Issue #6
URGENT INFORMATION FOR ALL ENTITIES INVOLVED IN PROPERTY TRANSACTIONS AND THE MARGIN SCHEME
Brady King v FCT: Where to from here for the margin scheme?
It is critical that any property transactions that seek to apply the margin scheme be urgently reviewed.
It is possible that the decision in Brady King v FCT (18 February 2008) has significant implications to the calculation of the ‘margin’ and for the application of the margin scheme.
We are continuing to review the potential implications of this decision. We are also conscious that the taxpayer may still appeal the decision, and that the law dealt with in the case can not yet be treated as settled. In the meantime, however, we understand that taxpayers may be committed to transactions or contemplating new transactions involving the margin scheme.
In this regard, if you have any questions regarding the application of the margin scheme please do not hesitate to contact us.
To assist you in understanding the possible implications of this decision, we have set out below:
- a synopsis of the decision;
- a basic outline of the ATO’s response in the form of a Decision Impact Statement (issued 20 February 2008); and
- some initial comments regarding issues that may arise from this decision.
Overview
On a broad reading, the Brady King decision essentially implies 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.
The decision in the case itself raises a number of issues. However, it is also what the decision implies that causes the potential for margin scheme headaches.
The Case
The case 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 (”BK”) 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 Court held that BK was not entitled to use the valuation method, because BK 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) prompt immediate caution.
The Decision Impact Statement
The ATO acknowledges in it’s Decision Impact Statement that:
- “The effect of this decision may be that developers would be unable to use the valuation method in calculating the margin for unit developments where the strata titles had not issued at the valuation date.”
- “It may follow from…[Middleton J's] view that developers would be precluded from using the margin scheme at all for unit developments”.
By way of summary the ATO’s Statement makes the following comments:
- The ATO says it will continue to carefully consider the implications of the decision, particularly the comments that an identity of interest is required between the interest acquired and the interest supplied, and the relationship with the Sterling Guardian decision. (The Sterling Guardian case involved the calculation of GST under the margin scheme for a residential unit development.)
- While the ATO considers the implications of the decision, the ATO does not intend to revise its current public rulings in relation to the issues addressed by the Court.
- The Commissioner is unable to appeal the decision as it is the taxpayer’s appeal that was dismissed.
- If an appeal is lodged the Commissioner’s intention is to contend the appeal on the basis of its submissions made before the Court.
- If an appeal is lodged, the ATO will maintain its views in its public rulings until the outcome of the appeal is known.
- If no appeal is lodged, the Commissioner will review his position at that time. He has stated “The guidance provided…[in his Decision Impact Statement] will continue to apply pending the outcome of the review”.
- The ATO states that developers and others who rely on the rulings to self assess GST liabilities under the margin scheme would be protected from retrospective adjustments where the relevant terms of the Taxation Administration Act (vis s105-60 of Schedule 1) are met. More specifically, “subject to compliance with all conditions set out in the rulings, developers will be able to continue to self assess GST during this period on the basis that the margin scheme is available for unit developments, and the valuation method may be used, notwithstanding that the strata titles have not issued at the valuation date”. Further the ATO states that the same principles apply to other subdivisions such as flat land subdivisions.
- If similar issues arise in other cases in the meantime, the Commissioner will make similar submissions to those made in the Brady King case, however counsel for the Commissioner would be instructed to draw the Tribunal or Court’s attention to the Brady King decision.
Issues to Consider
Taxpayers need to consider the ramifications of the case in much the same way that the ATO has stated it will do. In particular, taxpayers who are presently engaging in transactions involving the margin scheme and on which the decision potentially impacts need to consider their risk and avenues to ameliorate this.
Amend the law
If the Brady King decision ultimately stands and is not to be read down, it is possible that the ATO could seek (via Treasury) to have the legislation amended to be consistent with the ATO’s long standing interpretation as expressed in its rulings and as argued in the case. Such action would not be dissimilar to the approach adopted by the ATO with regard to ‘residential premises’ following the decision in the Marana Holdings case. This could apply both retrospectively and an ongoing basis.
Ruling Protection
Should the ATO not seek to amend the law, then based on the comments in the Decision Impact Statement, taxpayers that meet the relevant requirements of s105-60 of the Taxation Administration Act may be protected from retrospective amendments to public rulings. For this path to be available, however, taxpayers need to identify views expressed in rulings to justify their tax approach and show that they have relied on those views.
Further, the protection of s105-60 only arises where there is a later ruling which expresses a view that is contrary to the earlier ruling and additional tax would arise as a result of the view in the later ruling. Based on the comments made by the ATO in its Decision Impact Statement, it would be expected that the ATO would issue such a ruling to ensure that the relevant retrospective protection is afforded to those taxpayers that meet the necessary conditions.
Care needs to be taken by taxpayers (and their accountants) to ensure this protection is available assuming the necessary pre-condition exists. In particular, care needs to be taken that supporting evidence of reliance is preserved. Arguably, if no such later ruling is issued then the ‘protective provision’ above may not apply.
Administration of the law
Another matter to consider is whether the ATO has capacity to administer the law in the way it is proposing. On one view, this decision results in a number of transactions where the margin scheme has been incorrectly applied.
In such cases, a commercial purchaser may take the view that it should request a tax invoice from the developer and seek a full input tax credit for its acquisition. However, this would raise a further interesting question as to the effect of any contractual provision applying the margin scheme to the transaction.
If the legislation is not changed, and the interpretation in the Brady King case stands, any transactions that applied the margin scheme, or are seeking to apply the margin scheme, should be reviewed to ensure that the margin scheme is capable of being applied, as well as ensuring the calculation of an appropriate ‘margin’.
Conclusion
The ATO is commended on not only issuing its Decision Impact Statement in such a timely manner following the Brady King decision, but also for its approach of retaining the status quo (at least for now) with a view to providing some certainty to taxpayers. However, there remains a question whether the ATO is able to administer the law in this way and in effect selectively ignore the law as interpreted by the courts.
The ATO’s Decision Impact Statement provides some comfort against retrospective ATO action. However, this does not mean that current transactions being contemplated by taxpayers will not be effected. Taxpayers need to ensure they urgently review current or proposed transactions involving the application of the margin scheme.
The court adopted a position which neither the taxpayer nor the ATO advocated. Even if the decision is reversed, the arguments advanced by the ATO will still need to be considered. In the current uncertain environment, taxpayers should also consider possible implications of the ATO arguments being successful.
For assistance with the application of the margin scheme, please contact Simon Calabria or Andrew Orange on (03) 8662 3200
or via email at consult@webbmartinconsulting.com.au .
