GST and Real Estate Contracts

When things go wrong

(Presented at Russell Cocks’ CPD Seminar, 28 March 2013)

Introduction

1)   Since the introduction of the GST in 2000,[1] there has been a number of decisions by State Courts and Tribunals dealing with disputes as to the treatment of GST under real estate contracts. These disputes are between parties to the contract and the Commissioner is not involved.

2)   The disputes do not involve the question of whether GST is payable, but rather involve a dispute between the parties as to who is to bear the liability for GST – usually whether the price stated in the contract is “inclusive” or “exclusive” of GST. In the early days of GST, some unfortunate drafting of contracts may have contributed to these disputes.  Nevertheless, some 12 years on, the disputes continue to occur. As recently as last month there was a decision of the Victorian Supreme Court dealing with the question of whether a Contract of Sale was inclusive or exclusive of GST.

3)   I expect that these disputes will continue to occur, given the significant financial impact of GST. Practitioners need to take care when drafting contracts, to ensure that their client’s instructions are properly reflected. Practitioners also need to ensure that they, and their clients, understand the treatment of GST under the contract.

4)   At the end of this paper is an Appendix which takes a high level look at some of the other recent issues arising in the context of GST and real estate which do involve the Commissioner.

THE DRIVERS FOR DISPUTE

5)   Under the GST Act, it is the vendor (as the supplier) who incurs the liability to pay the GST. The vendor has no statutory right to pass on any part of its GST liability to the purchaser, although the presumption is that the GST will generally be passed on by the supplier to the recipient as part of their contractual relationship. Accordingly, how GST is dealt with in the contractual relationship between vendor and purchaser is critical.

6)   Disputes on who is to bear the cost of GST arise in two contexts, each of which has different considerations and different drivers for dispute.

a)    First, transactions involving purchasers who are registered for GST and can claim input tax credits with respect to the transaction. In these types of transactions, the GST is not intended to be a cost to either party because the purchaser is entitled to an input tax credit equal to the GST payable by the vendor. However, if the contract does not provide for the GST to be added to the Price, the vendor will still be liable to pay GST and will be out of pocket 1/11^th of the Price. Further, the purchaser will receive a windfall gain of 1/11^th of the Price. This is illustrated by the following examples:

Example 1 – GST gross up

A sells land to B for a stated price of $1,000,000 plus GST. At settlement a total price of $1,100,000 is paid and A pays GST of $100,000 (1/11^th) and B claims an input tax credit of $100,000. The net price paid by B is $1,000,000.

Example 2 – No GST-gross up

A sells land to B for a stated price of $1,000,000 and the contract is silent on GST – thereby being GST inclusive. At settlement, a total price of $1,000,000 is paid and A pays GST of $90,909 and B claims an input tax credit of $90,909. The net price paid by B is $909,091, thereby giving B a windfall gain and leaving A out of pocket.

The main driver for contractual disputes is clear – if the purchaser can establish that the price was inclusive of GST, it can claim an input tax credit whilst being under no obligation to pay a dollar more to the vendor. Another driver is stamp duty, which is payable on the GST-inclusive price. Taken the second example above, B would pay stamp duty on $1,000,000 rather than $1,100,000 – leading to a stamp duty saving of $5,500.[2]

b)   Second, transactions involving purchasers who are not registered for GST or purchasers who are registered for GST but cannot claim input tax credits[3]. In these transactions, the liability for GST will be a cost to either the vendor or purchaser, depending upon the terms of the contract. This is illustrated by the following examples:

Example 3 – GST gross up

A sells land to B for a stated price of $1,000,000 plus GST. At settlement a total price of $1,100,000 is paid and A pays GST of $100,000 (1/11^th). The net price paid by B is $1,100,000.

Example 4 – No GST-gross up

A sells land to B for a stated price of $1,000,000 and the contract is silent on GST – thereby being GST inclusive. At settlement, a total price of $1,000,000 is paid and A pays GST of $90,909. The net price paid by B is $1,000,000, leaving A out of pocket by $90,909.

In contrast to the first category discussed above, the main driver for disputes comes from the vendor, who can recover an additional amount from the purchaser if it can establish that the price was exclusive of GST. This would pass the GST cost to the purchaser, who would also then be subject to an increased liability for stamp duty.

The disputes – a look at the cases

7)   The cases show that the following contentions may be raised in disputes over who effectively bears the liability for GST under a contract:

a)    The proper construction of the contract;

b)   Rectification of the contract;

c)    Misleading and deceptive conduct.

