On 3 December 2014 the High Court handed down its decision on FCT v MBI Properties Pty Ltd  HCA 49. This case is important because it explains how GST (including the GST-free going concern concession) applies to the sale of leased property. This is relevant to vendors and purchasers of leased property and landlords and tenants of such property.
Facts and issue
The facts of the case involved the taxpayer (MBI) acquiring three residential apartments in a hotel company, which were subject to an existing lease between the vendor and a third party (being Mirvac which was the operator of the hotel). In a previous decision the Full Federal Court had ruled that the apartments were residential premises for the purposes of the GST Act and that the vendor’s supply of the apartments subject to the existing lease constituted a supply of a GST-free going concern to MBI.
The issue in this case was whether as a consequence of this prior Full Federal Court decision, MBI (as the purchaser of a GST-free going concern) had an increasing adjustment under Division 135 of the GST Act. Broadly, Division 135 aims to place the purchaser of the going concern in the same position as if they had paid GST on the purchase of the going concern and could not claim back all the GST paid because they have used the going concern to make supplies which are not taxable or GST-free.
The Commissioner of Taxation (Commissioner) argued that since the apartments were residential premises and they were sold subject to the existing lease, MBI was subject to a Division 135 increasing adjustment because it was making input taxed supplies of residential premises to Mirvac under the acquired existing lease.
Full Federal Court decision
In October 2013 the Full Federal Court rejected the Commissioner’s argument and ruled that MBI had no increasing adjustment under Division 135. This was because the Court considered that MBI made no leasing supply under the acquired existing lease. Rather it considered the supply of the lease occurred (only) when the vendor originally granted the lease to Mirvac.
The Full Federal Court’s decision presented practical difficulties in applying GST to leased property, including because (on the Court’s reasoning) the only supply would have been that made by an original lessor, while lease payments would continue to be made to an assignee lessor who acquired an existing lease. This had implications for who, if anyone, would be liable for GST, and be entitled to input tax credits on those continuing lease payments. The Full Federal Court’s decision also flew in the face of the Commissioner’s existing GST practice (as outlined in GST determinations GST 2012/1 and GSTD 2012/2), which operated on the basis that the purchaser of leased premises became liable to remit GST on the lease payments going forwards.
As a consequence of these practical difficulties the Commissioner appealed the Full Federal Court’s decision to the High Court. This appeal looked at two questions, namely:
- whether MBI, as the purchaser of leased property made a supply for GST purposes to the lessee under the existing lease (i.e. Mirvac) after it had completed its purchase of the property, and
- if MBI did make a supply, what was the ‘price’ of that supply for the purposes of calculating the increasing adjustment in Division 135 of the GST Act.
High Court’s decision
In a unanimous judgment the High Court ruled the Full Federal Court was wrong in deciding both that the only supply made under the lease arrangement was the original grant of the lease by the vendor (and original lessor) and that the purchaser of leased property (the new lessor) made no supply under the existing lease.
The High Court characterised a lease agreement as an executory contract which involvestwo supplies being:
- a supply which occurs at the time of entering into the contract, in the form of the creation of contractual rights and the corresponding entry into contractual obligations to perform the contract, and
- a supply which occurs at the time contractual performance - even if the supply involves the supplier doing no more than observing a contractual obligation to refrain from taking some action or tolerating a particular situation during the term of the contract.
In terms of the lease agreement, there was a supply when the original lessor initially granted the lease and then there was another supply as the lessor continued to observe the obligation to provide the lessee with quiet enjoyment of the property during the lease term.
When MBI acquired the leased property (as a leasing going concern) it became obliged under the law to continue to supply the residential premises to the lessee under the existing lease. An increasing adjustment arose for MBI under Division 135, because MBI intended to observe the obligations it had under the existing lease (i.e. MBI had made an ‘observing of contractual obligations supply’).
As to the question of what was the ‘price’ of this ‘observation supply’, the High Court dismissed MBI’s argument that the rent payable under the existing lease, after completion of the purchase, could not be related to the ‘observing of contractual obligations supply’ made by MBI.
MBI argued that the rent was consideration for the initial grant of the lease by the vendor (original lessor), and because of this it could not be related to the later observation supply. If it could, then there was a possibility of double GST taxation.
The High Court rejected MBI’s approach of relating consideration to a particular supply to avoid double GST taxation. The High Court indicated that the general operation of the GST Act avoided double GST taxation not by establishing an exclusive connection between a particular amount of consideration and a particular supply, but rather by establishing an exclusive connection between a particular amount of consideration and a particular tax period. Subject to special GST attribution rules (such as the one relating to security deposits), the way the GST Act works is that the general attribution rule in section 29-5 makes GST payable only once, in the tax period of the first payment or invoice.
Consequently, the rent paid to MBI by Mirvac after completion of MBI’s purchase of the property was the price for MBI’s continued observation supply.
The High Court’s decision, while unfavourable for the taxpayer MBI, will likely be welcomed.
It confirms the workable approach of treating the purchaser of leased property as making leasing supplies (and hence being liable to remit GST on the lease, if a taxable supply) from the time they complete the property purchase. Correspondingly, lessees of commercial properties will take comfort that they can claim input tax credits on the rent paid.
What is of particular note going forwards is the High Court’s view of how the payment of consideration converts to a GST liability where there are multiple supplies. The High Court has relied on the general GST attribution rule to prevent double GST taxation rather than engaging in a process of relating consideration to a particular supply. This aspect, particularly, will bear further study and consideration of the possible implications for other circumstances.