Foreign investors in Australian entities may be unaware that in some circumstances the Australian Taxation Office (ATO) can assess them for Australian tax on gains made from the sale of their investment. The circumstances in which tax can arise are described in this article. In addition, law changes are proposed which (amongst other matters) would, from 1 July 2016, require purchasers to withhold 10% from the purchase price and pay that to the ATO in some circumstances.

If such an assessment is issued, the ATO also has powers to collect that assessment, including to garnish or freeze the proceeds of sale to satisfy the assessment before those proceeds are remitted offshore. In our experience, the ATO issuing such assessments and garnishee notices has become more common, and foreign resident investors are not always aware how to react to and , some cases, how to challenge those assessments.

This article describes in general terms when such Australian tax could arise, and, if an assessment does arise to a foreign investor, how to deal with it.

Example used in this article

For the purposes of simplicity, this article will refer assessments arising for non-Australian resident shareholders in Australian companies and operates from a basic example of a non-Australian resident shareholder holding shares directly in an Australian company. We have operated from that basic example
because the most common assessments we have assisted non-Australian resident clients with have arisen as a result of a sale of shares in an Australian company.

However, it should be noted that:
(a) tax can arise on gains made from the disposal of investments in other entities, including particular kinds of trust; and
(b)  gains from a sale of shares in a holding company, which in turn holds shares in an Australian resident company, can, in some circumstances attract Australian tax.

When the ATO can assess Australian tax

There are two main requirements before any tax can arise. The two requirements test that the non-Australian resident shareholder holds a substantial interest in the Australian company, and (in broad terms) that more than 50% of the market value of the Australian company's assets arises from Australian real property assets.

Non-portfolio interest test

The first requirement tests that the non-Australian shareholder has a substantial interest in the Australian company. The requirement is that the non-Australian resident shareholder and/or its associates must hold a direct participation interest of 10% or more in the Australian company. This test can also be satisfied if such an interest was previously held for at least 12 months within the past two years. 

A direct participation interest can be shares or a right to acquire shares, or another interest in an Australian company which provides the non-Australian resident shareholder with rights to vote or participate in decision making, or provides rights to capital on winding up of the company. It should be noted that the interests of associates are also captured as part of this test.  What is an associate is a detailed definition, but for natural persons, associates include relatives, spouses, and partners for example.

Principal asset test

The second requirement tests that the underlying value of the Australian company is principally derived from Australian real property. The requirement is that the market value of the taxable Australian real property assets exceeds the market value of the assets that are not taxable Australian real property.

Assets that are taxable Australian real property include real property situated in Australia, including a lease of Australian land, mining, quarrying and prospecting rights for minerals, petroleum and the like situated in Australia.

It is only if both of these tests are met that the ATO can issue an assessment.

What to do if an assessment is issued to you

Often non-Australian resident shareholders are very surprised to receive an assessment from the ATO and take the view that they cannot be subject to Australian tax because they are not resident in Australia. This is not correct. Australian tax can arise on the basis of residence or source.[1]

To keep your rights alive if an assessment is received from the ATO you first need to seek advice from an experienced tax practitioner. Following that, you will need to either take steps to try and resolve and settle the matter with the ATO, and/or file an objection with the ATO within a fixed time period. The objection time
period can vary depending upon the underlying circumstances of the taxpayer, and can be 60 days, 2 years or 4 years. The usual course is to seek to do both – both file an objection and seek a resolution of the matter with the ATO. 

An objection needs to set out all of your grounds for objecting, as you will be limited to those grounds in any dispute that goes forward. This means it is important to obtain Australian tax advice and for the tax practitioner you engage to carefully formulate those grounds of objection.

Commonplace issues that arise include:
· The ATO considering persons to be associates when they are not – this is for the purposes of the non-portfolio interest test described above. If association does not arise, and as a result a less than 10% participation interest is held by the taxpayer, the entire assessment falls away.
· The ATO considering the principal asset test to have been passed, without obtaining a valuation of the underlying Australian company, or by making assumptions that certain assets are not counted for the purposes of that test. Often, if this is challenged by way of a competing valuation, this can result in a favourable outcome.
· The ATO not taking into account all of the costs incurred by the non-Australian resident shareholder in acquiring the shares in the first place. Often costs other than monetary costs are ignored – for example loan forgiveness, or the contribution of other property in return for shares. It is only the gains on sale that can be potentially taxable so the costs of acquiring the shares can reduce those gains

It is important that your arguments on objection are well formulated and supported at law and with documentary evidence. In addition, if additional evidence is sought (such as valuations of the underlying Australian company) care needs to be taken in instructing the valuer, and working with him or her. This means that a tax practitioner who is experienced in dispute management, in formulating evidence and in appearing before the courts should be instructed to assist at an early stage.

This will provide you with the best chance of succeeding with the ATO on objection or in settlement discussions, or, if the matter progresses further, before the courts.  

Minter Ellison's Tax Group can assist you if you have received an Australian Taxation Office
assessment. Please feel free to contact us. The contact details for our expert team can be found here.