GST AND REAL PROPERTY

RECENT ISSUES

 

CHRISTOPHER M SIEVERS, VICTORIAN BAR

INTRODUCTION

There have been significant developments in the operation of the Goods and Services Tax (“GST”) to residential and commercial property in recent times.  This paper focuses on some of these developments.

The topics discussed in this paper are:

(a)   New residential premises – the definition of “new residential premises” has been amended and GSTR 2005/4 and 2005/5 have been published to address some of the arrangements seen by the Commissioner as avoiding or reducing the GST payable on the sale of new residential premises;

(b)  Margin scheme – there have been a number of amendments to the margin scheme provisions, we have seen the first consideration of these provisions by the Federal Court in Sterling Guardian Pty Ltd v Commissioner of Taxation (which is on appeal) and Commissioner is readying for a fight with developers on the proper way to value partly completed premises as at 1 July 2000;

(c)   Anti-avoidance – a decision in the first case on the operation of Division 165 is pending, the Commissioner is taking a broad approach to the scope of Division 165 and in addition to the potential application of those provisions to the arrangements outlined in GSTR 2005/4 and 2005/5 he is also focusing his attention on arrangements which seek to use entities using reporting GST on different bases so as to create a timing mismatch.

NEW RESIDENTIAL PREMISES

The Commissioner has been concerned that a number of residential property developments were structured so as to avoid or reduce what the Commissioner considered to be the proper amount of GST payable.  The Commissioner’s concerns were initially reflected in 2004 by the publication of a number of taxpayer alerts[1] which dealt with the following arrangements:

(a)   The supply of a completed, or substantially completed, residential property development between members of a GST group or a GST joint venture and the on-sale of the development to third parties whereby:

i)      the GST was calculated by reference to the margin between the sale price and the intra-group sale price (the contention was that the sale between members of a GST group or a GST joint venture was not a taxable supply and thereby the margin scheme could be used for the third party sales); or

ii)    the sale was treated as input taxed but the GST group claimed input tax credits on the costs of constructing the development (the contention was that the supply of real property between members of a GST group or a GST joint venture meant that the real property was not new residential premises within s 40-75(1)(a) as the property had previously been sold as residential premises and thereby the third party sales were input taxed.  Further, this arrangement could be used to “freshen up” ineligible property so that the margin scheme could be used notwithstanding that the property had been initially acquired by the GST group member or GST joint venture participant as a taxable supply without the margin scheme being used).

(b)  The supply of a completed, or substantially completed, residential property development to another entity (which may or may not be an associate) as a going concern and the on-sale of the development to third parties whereby the sale was treated as input taxed but the both entities claimed input tax credits on the costs of constructing the development.  This provided an uplift to the margin as it was calculated by reference to the second entity’s acquisition cost.

The Commissioner has sought to address his concerns by amending various sections in the GST Act with effect from 17 March 2005 and dealing with the period from 1 July 2000 to 17 March 2005 by the publication of GSTR 2005/4 and GSTR 2005/5.

Amendments to the GST Act

The amendments deal with the first arrangement outlined above.  The Bill introducing the arrangements included provisions seeking to deny the uplift in the margin where a development was purchased as a going concern, however those provisions did not become law.

The focus of the amendments is to ignore the existence of the GST Group or the GST joint venture:

(a)   The meaning of “new residential premises” in s 40-75 of the GST Act was amended by inserting s 40-75(2A) which effectively disregards the supply of real property between members of a GST group or participants in a GST joint venture from making the residential premises for the purposes of applying s 40-75(1)(a).

(b)  Real property which is ineligible for the margin scheme has been extended by s 75-5(3)(c) and (d) to include real property that was acquired from a GST group member or GST joint venture participant in circumstances where that property was acquired by that GST group member or GST joint venture participant through a supply that was ineligible for the margin scheme.

GSTR 2005/4 and GSTR 2005/5

GSTR 2005/4 deals with first arrangement outlined above, which is said to include the following features:

(a)   A GST group member (“the supplying member”) acquires land and constructs or arranges, or substantially constructs or arranges the substantial construction, of a residential development on the land.

