Introduction

This decision was an appeal by the taxpayer against the decision of the Federal Court in MBI Properties Pty Ltd v Commissioner of Taxation [2013] FCA 56. The decision is related to the decision of the Federal Court in South Steyne Hotel Pty Ltd v Commissioner of Taxation [2009] FCA 13 (and on appeal [2009] FCAFC 155).

This issue in this appeal was whether the taxpayer had an “increasing adjustment” under Division 135 of the GST Act. The purpose of Division 135 of the GST Act is stated in s 135-1 as follows:

The recipient of a supply of a going concern has an increasing adjustment to take into account the proportion (if any) of supplies that will be made in running the concern and that will not be taxable supplies or GST-free supplies. 

S 135-5 provides as follows:

You have an increasing adjustment if:

(a) you are the recipient of a supply of a going concern, or a supply that is GST-free under section 38-480; and

(b) you intend that some or all of the supplies made through the enterprise to which the supply relates will be supplies that are neither taxable supplies nor GST-free supplies.

The Full Court agreed with the taxpayer that it did not have an increasing adjustment pursuant to Division 135 of the GST Act where it acquired, as a going concern, residential premises which were subject to a lease. This was because the supply was made on the grant of the lease and that while the lease (being the subject of the supply) may have continued, the supply made on the grant did not. The Full Court also agreed that on its proper statutory construction, s 135-5(1)(b) only applied to supplies made by the acquirer of the enterprise.

Facts

The facts can be summarised as follows:

• South Steyne purchased a hotel and pursuant to a strata plan the hotel was subdivided into 83 individual apartments and the management lot (comprising the reception area, offices and car parking spaces).
• South Steyne transferred the management lot to Mirvac Hotels and granted to Mirvac Management a 10 year lease in identical terms in respect of each of the 83 apartments. Under the lease Mirvac Management was obliged to operate a scheme whereby each apartment was, together with all other apartments, to be operated as part of a serviced apartment business.
• By three separate contracts South Steyne sold 3 of the 83 apartments to MBI (a related company of South Steyne). Each apartment was sold subject to the lease and was stated to be the sale of a going concern.  Each contract permitted MBI to participate in the serviced apartment business. MBI elected to participate.

In South Steyne the majority of the Full Federal Court made the following findings:

• the supply of the 83 individual apartment leases was the input taxed supply of residential premises, rather than the taxable supply of commercial residential premises.
• the sales of the 3 apartments to MBI were GST-free as the supply of a going concern.
• MBI did not make any supply to Mirvac Management (whether under s 40-35 of the GST Act or otherwise) following its acquisition of the reversionary interests in each of the 3 apartments.
• The supply of a hotel room to a guest was a taxable supply of accommodation in commercial residential premises by Mirvac Hotels acting as principal and not as agent of Mirvac Management.

In MBI the issue was whether MBI had an increasing adjustment pursuant to Division 135 of the GST Act in respect of the 3 apartments it acquired as a going concern on the basis that it intended to make input taxed supplies of residential premises.

Judgment at first instance

The contentions of MBI are outlined at [24] of the judgment at first instance, and the essential arguments appeared to be as follows:

• For the purposes of s 135-5 it should not be concluded that MBI intended to make supplies that were neither GST-free nor taxable through the enterprise acquired as a going concern because the section refers to the taxpayer’s intention in respect of its own activities and not the activities of another entity – this is supported by the reference in s 135-5(1)(b) to supplies that “will be” supplies that are neither taxable nor GST-free.
• MBI had no intention of making supplies of any character through the enterprise acquired by it (being the 3 apartments with leases to Mirvac Management) – its mere toleration of those leases did not constitute the making of a new or fresh supply.
• Division 156 has no application to s 135-5 – the Commissioner’s case effectively invites the Court to create a similar regime to that created by Division 156, but in respect of input taxed supplies.

