Under Australian tax rules, foreign residents are not subject to Australian Capital Gains Tax (CGT) on the disposal of Australian assets unless the asset is Taxable Australian Property (TAP). A number of asset classes fall into the definition of TAP. The most common of these asset classes is Taxable Australian Real Property (TARP) which includes land situated in Australia and mining, quarrying and prospecting rights over Australian resources.
It is well known to foreign investors directly holding TARP that their investment in Australian property constitutes TAP and is subject to CGT. However, one asset class that is also TAP but is easily overlooked are Indirect Australian Real Property Interests.
In broad terms, an Indirect Australian Real Property Interest arises where a foreign resident holds an interest of at least 10% in an entity holding TARP, and the market value of the TARP in that entity represents more that 50% of the assets of that entity by value.
Indirect Australian Real Property Interests can arise through both direct holdings of a land-holding entity as well as indirect interests in that entity. As an example, take a scenario where a foreign resident that wholly owns Company 1, which in turn wholly owns Company 2 which has TARP as its only asset. The foreign resident is taken to have an Indirect Australian Real Property Interest. Where the foreign resident sells the shares held in the Company 1, that sale would be subject to Australian CGT.
In AP Energy, a foreign resident sold 75% of their 21.4% interest in an Australia entity. The Australian entity was a mining company that held various mining rights that fell within the definition of TARP. It was clear that the 10% threshold had been reached. As such, the question of whether the shares held by the foreign resident were Indirect Australian Real Property Interests turned on the question of whether the market value of TARP interests held by the Australian entity was more than 50% of the value of all its assets (known as the principal asset test).
Central to the dispute was the methodology used by the taxpayer to value its non-TARP assets, in particular its mining information. It was the taxpayer’s assertion that the market valuation undertaken on mining information (a non- TARP asset) resulted in a value so high that TARP comprised less than 50% of the assets by value. The Commissioner of Taxation (the Commissioner) challenged the valuation. After a somewhat lengthy process, the federal court found for the taxpayer. The case highlights the role that valuation methodologies play in the principal asset test and confirms that this is an area that the Commissioner will review and challenge.
Foreign residents firstly need to be aware that indirect interests in Australian real property can give rise to an Australian CGT exposure. In addition, undertaking a sufficiently robust market valuation process is critical to determining if the principal asset test has been met.