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GST Property Traps

GST Property Traps

The first issue to be resolved with any sale of real estate is whether there is a GST liability.  If there is, and none is collected from the purchaser and remitted to the Taxation Office (ATO), this is going to be an expensive exercise down the track when the ATO finds out.

However, it should be noted there is only a liability to GST where:

  • an enterprise is being carried on and
  • the annual turnover is at least $75,000 ($150,000 for non-profit bodies) and
  • a taxable supply is made in the course of or advancement of the enterprise.

What is an enterprise

Enterprise is defined at section 9-20 of A New Tax System (Goods and Services Tax) Act 1999 (the GST Act) to include an activity or series of activities done:

  • in the form of a business (including any profession, trade, employment, vocation or calling);
  • in the form of an adventure or concern in the nature of trade; or
  • on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

An enterprise does NOT include activities done by an individual or partnership of individuals without reasonable expectation of profit or gain.

GST Determination GSTD 2006/6 states an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business, but which has the characteristics of a business deal. However, the sale of the family home, a private car or other private assets is not, without other factors being present, an adventure or concern in the nature of trade.

The ATO has issued Miscellaneous Taxation Ruling MT 2006/1 which discusses when it considers an enterprise is being carried on for GST purposes.

In that ruling, the ATO states that in isolated transactions where land is sold that was purchased with the intention of resale at a profit, the ATO considers these activities to be an enterprise.

This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale.  The ATO regards this to be in the form of an adventure or concern in the nature of trade.

Example 1 – GST payable

Stefan and Krysia discover that the local council has recently changed its by-laws to allow for smaller lots in the area. They decide to take advantage of the by-law change. They purchase a block of land with the intention to subdivide it into two lots and to sell the lots at a profit. They carry out their plan and sell both lots of land at a profit.

Their activities are an enterprise being an adventure or concern in the nature of trade. Their activities are planned and carried out in a businesslike manner.

Example 2 – GST payable

Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.

Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit and lives in the other.

His intentions and activities have the appearance of a business deal. They are an enterprise.

Further, there is a reasonable expectation of profit or gain as his plan has enabled him to be able to keep and live in one of the units.

Traps in determining whether a property being sold is residential premises or not

As mentioned, it is only where an enterprise is being carried on, and the annual turnover is over $75,000, that GST must be remitted on any taxable supplies.

Section 9-5 of the GST Act provides an entity (which includes individuals) makes a taxable supply if:

  • it makes a supply for consideration; and
  • the supply is made in the course or furtherance of an enterprise that it carries on; and
  • the supply is connected with Australia; and
  • it is registered or required to be registered.

Assuming an enterprise is being carried on, in the context of property sales, taxable supplies would include:

  • the sale of land
  • the sale of new residential premises (discussed later below)
  • the sale of commercial premises (including commercial residential premises such as motels).

However, taxable supplies generally do not include the sale of other residential premises as these are input taxed.  The seller does not have to charge GST on these sales.   However, note that GST on expenses associated with the supply (e.g. legal and accounting costs) cannot be claimed back as input tax credits.  They would be included in the cost base of the asset where capital gains tax is applicable.

What are residential premises?

Residential premises are defined at s195-1 of the GST Act as land or a building that:

  • is occupied as a residence or for residential accommodation; or
  • is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation;

(regardless of the term of the occupation or intended occupation) and includes a floating home.

Section 40-65(1) of the GST Act provides:

A sale of real property is input taxed, but only to the extent that the property is residential premises to be used predominantly for residential accommodation (regardless of the term of occupation). (Underline emphasis added.)’

The purchaser’s intention not to use premises for residential accommodation is not relevant to the determination of whether the premises are residential premises.

Sale of a rental property

Note that the sale of a residential rental property is regarded as a supply in the course of an enterprise leasing the property.   However, generally it will be an input taxed supply with no GST liability.

Sale of the private home

The sale of a private home would not normally be regarded as carrying on an enterprise and would therefore generally be outside the GST net.

However, the ATO in GST Ruling GSTR 2012/5 states that the value of a supply of premises that includes residential premises to be used predominantly for residential accommodation needs to be apportioned to the extent that part of the premises is not residential premises to be used predominantly for residential accommodation. The ATO use a modification test to determine this.  This is illustrated by the two examples below.

