GST-free supplies of going concerns and farmland – Going, going, gone? The Reverse Charge Regime

GST-free supplies of going concerns and farmland – going, going, gone?? The Reverse Charge Regime*

Introduction

1)   The GST-free treatment of going concerns and the sale of farmland has been a part of the GST system since its inception in 2000.[1] The provisions have had their difficulties, but the same can be said for many of the provisions of the GST Act when applied to real property transactions.

2)   In 2008 the Board of Taxation published a report proposing to replace the going concern and farmland provisions with a “reverse charge” regime, whereby the responsibility for the GST would be shifted to the purchaser. In 2009 the Treasury published a paper supporting the proposal.[2] No legislation was prepared and the concept languished, until 14 December 2013 when the Assistant Treasurer announced that the government would proceed with the measures.

3)   There is no firm timetable for the measures, save that it is expected to be introduced some time in 2014. No transitional rules have been proposed, but it is expected that it will apply prospectively.

4)   The proposed measures have important implications for vendors, purchasers and practitioners, which are discussed in this paper.

The current regime

The Going Concern exemption

5)   The exemption effectively removes the sale of an operating enterprise from the GST net. This has the following advantages for purchasers:

a)    There is a stamp duty benefit through the price not being grossed up for GST. Stamp duty is generally payable on the GST-inclusive price.

b)   The purchaser is freed from the obligation to fund the GST component of the purchase price. While the purchaser may ultimately receive an input tax credit for the GST component of the price, it may nevertheless be required to fund an additional 1/11th of the purchase price which is payable to the vendor at settlement.

Of course, while the purchaser gets all the benefits, the vendor carries the risk of the supply not properly being the supply of a going concern. That risk may be alleviated somewhat by appropriate indemnities and warranties in the contract of sale, but at the end of the day the liability to pay any GST will fall on the vendor.

6)   Section 38-325 provides that the supply of a going concern is GST-free in the following circumstances:

a)    Both parties must be registered or required to be registered for GST;

b)   Both parties agree in writing that the sale is of a going concern;

c)    The supply must be under an arrangement under which:

i)     The supplier supplies to the recipient all of the things that are necessary for the continued operation of the enterprise; and

ii)    The supplier carries on the enterprise until the day of the supply (whether or not as part of a larger enterprise)

7)   The going concern exemption has been the subject of a number of disputes and uncertainty, including the following:

What constitutes an agreement in writing?

a)    There have been a number of ceases before the Tribunal about whether the parties have agreed in writing that the supply is of a going concern.[3] Some of the principles which can arguably be gleaned from these decisions are as follows:

i)     The agreement must be made before the supply (ie, before settlement), although the agreement need not be embodied in the contract;

ii)    The agreement may be evidenced in writing by two or more documents;

iii)  The agreement may be evidenced by a “unilateral document”, being a document prepared by one party to the transaction, such as a tax invoice or a goods statutory declaration handed over at settlement – if that document reflects the mutual intentions of the parties at the time of settlement;

iv)  It may be possible to establish the existence of an agreement by reference to documents entered into by the parties after settlement – reflecting the statutory requirement that the agreement must be “evidenced in writing”. Accordingly, it may be that in some circumstances the existence of an agreement by the parties before settlement (eg, an oral agreement) can be properly “evidenced” by documents brought into existence after settlement.

What is covered by the agreement?

b)   For sales of business where the freehold is also sold, it is common to have separate contracts for the sale of the business and of the land. In Debonne Holdings Pty Ltd and Commissioner of Taxation [2006] AATA 886 the contract for the sale of the business included a clause stating that the parties agreed that the sale was GST-free as the supply of a going concern. The land contract did not have such a clause and the price was expressed to be inclusive of GST. The purchaser claimed that it was entitled to input tax credits on the purchase of the land. The Tribunal agreed with the Commissioner that both sales were GST-free and the agreement in the business contract applied to the land contract – essentially because there was in truth only one transaction.

Division 135

8)   The going concern provision also has a nasty “sting in the tail”, in the form of Division 135, which seeks to impose an increasing adjustment on purchasers of going concerns who make input taxed supplies through the enterprise acquired. The intended effect of the Division is to produce the same net GST outcome as would arise had the supply been taxable and the recipient had been entitled to claim a credit only to the extent of its creditable purpose.