8)   What the cases also show is that for (a) above, the contract is paramount, and for (b) and (c) the evidence critical.

Empire Securities Pty Ltd v Miocevich [2004] WASC 118

9)   The defendants/vendors entered into a contract to sell real property to the plaintiff for the price of $667,000. At the time of contract, the vendors were registered for GST in respect of a business operating on the land but the vendors had had ceased operating the enterprise some three months prior. The vendors were uncertain as to their GST liability on the sale and the contract position was that the purchase price was said to include any GST liability of the vendor and if GST was payable, that the vendor would provide a tax invoice to the purchaser. The Court observed that the purchaser may have made some assumptions as to the defendant’s liability for GST, but that for the purposes of the proceeding, those assumptions were irrelevant.

10)         Before settlement, the vendors sought to cancel their ABN. The Commissioner cancelled the vendors’ GST registration with an effective date prior to the contract date. The vendors sought a private ruling from the ATO whereby the ATO confirmed that the vendors were not liable to pay GST on the sale of the property.

11)         The purchasers unsuccessfully brought proceedings seeking orders that the vendors were obliged to remit GST and to provide the purchasers with a tax invoice (so that the defendants could claim an input tax credit). The Court observed that the purchaser had clearly anticipated that the vendors would be liable for GST and that a tax invoice would be provided, thereby allowing the purchaser to recover an input tax credit, thereby effectively reducing the purchase price payable.

12)         The Court rejected the claim for the simple fact that that the vendor was not liable to pay GST. The purchaser placed a heavy emphasis on the fact that the vendors were registered for GST at the time of entering into the contract.  The Court correctly noted that registration is merely one element of liability for GST. In concluding, the Court observed as follows (at [15]):

The contractual position is simple and straightforward. The purchase price did not include any GST, the defendants are not liable to remit any amount to the Commissioner of Taxation and the plaintiff is not entitled to a tax invoice. That was the position as at the date the contract was signed, no matter what the plaintiff may have thought.

ETO Pty Ltd v Idameneo (No 123) Pty Ltd [2004] NSWCA 378

13)         Under the contract (being the 2000 edition of the Law Society and Real Estate Institute form of contract), the vendor agreed to sell to the purchaser five contiguous parcels of land for the price of $3,900,000. The issue involved the adjustment of GST between the vendor and purchaser pursuant to special condition 13 of the contract.

14)         The particulars of sale referred to a price of $3,900,000 and included the following words: “NOTE: subject to clause 13, the price INCLUDES goods and services tax (if any) payable by the vendor”. On the second page of the contract there were a number of “choices” represented by a number boxes dealing with matters such as whether the sale was a taxable supply, farm land, the supply of a going concern and whether the margin scheme applied.  Only the taxable supply box was completed. Clause 13 relevantly stated as follows:

13.9 If this contract says this sale is a taxable supply and does not say the margin scheme applies to the property, the vendor must pay the purchaser on completion an amount of one-eleventh of the price if:

13.9.1 this sale is not a taxable supply…

The intent of the clause appears to be that where the parties contracted on the basis of a GST inclusive amount, where GST was not actually payable, the vendor was required to refund that amount to the purchaser.

15)         Prior to completion, the parties could not agree on whether the supply under the contract was taxable. A ruling was issued by the Commissioner to the effect that only one of the five parcels of land was a taxable supply. The contract was completed on the basis that this single parcel had a value of $557,500 and there was GST payable of $55,750. A fund representing the GST for which the vendor would have been liable if the supply of all the parcels had been taxable was put aside, being $298,795 ($354,545 less $55,750). The purchaser contended that by force of clause 13.9.1 the vendor was obliged to refund $298,765.

16)         The Court of Appeal rejected the purchaser’s submission that the clause should be given a distributive operation, so that it applied “to the extent that” the sale was not a taxable supply, as this would involve a radical re-writing of the contract. The Court of Appeal also rejected the purchaser’s alternate contention that the vendor was required to pay to the vendor the entire $354,545 because only one of the parcels was taxable, meaning that “the sale” was not a taxable supply.

17)         The Court of Appeal took the view that the clause was an “all or nothing statement” and that payment is only treated if the sale is not a taxable supply at all. In doing so, the Court acknowledged that the contract could be said to operate harshly against the purchaser, but the opposite result would operate harshly against the vendor. The Court observed that the clause lacked refinement, the apparent assumption being that the true GST position would be known by completion.

