CGT for foreign residents – ‘principal asset test’ | KPMG | AU

CGT for foreign residents – ‘principal asset test’

CGT for foreign residents – ‘principal asset test’

Jenny Wong discusses changes for foreign residents in relation to CGT treatment of small interests in Australian real property.

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Director, Tax

KPMG Australia

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Tucked away in the Federal Budget 2017-18 announcements are proposals to change the capital gains tax (CGT) treatment for foreign residents that have small interests, through shareholdings, in Australian real property. We now have an Exposure Draft legislation on this, released on the Treasury’s website on 21 July 2017.

Under the current law, it seems possible to disaggregate and have a number of small indirect interests in Australian real property ultimately held by foreign residents and avoid a CGT liability. The new proposals will ensure any associates are included in the testing of whether a CGT liability arises for the foreign resident in relation to disposal of interests in Australian real property.
Technically though, this is what the changes will do.

Consider this example:
 

Assume Foreign Resident will simultaneously dispose of its interests in A Co and B Co. Foreign Resident will make a capital gain or loss when it dispose of its membership interests in A Co and B Co if both the non-portfolio interest test and the principal asset test are satisfied.

The non-portfolio interest test (section 960-195) is satisfied in relation to each of these holdings as Foreign Resident holds more than 10 percent of the
membership interests in A Co and B Co respectively.

Foreign Resident’s interest in A Co passes the principal asset test if the sum of the market values of A Co’s assets that are taxable Australian real property (TARP) exceeds the sum of the market values of its assets that are not taxable Australian real property (non TARP).

Now, if the entity being tested A Co holds a membership interest in another entity (which it does, Aus Land Rich Co), the membership interest is treated as if it were two assets — a TARP asset and a non-TARP asset.

Under the current law (s855-30 ITAA 97), if A Co’s direct participation interest in the other entity is less than 10 percent then the market value of the deemed TARP asset is taken to be nil, which would result in the principal asset test not being passed in relation to Foreign Resident’s membership interests in A Co when it disposes of it and hence, there is no Australian CGT liability. The same analysis would apply to the disposal of membership interests in B Co.

Under the proposed changes, the market value of the deemed TARP asset is taken to be nil if the total participation interests (as defined in section 960-180) held in the other entity by the foreign resident holding entity and its associates (as defined in section 318Income Tax Assessment Act (ITAA) 36) is less than 10 percent.

In this example, the market value of the deemed TARP asset will be taken to be nil if the total participation interests Foreign Resident and its associates hold in Aus Land Rich Co is less than 10 percent. However, this does not apply because the total participation interests Foreign Resident and its associates (A Co and B Co) hold in Aus Land Rich Co is 16 percent. Consequently, for the purpose of applying the principal asset test in relation to the interests. Foreign Co holds in A Co and B Co, the market value of the deemed TARP asset and the deemed non-TARP asset must be worked (item 2 of the table in subsection 855-30(4)) to see if the principal asset test is passed and Australian CGT liability arises.

These amendments apply in relation to CGT events happening at or after 7:30 pm, by legal time in the Australian Capital Territory, on 9 May 2017. If you have these sort of structures in place with minority interests in Australian land rich companies and planning to dispose of your interests, you may want to review them. 

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