9)   The effectiveness of Division 135 is now uncertain, particularly where the enterprise involves the lease of residential property. This uncertainty resulted from the decision of the Full Federal Court in MBI Properties Pty Ltd v Commissioner of Taxation [2013] FCAFC 112. The Commissioner has filed an application for special leave to appeal to the High Court. A case summary of the decision is attached.

The farming exemption

10)         Section 38-480 makes the supply of a freehold interest in land GST-free where:

a)    The land is land on which a farming business has been carried on for at least 5 years; and

b)   The recipient intends that a farming business be carried on, on the land.

11)         The provision has similar benefits to the going concern provision. Some points to note about the provision are as follows:

a)    The purchaser/recipient is not required to be registered for GST – accordingly, it extends the GST-free treatment to transactions where the purchaser is not registered or required to be registered. For example, where the turnover from the farm is below the threshold.

b)   While there is 5 year time requirement for the vendor, there is no time limit on the purchaser. It would appear that an intention to carry on the farming enterprise for 1 day would be sufficient.

c)    Unlike the going concern provisions, no agreement is required.

The proposed regime – the “reverse charge”

12)         As no legislation had been introduced, regard needs to be had to the Treasury Discussion Paper to see what the provisions may look like. The Discussion Paper outlines the following principles, which would likely form the core of the legislation.

13)         Principle 1 – “The GST on a supply of a going concern or farm land may, at the agreement of the parties, be treated as reverse charged.”

a)    The effect of the reverse charge mechanism will be that the recipient of the supply is responsible for remitting the GST that otherwise be remitted by the supplier. The recipient is also entitled to claim the credits. Accordingly, where the acquisition is fully creditable, the GST and the credits will offset each other. See Slides 1 and 2.

b)   The reverse charge regime will be voluntary and can only be used where the parties agree. The Commentary states as follows:

The requirement that the agreement must be in writing and made on or before the date of supply is intended to avoid a source of dispute between a supplier and recipient as to the GST treatment on a supply and to remove confusion between the parties as to which party is liable to remit the GST…Where there is no agreement in writing that the supply is subject to a reverse charge the normal GST rules will apply.

As shown by the present going concern provision, imposing a requirement that the parties agree to something does not necessarily avoid a source of dispute.

c)    A recipient must be registered or required to be registered. This will mean that the supply of farmland to an unregistered purchaser will now attract GST – as noted in the Commentary, it would be expected that such recipients would be registered.

The requirement that recipients be registered or required to be registered also imposes a potential risk for vendors. If it turns out that a purchaser is not registered or required to be registered, the ordinary rules will apply and the vendor will be liable for the GST. Accordingly, protection will need to be sought in the contract in the form of warranties etc. Also, a search can be made on the register to ascertain whether the purchaser is registered – see www.business.gov.au.

d)   Where the supply is between associates for no, or inadequate, consideration, the rules in Division 72 will ensure that the GST is imposed under the reverse charge mechanism on the market value of the supply.

e)    The meaning of a “supply of a going concern” will be extended so as to require that the supply must consist of all or substantially all things that are necessary to allow the recipient to carry on an enterprise. Also, it will no longer be necessary that the enterprise be operated by the supplier at the day of supply – it will be sufficient that the enterprise had been operated by the supplier and is capable of operating at the date of supply.

f)     The intention is to maintain the current requirement to qualify for the GST-free supply of farmland (other than the new requirement that the recipient be registered or required to be registered for GST).

g)    It is unclear whether the effect of the new regime will be that parties can no longer gain the stamp duty benefits of applying the going concern and farmland rules. At present, GST is paid on the GST-inclusive price and the Revenue Office may take the view that the GST-inclusive price includes the GST component, notwithstanding that it is payable by the purchaser. The Duties Act 2000 defines “consideration” to mean “the amount of a monetary consideration or the value of a non-monetary consideration”. An argument could be run that the consideration payable by the purchaser includes the actually paid to the vendor at settlement, plus the value of the purchaser agreeing to take over the vendor’s obligation to pay GST on that price (valued at 10% of the purchase price).

