How do business losses affect GST?

The ATO identifies a profit motive as one of the key indicators of an intention to carry on an enterprise. For this reason, the ATO places heavy emphasis on the achievement of profits.

A business that consistently operates at a loss and does not have a reasonable prospect of achieving profits in the short term is at risk of having its GST registration cancelled and its GST credit claims recovered.

If you’re in this position as a developer, you may be required to defend yourself by objecting to the assessments issued and cancellation action taken by the ATO.

This would not be overly difficult where you have planned a development, as your project will likely be costed and the relevant research undertaken to determine that a potential profit is likely at completion and sale of the developed property. It is unlikely that you would proceed with any significant development without expert opinion regarding the build and the potential sales values. You would engage builders and real estate agents and any other relevant external party to quantify and qualify your development. The level of investment would warrant such activity.

Where the development is significant in size and therefore time, it may run over a number of financial years. If this is the case, the business may be reporting a loss based on the fixed overheads of running the business, not the variable costs directly related to the development. The reason for this is that the variable costs directly related to the development would be treated as trading stock and/or work-in-progress and therefore not have an impact on your profit or loss.

Trading stock is added back at the end of the financial year if that land is not sold, therefore being profit neutral. Similarly, any development costs relating to an incomplete project will also be added back and therefore not impact on the profit or loss of the business, as the project is not yet complete and therefore not sold. At sale, all work-in-progress is taken up against the sale, as is the trading stock – that is, the cost of the original land.

The ATO and the courts will seek to determine the prospective profitability and/or the strong likelihood of it in any development as a positive indicator of the most important criteria for whether someone is carrying on a business (and by extension an enterprise), namely, the intention to make a profit.

It can be tricky, but always best to be informed irrespective of how the cards may fall.

If you would like to discuss this aspect of your development with us, do not hesitate to get in touch.

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