Igloo Homes Pty Ltd v Sammut Constructions Pty Ltd [2005] NSWCA 280

18)         The contract of sale provided that the purchase price payable of $2.25m was exclusive of GST. The purchaser sought rectification of the contract on the basis that the common intention of the parties was that the purchase price should be inclusive of GST.

19)         Given that the claim involved rectification of the contract, it is important to have regard to the evidence in the proceeding, which can be summarised as follows:

a)    The purchaser was a company, the sole director (Mr A) of which had been involved in property development for 7-8 years and had been a solicitor for 22 years. Mr A also acted as the solicitor for the purchaser.

b)   The vendor was company with four directors.  Two directors, Mr AS and Mr JS made all the decisions of the vendor. The vendor retained solicitors to act in the conveyancing, with Ms P (a conveyancing clerk with 30 years experience) in control of the file. Ms P had acted for the appellant for 15-20 years.

c)    Ms K was the real estate agent who had acted for the appellant on many previous occasions.

d)   Mr AS told Ms K to find a purchaser for the land and that the land was to be offered for sale at a price of $2.4m inclusive of GST. Mr JS and AS calculated that the vendor needed to realize $2.3m on the sale of the land to make an acceptable profit. Mr JS thought that the GST margin scheme would apply and the GST would be about $91,000.

e)    Some time later, Ms K told Mr A that the vendor wanted $2.4m inclusive of GST for the land. Mr A then offered $2m for the land, which was later increased to $2.2m. These offers were rejected and Mr AS then instructed Ms K to make a counter offer of $2.25m. This offer was accepted.

f)     The evidence of Ms K was that she understood this counter offer to be inclusive of GST. However, Ms P produced two file notes of conversations with Mr JS which records his instructions that the price was “PLUS GST”.

g)    On the day of the exchange of contracts, Ms P produced a further file note that recorded the price being exclusive of GST.

h)   After the contracts had been exchanged, but prior to settlement, several events occurred which were found by the trial judge to be consistent with the respondent’s intention that the price was inclusive of GST:

i)     The transfers prepared by the purchaser showed the price on the contract, and no complaint was made by the vendor that this was not the full consideration;

ii)    Settlement figures were exchanged on the basis of the amount stated in the contract (ie, no increase for GST);

iii)  A clerk instructed by Ms P attended settlement and the clerk handed over the transfers at the stated price;

iv)  At settlement, the purchaser complained about the absence of a tax invoice, after which Ms P undertook to provide a tax invoice.

i)     After settlement, Ms P realised that GST had not been collected at settlement. Ms P then contacted the purchaser who disputed that there was any liability to do so.

20)         The trial judge accepted the evidence of Ms P, which was critical to the rejection of the purchaser’s claim for rectification, as disclosed in the following extract (at [65] – reproduced on appeal at [74]):

 65. If the plaintiff is to obtain rectification of the contract, the plaintiff bears the onus of establishing that it was the intention of the vendor that the contract entered would be at a purchase price inclusive of GST. I am not satisfied it has discharged that onus. The way in which the Contract of Sale was prepared…imposed a serious practical responsibility on Ms Pilgrim to ensure that she understood the client’s instructions about the essential commercial elements of any contracts to which she…handed over by way of exchange. Her contemporaneous notes show that she carried out this responsibility, and ascertained that it was the client’s wish to enter into a Contract for Sale at the price of $562,500 plus GST.

66. The conduct of Ms Pilgrim, in allowing the settlement to proceed on the basis that the price was inclusive of GST is suspicious. However, it seems to me more likely than not the reason for her doing so was carelessness.

21)         On appeal, it was common ground that at the time the contracts were exchanged, the intention of Mr A and the appellant, and of Ms K, was that the selling price of the land was inclusive of GST. The crucial issue was the respondent’s intention. The respondent contended that there was no mistake, at least on its part, and the intention of Mr AJ and Mr JS and Ms P was that the contract was exclusive of GST.

22)         The first ground of appeal for the appellant was that the trial judge erred in failing to hold that the intention of Ms K, as the respondent’s agent, was the relevant intention of the respondent. Ms K carried out all the pre-contractual negotiations on behalf of the respondent and her evidence was that the purchase price was inclusive of GST. The majority of the Court of Appeal[4] rejected this argument because while Ms K was authorised to negotiate a price for the land, she was not authorised to enter into a contract to sell the land on behalf of the respondent. Therefore, her intention as to the terms of the contract cannot be attributed to the respondent.