14)         Principle 2 – “The general GST adjustment principles and provisions apply to supplies that have been made under a reverse charge mechanism.”

a)    The intention is to ensure that the recipient is liable for an adjustment if they later change the extent to which a supply is used for a creditable purpose.

b)   Division 135 will be repealed. This is because a purchaser would only be entitled to an input tax credit to the extent that the acquisition was used for a creditable purpose. The operation of this new regime is outlined at Slide 3.

15)         Principle 3 – “A supplier of a going concern or farm land, under the reverse charge mechanism, will not have to supply:

  • A tax invoice for the recipient to be entitled to an input tax credit; or
  • An adjustment note where there is an adjustment event resulting in a decreasing adjustment.”

a)    This means that a purchaser can claim an input tax credit and attribute adjustments without the need to obtain tax invoices or adjustment notes from the supplier.

16)         Principle 4 – “If a supply of a going concern involves real property, the GST liability on that part of the supply which is a taxable supply of real property may be determined under the margin scheme and remitted by the supplier.”

a)    This allows the margin scheme to be used where part of a going concern involves the supply of real property (where that supply of real property would otherwise be eligible for the margin scheme).

b)   This will effectively split a transaction into two, being:

i)     the sale of business (ie non real property) being fully taxable, but subject to the reverse charge regime whereby the purchaser is liable for the GST but entitled to the input tax credits; and

ii)    the sale of real property being subject to the margin scheme, with the supplier remaining liable for the GST and the purchaser not entitled to input tax credits.

c)    It also means that two agreements between the parties will be required, namely that:

i)     The parties agree that the supply (of the business only) is a supply of a going concern; and

ii)    The parties agree that the supply of the real property is subject to the margin scheme and that the GST liability for this part of the supply will be determined under the margin scheme.

d)   The parties will also need to agree on the following matters:

i)     A division between the sale of real property assets under the arrangement (which are eligible for the margin scheme); and

ii)    A division of the purchase price between the sale of real property assets and the non-real property assets.

The stamp duty experience shows the difficulties that can arise when parties seek to allocate the purchase price between real property and non-real property assets.

Date of application/Transitional Provisions

17)         The Treasury Discussion Paper states that the measure is to apply from 1 July 2010. Given the passage of time, it is unlikely that the proposed regime would have that retrospective operation. Indeed, it is expected that the regime will have a prospective operation, given that it fundamentally changes the way real property transactions are treated for GST and the rights and obligations of the parties to the transaction.

18)         It is also expected that the regime will have transitional provisions which cater for the added difficulty that a supply of real property takes place at settlement, which can be a significant time after the parties enter into a binding contract. Some guidance on this type of transitional rule can be found in the transitional rules to the State Taxation Acts (General Amendment) Act 2005 which introduced the “sub-sale” provisions into Part 4A of the Duties Act. The transitional provisions provided that if a contract of sale was entered into before a particular date, the old provisions applied unless the parties elected to fall under the new provisions. Such a transitional regime would allow parties to an existing contract at the time the reverse charge provisions were introduced to elect to continue under the existing regime or fall under the reverse charge regime.

19)         Nevertheless, in the absence of legislation, one can only speculate as to the transitional provisions and its date of introduction. It will therefore be important to look to protect the interests of client by the inclusion of appropriate clauses in the contract.

 

Chris Sievers

Lonsdale Chambers

17 March 2014

 

* This paper was presented on 31 March 2014 at the CPD conference organised by Russell Cocks known as “The Last Chance Saloon”.

[1] Unless stated otherwise, all statutory references are to the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act).

[2] Treasury Discussion Paper, “Implementation of the recommendations of the Board of Taxation’s review of the legal framework for the administration of the GST”, Chapter 2.8.

[3] Midford v Deputy Commissioner of Taxation [2005] AATA 623; SDI Group Pty Ltd v Commissioner of Taxation [2012] AATA 763; Re YXFP and Federal Commissioner of Taxation [2009] AATA 805; Re Nitram Consulting Pty Ltd and Commissioner of Taxation [2008] AATA 1119; Brookdale Investments Pty Ltd and Commissioner of Taxation [2013] AATA 154.

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