1.Tribunal finds option fee did not form part of the consideration for the acquisition of real property
A recent Tribunal decision has underlined the importance of understanding what exactly is included in the acquisition cost of real property (land) for GST purposes, especially when applying the margin scheme in Division 75 of the GST law.
Specifically, in The Trustee for the Whitby Trust and Commissioner of Taxation  AATA 343, the Administrative Appeals Tribunal (Tribunal) determined that an option fee paid by the taxpayer was a separate supply under the GST Act and did not constitute consideration for the supply of the land to it. As the option fee did not constitute part of the acquisition cost for the supply of the land, it could not be included in the acquisition cost for the purpose of applying the margin scheme on the subsequent sale of subdivided residential lots made by the taxpayer.
This Tribunal decision highlights the requirement to use only the acquisition cost of the land in determining the ‘margin’ for the purposes of the margin scheme to not include other payments made in order to be in a position to acquire the land in determining the ‘margin’ for the purposes of the margin scheme.
The background facts to the case state that the Whitby Land Company Pty Ltd as trustee for the Whitby Trust (Whitby) entered into an Option Deed to acquire land in WA for a ‘purchase price’ of $28,000,000, including a non-refundable option fee of $2,000,000, which was payable in tranches. Whitby exercised the call option in the Option Deed and subsequently developed the land, subdivided it into residential lots and sold these lots to third parties. The GST on the sale of the subdivided residential lots was calculated by Whitby at 1/11th of the sale price of the lots less $28,000,000, being what Whitby had determined was the consideration for the acquisition of the land.
As a result of a tax audit conducted by the Australian Taxation Office, the Commissioner issued Whitby with GST assessments and penalty assessments based on the consideration for Whitby’s acquisition being $26,000,000, to which Whitby objected on the basis that it is entitled to include the option fees paid to the vendor as consideration for the acquisition of the land for the purposes of calculating the ‘margin’ under the margin scheme. That is, Whitby argued that the $2,000,000 was part of the purchase price of the land and should therefore be included in the acquisition cost of the land for the purposes of the calculation of the ‘margin’ under the margin scheme.
The Commissioner disagreed and disallowed Whitby’s objection. In the reasons for his decision, the Commissioner referred to paragraph 1 of GST Determination GSTD 2014/2, which states that the call option fee does not form part of the consideration for the purposes of calculating the ‘margin’ on the supply under the margin scheme provisions in the GST law. This position is in line with common law, subsection 9-17(1) of the GST law and the Commissioner’s view as published in paragraph 4 of GSTD 2014/2, which states:
The supply of a the (sic.) call option and the supply of the vacant land are two separate supplies as a consequence of subsection 9-17(1), the consideration for the supply of the vacant land is limited to any consideration provided in addition to the call option fee.
Accordingly, the Commissioner was of the view that in this case, the vendor made two taxable supplies. The first being the supply of an option (or a bundle of rights) for consideration of $2,000,000 and the second being the supply of the land for consideration of $26,000,000 (calculated as $28,000,000 less the $2,000,000 option fee). The Tribunal agreed with the Commissioner.
One key learning from this Tribunal judgment is that property developers should seek to understand what forms part of the acquisition cost of the land that they will use for the purposes of a residential development before entering into any agreement to purchase that land. A proper understanding of this matter will also be required for the purposes of the developer’s financial modelling under which pricing for the development is determined.
2. GST recovery on increasing adjustments under the Margin Scheme
Where real property is sold under the margin scheme the GST Act, in circumstances where part of the real property sold was acquired fully taxed, may require the supplier to make an increasing adjustment in respect of any input tax credits previously claimed on the initial acquisition of the property by the supplier. The practical effects of this provision were the subject of dispute in McEwans Australia Pty Ltd v Brisbane City Council  QDC 347, a decision handed down by the District Court of Queensland in December 2016.
The applicant (the “Supplier”) acquired two blocks of land, one of which was subject to the margin scheme and one which was not. The Supplier then entered into an agreement with Brisbane City Council (“the Purchaser”) for the subdivision and development of the two blocks of land (the “Infrastructure Agreement”). The Infrastructure Agreement provided that the margin scheme would apply to the sale of the land to the Purchaser and, crucially, that the Purchaser would pay, in addition to the “Agreed Balance,” an amount equal to “the GST payable by the [Supplier] on account of GST associated with the receipt of the Agreed Balance.”
Between July 2013 and November 2014, the ATO conducted an audit and assessed the Supplier on $250,881 of GST payable on the sale of the land to the Purchaser, $161,116 of GST payable by way of an increasing adjustment, and general interest charge payable on these amounts. The Supplier sought reimbursement from the purchaser for the increasing adjustment under the terms of the Infrastructure Agreement.
The Tribunal held that the indemnity clause contained in the Infrastructure Agreement did not extend to the increasing adjustment under the GST Act and that, accordingly, the Purchaser was not liable to reimburse the Supplier for this amount.
This case has important practical implications for the drafting of GST clauses in contracts for the sale of real property under the margin scheme. From the supplier’s perspective, it is obviously desirable to shift responsibility for any increasing adjustment arising under section 75-22 onto the recipient and, with appropriate wording; the Tribunal recognised that it may be possible to do so.
However, practically a recipient would likely be wary of such clauses and not agree to their inclusion, as section 75-22 adjustments are the supplier’s responsibility and generally have little to do with the recipient. If the supplier has not built such adjustments into its own budgets, then it is the supplier who has misinterpreted the GST law. Given this, it would make sense that the supplier wears the responsibility for the GST adjustment.
Overall, this case serves as a good reminder that real property which is acquired partly under the margin scheme can still be sold under the margin scheme but that if the margin scheme is applied the supplier must also pay back the GST previously claimed on the acquisition of non-margin scheme part of the real property.
