The Commissioner’s approach to GST and
Real Property Transactions
The effect of GST on real property transactions has been the subject of significant confusion within the property sector. This paper looks at how the Commissioner has generally tried to resolve these issues in a pragmatic and commercially realistic manner and outlines some further issues which will hopefully be resolved in a similar manner.
Since the goods and services tax (GST) bill was introduced into the House of Representatives on 2 December 1998, there has been widespread confusion as to the effect of GST on the sale of real property. Much of this confusion stems from two factors. First, the concessional treatment given to dealings in certain types of residential property. Second, the inherent difficulty in drafting rules which, while designed to deal with general commercial transactions, can also cater for the special nature of real property transactions.
The purpose of this paper is to look at how, if at all, the Commissioner has clarified the position of the Australian Taxation Office (ATO) in respect of the following issues:
(a) Is an unconditional contract for the sale of land an ‘invoice’ for the purpose of attributing GST?
(b) How are deposits treated?
(c) What is the relationship between the margin scheme and mortgagee sales?
While some of these issues are yet to be addressed, the Commissioner has endeavoured to resolve a number of real property issues by the release of public rulings and other publications. As a general rule, the approach taken by the Commissioner has been pragmatic and where required, has involved a departure from a literal interpretation of the legislation in an attempt to arrive at a more realistic and commercially satisfying solution. It is hoped that the Commissioner will continue to apply this approach to those issues still awaiting attention.
Is an unconditional contract for the sale of land an ‘invoice’?
For those enterprises that account for GST on an accruals basis, the liability to pay GST arises in the tax period in which the enterprise receives any part of the consideration or issues an invoice, whichever is the earlier.1 Accordingly, whether a document issued by a supplier is regarded as an invoice may often be of critical significance.
An invoice is defined in the GST Act as ‘a document notifying an obligation to make a payment’.2 ‘Invoice’ is similarly defined in New Zealand and the view of the New Zealand Inland Revenue Department (IRD) is that an unconditional contract for the sale of land can constitute an invoice. On this view, the execution of an unconditional contract of sale could trigger the vendor’s GST liability in the tax period in which execution took place, notwithstanding that settlement may not take place until a subsequent tax period. This would require a vendor to remit the GST payable on the whole purchase price notwithstanding that the vendor was yet to receive the balance of the purchase money.
In GST Ruling GSTR 2000/28 the Commissioner declined to follow the view of the IRD. The ruling states that a standard contract for the sale of land will not be regarded an invoice for GST purposes. Accordingly, the execution of such a contract will not trigger GST liability in the tax period in which execution of the contract takes place. Rather, GST will be attributed in the tax period in which settlement takes place.3
The approach taken by the Commissioner is a pragmatic one and provides a commercially satisfactory solution to a potentially difficult issue which could have had significant cash flow implications for vendors.
(a) Deposits generally – Division 99
For an enterprise reporting on an accruals basis, the receipt of any part of the consideration for a taxable supply will trigger the GST liability on the whole amount of the consideration, notwithstanding that the enterprise may not receive the whole of the consideration for some time. Division 99 of the GST Act is intended to ensure that where a supplier receives part of the consideration in the form of a deposit, the receipt of such a payment will not trigger the supplier’s GST liability unless the deposit is forfeited or applied as part of the consideration.4
The payment of a deposit on a land contract will fall within the provisions of Division 99 and will not be regarded as the receipt of consideration while the payment retains its nature as a deposit. However, the effect of GST on the release and forfeiture of deposits on land contracts is less clear.
(b) Release of deposit prior to settlement
Under the Sale of Land Act 1962(Vic), the general rule is that a deposit must be retained by a stakeholder until settlement. Accordingly, it will be rare in the context of land contracts for GST to be triggered by the early release of the deposit.
However, section 27 of the Sale of Land Act provides for an exception to the rule and allows for the deposit to be released by the stakeholder to the vendor prior to settlement in certain circumstances. The release of the deposit to the vendor pursuant to this section would appear to cause the deposit to be applied as part of the consideration for the sale. If so, this would trigger the vendor’s GST liability on the entire sale price notwithstanding that settlement may not take place for some time.
Ruling GSTR 2000/28 deals with this issue by stating that the early release of the deposit pursuant to section 27 of the Sale of Land Act will not trigger GST and that Division 99 will continue to apply to the deposit until it is released to the vendor upon settlement or forfeited by the purchaser.5 The Commissioner has again taken a pragmatic approach to this issue which could have had cash flow implications for vendors.
(c) Forfeiture of deposits
The Ruling views the forfeiture of the deposit on a land contract in the following manner:
If the vendor exercises a right to terminate the contract and retain the deposit, the vendor surrenders the remaining rights acquired under the contract. The surrender of those contractual rights is a supply by the vendor. Under paragraph 9-10(2)(e) a supply includes the surrender of any right.6
The forfeiture of the deposit to the vendor is therefore treated as consideration for the vendor’s surrender of its rights under the contract of sale. If this vendor is registered for GST, this will generally be a taxable supply.
The approach of the Commissioner creates two issues in respect of the forfeiture of deposits on land contracts.
(i) Forfeiture of deposits on the sale of existing residential premises
The sale of existing residential premises to be used predominantly for residential accommodation is an input taxed supply.7 This means that no GST is payable on the sale. Also, the supplier is not entitled to any input tax credits in relation to the sale.
Is a forfeited deposit for an input taxed sale also input taxed?
Ruling GSTR 2000/28 takes the view that the vendor receives a forfeited deposit as consideration for the vendor’s surrender of its rights under the contract. This is arguably a separate supply to those rights supplied by the vendor under the contract of sale. Furthermore, this supply would not be input taxed as it does not involve the sale of existing residential premises but the surrender of rights under a contract. Accordingly, there appears to be a real risk that a vendor who enters into a contract for the sale of existing residential premises, a sale which will be input taxed if it proceeds to settlement, will be required to pay GST if the purchaser defaults and the deposit is forfeited.
