As we approach 14 years since the introduction of a goods and services tax (GST) in Australia, it is remarkable that commonplace transactions can give rise to very unexpected results.
A case that has given rise to considerable confusion in recent times so far as GST and property transactions are concerned is the decision of the Full Federal Court in October 2013 in MBI Properties Pty Ltd v Commissioner of Taxation  FC FCA 112. On 11 April 2014 the High Court granted the Commissioner special leave to appeal against the Full Court’s decision.
The case concerned Division 135 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), however the ramifications of the decision go much further than this particular Division. Suffice to say that if the decision of the Full Federal Court is not overturned by the High Court there is an expectation that amendments to the GST Act may be required.
Increasing Adjustments and Going Concern Treatment
Most property lawyers, even if they do not purport to be proficient in tax, are no doubt familiar with Division 135 of the GST Act which deals with, what are termed “increasing adjustments”.
In simple terms, an increasing adjustment means that the taxpayer has an increased net GST obligation. In the circumstances that are relevant to Division 135, this could arise in the sale of, for example, a new block of tenanted apartments. This sale would ordinarily be subject to GST although, if the apartments have tenants occupying them, could qualify as a GST-free supply of a going concern, thereby relieving the vendor of a GST liability on the sale of new residential premises and the purchaser having to increase the purchase price for the GST payable.
However, if the purchaser after the acquisition of the apartments, continues to rent out the premises for residential accommodation then, for the purposes of section 135-5 of the GST Act, it has been the recipient of a supply of a going concern and some or all of the supplies made through the enterprise to which the supplies relate will be neither taxable supplies or GST free supplies but the supply of input taxed residential accommodation (section 40-35, GST Act). In that situation an increasing adjustment will arise for the purchaser of the apartment block.
Although the treatment of the sale as a GST-free going concern may, at first sight, have appeared to be appealing so far as the purchaser was concerned because it then relieved the purchaser from the obligation to gross up the purchase price paid to the Vendor for GST, the purchaser is then faced with the prospect of an increasing adjustment which effectively recoups the GST which the purchaser did not need to pay to the Vendor due to the treatment of the property sale as a going concern.
The recoupment of GST under a Division 135 increasing adjustment may come as a rude shock for a purchaser who did not expect it. However, there may nevertheless be benefits when compared to the position of the purchaser making a payment of GST to the Vendor upfront. The benefits are a possible reduction in the purchase price for stamp duty purposes and also a possible timing benefit in terms of delaying the payment of a GST liability and needing to fund that liability.
Facts in the MBI Case
The decision of the Full Federal Court in the MBI cases follows on from a number of quite complex cases involving South Steyne Hotel Pty Ltd (South Steyne) and the Sebel Manly Beach Hotel (Hotel). In simple terms:
- in December 2000 South Steyne purchased the Hotel;
- in August 2006 each apartment in the Hotel was individually strata-titled;
- in September 2006 South Steyne:
- sold the “Management Lot” which included the reception area, offices and car parking spaces, to Mirvac Hotels Pty Ltd (MHL);
- leased 83 apartments in the Hotel to Mirvac Management Pty Ltd (MML) under 83 separate leases although the leases effectively obliged MML to operate each apartment together with the other apartments as a part of a serviced apartment business; and
- between September 2006 and October 2007, South Steyne sold 15 rooms to various investors including three rooms to MBI Properties Pty Ltd (MBI). Each room was sold subject to the lease to MML.
The cases had been concerned with the characterisation of four categories of supply which arose from the above facts – three of which were relevant to the issue in question in the MBI case, namely:
- the supply by way of lease of each Hotel room from South Steyne to MML;
- the sale of Hotel rooms from South Steyne to investors including the three rooms to MBI above which took title subject to the ongoing lease of those rooms to MML; and
- the continuation of the leases of the three apartments by MBI to MML as a result of MBI’s purchase of the reversion from South Steyne.
The various cases leading up the MBI case had decided:
- in relation to the supply in (1) above, the leases of those apartments were input taxed supplies of residential premises; and
- in relation to the supply in (2) above, as a matter of construction of the terms of the contract of sale, that this was a GST free supply of a going concern.
