GST and sales of commercial real estate – June 2000
In brief: On 8 July 1999, A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Law) became law in Australia. There are some important implications for vendors and purchasers of retail, commercial and industrial real estate.
GST – not intended to be a cost of commercial property transactions
For all vendors and most purchasers of commercial property after 30 June 2000, GST will not be a cost item in any real economic sense. GST should have a neutral economic effect on most commercial property transactions.
Vendors pay GST to the ATO but should be reimbursed by purchasers
Most vendors will pay 1/11th of the total consideration under contracts of sale to the ATO as GST. This is treated by the GST Law as collected from purchasers either as a component of the nominated contract price (GST inclusive price) or under a clause in a contract which requires the purchaser to pay GST in addition to the nominated contract price (price plus GST).
Agents, lawyers and tax advisors need to ensure vendors' expectations are consistent with the GST Law treatment of sales of commercial property by ensuring vendors 'gross up' nominated contract prices to include GST or include price plus GST clauses in contracts of sale.
Purchasers pay GST to vendors but should be reimbursed by the ATO
If they are registered under the GST, most purchasers of commercial property will be entitled to an input tax credit from the ATO equal to the GST they pay to vendors. Purchasers will require tax invoices at settlement to claim the credit.
Purchasers who intend to use property for the purpose of making taxable supplies are entitled to full input tax credits. Most purchases of commercial property will be for the purpose of making taxable supplies. This includes purchases by investors to let to commercial tenants.
However, the effect of stamp duty needs to be taken into account. Most states intend to charge stamp duty on the GST-inclusive price of property, which means the GST will result in additional tax being paid by purchasers in the form of stamp duty.
Stamp duty is a true economic cost to the purchaser. This additional stamp duty is not only a 'tax on a tax', it is also a 'tax on business', contrary to the stated intent of the GST Law.
The exceptions – Input taxed supplies
A few supplies are designated under the GST Law as 'input taxed supplies' (for example, financial services and letting residential premises). For those few purchasers who intend to use property to make input taxed supplies (such as banks and residential property investors), only partial or no input tax credits will be available, depending on the extent to which the property will be used for input taxed supplies.
Input taxed supplies – Some examples:
- A bank purchases property with the intention of using it for financial services (90 percent) and for other taxable supplies (10 percent). The bank will only be entitled to 10 percent of the GST paid to the vendor in respect of the purchase as an input tax credit.
- A public housing authority buys a property to redevelop as a 'mix' of 50 percent public housing rental stock and 50 percent new housing to sell to private owners. The authority will only be entitled to a 50 percent input tax credit.
The sale of a going concern is a GST-free supply if both parties are registered and they agree in the contract it is a sale of a going concern. No GST will be payable in respect of a GST-free supply, but both parties will have the right to claim input tax credits (for example for lawyers' and agents' fees).
The circumstances in which tenanted commercial real estate can be sold as a going concern remain uncertain. The ATO will issue a draft ruling setting out its considered opinion on when a sale of investment property constitutes a sale of a going concern.
It is clear that real estate can be sold as part of a business. For example, freehold title to a hotel can be sold with the other assets and goodwill of a hotel business as a going concern.
Vendors and purchasers of going concerns need to have a clear understanding about which party is liable for GST if the sale becomes subject to GST. Purchasers' entitlement to input tax credits will be relevant to whether purchasers agree to pay any unexpected GST in respect of a sale that is supposed to be a sale of a going concern. Vendors should seek to include a price-plus-GST clause to ensure the vendor is not left bearing any unintended GST liability. Purchasers may still be disadvantaged to some extent if a sale is subject to GST, rather than being GST-free, as additional stamp duty is likely to be charged on the GST-inclusive price.
The Margin scheme
The GST Law gives vendors the option to pay GST under the margin scheme rather than under the normal rules requiring 1/11th of the total consideration for the sale to be paid as GST.
The margin scheme is only available if a property has not previously been sold since 1 July 2000 or, if it has been sold since 1 July 2000, it has only been sold under the margin scheme or as part of a going concern. Once a property is sold under the normal GST regime, the margin scheme will cease to be available for further sales of that property.
How the margin scheme affects vendors
If the margin scheme is available and the vendor elects to apply it, GST will be paid at the rate of 1/11th of the margin, calculated as the difference between the current GST inclusive sale price and:
- the value of the property as at 1 July 2000 as determined by a qualified valuer, if there has been no settlement of a previous sale of the property on or after 1 July 2000; or
- the last GST inclusive sale price, if the property was last sold (or settled) after 1 July 2000 and the margin scheme was applied; or
- the amount of the last sale price attributable to the property, if the property was last sold (or settled) after 1 July 2000 as part of a going concern.
Vendors need to ensure they 'gross up' the price to include GST under the margin scheme to ensure they receive the same net amount under the margin scheme as they would receive if the property was sold under the usual GST rules.
If properly applied, the margin scheme will make no real economic difference to vendors. However, the margin scheme will assist some vendors – those under contracts which predate the GST if they are unexpectedly caught with a GST liability after 30 June 2000 where the contract contains no price plus GST clause. For the cost of a valuation, a vendor might reduce or eliminate GST by applying the margin scheme.
