Webb Martin Consulting - Expert Tax Advice

Issue #16

If there is one area of GST it is crucial to understand, it is GST and Property.

Rules have constantly evolved since introduction, culminating in a raft of changes towards the end of 2008, with some interpretations dramatically changing from the initial views of the ATO. It is essential to get to know the current issues and their implications.
Keys issues include:

• Recent margin scheme amendments;
• The Brady King decision;
• The South Steyne decision; and
• Change in use adjustments (Division 129).

Other issues that keep popping up include:

• Enterprise – whether carrying on an enterprise, or whether supplies made in the course or furtherance of an enterprise;
• Forfeited deposits; and
• Partitioning.

Margin Scheme Part 1
Recent Margin Scheme Amendments

Using the tag line of ‘maintaining the integrity of the GST regime’, Tax Laws Amendments (2008 Measures No 5) Act 2008 introduced changes to the margin scheme provisions.

The changes relate to the interaction between the margin scheme provisions and the going concern, farmland and associates provisions and focus on not allowing transactions to be structured such that GST does not apply to the value added (or ‘margin’) to property from 1 July 2000.

In Issue # 10 of The Assessment we summarised the new rules as follows:

“Proposed Changes

The Explanatory Memorandum (EM) to the Bill describes that the introduction of the proposed rules are to ‘maintain the integrity of the GST tax base by ensuring that the interaction of the margin scheme provisions and the going concern, farmland and associates provisions does not allow property sales to be structured in a way that results in GST not applying to the value added to real property from 1 July 2000 by an entity registered or required to be registered for GST’.

The key changes relate to:

• ensuring the GST cannot be minimised by interposing certain GST-free or non-taxable supplies prior to a sale under the margin scheme – that is, the margin scheme ‘base value’ cannot be refreshed via the use of a GST-free or non-taxable acquisition
• amends the way the margin is calculated, making it necessary to look through certain GST-free or non-taxable supplies of real property when calculating the margin; and
• amends the GST general anti-avoidance rules so that contrived arrangements arising from a choice, election, application or agreement do not result in a GST benefit.”

For the margin scheme to apply there must be:

1. A taxable supply of real property by:

• (i) selling a freehold interest in land; or
• (ii) selling a stratum unit; or
• (iii) granting or selling a long-term lease (essentially greater than 50 years); and

2. The supplier and recipient must agree in writing that the margin scheme is to apply.
However, the margin scheme does not apply if the acquisition was ‘ineligible for the margin scheme’.
Prior to the recent amendments, the main type of acquisition of property that was ‘ineligible for the margin scheme’ was if the acquisition was as a taxable supply without applying the margin scheme (i.e. ‘a full taxable supply’).

Other ‘ineligible’ acquisitions related to variations on the above primary transaction, such as:

• inheriting the property from someone who acquired it under a full taxable supply; or
• acquiring it from a GST Group member where the GST Group acquired it under a full taxable supply; or
• acquiring it from a GST Joint Venture operator where the GST JV Group acquired it under a full taxable supply.

A key reason is that where the acquisition was a full taxable supply, the purchaser would have an entitlement to full input tax credits (ITCs) on the acquisition, and therefore the purchaser should not be entitled to further relief via application of the margin scheme.

Prior to these new amendments, the entity intending to make a supply of the property only had to look at how it acquired the interest in the property to determine whether it was eligible (or ineligible) to apply the margin scheme. The new rules require that entity to look back through one transaction to determine eligibility.

Post amendment, the following acquisitions will also be ‘ineligible for the margin scheme’.

• An acquisition from an entity as part of a GST-free supply of a going concern, where the entity had acquired the property under a ‘full taxable supply’;
• An acquisition from an entity as part of a GST-free supply of farm land, where the entity had acquired the property under a ‘full taxable supply’;
• An acquisition from an associate (who was GST-registered or required to be GST-registered) where the supply was made in the course of the associate carrying on an enterprise, but was not a taxable supply and was without consideration, and where the associate had acquired the property under a ‘full taxable supply’.

