Can you avoid the GST pitfalls?

Many of the pitfalls that you could be faced with as the property developer can be avoided by asking some key what, who, how and why questions in the early stages.

Many of these pitfalls begin with the acquisition and in particular the contract of purchase. Things like:

  • Is the property actually subject to GST?
  • Is the vendor registered for GST? Should they be?
  • Is the margin scheme applicable?
  • Is it a sale of a going concern? Is that stated in the contract?

Not knowing the answers to these questions could have you claiming GST when you are not permitted and then having to repay that GST, possibly with interest and penalties. Alternatively, you may not have claimed the GST when in fact you possibly could.

What?

What is it that you are purchasing to develop? Is it vacant land, farm land, residential property, operating or non-operating commercial residential premises, leased or vacant commercial premises, or a mixed site (for instance, a downstairs shop and an upstairs residential apartment)?

You need to confirm that the vendor has adopted the correct and optimum GST treatment in the contract of sale. The simple approach of accepting that GST is to be added or included in the contract price (and can be recovered by the developer as an input tax credit) should be questioned and only accepted if no other GST treatments are available.

In a 2013 Supreme Court of Victoria case, two parties were in dispute over whether a property’s contract price (around $900,000) included ten per cent GST.

The property was an existing residence and the sale that was not subject to GST, but the purchaser argued that the contract was GST-inclusive, and therefore the total price of the property should be reduced to $818,181. The vendor, on the other hand, argued that the contract was GST-exclusive, so the sale price should hold at $990,000.

The court found that the purchaser was required to complete the contract. With a better understanding of the GST issues the dispute could have been fully and simply resolved during the contract negotiations.

Who?

Who is the supplier of the development site? Is the vendor named in the contract of sale acting as a trustee of a trust, as a nominee or agent, or as a bare trustee?

If the contract provides for the sale to be plus GST, or a GST-free supply of a going concern, you should confirm that the supplier is in fact registered for GST.

Some unregistered vendors of commercial property are unaware of the exclusion for the sale of capital assets and register for GST so that they can charge, collect and remit the GST. This is incorrect on so many levels, as it adds to your duty liability and financial pressure, it sets you up for an early review by the ATO and it renders you ineligible to use the margin scheme upon resale.

A 2010 case in the Supreme Court of New South Wales heard two parties dispute the contract price of a residential apartment above a fruit shop that had been sold at auction. The vendor insisted that it was plus GST and the purchaser insisted that it was GST inclusive.

The vendor proved to the satisfaction of the judge that the auction had been conducted on the basis that a further ten per cent would be added for GST.

When a ruling was sought from the ATO as to the amount of GST required to be paid (the fruit shop being commercial premises and the apartment being residential), the Commissioner ruled that the sale was not a taxable supply to any extent because the vendor was neither GST-registered nor required to be.

The second ‘who’ to consider is who is the developer entity?

Where a property is being acquired and there is flexibility for deciding which entity is going to make the acquisition, you should give careful consideration to the entity that is going to undertake the development. Individuals and partnerships of individuals carry inherent risks as do partnerships of companies or trusts.

The decision should be made carefully and with regard to issues of asset protection, income tax and GST.

How?

How is GST accounted for in the contract of sale? Is it expressly stated? Is there a clause defining the exact treatment of GST? Has this been correctly stated?

The GST clause in a typical contract of sale for real estate will offer several GST outcomes to choose from, including plus GST, inclusive of GST, margin scheme, supply of a going concern and farm land.

Rented residential premises should never be acquired as a going concern as this may render you liable to a non-creditable increasing adjustment, applicable where going concerns are acquired with a view to making input taxed supplies.

The failure to adopt the most appropriate GST treatment in the contract may also deny you access to the margin scheme upon resale and embroil you in a costly, time consuming and avoidable contractual dispute.

In 2013 the Supreme Court of Victoria handed down its decision in a case where the parties were in dispute as to whether the contract price was inclusive of or plus GST. (The case had been back and forth to that court since 2008!)

The purchaser made an offer of $2,250,000 for the property, which the vendor accepted. However, the contract of sale contained a GST clause and a dispute later arose between the parties as to whether the GST clause required the purchaser to pay an additional $225,000 to the vendor on account of GST.

The judge decided that the GST clause was obscure and meaningless and did not clearly state whether the parties intended the price to be inclusive or exclusive of GST. The court declared the clause was void for uncertainty and severable from the contract.

Why?

Why are you acquiring the property? If the development involves the construction of residential premises, are they for sale or for rent? These questions are directly relevant to your decision to register for GST and to your entitlement to recover in full, partially or not at all, the cost of any GST imposed on the construction inputs.

Sometimes you will be undecided about your plans to sell or rent. This complicates the decision-making about registration and the claiming of input tax credits. These issues should be identified and confronted by you sooner rather than later. To do otherwise is to risk a GST compliance nightmare.

In Appendix A, I discussed the implications of a change of purpose for your development. This is particularly important when it comes to GST.

You need to have a clear intention as that will determine whether or not you are required to register for GST and/or can claim GST on acquisitions and whether there will be GST on sales. However, intentions can change.

You may have intended to develop your land with three townhouses and sell all three. In so doing, you claim back GST on those acquisitions, say $120,000. At the completion of the development, the market conditions are such that you believe you would be best to hold and rent with a view to selling some time in the future. At that point, the $100,000 of GST you have already claimed back from the ATO will need to be repaid. This will likely have significant cash flow implications, as you would have likely used those funds to assist with the costs of development and, as such, do not have access to the funds anymore. In addition, you have likely borrowed for the development and, depending on how that debt was structured, the banks may also be seeking repayment in some form.

I think you can now clearly see the importance of intention and, where possible, planning accordingly.

You must document your intentions at the time of acquisition and monitor changes of use (if any) for the change of use adjustments described above.

Documentation

So many legal cases are decided against taxpayers because they are unable to prove that the taxation decision should have been made differently. Unfortunately, the onus is on you.

Evidence in the form of emails, text messages, letters and file notes is vital to support your claims of intended use in any dispute with the ATO. The support of third parties, such as agents and financiers, is also extremely useful.

Are you confused?

It can seem simple on the surface, but it is definitely not.

Speak with your trusted adviser and make sure you do not make the wrong decision with GST. It could cost you plenty.

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