Generally under Australian law, residents are taxed on their worldwide income and on capital gains from the disposal of most assets. Foreign residents are taxed their Australian sourced income and on capital gains from the disposal of taxable Australian property.
The income tax law is contained in various acts of the Australian Parliament and in a number of double taxation agreements which Australia has with other countries.
The tax law is administered by the Australian Taxation Office, which has also issued extensive administrative guidance on obligations imposed by Australia’s taxation law. Further information on taxpayers’ obligations under Australia’s taxation laws is available on the ATO website.
The Australian Government expects foreign enterprises operating in Australia to meet all obligations imposed under the tax laws and to cooperate with the Australian Taxation Office in a timely and complete manner. In addition to various provisions of the law which calculate tax liabilities and impose reporting requirements the following areas will be particularly relevant to firms involved in cross border arrangements.
Australia’s transfer pricing rules seek to ensure that an appropriate return for the contribution made by Australian operations is taxable in Australia. This is achieved through the application of the internationally recognised arm’s length principle, which has been endorsed by the Organisation for Economic Co-operation and Development (OECD).
Under the arm’s length principle, businesses are required to enter into international dealings under terms and conditions similar to what independent parties acting truly independently would reasonably be expected to have done in comparable circumstances.
The Australian Taxation Office has tax rulings and other publications that assist a business in understanding and complying with its obligations under the transfer pricing rules. These publications can be found on the ATO website. Guidance on transfer pricing and the arm’s length principle can also be found on the OECD website.
The thin capitalisation rules limit the amount of debt deductions available to Australian operations of both foreign entities investing into Australia and Australian entities investing overseas. A debt deduction is an expense an entity incurs in connection with a debt interest, such as an interest payment or a loan fee that the entity would otherwise be entitled to claim a deduction for.
The rules apply when the entity’s debt-to-equity ratio exceeds certain limits. Three alternative limits may be available to an entity in any given situation, a safe harbour test, world-wide gearing test and an arm’s length debt test. Broadly under the safe harbour test, where the debt exceeds 60 per cent of the net value of the Australian assets (this threshold is higher for certain financial entities), a portion of the debt deductions may be disallowed. The thin capitalisation rules affect both Australian and foreign entities that have multinational investments, subject to certain exemptions.
If an entity is affected by the thin capitalisation rules, the Thin Capitalisation part of the International Dealing Schedule (IDS) must be completed regardless of whether any debt deductions are disallowed by the rules. The IDS is lodged at the same time as the tax return.
Further information on the thin capitalisation rules is available on the ATO website.
Australia’s tax law includes anti-avoidance rules. These rules could apply to private equity investment arrangements designed to avoid Australian tax becoming payable on investment gains. Of particular concern to the Australian Taxation Office are arrangements featuring holding companies that have no obvious commercial purpose and which appear to exist only in order to attract the operation of international tax treaties.
The Australian Taxation Office has published a number of tax determinations relevant to foreign private equity funds disposing of Australian investments. These can be found on the ATO website.
Capital gains tax
Australia’s capital gains tax (CGT) regime imposes an income tax liability on a foreign resident in relation to any gains on the disposal of taxable Australian property.
Australia’s domestic regime is consistent with international practice, reflected in the OECD Model Tax Convention.
Broadly, taxable Australian property includes direct or indirect interests in Australian real property and the business assets (other than Australian real property) of an Australian permanent establishment.
Previously, foreign residents with a capital gain (for example, from the sale of an investment property) were eligible for a CGT discount of 50 per cent. From 8 May 2012, the 50 per cent CGT discount for capital gains made by non-residents was removed. However, for assets purchased before this date a partial discount may apply. An online CGT discount calculator is available to help determine a person’s eligibility and the amount of discount that can be applied. The CGT discount calculator and further information can be accessed on the ATO website. Foreign residents (individuals or entities) affected by these CGT rules are required to comply with Australian tax obligations.
In support of this, from 1 July 2016, the Government is proposing to introduce a new withholding tax regime. Under this proposal, where a foreign resident disposes of certain taxable Australian property, the purchaser of that property will be required to withhold and remit 10 per cent of the purchase price to the Australian Taxation Office. It is not proposed that this measure will apply to residential property valued under $2.5 million. This measure is still being finalised but further information will be made available on the ATO website.
Guidance regarding ‘CGT rules - foreign residents, temporary residents, changed residency status’ can be found on the ATO website searching for foreign residents, temporary residents, changed residency status.
Information concerning the lodgement of an Australian tax return can be found on the ATO website searching for ‘lodging tax returns for foreign residents’.