23)         The second ground of appeal involved the claim for rectification. The appellant argued that Mr JS and Mr AS, and Ms Pilgrim, were lying and that the supporting documents had been fabricated. The majority of the Court of Appeal observed that the issue was really one of credit, and the trial judge accepted the evidence of Ms P in preference to the evidence of Ms K. In this context, the Court noted that a finding of fact by a trial judge based on credibility of a witness is not to be set aside because an appellate court things that the probabilities are against – even strongly against – that finding of fact.

24)         In rejecting the claim for rectification, the majority noted the difficulties in establishing a claim for rectification, and that it was open to the trial judge to find that the appellant had failed to discharge its onus. As observed by the Court (at [168]):

Moreover, it has often been said that for a claim of rectification to succeed the requirements must be satisfied by “convincing proof” and that mere suspicion, although strong, is not enough. See Australian Gypsum Ltd & Australian Plaster Company Ltd v Hume Steel Ltd [1930] HCA 38; (1930) 45 CLR 54 where the High Court (Rich J, Starke J and Dixon J) at 64 quoted with approval the following statement by Lord Chelmsford in Fowler v Fowler (1859) 4 De G & J 250 at 265:

“It is clear that a person who seeks to rectify a deed upon the ground of mistake must be required to establish, in the clearest and most satisfactory manner, that the alleged intention to which he desires it to be made conformable continued concurrently in the minds of all parties down to the time of its execution…”

25)         Basten JA ultimately agreed with the majority but observed that he had misgivings in relation to aspects of the facts, as found, and considered that there were critical matters which had not been the subject of express findings. His Honour also noted that the result was that the respondent obtained a judgment giving it an amount well in excess of its initial asking price for the property, which, on any view, was more than either party expected to pay or receive. Nevertheless, his Honour dismissed the appeal because the appellant had not relied below on “the commercially implausible” result of accepting the vendor’s case and, in effect, eschewed the course which would have allowed a plausible resolution of the dispute.

AFC Holdings Pty Ltd v Shiprock Holdings Pty Ltd [2010] NSWSC 985

26)         The vendor/defendant entered into an option deed by which an option was granted to the purchaser/plaintiff to purchase the vendor’s properties. The price stated in the option deed was $4m and clause 5 of the deed stated that “if the Grantor incurs a liability to pay GST in connection with this Deed, the Grantee must pay to the Grantor on demand in addition to the Option Fee and any Extension Fee(s) the amount of the GST”.

27)         The purchaser exercised the option and a contract of sale was entered into, in the standard form of the NSW Law Society – 2005 edition. Towards the bottom of the first page of the contract, under the heading “Tax information”, against the statement “GST: taxable supply” the box “yes in full” was marked with a cross. Special condition 4 provided that “The sale is a taxable supply and the purchaser will pay to the vendor on completion the amount of Goods and Services Tax for which the vendor is liable”.

28)         The purchaser contended that special condition 4 simply recorded that the amount payable by the purchaser included an amount payable by the defendant in respect of GST. The vendor contended that the effect of the clause was that the purchaser was required to pay an additional amount on the account of GST. The Court preferred the vendor’s construction. In doing so, the Court observed that the difficulty with the purchaser’s construction was that the clause would have no practical effect – why would the parties have included special condition 4 if it were simply stating the obvious.

Booth v Cityrose Trading Pty Ltd [2011] VCAT 278

29)         This proceeding has a long (and expensive) history. The essential question was whether the purchaser was bound to pay, in addition to the stated purchase price, an amount on account of GST. The disputed sum of $225,000 was deposited into a trust account pending resolution of the issue. Mr Booth also had to pay an addition $12,375 in stamp duty. In 2007 there was a hearing before the Tribunal which took 6 days and found in favour of the purchaser. That decision was appealed to the Supreme Court, which allowed the appeal and referred the matter to the Tribunal for re-hearing.[5]

30)         Again, as the matter involved a claim for rectification, it is important to have regard to the facts of the case.

a)    The land was at 7 Albany Court, Sorrento and Cityrose had constructed a dwelling on the land. Kay and Burton conducted the auction on behalf of Cityrose. The land did not sell at auction and later that day, Mr Booth, who had attended the auction, made an offer of $2,250,000 and signed the contract which included that figure.

b)   The contract contained special condition 7 which has headed “Goods and Services Tax”. The Tribunal found that neither Mr Booth or the agents realised, at the time contract was concluded, that Special Condition 7 arguably made the price GST exclusive.

c)    Mr Booth’s solicitors were given a copy of the draft contract the day before the auction and a copy was given to Mr Booth.  Mr Booth did not pay attention to Special Condition 7.

d)   The agents said nothing about GST during the action and nobody else said anything about GST.

e)    Seven days before settlement, the solicitors for the vendor gave the first indication that Mr Booth was obliged to pay an additional amount under the contract for GST.