The contentions of the Commissioner are outlined at [25], and the essential arguments appeared to be as follows:

• the intention in s 135-5(1)(b) is to be objectively determined and ascertained by reference to the nature of the enterprise to which the supply of the going concern relates and through which the supplies will be made.
• if the character of an enterprise that is to be supplied as a going concern is such that input taxed supplies are made through it, the recipient of that enterprise as a going concern is objectively taken to have intended that input taxed supplies will be made through that enterprise because that is the character of the supplies which the enterprise makes.
• there is no warrant to read into s 135-5(1)(b) a requirement that the relevant supplies have to be made only by MBI.
• it is not determinative that South Steyne made no further supplies after it supplied the serviced apartment business to MBI because, by their very nature, input taxed supplies of residential premises by lease are continuous or progressive supplies – it is sufficient that the supply continues to be made “through the enterprise” after its supply as a going concern.

The Court accepted the Commissioner’s submissions and made the following findings:

• s 135-5(1)(b) should not be construed so that it only applies to supplies made by the recipient and not a third party. This construction required the provision to be read as though it referred to “supplies made by you through the enterprise” – there was no basis to read those words into the provision.
• The Court did not consider that the presence of the words “will be” in s 135-5(1)(b) advanced MBI’s case. All the paragraph required was that the recipient intend that some or all of the supplies made through the enterprise to which the supply of the going concern relates will be supplies that are neither taxable nor GST free supplies.
• The Court considered that the words “will be” were sufficiently broad to cover the situation where supplies continue to be made through an enterprise, as in this case.
• To the extent there is any dispute about the matter, the Court accepted the Commissioner’s contention that, for the purposes of s 135-5(1)(b), the issue of MBI’s intention is to be determined objectively and by reference to the nature of the enterprise to which the supply of the going concern relates.
• The Court accepted the Commissioner’s contention that the leases are intrinsically linked with the serviced apartment business which constitutes the relevant “enterprise” for the purposes of s 135-5(1)(b) of the GST Act

The Court came to the following conclusion (at [38]) (emphasis added):

Having regard to all these matters, I consider that the requirements of [s 135-5(1)(b)] are satisfied in circumstances where there is a supply that is treated as a continuing supply (namely the supply of the residential premises by lease) which continues to be made through the enterprise constituted by the serviced apartment business after its supply as a going concern. Moreover, for reasons given above in [35], I find that MBI as recipient of the going concern intended that that be the case.

The appeal

The lead judgment was given by Edmonds J (Davies and Farrell JJ agreed with his Honour’s reasons).

Edmonds J began with a consideration of the decision in South Steyne, noting that the Full Court unanimously held that there was no supply by MBI when it purchased the reversionary interest in the three apartments – there was merely a continuation of the initial leases granted over those three apartments.

His Honour then considered the contentions of MBI on appeal.

Was there a continuing supply?

The principal error identified by MBI was the primary judge’s conclusion that South Steyne was “treated” by the GST Act as continuing to make input taxed supplies to MML after it had ceased to have any interest in the units. The Commissioner acknowledged that this was the critical issue in the appeal and he conceded that “if there is no continuing supply there is no basis on which MBI would be liable to an increasing adjustment”.

His Honour noted that Division 156 had no application in this case because that provision was only concerned with the attribution of GST payable on a taxable supply. Accordingly, the treatment worked out by s 156-22 was not applicable. Also, Counsel for the Commissioner was unable to identify any other provision of the GST Act which “deems continuation of supply” during the continuation of a lease, at least “explicitly”. Rather, the contention of the Commissioner was as follows:

The proposition, if one can boil it down as much as possible, is simply this: If there is a continuing lease, there must be a continuing supply. The proposition is, your Honours, as simple as that…

His Honour considered that this proposition was flawed, observing that the lease was the subject of the supply, not the supply (being the grant of the lease) and the supply was complete on the lease coming into existence. Further, if the the “supply” constituted by the grant of the lease did not survive the grant, it certainly did not survive the sale of the reversion from South Steyne to MBI.