How the margin scheme affects purchasers
Most purchasers will be disadvantaged by the margin scheme. The margin scheme can result in much less GST being paid. However, purchasers will not be entitled to input tax credits if vendors apply the margin scheme. Purchasers with full input tax credits – for whom GST is not a real cost – should normally insist vendors do not apply the margin scheme. One qualification is needed here: the amount of stamp duty on the GST-inclusive price needs to be taken into account by purchasers entitled to full tax credits. The margin scheme might still be cheaper if the cost of the valuation and GST on the margin is less than the additional stamp duty on the full 10 percent GST.
Purchasers who are not entitled to input tax credits in respect of purchases will benefit if the margin scheme is available. For them, GST is a real economic cost and the margin scheme provides them with an opportunity to minimise the GST cost. Purchasers who are not entitled to full input tax credits should speak to their tax advisors and lawyers to find out if the margin scheme should be applied (if it is available).
The margin scheme may also benefit developers who purchase commercial property to redevelop into residential apartments. Those developers might improve profit margins by having the margin scheme available for later sales.
Note that the decision whether to apply the margin scheme (if it is available) is the vendor's. Purchasers will need to negotiate with vendors to ensure it is applied – or not applied – by the vendor, depending on the purchaser's particular requirements.
Release of deposits
No GST is payable by a vendor and no input tax credit is available to a purchaser while a deposit is retained by the vendor's agent or lawyer as stakeholder.
When deposits are released to vendors, GST becomes payable by vendors as follows:
- for vendors taxed on a cash basis (ie vendors having an annual turnover – excluding input taxed supplies – less than $1,000,000), only the GST attributable to the deposit becomes payable; or
- for vendors taxed on an accruals basis (ie vendors having an annual turnover – excluding input taxed supplies – greater than $1,000,000), the GST attributable to the whole sale price becomes payable.
When deposits are released to vendors, input tax credits become available to purchasers as follows:
- for purchasers taxed on a cash basis, only the input tax credit attributable to the deposit becomes claimable; or
- for purchasers taxed on an accruals basis, the input tax credit attributable to the whole purchase price becomes claimable.
It is anticipated that vendors with an annual turnover from taxable supplies greater than $1,000,000 will not seek a release of deposits after 1 July 2000. An alternative is for lawyers to retain deposits as stakeholders and invest them.
There is an argument that interest earned on any GST component collected with deposits should be paid to purchasers at settlement under the price exploitation provisions of the Trade Practices Act 1974 (Cth) which prevent vendors from profiting from the GST. To avoid withholding tax, purchasers should provide tax file numbers to vendors' lawyers.
Financial institutions duty disadvantages parties transferring deposits to lawyers for investment. FID will be abolished from 1 July 2001.
Forfeiture of deposits
Forfeiture of a deposit for a purchaser's default is a seperately defined taxable supply under the GST Law. If a contract nominates a GST inclusive price, the deposit will include the GST attributable to the deposit. Most nominated contract prices will not be GST inclusive. The contract should then require purchasers to pay the deposit plus the GST attributable to the deposit and to forfeit that GST at the same time as the deposit is forfeited.
Agents should collect the GST attributable to the deposit with the deposit on the exchange of contracts. This procedure does not result in an '11 percent deposit' being paid under a contract nominating a GST exclusive price. The GST Law treats GST payable under a price plus GST clause as part of the consideration for the sale so it is appropriate agents collect a deposit of 10 percent of the total consideration for the sale (ie10 percent of the GST exclusive price plus 1 percent GST).
The Australian Competition and Consumer Commission stated in its March 2000 Guidelines on Price Exploitation and the New Tax System that auction prices may be GST inclusive or GST exclusive as long as the basis of the bidding is made known at the beginning of the auction.
It is anticipated most auctions of retail, commercial and industrial properties will proceed on a GST exclusive basis. If the highest bid at the auction is accepted on a GST exclusive basis the auctioneer will need to check that the contract is drawn on the basis of a GST exclusive price, plus GST. Otherwise the auctioneer will need to gross up the GST exclusive price by adding 10 percent to insert a GST-inclusive price into the contract particulars of sale.
No GST is payable on sales of existing residential property. However, vendors of new and substantially renovated residences will pay GST.
The margin scheme (if available) benefits purchasers of new residential properties by minimising the GST payable in respect of the purchase.
A sale of farm land used for farming for at least five years before the sale will be GST-free if the purchaser intends to continue using it for a farming business.
A sale of land that is subdivided from land used for farming for at least five years before the sale will be GST-free if the purchaser is an 'associate' of the vendor, the land is potential residential land and the consideration is less than the land's GST inclusive market value. (Associates include relatives, business partners and others associated with the vendor through family trusts and companies.)
The introduction of the GST on 1 July 2000 will make it even more essential for real estate agents and vendors to seek legal advice before preparing or amending a contract of sale. Careless amendments could have costly consequences if they affect the GST or stamp duty liability of the parties under the contract.
- Charles ArmitagePartner, Practice Leader, Tax,
Ph: +61 2 9230 4756
- Martin FryPartner,
Ph: +61 3 9613 8610
- Peter AllenConsultant,
Ph: +61 7 3334 3350