31)         Mr Booth’s claim can be summarised as follows:

a)    The contract required him to pay no more than $2.25m and Special Condition 7, on its proper construction, had no application; meant that the purchase price was GST-inclusive; or was so uncertain as to be meaningless.

b)   Rectification of the contract.

c)    Excision of special condition 7 from the contract as a consequence of Cityrose’s misleading or deceptive conduct in contravention of the Fair Trading Act 1999.

d)   Damages in the amount of $225,000 and the additional stamp duty of $12,375 because of the misleading and deceptive conduct of Cityrose.

32)         The Tribunal found that the Special Condition in the contract required the purchaser to pay an additional amount on account of GST. However, rectification of the contract was ordered to remove the Special Condition so that the purchase price specified in the contract of sale was the price stipulated in the contract, and no more.

Construction of Special Condition 7

33)         Special Condition 7 provided as follows:

7.1 For the purposes of this special condition:

(a)       ‘GST’ means GST within the meaning of the GST Act;

(b)       ‘GST Act’ means A New Tax System (Goods and Services Tax) Act 1999;

(c)        Expressions used in this special condition which are defined in the GST Act have the same meaning as given to them in the GST Act.

7.2 The consideration payable for any taxable supply made under this contract represents the value of the taxable supply for which payment is to be made:

Where a taxable supply is made under this contract for consideration which represents its value, then the party liable to pay for the taxable supply must also pay at the same time and in the same manner as the value is otherwise payable the amount of any GST payable in respect of the taxable supply.

 

34)         The difficulties in construing this clause were outlined by Whelan J of the Supreme Court (at [21]-[24]):

21 As the special condition says expressions used are to have the meanings given in the GST Act, what then does it mean to say that consideration “represents” value? If what was intended was that for the purposes of the special condition the consideration under the contract is to be the “value” under the GST Act, that would not be consistent with the provision stating that defined expressions in the GST Act have the same meaning in the special condition. The difficulty of determining what is meant by saying that consideration represents value is exacerbated by the fact that if “consideration” has the meaning it has in the GST Act, then any amount payable under special condition 7 must also be part of the “consideration” because it would be an amount in connection with, in response to, or for the inducement of a supply.

22 The difficulties continue, as the clause then provides: “[w]here a taxable supply is made … for consideration which represents its value …”. If consideration represents value because of the first part of clause 7.2, it is difficult to understand why the second part is qualified in this way.

23 The second part of clause 7.2 then says the party liable to pay for the taxable supply must also pay at the same time and in the same manner as “the value is otherwise payable” the amount of any GST payable. If “value” has the meaning given in the GST Act, this then means the person must pay whatever obligation special condition 7 imposes at the same time and in the same manner as the price is payable. Again, the second part of clause 7.2 is difficult to understand because to the extent the special condition imposes a liability in addition to $2,250,000 that liability itself becomes part of the “consideration” within the meaning of that term in the GST Act.

24 All of these difficulties arise in a context where if what was intended was that the purchaser was to pay to the vendor any GST liability the vendor had, it would not have been difficult to say so. (the Court referred to the clause the subject of the decision in Igloo Homes[6]).

The Supreme Court declined to form a final view on the construction of the special condition and referred the matter back to the Tribunal to be heard again.

35)         The Tribunal eventually came to the conclusion that the proper construction of the special condition was that the price was exclusive of GST and that Mr Booth was obliged to pay a further amount on account of GST.  As observed by the Tribunal (at [49]):

In the end, whichever view one takes of it, the drafting of the special condition is thoroughly unsatisfactory. But it can be given a meaning. It is not void for uncertainty. I acknowledge too that the “contra preferentum” rule, if given operation, tends to push one away from a construction for which Cityrose argues. Nevertheless, ultimately for the decisive reason that the construction gives a point to the condition whereas the competing constructions seem to result in the condition having no practical point to it at all, I have concluded that the preferable construction is Cityrose’s. It is preferable only to the extent that it is the least unsatisfactory of all the competing constructions.