(b)  The supplying member sells the completed premises, or substantially completed premises, to another GST group member (the acquiring member), sometimes as a going concern, for consideration.  There is no GST paid on the supply.

(c)   The acquiring member:

i)      sells the completed premises, or substantially completed premises, to third parties and treats the sales as input taxed supplies; or

ii)    completes the premises and sells them to third parties applying the margin scheme to calculate the GST.

The views of the Commissioner in the ruling essentially reflect the amendments to the Act which took effect from 17 March 2005:

(a)   The intra-group sale of real property which comprises completed premises is not the first sale of new residential premises for the purposes of s 40-75(1)(a).  The basis for this view is that in the context of the GST Act and Division 75 a Court would prefer that construction.[2]  Further, the intra-group sale of real property comprising substantially completed premises does not involve the sale of residential premises because substantially completed premises cannot be regarded as residential premises until they are capable of being occupied as a residence.

(b)  The acquiring member can only use the margin scheme where the supplying member would have been able to use the margin scheme had it made the supply to the third party.[3]

(c)   As the real property sold by the acquiring member to third parties is new residential premises (and a taxable supply), the GST Group is entitled to input tax credits on the cost of the acquisition of the land and the construction costs of the premises.

(d)  If the Commissioner is incorrect in his views, he will consider the application of the anti-avoidance provisions in Division 165 on a case by case basis.  In this respect the Commissioner rejects the contention that Division 165 cannot apply because the GST benefit is “attributable” to the making of a choice, election, application or agreement (ie, the application to form a GST group) and considers that the GST benefit is attributable to the structuring of the arrangement and the transfers of title.[4]

GSTR 2005/5 deals with the second arrangement which is outlined above and is said to include the following features:

(a)   The supplying entity owns or acquires land and constructs or arranges for the construction of a residential development on the land.  The supplying entity sells the partially or substantially completed premises to the acquiring entity as a going concern.

(b)  The acquiring entity completes the development and sells the completed premises to third parties applying the margin scheme.

(c)   The supplying entity and the acquiring entity claim input tax credits for their costs.

(d)  The supplying entity and acquiring entity are commonly associates or otherwise acting in concert to obtain a GST benefit.

In the ruling the Commissioner concedes that the supply of substantially or partially completed premises can be the supply of a going concern, provided that all of the other things necessary for the continued operation of the enterprise are supplied, for example, council approvals, intellectual property, plans, assignment of sub-contractors, sales and marketing offices.[5]

The Commissioner also concedes that the margin scheme can be applied to the subsequent sale of the development as the real property was acquired as part of a GST-free supply of a going concern.  However, the Commissioner stresses that the choice to use the margin scheme may be subject to the overriding operations of the anti-avoidance provisions in Division 165.[6]

margin scheme

In addition to the amendment referred to above, there have been a number of amendments to the margin scheme provisions in Division 75.[7]

Agreement in writing

A fundamental amendment has been to introduce a requirement that the parties agree in writing that the margin scheme is to apply[8].  The agreement must be made on or before the supply is made (ie, settlement) or within such further period as the Commissioner allows.  The requirement came into operation on 29 June 2005.

By requiring the parties to agree in writing, many of the disputes between vendor and purchaser as to whether the margin scheme should, can or will be used can be avoided.  However, there is no requirement for a vendor or a purchaser to agree to use the margin scheme.  This could lead to disputes.  For example, a vendor signs a GST inclusive contract on the erroneous belief that there is no GST.  On discovering that GST is payable the vendor seeks the agreement of the purchaser to use the margin scheme, who is under no obligation to so agree.

Calculation of margin in particular circumstances

S 75-11 has been inserted to deal with calculating the margin in particular circumstances:

(a)   Acquisitions from a GST group member or GST joint venture participant[9]

i)      If the real property was acquired by the GST group member or GST joint venture participant from a fellow member or participant after 1 July 2000 the margin will be the consideration for the sale to a third party less:

(1)  the consideration paid by the initial GST group member or GST joint venture participant; or

(2)  if the initial GST group member or GST joint venture participant acquired the real property from an associate, the GST inclusive market value of the property at that time.

ii)    If the real property was acquired by the initial GST group member or GST joint venture participant prior to 1 July 2000 the margin will be the consideration for the sale to a third party less an approved valuation as at 1 July 2000.