Below is an example of how the new rules are intended to apply (as provided in the EM):

A is registered for GST, and held vacant land before 1 July 2000. A sells the property to B, a property developer who is also registered for GST. This sale is made under the basic rules. A and B do not use the margin scheme, because B wishes to be eligible to claim an input tax credit on the purchase.

B begins construction of a unit complex on the land. Before completing construction, B sells the partly constructed unit development to C, along with the necessary arrangements for C to carry on its construction. B and C have agreed that it is a supply of a going concern. Therefore B does not remit GST, nor is C entitled to an input tax credit.

C finishes the development, and sells a unit to D, who is a private individual not registered for GST. This is a taxable supply of new residential premises. C cannot make the sale to D under the margin scheme, because B acquired the property under the basic rules, and would therefore also have been ineligible to apply the margin scheme.

Calculation of the Margin Scheme

Ordinarily, the margin is calculated as the difference between the consideration received for the supply of the property and the consideration provided for the acquisition of the property. Generally, if the land was held prior to 1 July 2000, and the entity was registered as at 1 July 2000, the margin was the difference between the consideration received for the supply of the property and the relevant margin scheme valuation.

These recent amendments also change the way the margin is calculated where the entity acquired the property under a GST-free acquisition (either as a supply of a going concern or as farm land) or from an associate without consideration.

Instead of using the consideration that the entity provided for the acquisition of the property, it is required to go one step back. For example, if the property was acquired as GST-free farm land, the margin is calculated based on the amount the farmer paid to acquire the land or the market value of the property as at the time the farmer acquired the property.

General Anti-Avoidance Rules

The general anti-avoidance rules in the GST law do not apply where a choice, election, application or agreement is made under the GST law. These changes amendment the general anti-avoidance rules to ensure that if the choice, election, application or agreement is part of a contrived scheme, then the general anti-avoidance rules will apply.

To minimise complexity and administration for entities, the new rules only require an entity to look back through one transaction. The types of circumstances where the general anti-avoidance rules would apply would include a string of contrived GST-free sales or non-taxable supplies that attempt to circumvent the new rules.

Note, that this amendment to the anti-avoidance rules is not limited only to margin scheme transactions.
Transitional Rules

These new changes only apply to ‘new supplies’. That is, to supplies of real property made under written agreements that are entered into after the date of Royal Assent given to the changes (being 9 December 2008).

Margin Scheme Part 2
The Brady King Decision

The initial decision of this case resulted in a view that potentially impacted on the way the margin scheme applied. Ultimately, the Full Federal Court decision was consistent with the way the margin scheme had been applied and administered since the commencement of the GST regime.

The Federal Court Decision

The Federal Court decision in the Brady King case (Feb 2008) deals with the application of the margin scheme to a development of strata title units.

The contract to acquire the property was entered into pre-GST and included granting to the taxpayer immediate access to the property. The property was not due to settle, and did not settle, until after 1 July 2000. The taxpayer applied the margin scheme on the basis that it acquired or held the property prior to July 2000 and could therefore calculate the margin based on a valuation of the property as at 1 July 2000. The relevant provision is s75-10(3) of the GST Act.

The Commissioner argued that:

• Brady King Pty Ltd was unable to calculate the margin using the valuation method, as BK did not acquire or hold the property as at 1 July 2000;
• and (in the alternative),
• the valuation did not comply with the Commissioner’s relevant valuation Determination.

The Federal Court held that Brady King was not entitled to use the valuation method, because Brady King did not meet the pre-conditions in s75-10(3). BK did not hold at, or acquire prior to, 1 July 2000, the same interest that it supplied. That is, as the taxpayer did not hold the interest in the stratum units as at 1 July 2000, the taxpayer could not apply the valuation method to calculate the margin.

However, later in the judgement, Middleton J made the more general statement that:
“The margin scheme can only apply to the same property (in the juridical sense) being acquired and subsequently sold”. (underlining added)
The implications of the court’s rationale for the whole of Division 75 (supported by the broader context of this statement) prompted immediate caution.

Overview of Impact

On a broad reading, the Brady King decision essentially implied that the margin scheme may only apply where the same legal interest in real property is acquired and supplied.

This puts at risk any transactions, subdivisions or developments of land where the legal title acquired differs from the legal title (or titles) being supplied. This might be more extensive than initially apparent.