Rectification

36)         In considering Mr Booth’s claim for rectification, the Tribunal made the following findings as to the parties’ intentions:

a)    Mr Booth intended that the contract should provide for a price of $2.25m, and did not intend that it should provide for payment of GST on top of that figure. The prospect of GST being payable, inclusive or exclusive of the purchase price, had not occurred to him.

b)   The intentions of the controlling mind of Cityrose (Mr Salvo) and the agent was the same. Mr Salvo accepted the offer of $2.25m and the prospect of GST being payable, inclusive or exclusive of the purchase price, had not occurred to him when he signed the contract. He had not turned his mind to the matter – he said so in evidence. Likewise, the agent intended that Mr Booth should pay $2.25m and the prospect of GST being payable was not something about which she had been instructed.

c)    When the manager for Cityrose handling the sale instructed its lawyers to prepare the contracts, the manager intended that the contract should provide for GST to be payable on top of the price.

37)         The Tribunal observed that “very clear and convincing proof” must exist to establish a claim for rectification and referred to the judgment of Ipp JA in Igloo Homes, noting that the relevant time was when the contract was entered into. Taking this approach, the Tribunal found that the intention of Cityrose’s manager at the time of instructing its lawyers to prepare the contract was not relevant as this arose at an earlier time to the entry into the contract. The Tribunal then noted that the evidence of Mr Booth and Mr Salvo was clear and convincing and found that an order for rectification should be made.

38)         Finally, the Tribunal found that the conduct of Cityrose and the agents was misleading and deceptive within the meaning of the Fair Trading Act. However, no penalty was imposed on the agents because the responsibility for Mr Booth’s loss and damage rested solely with Cityrose. The Tribunal found that if the Contract could not be rectified, the contract should be varied by the excision of special condition 7 or alternatively an award of damages of $225,00 to compensate Mr Booth for loss and damage.

Duoedge Pty Ltd v Leong & Anor [2013] VSC 36

The Facts

39)         On 3 September 2009 the defendant entered into a contract of sale to purchase property for a price specified in the contract as “$916,000 GST inclusive”. The contract was in the standard REIV form (in Victoria) and the particulars of sale stated “GST: (refer to general condition 13) – the Price includes GST (if any) unless the words “plus GST” appear in this box.’ The box contained a hand written strike through its centre.

40)         The defendant was the director of a company which intended to develop the land – that company was later nominated as the purchaser. On 28 October 2009, at the company’s request, the vendor provided it with a tax invoice showing a purchase price of $832,727.27 plus GST of $83,272.13. On 10 November 2009 the contract settled.

41)         The company commenced its development on the land and in 2010 lodged a BAS claiming an input tax credit of $83,272. The ATO revised the BAS and rejected the claim to an input tax credit on the basis that the property was the supply of residential premises and therefore was not a creditable acquisition. The company requested that the vendor refund the GST component of the sale. The company knew that the vendor had not remitted GST on the sale to the ATO.

The findings of the magistrate

42)         The magistrate found that the vendor should refund the GST amount to the company. In doing so, the magistrate found as follows:

a)    it was arguable that the language used in the contract of sale was ambiguous or susceptible to more than one meaning and the Court was entitled to take into account ‘surrounding circumstances’ to interpret the contract.

b)   a reasonable observer would conclude that the parties contracted on the basis that the price included GST – a reasonable observer would not have concluded that the purchase price included GST “if any”.

c)    at the time of executing the contract, both the vendor and the purchaser believed that GST was applicable to the sale.

d)   there was an implied term in the contract that if the purchaser paid to the vendor a total price that included provision for GST of $83,272.73, and it was later discovered that GST was not assessable on the transaction, the GST component was refundable to the purchaser on demand – the claim was described by the Magistrate as “money had and received”.

e)    the vendor would be unjustly enriched if it retained $83,272.73.

f)     the contract should be rectified to given effect to the intention of the parties.

Reasoning of the Judge on appeal

43)         Justice Dixon allowed the vendor’s appeal, being satisfied that the Magistrate erred in law for the reasons set out below.

44)         It was not open to the magistrate to find that there was an implied term of the contract that, if GST did not apply to the sale, Duoedge would refund the GST amount of $83,272.73 and then to rectify the contract to give effect to the implied term. The Judge found that the language used in the contract with respect to GST had a plain meaning. In a comforting statement for those real estate practitioners in Victoria (and to those involved in drafting the standard form REIV contract), his Honour observed as follows (at [22]-[23]):

What the parties needed to negotiate was the allocation of the risk that GST might need to be remitted to the ATO if the sale was a taxable supply. This is a common consideration as the printed terms of the standard form of contract in use in Victoria for property transactions makes clear.

