Specific Implications of GST on Property Transactions Prafula Fernandez School of Business Law Curtin University of Technology Abstract The introduction of A New Tax System (Goods and Services Tax) Act 1999 is likely to have implications on property transactions, be it buying, selling, building, renovating, or renting a residential or a commercial property. A number of specific implications are addressed in this paper. It is important to understand the impact of the GST on property transactions, since these transactions have a tendency to involve large amounts of money. Proper GST planning may not only save money, but may also prevent nasty surprises. Introduction Like any other transaction, the A New Tax System (Goods and Services Tax) Act 1999 1 (the GST Act) applies to a property transaction. Basically, under the GST Act, a taxable supply made by a registered entity on or after 1 July 2000 will attract GST. However, the registered entity will be allowed to offset an input tax credit, being the GST it has paid on its purchases and expenses against the GST payable on its supplies. A property transaction would be considered a supply under Part 2-2 of the GST Act if it involves: rights of way for property development. 2 Not all supplies relating to property transactions are subject to GST. A supply relating to a property transaction has to be a taxable supply before GST can be charged on that supply. A supply only becomes a taxable supply if: it is made for consideration; it occurs in the course of carrying on an enterprise or a business; supply is connected with Australia; and the entity is registered (unless the supply is GSTfree or input taxed). the supply of goods, services, advice or information relating to a property transaction; the grant or assignment or surrender of real property; the creation, grant, transfer, assignment, surrender of rights relating to a property; or a financial supply. Since the definition of supply is broad, it is likely to include supplies of land for parks, roads, easements and Division 38 of the GST Act lists supplies that are GSTfree. This means that the entity cannot charge any GST on the supply, but is still able to obtain input tax credit for the GST paid on the acquisitions relating to that supply. Division 40 of the GST Act lists supplies that are input-taxed. This means that the entity cannot charge GST on that supply and cannot obtain an input tax credit for those supply either. 1 This Act is referred in this proposal as the GST Act. 2 Fiona Martin, Goods and Services Tax: The Effect on Property Transactions, The Tax Specialist, August 1999, Vol 3/1, p30.
Legal Issues in Business S40-35 of the GST Act provides that a supply by way of lease, hire or license of residential premises to be used predominantly for residential accommodation is input taxed. Landlords of residential properties cannot charge GST to the tenants and also will not be able to claim any input tax credit on the GST they have incurred. Landlords will therefore be likely to pass on the cost of the GST they have incurred to the tenants by increasing rents charged. Alternatively, commercial residential premises are taxed in the normal manner; that is, credit can be claimed on the GST incurred and GST can be charged to the tenant as an addition to the rent. The sale of residential premises and supplies of residential premises by way of long-term lease are input taxed under S40-65 of the GST Act. This exemption does not apply to commercial residential premises or new residential premises. The definition of commercial residential premises includes hotels, motels, inns or boarding houses and caravan parks or camping grounds. New residential premises means residential premises that have not previously been sold as residential premises. Residential premises include floating homes. The impact of GST on a property transaction can be summarised as being dependent upon the following five significant factors: The requirement to register for GST; The nature of the property transaction; Sale of property as part of a going concern; Election for the margin scheme to apply; and The timing of the property transaction. First GST Impact Factor: The requirement to register for GST GST is a tax on private consumption of goods and services. It is not a tax on business, but registered businesses become the GST collector. If a buyer purchases a block of land, for example, their payment of GST depends upon whether the seller is registered for GST. If the seller carries on an enterprise with more than $50,000 turnover, then the seller will have to obtain an Australian Business Number ( ABN ). The seller s ABN number becomes the seller s GST registration number. An enterprise is defined in S9-20 of the GST Act. The definition includes an activity or a series of activities. This seems to incorporate one-off transactions. An activity done in the form of a business amounts to an enterprise. The definition of business in S195 of the GST Act has been borrowed from S995 of the Income Tax Assessment Act. S995 of the Income Tax Assessment Act defines a business as profession, trade, employment or calling but excludes occupation as an employee. In determining whether a person is carrying on a business or not, the courts have identified a number of factors to be considered. 3 These factors are: repetition of transaction; the commercial nature of activities; size and scale; the profit motive; and the system and organisation. The definition of a business does not require the enterprise to be conducted for a profit motive. However S9-20 of the GST Act excludes a private recreational pursuit or a hobby. It also excludes activities by an individual or a partnership without a reasonable expectation of profit. Unlike a property investor, a property developer is likely to be carrying on a business. S9-20(c) of the GST Act states that an enterprise includes an activity done on a regular or continuous basis, in the form of a lease, licence or other grant of an 22