(b)  Acquisitions from a deceased estate[10]

i)      If you inherit real property which was acquired by the deceased prior to 1 July 2000, the margin is the consideration for the sale less:

(1)  If you choose to use this method – the consideration paid by the deceased for the real property;

(2)  If the deceased was not registered for GST nor required to be registered, an approved valuation of the real property on the latest of 1 July 2000, the day you inherited the property and the day you registered for GST or were required to be registered;

(3)  If the deceased was registered for GST or required to be registered, an approved valuation of the real property on the latest of 1 July 2000 or the day the deceased registered for GST or was required to be registered.

ii)    If you inherit real property which was acquired by the deceased after 1 July 2000, the margin is the consideration for the sale less:

(1)  If you choose to use this method – the consideration paid by the deceased for the real property;

(2)  An approved valuation of the real property as at the day the deceased acquired it.

(c)   Acquisitions from associates[11]

i)      If you acquired the real property from an associate after 1 July 2000 the margin is the consideration for the sale less the GST inclusive market value of the real property.

Other amendments

The margin is to be calculated by reference to the actual consideration paid for the real property, not the amount stated in the Contract.[12]  In GSTR 2005/D4 the Commissioner takes the view that adjustments will either increase or decrease the consideration paid at settlement.  However, money withheld by the purchaser at settlement to pay outstanding rates or taxes will not reduce the consideration paid as it is merely applying part of the consideration to meet those rates or taxes.[13]  If you subsequently pay further consideration for the acquisition, you will be entitled to a decreasing adjustment equal to 1/11^th of the further amount paid.[14]

The consideration for acquiring the real property does not include the cost associated with the purchase, such as legal expenses and stamp duty, nor the costs incurred in developing the real property.[15]  The basis for this view is that the input tax credits would be claimed in respect of these costs.

Approved valuations

S 75-35 provides that the Commissioner may, by legislative instrument, determine in writing requirements for making valuations for the purposes of Division 75 (an “approved valuation”).  The A New Tax System (Goods and Services Tax) Margin Scheme Valuation Requirements Determination MSV 2005/3 outlines the methods which valuations can be made as from 1 December 2005.  This replaces the previous determinations.

The methods are as follows:

(a)   Method 1 – a written valuation by a professional valuer determining the market value of the interest, unit or lease at the valuation date which is made in a manner that is not contrary to the professional standards recognised in Australia for the making of real property valuations.

(b)  Method 2 – adopting as the value the consideration provided by a purchaser in a contract for sale and purchase of the real property executed or exchanged before the valuation date by parties dealing at arm’s length.

(c)   Method 3 – adopting as the value the most recent value as determined before the valuation date by or on behalf of a State Government or a Territory Government department as the unimproved value, the site value, or the capital value of the land, for rating or land tax purposes.

The use of prescribed valuation methods is currently the subject of controversy and, as I understand, at least one application before the Federal Court.  The controversy is whether a valuation of partly completed premises as at 1 July 2000 complies with the requirements of paragraph 5 of the A New Tax System (Goods and Services Tax) Margin Scheme Valuation Requirements Determination (No.2) 2000 in circumstances where the valuer fails to take account of the pre-sale contracts entered into between the supplier and third parties prior to 1 July 2000.  The Commissioner’s position is that these pre-sale contracts must be taken into account by the valuers.  Some valuations have been prepared without taking those contracts into account and because of the increase in property prices, the Commissioner considers that the margin has been inflated and the GST liability decreased.