The plain meaning of this contract is that the GST risk lay with the vendor. That this was the contractual intention appears from at least two places. It is clear from the particulars of sale that the agreed contract price was GST inclusive, although adding those words after the price is not the correct way to complete the standard form of contract. The absence of the words ‘plus GST’ in the box confirms the handwritten addition of the words ‘GST inclusive’. The parties have expressed the intention that the purchaser has no obligation to make a further payment in respect of any GST assessment that might later follow. In other words, the parties plainly intended that the risk that GST might need to be remitted to the Tax Office lay with the vendor. If the transaction did not involve a taxable supply, that risk was abated to the benefit of the vendor, who retains the full price that it contracted to receive for the property. Objectively assessed, this is what the terms relating to GST show to be the intention of the contracting parties. This construction is neither uncertain, nor ambiguous. To reverse the allocation of that risk to the purchaser, the words ‘plus GST’ are added to the box.

45)         The Judge also found that the position of the purchaser was “opportunistic”. This is because the purchaser would receive the benefit of the refund of part of the purchase price, plus also the benefit of being able to use the margin scheme for the sale of the developed units. In light of this, the Judge found that it was not open to the magistrate to find that the vendor would be unjustly enriched if it retained the GST amount.

46)         The Judge found that the magistrate had not directed himself properly as to the principles for rectification. In this context, the Judge observed that the magistrate was satisfied that the parties were under a mistaken impression that the sale was a taxable supply – and that this was no more than a common “belief”. This was not an actual agreement. Accordingly, the findings were not to the effect that the common intention of the parties was that the actual price was $832,727.27 – and there was no evidence that the true intention was that the agreed price was $832,727.27 and that it was grossed up to $916,000 because the parties believed that the sale was a taxable supply and the vendor was liable to remit the GST to the ATO. Accordingly, the evidence of a “common belief” fell short of the requisite finding for rectification, namely that there was a common “agreement”.

Conclusion

47)         This case illustrates the difficulties which GST can cause in drafting contracts. Also, the case illustrates the importance of the facts and the evidence adduced at trial where a claim for rectification is made.

48)         If the parties’ true intention was that the price was negotiated with GST in mind (and an entitlement to an input tax credit), the result does appear harsh. This is because commercial parties tend to negotiate on the basis of GST-exclusive amounts, on the assumption that the GST will be a “wash”. If this was the case, the vendor has received an extra $83,272.73 because of a mistake made by both parties as to whether the supply was taxable. The purchaser is not able to recover an input tax credit and is effectively out of pocket.  As observed by the Judge, it is true that, over time, the purchaser may indirectly recover that benefit through the ability to use the margin scheme when the developed units are sold. However, that recovery would likely be over time and would be dependent upon the development being successful and the sales being made.

49)         The importance of the facts is illustrated by the following cases which all dealt with the proper construction of a GST clause in a contract and also the issue of whether rectification could be ordered. Interestingly, and perhaps unfortunately, it appears that none of these decisions were provided to the Supreme Court in the recent decision.

CONCLUSION

50)         It is likely that there will be more disputes between parties as to who is to pay the GST liability on real estate contracts. The cases show that, to an extent, some unfortunate drafting of standard form real estate contracts in the early days of GST contributed to these disputes. However, the drivers for continued disputes remain.

51)         For practitioners, these cases illustrate the importance of understanding the GST position before the contract is signed and ensuring that the contract, and any special conditions, properly reflect the instructions received from their client (whether they be the purchaser or vendor).

 

 

8 March 2013

Christopher Sievers

Lonsdale Chambers

 