Example from GSTR 2012/5 – Residential premises partly converted for business use

Shannon decides to partly modify her house to use in her profession as a doctor. She modifies an area of the house to provide office and consulting room space, an operating theatre, a waiting room and storage for the business. A sealed car park is also added to the property. Significant physical modifications are made to these areas, including the removal and alteration of walls, and the addition of lighting, hygiene facilities and security to meet industry standards. The existing lounge room is used as the patients’ waiting room. An existing bedroom is used for storage. No physical modifications are made to the lounge room or bedroom.

The modifications result in the part of the premises consisting of the office, consulting room, operating theatre and car park no longer being residential premises to be used predominantly for residential accommodation. Objectively, part of the premises is still designed predominantly for residential accommodation, comprising bedrooms (including the bedroom used for storage), bathroom, kitchen, living room, lounge room and gardens.

If Shannon later sells or leases the premises, she will need to apportion the value of the supply between the taxable and input taxed parts of the supply.

Example from GSTR 2012/5 – No apportionment necessary

Rebecca is a solicitor. She lives in a terrace house that is not new residential premises and decides to convert a room at the front of the house into an office for her practice. Rebecca arranges the installation of an electricity point and telephone line for the place in the room where she intends to set-up a printer and facsimile machine. She fits the room out with book shelves, filing cabinets, desk, office chairs, a table for the printer and facsimile machine, and suitable floor coverings. She also has an advertising sign placed outside the front door of her house. Rebecca does not modify any of the other rooms in the house.

The ruling states these changes are not sufficient to modify the physical characteristics of the terrace house into premises other than residential premises to be used predominantly for residential accommodation. If Rebecca sells or leases the premises she will be making a wholly input taxed supply.

The sale of vacant land

Vacant land cannot be residential premises.

In GSTR 2012/5, the Commissioner states he regards the residential premises as the land and the residential building on the land (i.e. the land and building are seen as a ”package”).

The sale of vacant land is therefore a taxable supply when sold in the course of carrying on an enterprise.   There will generally be GST on the sale and input tax credits available to the purchaser where the land is acquired for a creditable purpose.

Trap with the sale of new residential units – the change of use rules

The sale of new residential premises by a registered entity (such as a builder or developer) in the course or furtherance of an enterprise it carries on will be a taxable supply.

New residential premises

Residential premises are ”new residential premises” if they:

  • have not previously been sold as residential premises and have not previously been the subject of a long-term lease
  • have been created through ”substantial renovations” of a building (a renovation in which all, or substantially all, of the building is removed or replaced); or
  • have been built, or contain a building that has been built, to replace demolished premises on the same land.

However, where the residential premises are sold after five or more years of having been rented continuously, they are not regarded as new residential premises and the sale is an input taxed supply.

Sale of new residential premises and changes in creditable purposes

The sale of new residential premises is a taxable supply whereas the renting out of residential premises is an input taxed supply, as is the sale of residential premises which are not ‘new’. Consequently, input tax credits are available where residential premises are constructed for the purpose of sale but not where they are constructed for the purpose of renting.

Where residential premises built for sale are subsequently rented out, there is a change in creditable purpose. Changes in the extent of creditable purpose may lead to adjustments under Division 129 of the GST Act.

Division 129 provides for adjustments in relation to things in tax periods that are adjustment periods. The number of adjustment periods that relate to a thing are determined by the GST-exclusive value of the acquisition.

The number of adjustment periods for acquisitions (that do not relate to business finance) are set out in the following table.

GST-exclusive value of the acquisitionAdjustment periods
$5,000 or lessTwo
$5,001 to $499,999Five
$500,000 or moreTen

GST Ruling GSTR 2009/4 explains the Commissioner’s view of when adjustments arise. The ruling states the Commissioner accepts there can be a dual purpose where new residential premises are rented out at the same time they are available for sale.

How the change of use adjustment works

The Commissioner in GSTR 2009/4 accepts that developers constructing residential premises may have a dual planned use for the premises – the premises can be applied to creditable and non-creditable purposes at the same time. For example, an entity may construct new residential premises for the purpose of sale. The premises may continue to be held for sale as part of the entity’s enterprise of constructing new residential premises for sale. However, due to a downturn in the property market, the entity may also make the premises available for lease for a period until the market conditions improve. This will be a dual application of the premises during the relevant period (the period between acquisition and the end of the adjustment period).