GST Treatment of Continuation of Leases
The main point of interest in the cases relates to the third category of supply, namely, the continuation of leases of the three apartments by MBI. The question of whether a supply took place was relevant to the increasing adjustment provision in section 135-5(1)(b) of the GST Act.
If MBI was taken as having made a supply, namely, an input taxed supply to MML, then an increasing adjustment would arise as the second supply had been determined by the preceding cases to be a GST supply of a going concern. Whereas, if there was not any supply made by MBI, then section 135-5(1)(b) could not apply and there would be no increasing adjustment.
The Full Federal Court in the MBI case determined that there was no continuing supply by South Steyne to MML following the sale of the reversion to MBI. There was merely a continuation of the lease by South Steyne to MML. As Edmonds J stated in that case:
“The lease is the subject of the supply, not the ‘supply; the ‘supply’ is the grant of the lease … . The act of grant does not continue for the term of the lease; the ‘supply’ is complete on the lease coming into existence. The ‘supply’ constituted by the grant of the lease did not continue beyond the grant; the fact that the lease continued was solely a function of the terms of the grant, not a continuing supply by the grantor.”
Accordingly, as MBI was not making any supplies that would be input taxed, there could not be any increasing adjustment so far as MBI was concerned.
Possible Ramifications of Decision
To say that the decision in the MBI case caught many by surprise would be an understatement.
The decision is also contrary to the ATO’s position as stated in two GST determinations. Although the ramifications of the decision in the MBI case that were of concern to the parties in this case at first sight may not seem that critical, the principles espoused by the Full Federal Court do have some quite serious repercussions. For example:
If there is a sale of leased commercial premises:
- does the Vendor have a continuing liability for GST on payments of rent after the sale rather than the purchaser being liable for that GST? If so, should the Vendor seek an indemnity from the Purchaser for such possible GST liabilities?
- is there a risk that a lessee of the premises would not be entitled to input tax credits in respect of rent paid to the Purchaser;
- following on from above, is there a possible risk for Purchasers that the lessees of the premises acquired may refuse to pay GST on the rent to the Purchaser or may seek a refund for GST already paid? It may be the case that lessees that are not entitled to a full input tax credit for the GST paid (such as financial institutions) may be more inclined to seek such a refund; and
- can the Purchaser claim input tax credits for costs associated with the rental of the premises?
If there is a sale of new (and leased) residential premises:
- on a similar basis to what happened in the MBI case, should the sale of those premises be structured as a going concern which is not subject to GST and the Purchaser not subject to any increasing adjustment? The risk for the Purchaser is the High Court overturning the MBI case or retrospective legislation being introduced to make it clear that the Purchaser would be subject to an increasing adjustment; and
- for Purchasers that may have acquired new residential premises as a going concern, and been subject to a Division 135 increasing adjustment, there may be an opportunity, within the time frame allowed, to seek a refund of GST paid.
ATO Interim Decision Impact Statement
On 21 November 2013 the ATO issued an Interim Decision Impact Statement (Statement) on the MBI case. In the Statement, the ATO noted some of the concerns referred to above. It is stated that, pending the outcome of the appeal to the High Court, the ATO does not intend to revise its current published GST determinations concerning the sale of leased residential premises and leased commercial premises.
The Statement stated that taxpayers can continue to lodge returns on the basis of those determinations and, those that do so will be protected from having to pay any underpaid tax, penalty or interest if the views expressed by the ATO in those determinations are found to not correctly state the application of the relevant provisions. It is stated in the Statement:
“Reliance on those views enables Vendors of leased commercial premises to self-assess their net amount on the basis that they are not liable for GST on rent paid by the Tenant to the Purchaser of the property. It also allows tenants of commercial premises to self-assess their net amount on the basis that they are entitled to input tax credits in relation to rent paid to a purchaser of the premises.”
As indicated above, on 11 April 2014 the High Court granted the Commissioner special leave to appeal against the Full Court’s decision. Hopefully the High Court’s decision will bring some clarity to the current GST uncertainty in relation to the sale of leased premises.