It is also worth remembering that, in respect of the sale of lots/real property:
- A lot which is made up entirely of underlying fully taxed land cannot use the margin scheme and there is no increasing adjustment;
- A lot which is made up of entirely underlying margin scheme land can use the margin scheme without the need for any increasing adjustment, but can also be sold fully taxed if the supplier so wishes;
- Section 75-22 increasing adjustments are only required in respect of sales of lots where the lot is made up of underlying land which was acquired part margin scheme and part fully taxed.
3. Is the premises still new?
The Tribunal in the case of FKYL and Commissioner of Taxation  AATA 810 has found that a taxpayer was liable to GST in respect of the sale of four residential premises even though the premises, some of which were sold more than 5 years after their construction, had previously been rented.
FKYL constructed residential premises on vacant land blocks in Victoria and leased some of the properties prior to sale. FKYL treated the sale of these properties as input taxed supplies as it contended that the properties were no longer “new residential premises” for GST purposes, especially because they were previously used for residential rental purposes (and therefore it had made input taxed supplies in respect of the residences). It is worth noting that, broadly, the sale of “new residential premises” is a taxable supply subject to GST but that residential premises are generally not classified as “new residential premises” (and are input taxed at sale) if they have been used for input taxed supplies for a period of five years or more post construction.
FKYL contended that the properties were no longer new residential premises on the basis that the properties were more than five years old and had been used to make input taxed supplies (i.e. rental of residential premises) for a period of more than 5 years. However, the Tribunal instead determined that the properties were still “new” residential premises and, therefore, liable to GST. In reaching this conclusion the Tribunal considered the following factors:
- Some of the premises were sold less than five years after construction was completed but it was acknowledged that the time period for the five-year rule starts once a person has the right to occupy the premises (which is not necessarily the date of completion of the building). As the premises previously consisted of vacant land, which was not an occupiable premise, the time period for the five-year period commenced when a person had the right to occupy the premises
- Due to difficulties with tenants, the premises were vacant for substantial periods of time. Further, some of the premises were not rented until some time after the premises were completed and thus the total amount of rental time was less than five years.
- FKYL required the tenants to sign an agreement to purchase the house after a period of rental.
The Tribunal found that FKYL did not satisfy its onus of showing the premises were not new residential premises and held that sale of the properties was therefore a taxable supply of new residential premises. FKYL contended that it was entitled to use the margin scheme for the sale of the properties. In accordance with the GST Act, a written agreement between the respective parties agreeing to use the margin scheme is required. FKYL failed to provide evidence of the written agreement, even after being granted an extension time to do so. Therefore, the Tribunal determined that the margin scheme could not be used for the sale of the properties as the statutory requirement of a written agreement was not satisfied.
Furthermore, noting FKYL had claimed input tax credits on the construction costs of the premises, the Tribunal also determined that FKYL was only entitled to claim some of those input tax credits because the properties were rented out prior to their taxable sale and, therefore, the costs related partially to input taxed supplies.
There are some important lessons to take away from this case, and we have detailed a few of these below:
- In respect of “new residential premises”, the time period for the five-year rule commences once a person has a right to occupy the premises. The five-year rule does not commence upon acquisition of a premise (if, for example, the premises is initially acquired as a vacant block) or necessarily on completion of construction of the premises. Those seeking to treat sales of such premises as input taxed should ensure that the 5-year rule is met with reference to ATO rulings on this matter and the findings of the Tribunal in this case.
- A written agreement between respective parties to utilise margin scheme on the sale/purchase of a property is obligatory if the margin scheme is to be applied
- Renting out newly built residential premises for any period of time will impact the extent of entitlement to input tax credits claimed in respect of GST applied to related construction costs.
4. The devil is in the detail
The Supreme Court of Victoria has found that GST was not to be added to the purchase price payable under a contract of sale in the case of A&A Property Developers Pty Ltd v MCCA Asset Management Ltd  VSC 643.
The parties entered into an agreement in relation to the sale/purchase of a commercial property. The price of the property was stipulated at $2,900,000 with a (10%) deposit of $290,000. A standard form contract of sale was entered into in respect of the sale of the property. The contract provided a “tick the box” process in respect of GST and the word “GST” was included in the box dealing with GST, and not the required words “plus GST”. This created a point of dispute between the two parties.
The contract also included a generic GST clause within the General Conditions which provided at Clause 13.1 “The purchaser does not have to pay the vendor any GST payable by the vendor in respect of a taxable supply made under this contract in addition to the price unless the particulars of sale specify that the price is ‘plus GST’.”
The purchaser contended that the price was $2,900,000 inclusive of GST and therefore it was not liable to pay an extra amount of GST to the vendor. It contended that Clause 13.1 of the contract was clear in that it was not required to pay GST unless the particulars of the sale specified that the price was “plus GST”.
The Court agreed with the purchaser that the language of Clause 13.1 of the contract was clear and that the purchaser was not liable to pay an extra amount of GST. Broadly, it was determined that additional GST would only have been due to the vendor by the purchaser had the particulars of the sale clearly specified that the price agreed was “plus GST”. As a result of the decision, the vendor was left “out of pocket” and did not receive the $2,900,000 (net of its GST liability) that it had expected to receive from its sale.
The decision, in this case, highlights the difficulties that can arise for taxpayers in ensuring that contracts entered into in respect of the sale of real property reflect their intentions from a GST perspective. Where you are entering into a contract either as a vendor or a purchaser of a property, it is always important to first consider your GST position and then to ensure that the particulars of the GST clauses included within the contract reflect and support that GST position thus avoiding potential unexpected future GST liabilities.