After 6 months of the so-called foreign resident capital gains tax (CGT) withholding tax rules, companies undertaking public market transactions face uncertainty in their obligations in schemes of arrangement and on-market takeovers. Some tax advisers in the Australian market are understandably taking quite strict interpretations of the rules, but to the detriment of the transaction.
The following is a guide to practically dealing with some, but by no means all, of the uncertainty in these transactions.
What are the foreign resident CGT withholding tax rules?
Since 12 December 2006, foreign residents have been taxable in Australia on capital gains made on Australian land or indirect interests in Australian land (taxable Australian property (TAP)) (as well as certain income or gains of a revenue character, which are not discussed in this article).
The foreign resident CGT withholding tax rules were enacted on 25 February 2016, with effect for transactions occurring from 1 July 2016. They were first announced on 14 May 2013 as a strengthening of the non-resident CGT rules. However, arguably, they hark back to November 2009, when the Australian Taxation Office (ATO) unsuccessfully tried to seize proceeds from TPG’s sale of Myer on account of tax.
What is in a name?
Ironically, the rules do not operate in line with their name. This creates a few issues in public market transactions.
- It is not a withholding tax. There is no statutory obligation to withhold tax from payments of consideration. Instead, there is an obligation on the buyer to pay the amount determined under the rules to the ATO. Statutorily, that amount “can also be treated as withholding payments” and the buyer is “discharged from all liability to pay or account for that amount to any entity” other than the ATO.
Instead of dealing with the relevant issues directly, the Government has dealt with them by beating around the bush. The problems with this approach are obvious – in the absence of a statutory obligation to withhold, a contractual right must be sought, which is not available in public market transactions; and absolution for the “withholding” does not adequately address the conflict between the requirements of the corporations law and the tax law, especially in the absence of a statutory obligation to withhold.
- It does not apply to CGT only. It applies to all income tax, including tax on revenue account (for example, disposals by private equity, disposals of inventory and depreciating assets).
- It does not apply to foreign residents only. Provided that there is at least one non-resident, the whole transaction (and not merely the transaction effected by non-residents) is caught by the rules.
To its credit, the ATO has recognised this is a problem and tried to deal with it through a variation (broadly, a document that applies a variation to the rate of withholding, similar to the PAYG withholding tables employers would be familiar with, except in this case the ATO has used a principle, rather than a specific rate). However, the variation only deals with the overall amount required to be paid to the ATO; not the withholding of amounts from individual sellers, resulting in the absurd position that a smaller percentage must be withheld from every seller.
A logical and practical approach is to treat the disposal of each share as a separate transaction, which is a theme adopted throughout the tax law. Yet, here, the ATO clearly did not see that this interpretation was open, necessitating this principled variation. We suspect the ATO’s approach arises from the fact that the relevant trigger for the withholding is the reference to there being at least one non-resident, a part of the provisions that would be robbed of operation if the practical approach was to be adopted.
- The rules apply where the asset acquired is TAP. In the case of shares and units, this requires a tracing through to underlying assets of the entity being acquired. Even the acquisition of a minority interest of above 10% of an entity triggers the provisions. So the buyer in a off-market takeovers and minority acquisitions is required to determine the nature of the asset being acquired with imperfect information, and yet faces penalties for failing to withhold correctly.
In schemes that Gilbert + Tobin has acted on recently, we have seen buyers demanding warranties from company directors as to the whether the shares in the company are TAP. We have also seen a reluctance on tax advisers to provide definitive advice in this regard, often at critical stages of the scheme process. Shareholders face the situation where a literal reading of the rules, without such warranties from the company, could mean that tax is withheld from the scheme consideration.
- The withholding amount is determined by reference to the buyer’s cost base in the asset just after acquisition, not consideration provided. Cost base can be markedly different to consideration provided. Certain scrip-for-scrip acquisitions can result in differences between the consideration provided and the cost base for the target shares. This will not always be ascertainable by the time that the shares or units are acquired.
- Unconditional off-market takeovers result in a series of acquisitions over time. Each acquisition triggers the payment obligation if all of the other conditions are satisfied, with just as many payments to the ATO.
- The provisions do not deal with nominee shareholders. In such cases, the acquirer should be entitled to rely on the apparent residence of the nominee to determine its withholding obligations. But there is no mirroring withholding obligation on the nominee.
What to do in schemes
The first thing to do is determine, as best as a buyer can, whether the shares or units that are subject to the scheme are TAP. Even if this is only an approximation, it will give the buyer a degree of comfort around the risk it is assuming. In a scheme that has the support of the company, this is obviously a much easier process, with due diligence enabling the ascertainment of the TAP status.
If the shares or units are (or could be) TAP, in the scheme booklet, court orders, shareholder voting resolutions and other related documents (collectively, scheme documents), specific agreement must be sought from shareholders on the following:
- A declaration that the relevant shareholder is an Australian resident (but watch out for the 6 month validity of such declarations);
- consent to withhold tax of 10% from the payments otherwise due to them (but do not use words that refer to a statutory obligation to withhold); or
- withhold a varied amount or rate of tax from those payments. Shareholders would be given a mechanism with the forms to be returned to the company to specify the varied rate and provide evidence of the approved variations from the ATO.
The scheme documents must approve the different amounts being paid to resident versus non-resident shareholders.
In time, the courts, the Australian Securities and Investments Commission and the Australian Securities Exchange may require a higher standard of disclosure from companies implementing schemes, specifically confirmation of whether the shares in the company are TAP (such as by inclusion in class rulings). This may obviate the need for individual shareholder actions in many cases.
What to do in off-market takeovers
Like in schemes, the first thing to do is determine, as best as a buyer can, whether the shares or units that are subject to the scheme are TAP. However, unlike a scheme, there is unlikely to be co-operation about access to information to form this view.
In the absence of appropriate mechanisms within the corporations law and the tax law, the best that can be done is to seek a ruling from the ATO that either:
- Varies the payment that must be made down to nil (which potentially means a loss to the revenue, so it is questionable how often the ATO would make such a variation); or
- Confirms that the shares in the target are not TAP, a determination which must be made with imperfect information, which the ATO may well be willing to do in relatively clear cases (for example, an information technology company which shows no land or buildings on its financial statements). Alternatively, the ATO certainly could exercise its powers to compel the target to produce relevant information to enable it to make its determination, but this would seem highly unlikely.
There is no doubt that the foreign resident CGT rules are difficult to apply in takeovers. A literal reading of the provisions is unworkable and a practical approach must be taken. ATO guidance or amendments to the law would go a long way in this regard.