The Commissioner also sought to rely on the decision of the Full Court in Westley Nominees Pty Ltd v Coles Supermarket Australia Pty Ltd [2006] FCAFC 115 where the Court referred to the “oddness” of the result if a supply by way of lease was to come to an end when the owner of the property and grantor of the lease sold the reversion to a third party purchaser so that, while the third party purchaser of the reversion and the lessee would remain bound in terms of the lease and entitled to enjoy the respective benefits therefrom, there would no longer be a “supply” upon which a liability to GST could be founded. His Honour observed that this passage concerned the GST Transition Act, in particular s 12 which applied to periodic or progressive supplies beginning before and ending on or after 1 July 2000. 

His Honour found (at [29]) that the primary judge erred in concluding that, following the sale of the reversion from South Steyne to MBI, there was a continuing supply by South Steyne to MML – rather there was no continuing supply, merely a continuation of the lease, the subject of the supply made by South Steyne to MML by the grant. The appeal was therefore allowed.

The construction of s 135-5(1)(b)

Given the finding on the first point, it was not necessary to consider the issue of the statutory construction of s 135(1)(b) and whether it was limited to supplies made by the person who acquired the enterprise. Nevertheless, the Court considered the issue.

His Honour agreed with the following contention of MBI (at [33]):

…there were quite powerful indicators in s 135-5(1)(b) and in its wider statutory context that the relevant “supplies” are those which the purchaser of the enterprise intends to make in carrying on that enterprise. I agree. Apart from anything else, his Honour’s conclusion involves the startling proposition that someone other than the person making the supply, indeed a person who is not even the recipient of the supply, is liable to pay GST on the supply.

His Honour stated that the proper construction of s 135-5(1)(b) must be approached with an appreciation of its wider setting and the achictecture of the GST Act as a whole. In this context it was not  in dispute that MBI makes no supplies, input taxed or otherwise, in leasing the units to MML (ie, it makes no supplies which could be regarded as being made “through” its enterprise), but on the construction adopted by the primary judge MBI has been made liable for GST in any event. That was not an outcome that can be reconciled with the stated purpose of Division 135, nor the architecture of the GST Act as a whole.

His Honour concluded as follows (at [40]):

In my view, both the direct statutory context and the wider architecture of the GST Act suggest that the relevant supplies for the purposes of s 135-5 are those made by MBI and not by some other entity. The section only applies where “all of the things that are necessary for the continued operation” of the supplied enterprise (s 38-325(2)(a)) have first been supplied to the taxpayer. The section also only applies where “you intend” that certain supplies “will be made” and does not apply to supplies that have previously been made by another entity.

Finally, his Honour observed that at trial MBI contended that the the construction adopted by the primary judge also gave rise to practical difficulties, in that a taxpayer’s liability depended upon the extent to which some other person will make, or be “treated” as making, input taxed supplies “through” the taxpayer’s enterprise. On that construction, the GST liability on acquisition of leased real property depends upon knowing whether the original grant of the lease (which may not have been made by the vendor) was taxable or input taxed. This matter was seen in the Court below to be an insignificant “theoretical” practical difficulty: at [28]. His Honour concluded that the difficulty, however, was neither theoretical nor insignificant.

Concluding thoughts

My first thought is whether the Commissioner will seek special leave to appeal to the High Court. The following thoughts are subject to an application being made.

The GST effect of the sale of a reversionary interest is settled 

After the decisions of the Full Court in Westley Nominees and South Steyne there appeared to be some confusion (and indeed conflict) as to whether the purchaser of a reversionary interest in land (ie, land which was leased) made a separate supply to the lessee and if not, whether the initial supply under the lease continued notwithstanding the change in ownership of the reversion. This decision of the Full Court confirms the following matters:

• the acquirer of the reversionary interest does not make a supply to the lessee; and
• the supply made on the grant of the lease is not “continued” by the purchaser of the reversion – indeed it would appear that the supply made on the grant of the lease is not even continued by the original grantor of the lease. The lease may continue, but that is the “subject” of the supply, not the supply itself (which is the grant of the lease).