The Real Estate Industry - Volume 2, 2000 interest in property. The words continuously and regularly have been examined in the New Zealand case of Newman v C of IR (1995) 17 NZTC 12,097, to mean repeated over time. In New Zealand, there has been a number of cases regarding a person s home being subdivided and sold. The sub-divisions of four or more blocks of land have been held to be continuous. 4 The question is if the Australian courts will adopt a similar ballpark figure to determine whether or not an entity is carrying on an enterprise, especially when it comes to sub-division of a person s home. The definition of an enterprise excludes employees. By excluding employees from the definition of an enterprise, the value added from an employee s labour is not taxed, whereas the value added from a subcontractor s labour is taxed. The distinction between an employee and sub-contractor remains for GST purposes and will affect the decision by a developer whether to employ an employee tradesman or use a sub-contractor. Although the developer may be able to obtain the inputtax credit for the GST incurred on the sub-contractor s labour, the cash flow impact can be significant in a large project. At times it is difficult to determine whether a person is an employee or a sub-contractor. Under the Income Tax Assessment Act, the term employee is defined as a person who receives salary or wages and includes payments made to employees as such. This includes payments to employees within the ordinary meaning of that expression. To identify the ordinary meaning of the word employee as distinct from an independent contactor, the courts have identified the following indicators: 3 Thomas v FCT (1972) 3 ATR 165; FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; Ferguson v FCT (1979) 9 ATR 873; Evans v FCT (1989) 20 ATR 922. 4 Case 70 (1996) 17 NZTC 7,431; Wakelin v C of IR (1997) 18 NZTC 13,182. who has control over the way work is carried out, who can hire and who can fire; whether the work can be delegated; and the amount of exposure to the financial risk, assets used and expenses incurred. Following the Ralph review of business taxation, a subcontractor may no longer be able to channel personal service income through a partnership, trust or a company, if at least 80% of the personal service income is obtained from one service requirer and the services are provided in an employee like manner. This is to prevent income splitting when the income is from personal services mainly provided to one entity. Second GST Impact Factor: The nature of the property transaction The sale of existing residential premises and the renting of residential premises will be input-taxed. Conversely, the sale of commercial premises and the renting of commercial premises will be subject to GST. It is sometimes difficult to determine whether the premises are residential or commercial. In New Zealand, the taxation department uses the following criteria to determine if a dwelling is commercial or residential: whether the facilities are provided for more than one group of people at a time; the presence of the owner at the site; and the length of stay. 5 In the New Zealand Case L75 (1989) 6 Keane DJ held that a commercial dwelling existed in a 13-bedroom house let out individually and the vendor visited the dwelling several times a week for cleaning and maintenance. The court found that the larger the number of occupants the more likely the premises are to be classified as commercial. 5 Alastair McKenzie, GST-A practical Guide, CCH p52. 23
Legal Issues in Business The GST liability also depends upon the intended use of the property by the tenant or the purchaser. The tenant or the purchaser must predominantly use the property for residential purposes to obtain the status of being input-taxed. The problem for the lessor or the seller may arise in accurately determining the use of the property by the tenant or purchaser to ensure that it is predominantly used for residential purposes. It is not clear in the Australian legislation as to what is meant by the word predominantly. In New Zealand, a prorata measurement has been used where a property is used partially for residence and partially for business. However the pro-rata measurement was not applied where the predominant purpose was not residential, for example, when an interior designer used her private residence as an advertisement for her interior design business. 7 considered predominantly used for long-term letting if 70% of its residents are provided with long-term accommodation. 10 New residential premises will also be subject to GST. S195-1 of the GST Act defines new residential premises as residential premises that have not previously been sold as residential and have not been the subject of long- term lease. It appears that land and buildings that were previously sold as commercial premises but are now resold as residential premises will attract GST as new residential premises since they have not previously been sold as residential. 11 Special rules apply to commercial accommodation let out over a long term and GST will only be charged on 50% of the supply under division 87 of the GST Act. The reason for this arbitrary 50% reduction is that if long-term commercial occupancies were input taxed, then suppliers would have the tendency to split the service element from the accommodation element to obtain the input tax credit on the service element. To avoid this, division 87 of the GST Act grants a 50% reduction in the value of the supply. A typical example could be a caravan park where caravans are mainly let out for short-term lettings, but the caravan park has a few long-term residents occupying the caravans. Long-term letting means more than 28 days. 8 If commercial accommodation is not predominantly used for long term letting, than the first 27 days will be fully taxed, and days thereafter can obtain a 50% reduction in the value of the supply. 9 Accommodation will be 6 Alastair McKenzie, GST-A practical Guide CCH p52, relating to Case L75 (1989) 11 NZTC 1,435. 7 Alastair McKenzie, GST-A practical Guide CCH p174, relating to Case Q51 (1993) 15 NZTC 5,284. 8 Section 87-5 of the GST Act. 9 Section 87-10 of the GST Act. Third GST Impact factor: Sale of property as part of a going concern Although the sale of commercial properties will normally attract GST, if the properties were sold as part of a business that is a going concern, then the sale can 10 Section 87-20 of the GST Act. 11 Fiona Martin Goods and Services Tax: The Effect on Property Transactions, p33. 24