APPENDIX

Recent examples of other trips and traps

1.    Written agreement of the parties that a supply is a going concern or to use the margin scheme

• For transactions to be GST-free as the supply of a going concern in Subdivision 38-J, or to receive concessional treatment under the Margin Scheme in Division 75, it is a requirement that the parties agree in writing that the sale is a going concern or the margin scheme is to be used. This written agreement must be made before the supply takes place, namely before settlement is completed.[7]
• It is not necessary that the written agreement of the parties is found within the terms of the Contract of Sale, although that is usually the case. It will be sufficient if the parties can point to some other evidence of a written agreement.
• In SDI Group Pty Ltd and Commissioner of Taxation [2012] AAT 763 the Tribunal recently found that the parties had agreed in writing that the supply was a going concern, notwithstanding that no document was actually signed by the purchaser to that effect. The facts can be summarised as follows:
  • In December 2009 the applicant and the purchaser executed a contract of sale for the sale of commercial property. At the time there was a tenant of the property on a monthly lease – the contract was expressly subject to the lease.  The Contract did not refer to the property being a going concern.
  • After the contract was signed, there was a dispute between the parties as to whether the sale was a going concern due to there being a only a monthly lease.
  • Prior to, or at settlement, the applicant provided the purchaser with a tax invoice which contained the words “NO GST (SOLD AS A GOING CONCERN)” and a Goods Statutory Declaration in which the Box was ticked “Yes” in answer to the question “Does the contract relate to the sale of a going concern?”
• The Commissioner contended that the parties had not “agreed in writing” that the sale was the supply of a going concern, and that the tax invoice and Statutory Declaration were “unilateral documents”.
• The Tribunal found in favour of the applicant on the basis that there was sufficient evidence that the applicant and purchaser agreed in writing that the supply involved a going concern – indeed the Tribunal found that the parties had “incorporated an agreement in writing that the supply involved a going concern”.  The requirement for the agreement to be “in writing” was satisfied by a combination of the contract of sale, the tax invoice and the Statutory Declaration.
• The Commissioner’s concern appeared to be that the applicant could not point to a document evidencing an agreement in writing which was signed by the purchaser – the Commissioner accepts that such an agreement need not be found exclusively in the Contract of Sale. One way of looking at the Tribunal’s decision is that by the purchaser proceeding with settlement after receiving the tax invoice and the Statutory Declaration, the purchaser, by conduct, agreed that the sale was of a going concern in accordance with those documents.  Such an agreement is arguably still an agreement “in writing”, as it is evidenced by the written terms of the tax invoice and the Statutory Declaration.

2.    Sales of going concerns and Division 135 adjustments

• A supply of a going concerns is GST-free. However, great care needs to be had if the property is residential or could be used for residential purposes.
• Division 135 imposes an “increasing adjustment” on the purchaser of a going concern where the purchaser of the property is intending to use the property other than to make taxable or GST-free supplies (eg, the input taxed supply of leasing residential premises, or the domestic supply of residing in the property). The amount of the increasing adjustment can be as high as 1/10^th of the price.
• Example[8]
  • A enters into a contract to purchase property from B which is currently leased for use as a medical practice. The price is $1,000,000. The lease is due to expire shortly after settlement and A intends to reside in the premises. A and B agree the sale is of a going concern. A will have an increasing adjustment under Division 135 of $100,000 as A intends to use the premises other than to make taxable or GST-free supplies.

3.    Partnership or Joint Venture?

• Determining whether a property development arrangement between parties is a partnership or a joint venture is often a complex and difficult task. However, the implications of getting it wrong can be significant. A ready example is that each partner will be jointly and severally liable for the GST payable by the partnership, whereas for a joint venture[9] each participant will only be liable for GST on its share.
• This issue was recently highlighted by the Federal Court in Yacoub v Commissioner of Taxation [2012] FCA 678[10] where the Federal Court found that the applicants were liable for pay the whole GST liability for a property development on the basis that the entity was a partnership rather than a joint venture.  The applicants contended that they were only liable to a share of the GST liability on the basis that the entity was a joint venture.  The Court rejected this contention and as the other participant had gone into external administration, the applicants were left with the entire GST debt.
• The applicants had entered into a “Syndicate Agreement” in 2005 with another entity (without legal assistance). In 2007, the parties entered a further agreement, this time with legal assistance.  In August 2007, an entity (ML) was registered for GST.  Construction of the development occurred between October 2007 and June 2009 and over that time ML lodged activity statements.  The Commissioner issued a notice of assessment to ML for the GST owing in respect of the sale of the development and the applicants paid 50% of the assessments in discharge of what they believed to be their liability.  The other entity did not pay the remaining 50% and was placed into external administration.  The Commissioner then commenced recovery proceedings against the applicants for the balance on the basis that the 2007 agreement superseded all previous agreements and made the applicants and the other entity partners for tax purposes, even if not partners in general law.
• In deciding that there was a partnership, the Court looked at the “substance and reality” of the transaction. The agreements expressly stated that no partnership was being carried on, but the Court noted that while the existence of such a statement may be relevant, it did not determine the issue.  The Court found that the proper construction of the 2007 agreement was that the parties had replaced the 2005 agreement with one in which they expressly agreed to “share equally all costs, liabilities, mortgages and proceeds derived from any sale arising from the property”.  Accordingly, as a matter of substance the parties created between themselves both a partnership at general law and a tax law partnership.