The future of Division 135?

Adopting the decision of the Full Court, any purchaser of a reversionary interest in land where the land is subject to a residential lease (being input taxed) will not be liable to an increasing adjustment under Division 135. This would appear to strip much of the operative scope of the Division.

This also raises the question of what the Commissioner does with respect to those taxpayers who have been assessed for an increasing adjustment in similar circumstances. In this context, it may be doubted whether the discretion to retain refunds in s 105-65 of Schedule 1 to the TAA (or the proposed provisions in Division 142 of the GST Act) applies to increasing adjustments mistakenly assessed under Division 135. It that is the case, taxpayers who have been assessed for increasing adjustments may be entitled to claim refunds of those adjustments.

How does Division 156 work?

Section 156-5(1) of the GST Act provides as follows:

The GST payable by you on a taxable supply that is made:

(a) for a period or on a progressive basis; and

(b) for *consideration that is to be provided on a progressive or periodic basis;

is attributable, in accordance with section 29-5, as if each progressive or periodic component of the supply were a separate supply.

Given the findings of the Full Court, one may question whether Division 156 works for leases of real property at all. The Full Court found that where a lease is entered into, the supply is the grant but it is the lease (being the subject of the taxable supply) which continues over time. The Full Court made a clear distinction between a supply and the subject of a supply. Looking at the words of s 156-5(1), the division applies to “a taxable supply that is made for a period or on a progressive basis” – the section does not refer to the “subject” of the taxable supply being made for a period or on a progressive basis.

However, it would appear that s 156-22 may save the day. It provides as follows:

For the purpose of this Division, a supply or acquisition by way of lease, hire or similar arrangement is to be treated as a supply or acquisition that is made on a progressive or periodic basis, for the period of the lease, hire or arrangement.

Accordingly, the effect of s 156-22 would arguably be to “deem” the supply made on the grant of the lease to be made on a progressive or periodic basis. Of course, this only applies to leases that involve taxable supplies.

If Division 156 does work – then how?

In MBI the primary judge appeared to take the view that where the supply of the lease was taxable, the effect of Division 156 was that the GST treatment  continued over the term of the lease. The Full Court did not deal with Division 156, save to observe that it did not apply to input taxed supplies.  Nevertheless, , there are many unanswered questions about the impact of Division 156 where the reversionary interest is sold to a third party, two of which are discussed below.

Issue 1  – What if the purchaser of the reversion is not registered for GST and not required to register (eg, because its turnover is below the threshold)?

The purchaser of the reversion makes no supply under the lease, but the effect of Division 156 appears to be that the taxable supply made on the grant of the lease is deemed to continue on a periodic or progressive basis and this continues after the purchaser acquiring the reversion. Does Division 156 make a purchaser who is not registered liable to pay GST? Interestingly, s 156-5(1) simply refers to “the GST payable by you on a taxable supply that is made…“. The section is not limited to taxable supplies “made by you“. It would seem a strange result if a purchaser of the reversion who is not registered for GST incurs an ongoing GST liability when it does not actually make any supplies itself under the lease.

Further, if the purchaser was liable to pay GST, to whom would the lessee need to look to for a tax invoice – being a document which is to be provided by the supplier?

Issue 2 – What if a registered entity acquires the reversion from an unregistered entity?

If a lease is granted by an unregistered entity, GST will not be payable on the lease. If the reversion was purchased by a registered entity, the purchaser would not make a fresh supply.  Division 156 would have no application because it only applies to taxable supplies. This appears to lead to the strange outcome that purchaser who is registered for GST has no liability to pay GST on rental received by it under the lease.

Conclusion

The decision of the Full Court in MBI Properties is an important decision and one that has significant implications for leasing transactions, particularly in the context of real property.

One must wait to see if the Commissioner seeks special leave to appeal to the High Court. But in the interim, the decision raises a number of difficult issues.