The Commissioner’s view is that where there is a dual purpose, input tax credits may be available to the extent they relate to the planned taxable supply of the premises.  However, the ATO must be satisfied of this dual purpose and it is up to the taxpayer to prove it to the ATO.  If the dual purpose cannot be proved, an adjustment will have to be made to return all input tax credits claimed in relation to the premises being leased out.  This happened in the case of AAT Case [2009] AATA 569, Re GXCX and FCT.

Change of use adjustments

If an entity is required to apportion its creditable purpose it must do so by applying a method that is fair and reasonable in the circumstances of each case.

A formula provided in the Ruling is:

“Consideration for the taxable supply of the premises” divided by “consideration for the taxable supply of the premises plus consideration for the input taxed supplies of residential premises by way of lease”.

Example – Partly input taxed and partly creditable planned use

Jane is registered for GST and constructed new residential premises for sale and was entitled to full input tax credits on her acquisitions. However, because the market for new premises was slow Jane leased the premises for six months before the premises were finally sold. Jane received $15,000 in rent over the six months. The premises were sold for $500,000. There had been no private or domestic use of the premises.

At the end of the next adjustment period following the sale, Jane calculates the extent of creditable purpose using the formula above as follows:

                                        $500,000
                               $500,000 + $15,000
                                         = 97.09%

Jane has an increasing adjustment of 100% – 97.09% = 2.91%.

Trap with vendor finance

The case of AAT Case [2013] AATA 496, Re Rod Mathiesen Truck Hire Pty Ltd as trustee for the Mathiesen Family Trust highlights a trap with the provision of vendor finance.

The Trust returned on a cash basis.  It was selling vacant land for $3.177m plus GST.  At some time after entering into the contract, the purchaser notified the Trust that it was unable to pay the whole amount of the purchase price at settlement.

On settlement on 16 May 2008, the Trust and the purchaser entered into a Settlement Balance Facility Agreement and the Trust received from the purchaser just over $2m. Under the Agreement, the Trust agreed to lend the purchaser some $1.498m by way of an adjustment on settlement. The Trust did not receive any amount of the balance owing or accrued interest from the purchaser by 30 June 2008 as required under the Settlement Balance Facility Agreement.

On 23 February 2009, the Trust and the purchaser entered into a Deed of Variation – Settlement Balance whereby both parties agreed that in place of the purchaser’s obligations contained in clauses of the Settlement Balance Facility Agreement, the purchaser would pay the Trust $500,000 within 21 days and transfer to the Trust 3 developed lots. The purchaser paid $500,000 to the Trust by cheque on 23 February 2009. The Trust did not receive any developed lots from the purchaser.

The Commissioner assessed the Trust on the basis that it received full consideration on the transfer of the Property in the 2008 tax year in part through the vendor finance agreement.

The Trust argued that it was only liable for GST to the extent of the payments actually received for the property, made in the 2008 and 2009 tax periods, and amounting to less than the full consideration.

The AAT held that (for the purposes of the GST Act) all the consideration in relation to the sale of a property was received by the taxpayer at the time of settlement on 16 May 2008.

The AAT considered that the Agreement clearly provided for a loan from the Trust to the purchaser. The AAT stated the dealings between the Trust and the Purchaser were not unusual. They consisted of a contract for the sale of land (in a usual REIQ form), a loan agreement whereby the vendor advanced money to the purchaser (commonly referred to as vendor finance), and a mortgage over the subject property to secure repayment of the loan. Each was a distinct dealing and there was no reason, from a business perspective or otherwise, not to recognise them as such.

The ATO in its Decision Impact Statement on the case said the findings made by the Tribunal were consistent with the principles set out in its Rulings that:

  • for a taxpayer that accounts on a cash basis, attribution of GST or an input tax credit is determined by the meaning of “consideration” and whether “consideration” was received or provided and not by reference to the ordinary meaning of “cash”;
  • in a vendor financing arrangement, consideration is received by a supplier on set-off of the loan against amounts owing to the supplier by the purchaser;
  • the postponement of payment of a debt does not constitute a loan where the recipient remains obliged to pay for the supply under the original supply contract.

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