Recognising the potential impact that the decision may have, the ATO responded swiftly by issuing its Decision Impact Statement two days after the judgement was handed down. In this statement, the ATO essentially said it would maintain its current public view and will monitor the progress of the other aspects of the Brady King decision.

The Full Federal Court Decision

In broad terms, the Full Court held that a developer was entitled to calculate GST on sales of strata title units under the margin scheme using the value at 1 July 2000, even though the developer only had a contractual interest at 1 July 2000 in the parcel of land that was subsequently developed and subdivided by a strata title plan.

More particularly, the case concerned the application of s 75-10(3) of the GST Act. The Court held that it was sufficient that prior to 1 July 2000 the developer had entered into a contract to purchase land which, after that date, was developed and subdivided into strata title units. The subsection was not predicated on the developer having completed the purchase of the land prior to 1 July 2000.

Having decided that the margin scheme could be applied, the Full Court remitted the matter back to the trial judge to determine the margin on which GST is payable.

The South Steyne Case
GST and the sale and lease of strata apartments in a hotel complex
This case looks at the GST treatment of four separate supplies involving a serviced apartment building.

The South Steyne Hotel building was being operated as a multiple occupancy hotel containing guest rooms, a reception area, conference facilities, a restaurant, a bar, and a swimming pool. In 2000 the building was acquired by South Steyne Hotel Pty Ltd as a taxable supply with GST calculated under the margin scheme.

In September 2006, the guest rooms were strata titled (but included conditions that required further consent before the land could be used as permanent accommodation or as a residential building).

Also in September 2006, the reception, office and car spaces were sold to Mirvac Hotels Pty Ltd (the manager and operator of the hotel), and all strata titled apartments were individually leased to Mirvac Management Pty Ltd requiring each apartment to be operated as part of a serviced apartment business. An agreement between Mirvac Management and Mirvac Hotels essentially resulted in Mirvac Hotels having exclusive control of the building.

Subsequently, 15 strata titled apartments were sold subject to lease to various investors with each investor electing to participate in the management rights scheme operated by Mirvac Management.

The taxpayer sought, via declaratory relief, clarification of the GST treatment of four separate supplies:

1. The from South Steyne to Mirvac Management;

2. The sale of a hotel room to an investor;

3. The supply made by the investor under the continuation of the ongoing lease to Mirvac Management; and

4. The supply of a hotel room to a guest.

The taxpayer’s primary contention was that supplies 1, 3 and 4 were all input taxed supplies, and that supply 2 was GST-free. The case found as follows:

Change in Use Adjustments

The GST regime has always included rules that require adjustments to be made. One specific adjustment that is required relates to changes in use, or changes in creditable purpose.

These adjustments arise where an entity has an actual use that differs from its intended use.

In a property context, these ‘change in use’ adjustments tend to arise where there are dealings in residential property as residential rental supplies are input taxed, and the sale of new residential property is taxable.
For example, a property developer may acquire land and build new residential apartments with the original intention of selling all the apartments. As these sales would be of ‘new residential premises’ which are subject to GST, the developer would be entitled to claim full input tax credits (ITCs). In this case the developer’s creditable purpose is 100%.

On completion, however, it may be that circumstances have changed (e.g. economic downturn or slump in the new residential apartment market) and the developer is unable to sell the apartments for the asking price. In such a case, the developer may take the apartments off the market and commence renting them out. The developer would have no (or 0%) creditable purpose when only renting residential premises.

As the rental of residential premises is input taxed, there has been a change in use of the acquisitions by the developer. The initial intention was a 100% creditable purpose, and the current actual use is 0% creditable purpose. This change in use gives rise to a need to review the ITCs claimed and to make adjustments. Assuming the apartments continue to be rented for some time and remain unsold (e.g. more than 12 months), the developer would need to pay back to the ATO all (or the majority) of the ITCs claimed.

The above example provides a simple illustration of how the change in use adjustments operate, and is consistent with the current (and long-standing) view of the ATO. There are some limited circumstances, however, where the ATO has changed its view. These essentially relate to the situation where:

• the original intention is to build and sell residential property (100% creditable purpose);
• there is a change in circumstances and the premises are rented out, but the developer keeps the property(ies) on the market and for sale.