Existing residential premises are sold by a registered vendor for $100,000. As the sale is input taxed, the vendor receives a deposit of 10% of the sale price (ie, $10,000). The purchaser defaults and the deposit is forfeited.
Upon forfeiture of the deposit, the vendor is deemed to have received the forfeited deposit as consideration for the surrender of its rights under the contract, a taxable supply, and is required to pay GST equal to 1/11th of the amount forfeited.
This issue creates the difficult situation of a vendor needing to seek a deposit equal to effectively 11% of the purchase price to ensure that it can pay the GST if the purchaser defaults.
A more satisfactory alternative is confirmation from the Commissioner that an amount received as forfeiture of a deposit paid in respect of a land contract retains its original character as consideration paid for an interest in real property. This would enable both the deposit and the forfeited deposit under an input taxed contract to be treated as consideration for an input taxed supply. Such an approach would also be consistent with the pragmatic approach taken by the Commissioner in relation to real property issues in Ruling GSTR 2000/28.
(ii) Forfeiture of deposits on the sale of real property subject to the margin scheme
Similar considerations apply to forfeiture of the deposit on a sale subject to the margin scheme.
The margin scheme can only be used for the sale of real property.8 As the Ruling regards the forfeiture of a deposit as consideration for the surrender of the vendor’s rights under the contract rather than the sale of real property, it appears that the margin scheme could not be applied. The vendor would therefore be required to pay GST on the whole of the deposit forfeited, not just on the margin. Furthermore, as many margin scheme contracts will be GST inclusive, the vendor may have no recourse to the purchaser for this GST under the contract.
As with forfeiture of deposits on input taxed sales, it is suggested that the Commissioner confirm that forfeited deposits for sales subject to the margin scheme retain their original character as consideration paid for an interest in real property. This would enable the margin scheme to be used to determine the GST payable on the forfeiture of the deposit and would remove the vendor’s potential financial exposure.
Can the margin scheme be used for mortgagee sales?
The margin scheme is a concessional regime whereby GST will only be charged on a particular margin instead of on the total consideration received for the sale.9 This will result in a lesser amount of GST being payable on the sale. The margin will be popular with developers of residential projects because they can effectively reduce the GST payable on the subsequent sale of residential sites. This will have the effect of reducing the actual price paid by purchasers who are unable to claim input tax credits.
An issue which may arise, especially where an enterprise such as a residential developer gets into financial difficulties, is whether a mortgagee can utilise the margin scheme if it exercises its power to sell the property. If the mortgagee cannot utilise the margin scheme, the mortgagee may be faced with paying GST on the whole of the consideration and will need to choose between passing on this cost to the purchaser or incurring the cost and effectively reducing the amount recovered.
When a mortgagee exercises its power of sale, it is effectively selling the property in satisfaction of the debt owed to it by the mortgagor.10 For the purposes of the margin scheme, the margin is defined as ‘the amount by which the consideration for the supply exceeds the consideration for your acquisition of the interest, unit or lease in question’.11 Accordingly, it is arguable that if a mortgagee exercising its power of sale seeks to use the margin scheme the margin will not calculated by reference to the consideration paid by the mortgagor for the land, but by reference to the consideration paid by the mortgagee for its interest in the land.
No specific Public Ruling as has been issued on this point, but the position of the ATO has been recently outlined in the Issues Register of the Property and Construction Industry Partnership. This register comprises a list of major issues and subsidiary questions which have been collated as a result of consultations between the ATO and the representatives of the property and construction sector. Importantly, to the extent that the position of the ATO is outlined in this document, it is to be regarded as a Public Ruling and is binding on the Commissioner.12
In response to a question as to whether a mortgagee in possession could utilise the margin scheme when it exercised its power of sale, the ATO outlined its response as follows:
Having regard for the provisions of Division 105 of the GST Act, the creditor (which could either be a receiver manager, mortgagee in possession or a liquidator) is taken to be standing in the shoes of the debtor when the creditor makes the supply or is acting as agent for the debtor. As a result, for the purpose of the creditor applying the margin scheme to the sale, the word “you” as used in Division 75 is taken to mean the debtor.13
This means that a mortgagee exercising a power of sale can utilise the margin scheme and determine the margin by reference to the price the purchaser paid for the property.
As this approach appears to require a departure from the literal words of the legislation and is another example of the pragmatic approach the Commissioner has taken in relation to the effect of GST on real property.
When the GST legislation was introduced into Parliament, the inter-action between GST and real property transactions caused great concern to a number of people, including practitioners, real estate agents and developers. It is pleasing that, as a general rule, the Commissioner appears to have taken a pragmatic and commercial approach to many of the issues which have arisen rather than following a literal approach. It is hoped that the Commissioner continues to apply this approach to those real property issues which are still awaiting attention.
1. Section 29-5(1) of The A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)
2. Section 195-1 of the GST Act
3. See GSTR 2000/28 paras 42-57 and see also GSTR 2000/34 paras 51-52.
4. Section 99-10(1) of the GST Act
5. GSTR 2000/28 para 28
6. GSTR 2000/28 para 97
7. Section 40-65(1) of the GST Act
8. Section 75-5(1) of the GST Act
9. Division 75 of the GST Act
10. Division 105 outlines how GST will apply to supplies made in satisfaction of debts
11. Section 75-10(2) of the GST Act
12. See GSTR 1999/1 ‘Goods and Services Tax: the GST rulings system’
13. See Section 15.1.27 of the Issues Register