Sterling Guardian Pty Limited v Commissioner of Taxation [2005] FCA 1166[16]

This case involved a strata-unit development by the taxpayer.  The taxpayer contended that the margin scheme was available because the stratum units could not be regarded as land acquired as a taxable supply.  This was because of the lack of identity between the land acquired for development and the stratum units arising on the registration of the strata plan.  The taxpayer relied on a number of stamp duty cases which supported the taxpayer’s contention that on registration of a strata plan (or a plan of subdivision), new land was created.[17]  Justice Stone of the Federal Court found that the attractiveness of the submission diminished somewhat when its implications were considered (for example, whether the margin scheme applied would depend on whether there was a subdivision or whether the subdivision took place before or after the developer purchased the property).  In the end, Her Honour rejected the taxpayer’s contention by taking a substantive approach and focusing on the nature of the GST as a tax on business transactions.  As stated by Her Honour (at [39]):

“The clear thrust of the GST Act, both in its wording and as explained in the EM, is that of a practical business tax imposed with respect to elements of commerce.”

This allowed Her Honour to essentially ignore the fact of the subdivision and treat the transaction as one which involved the acquisition of land by the taxpayer and the subsequent sale of pieces of that land.

THE ANTI-AVOIDANCE PROVISIONS

As at the date of this paper my understanding is that there has been no Australian decision involving the operation of the anti-avoidance provisions in Division 165, so there is little guidance as to how the provisions will apply other than the views of the Commissioner as set out in a number of rulings.[18]  GSTR 2005/4 and 2005/5 show that the Commissioner appears quite ready to apply the anti-avoidance provisions in Division 165 to any arrangement which he considers has the effect of giving an unwarranted GST benefit.  It will be interesting to see whether the Courts take a similarly aggressive position on the operation of the provisions.

In addition to the arrangements outlined in the rulings, a further matter which I understand is of concern to the Commissioner is the structuring of arrangements between entities reporting for GST on different bases (ie, cash and accruals) to take advantage of a timing mismatch between the entitlement to input tax credits and the obligation to pay GST.[19]

The decision of the New Zealand High Court in Ch’elle Properties (NZ) Limited v Commissioner of Inland Revenue (2004) 21 NZTC 18,618 is illustrative of such an arrangement.  The facts in this case were essentially as follows.  The taxpayer contracted to purchase 114 sections of land in a subdivision from a similar number of companies by separate agreements.  The agreements were conditional on each of the vendor companies completing a purchase agreement with W, the developer owner of the land.  Each contract provided for payment of $10 on signing, as part payment of an agreed deposit of $30,000.  Each contract provided that the vendor would build a house on the land and the consideration reflected the expected market value of the land on completion.  Settlement of the Contracts was to take place between 10 and 20 years from the date of the contracts.  The taxpayer was registered for GST on an invoice (accruals) basis and each vendor company was registered on a cash basis.   This created a timing mismatch similar to that presently before the Tribunal.  The amount of input tax credit claimed was nearly $9,000,000.

The High Court upheld the decision of the Commissioner to apply the general anti-avoidance provisions in the NZ Act (s.76)[20] so as to negate the input tax credit.  In doing so, the High Court made a number of findings which an Australian Court or Tribunal may well find persuasive:

(a)   The balance between outputs and inputs was grossly distorted by the gap of between ten and twenty years between Ch’elle receiving an input tax credit and the time at which liability may arise for output tax on Ch’elle’s taxable supply;

(b)  Because of the uncertainty of the underlying contractual arrangement, there is doubt whether liability for output tax will ever arise;

(c)   The degree of mismatch between the liability for output tax and the entitlement to an input tax credit, which was both contemplated and tolerated by the Act, escalated to a level which could never have been intended;

(d)  The tension between the commercial and juristic character of arrangement was stretched to breaking point.  It conformed to the letter of the Act while departing from its fundamental objectives and had therefore the purpose and effect of defeating the intent and application of the Act.

CONCLUSION

Real property, in particular residential property, is continuing to be a major source of controversy with regards to the operation of GST.  Not surprisingly, advisers have sought to use some of the concessions in the GST Act, namely the margin scheme, GST groups, GST joint ventures and the going concern exemption to their clients’ advantage.  Notwithstanding the amendments to the GST Act and the publication of the rulings, advisers will no doubt continue to develop arrangements which are beneficial to their clients and the Commissioner will continue to seek to address those arrangements which he views to be inappropriate.  In this respect, the GST is no different to any other tax.

CHRISTOPHER M SIEVERS

Owen Dixon Chambers West

23 February 2006