The original and long-standing view of the ATO was that when the property commenced being rented, the only use taken into account when calculating the adjustment was the rental. This meant that a full adjustment of all ITCs claimed was required at the relevant adjustment period (as per the above illustration).

If the property was later sold and was a taxable supply, then a further adjustment was made. Practically, this would result in the following:

• during construction phase with intention to sell – originally claim 100% ITCs;
• property is rented out – pay back to the ATO 100% of ITCs;
• when the property is sold as a taxable supply – re-claim a portion of ITCs (e.g. 75%).

The ATO has recently reviewed its approach to the above situation (see GST Ruling GSTR 2008/D5). Instead of requiring the entity to pay back 100% of the ITCs and then re-claim 75% of ITCs, in limited circumstances (i.e. where the property remains actively marketed for sale) the ATO will allow adjustments to be made progressively.

Using the example percentages above, instead of paying back to the ATO the full 100%, the entity would instead only pay back 25%. The change in view by the ATO takes into account the active marketing for sale of the property as an actual use of the property. The ATO also explains its new view takes a practical approach, and is essentially in anticipation of the end net result of ITCs claimed.

Note, however, that this apparent relaxation of the ATO view does require a number of specific conditions to be met. The entity would need to objectively show:

• that it’s original or planned intention was to sell the new residential premises; and
• that it objectively continues to hold the property for sale (i.e. property continues to be actively marketed).

Interaction with 5-year Rule

There is a rule in the GST law that states premises will not be ‘new residential premises’ where for the period of at least 5 years since the premises became new residential premises, the premises have only been used to make input taxed residential rental supplies.

The change in ATO view above that holding premises for sale is an actual use of the premises will therefore impact on the 5 year rule. The 5 year period will essentially only start where the premises are only being rented and not held for sale.

Other GST and Property Issues

In addition to the above recent developments, other issues relating to GST and property consistently arise. These include:

Whether an isolated property transaction is an ‘enterprise’?

The definition of ‘enterprise’ includes inter alia an activity or series of activities done ‘in the form of an adventure or concern in the nature of trade’. The ATO has ruled (see Miscellaneous Tax Ruling MT 2006/1) that this phrase essentially has the same meaning as a ‘profit-making undertaking or scheme’ for income tax purposes. The ruling also sets out in reasonable detail the factors that need to be evident for an adventure or concern in the nature of trade to exist, these factors having been drawn from Australian common law.

Whether a one-off or isolated property transaction will be an enterprise will depend on the facts and circumstances of each case.

Forfeited Deposits

This issue was dealt with in the Reliance Carpet decision (also see Issue # 11 of The Assessment).
The outcome of this case was that the forfeiture of the deposit can be consideration for a supply. Where the entity receiving the deposit is registered for GST purposes that entity would be subject to GST.

The practical problem arising as a result of this case was whether the forfeiture of a deposit would be subject to GST notwithstanding that the underlying supply would not have attracted GST – e.g. the acquisition of ‘old’ residential premises. The ATO has essentially provided a ruling for entities to rely on that where a deposit for what would have been a non-taxable supply is forfeited, the forfeited deposit will not be subject to GST.

Partitioning

The concept of partitioning is essentially the process where property held by co-owners is physically divided among them so that each co-owner is entitled to a separate part of the physically divided property.

During 2008 the ATO released a draft GST ruling (GTSR 2008/D3) looking at GST issues for partitioning of land. While this draft ruling was due for finalisation late in 2008, it has been delayed and is not expected to be finalised until April 2009.

This is an issue that has been around for some time, and the delay in finalising the ruling is probably an indication of the complex issues involved.

In addition to the technical issues, such as whether the margin scheme can be applied to the transferred interests, partitioning also raises practical issues including compliance and administration.

Conclusion

Given the activity during 2008 it looks like GST and property issues are here to stay for a while, and the complexity of the issues being dealt with only appears to be increasing.

If you have any questions in relation to this edition of The Assessment, please contact Simon Calabria on simonc@webbmartinconsulting.com.au.