The Real Estate Industry - Volume 2, 2000 be treated as GST-free. It requires the following conditions to be satisfied to claim the GST-free status: recipient must be registered; the supply must be made for consideration; and the parties agree that supply is a going concern. The GST-free status can also be obtained if only part of the enterprise is sold. However, in order to achieve this, the part enterprise must be capable of independently operating as an enterprise. For example, if a farm is sub-divided into two and only one part of the farm is sold as a going concern business, then an election can be made for the GST-free status under S 38-325 of the GST Act. The seller has to be careful to ensure that the GST-free status applies or risk bearing the cost of the GST without being able to pass it on to the buyer. The sale must be the sale of assets of the business and not the sale of shares in a company. If the seller makes a mistake on the GST-free status then the sale price will be deemed to be GST inclusive. The seller will have to pay GST on that price to the Australian Taxation Office ( ATO ) and the buyer may be able to obtain the inputtax credit. Fourth GST Impact factor: Election for the margin scheme to apply Division 75 of the GST Act allows GST to be calculated on just the margin, being the difference in the sale price less the purchase price (or property value at 1 July 2000), if the developer had acquired the property which has not gone through the GST system. A property developer may be able to use the margin scheme on the sale or long-term lease of a property to reduce the amount of GST on the property supplied. The property developer can use the margin scheme on either land or properties acquired before 1 July 2000 or land acquired after I July 2000 that is not a taxable supply, for instance unimproved residential land acquired from the government after 1 July 2000. If the supplier elects to use the margin scheme and the land was acquired before 1 July 2000, then a valuation of the land before 1 July 2000 is required and only the margin is assessed. The cost of improvements made since 1 July 2000 is ignored in calculating the margin, since input tax credit can be claimed on such improvements. Where a developer is selling units in a multi-unit residential development, the developer may apportion the value of the development at 1 July 2000 to the individual units. 12 The person who purchases a property on which the margin scheme has been applied cannot claim input tax credit and if such a purchaser is carrying on a business, than the margin scheme may not suit that person. Thus, the developer may need to negotiate with potential purchasers on the sale price after taking into account the purchaser s circumstances. Fifth GST Impact factor: The timing of the property transaction Although the GST only applies to transactions from 1 July 2000, any agreement entered into after 2 December 1998 for supplies to be made after 1 July 2000 may have GST implications under the transitional rules. The 2 December 1998 is the date when the Government announced the GST. For a property transaction, this may affect contracts of construction relating to a building or leases entered into before 1 July 2000 for a period that will extend beyond that date. If a lease agreement spans 1 July 2000, the agreement will be deemed under S12 of the GST Act to have been made continuously and uniformly throughout that period. The GST position will then depend upon: when the agreement was entered into; if there is an opportunity to review the agreement; and whether the supplier or lessor is entitled to full input tax credit or only partial input tax credit. 25
Legal Issues in Business S13 of A New Tax System (Goods and Services Tax Transition) Act 1999, determines the GST-free status of agreements entered into before 1 July 2000 for supplies that spans 1 July 2000. The tables below illustrate the effect of S13. Table 1: Non-reviewable contracts Date of Contract 2/12/1998 2/12/1998 Date of Supply, before Recipient entitled to input tax credit yes GST Status GST-free N/A Subject to GST, No GST-Free before No Subject to GST If payment for the above contracts was made before 2 December 1998, then supplies will be GST-free, even if supplied after 1 July 2005. Table 2: Reviewable contracts Date of contract 2/12/199 8 2/12/199 8 Date of supply Recipient entitled to input tax credit N/A N/A N/A No GST Status GST-Free until first opportunity for review or Subject to GST GST-Free until first opportunity for review or Subject to GST Agreements entered into after 2 December 1998 will be subject to GST on the supplies made after 1 July 2000 where the supplier (lessor) is not entitled to full input tax credit. Thus, if a person enters into a 20-year lease of commercial premises before 8 July 1999, and the lease agreement is reviewable, then lease payments 12 Notes from the treasury on GST treatment of real property, extracted from made up to 1 July 2000 will not be subject to GST. Lease payments made after 1 July 2000 will also be GST-free until 1 July 2005 or until the opportunity for review before that date. Special transitional rules apply to construction contracts to ensure that no GST is charged on works done prior to 1 July 2000. Under S19 of A New Tax System (Goods and Services Tax Transition) Act 1999, if a written construction agreement is made prior to 1 July 2000 between the owner and the head contractor, and goods or real property are made available after 1 July 2000, then GST is only payable on the value of supply that exceeds the value of all works and materials permanently incorporated or affixed to the site as at 1 July 2000. The ATO has issued a public ruling on the 14 September 1999 of the methods available to determine the value of construction work-in-progress as at 1 July 2000. 13 Conclusion Property transactions have a tendency to involve a considerable amount of money. Any party involved in a property transaction, such as property developers, estate agents, settlement agents, property managers, lessors, lessees, and owners of any property, should take into account the GST implications. There are several areas of uncertainty that will only be clarified by tax rulings and legislation in the years to come. Despite these uncertainties, there are opportunities for GST planning by making appropriate elections, for example, by selling a property as a going concern and applying the margin scheme. The entity making the supply should bear in mind that it has the legal liability to pay the GST, and whether the entity can pass on the cost of the GST to its customer depends upon the wording of the agreement. http://www.cpaonline.com.au/html/taxreform. 13 This ruling can be accessed from: http://www.taxreform.ato.gov.au/publications/1999. 26