seller, would pay for the asset. Where a market valuation is not available, the asset value determined under the revaluation method in the audited accounts of the entity may be used. These accounts must be prepared in accordance with the Australian equivalents to the International Accounting Standards. The bill applies to all foreign residents, be they individuals, companies, trusts or trustees of foreign trusts who hold interests in Australian assets or resident entities. The existing policy for taxpayers ceasing to be residents of Australia remains unchanged. A taxpayer, upon ceasing to be an Australian resident, is deemed to have disposed of all assets other than those assets continuing to have the necessary connection with Australia or assets acquired before 20 September 1985.

A foreign resident taxpayer, on becoming a permanent Australian resident, is deemed to acquire those assets that would not be taxable Australian property if held by a foreign resident. Those assets will be valued in line with existing practice whereby the cost base is the market value of the relevant asset at the time of the foreign resident becomes an Australian resident.

A temporary resident taxpayer, who is a foreign resident, will have a capital gain or loss disregarded as a foreign resident under the new law.

Rollovers of taxable Australian property between an Australian resident and a foreign resident, or between two foreign residents, will continue to be available.

The new law maintains equity across all investments by including direct and indirect holdings in calculating the ownership of an ultimate foreign resident in taxable Australian properties before CGT is applicable. Interposed entities that have been set up by foreign investors to avoid CGT consequences will be ineffective under the new law.

Pansy Kwan BBA (Hons) FCCA FCPA is an accountant and writer.