Latest constitutional challenge to notional GST fails

By Craig Milner, Scott Lang, Jon Wenham
Disputes & Investigations Property & Development Real Estate Tax

Greater clarity for government entities and developers 11 min read

Twice in the last two years the courts have rejected constitutional challenges to the notional goods and services tax (GST) voluntarily paid by the Commonwealth, states, local councils and statutory authorities.

While these decisions recognise that notional GST is technically voluntary, they also hold that the Commissioner of Taxation (Commissioner) has a legal duty to pursue its collection and the Commonwealth can make grant funding conditional upon payment of notional GST.

In these circumstances, government entities should ensure they are properly accounting for notional GST and recovering it by way of a gross-up from their counterparties. Persons dealing with government entities (in particular, developers) should be aware that government entities are likely to have an increased focus on recovering the correct amount of notional GST from them, which will have implications for their input tax credit entitlements.

In this Insight, we examine the reasoning behind both decisions and assess their implications for both government entities and persons dealing with them.

Key takeaways

  • In Hornsby Shire Council v Commonwealth, the High Court held notional GST did not contravene the prohibition in section 114 of the Constitution against Commonwealth taxes on state property.
  • In Landcom v Commissioner of Taxation, the Federal Court held government entities subject to notional GST had the same private ruling, objection, review and appeal rights as other taxpayers.
  • Government entities should ensure their standard GST clauses also apply to notional GST, otherwise they may not be entitled to a gross-up for notional GST from counterparties.
  • If there is any uncertainty regarding the application of notional GST or associated input tax credits, either a government entity or the counterparty can seek a private ruling from the Commissioner.
  • The Australian Taxation Office (ATO) is expected to provide further guidance in relation to disputes regarding notional GST.
  • The reasoning in Hornsby and Landcom is unique to notional GST and, arguably, should not have implications for notional income tax paid under the National Tax Equivalent Regime (NTER).

What is notional GST and why was it challenged?

Constitutional prohibitions

GST is a tax imposed by the Commonwealth Parliament at every stage of a supply chain upon the value added by each supplier in the chain (except for specified GST-free and input-taxed supplies). The tax is restricted to value added by providing each supplier with input tax credits for the GST paid on the acquisitions they made in the course of making their own supplies (except acquisitions related to making input-taxed supplies).

However, this efficient operation of the GST is interrupted if the Commonwealth or a state (including local councils and statutory authorities) forms part of the supply chain. This is because, as a matter of logic, the Commonwealth cannot impose a tax upon itself, and s114 of the Constitution prohibits the Commonwealth from taxing the property of a state:1

[N]or shall the Commonwealth impose any tax on property of any kind belonging to a State.

Consequently, no GST is imposed on any supply by the Commonwealth or any supply of property by a state (noting that other supplies by a state, such as services, are validly subject to GST).2 This means any taxpayer who makes such an acquisition from the Commonwealth or a state would not be entitled to an input tax credit.

In the absence of a solution, this would create distortions in valuing/costing such supplies.

Notional GST is the solution

To remove such distortions, the Commonwealth, states and territories entered into an intergovernmental agreement in 1999, subsequently revised in 2009, pursuant to which they agreed that the Commonwealth, states, territories, local councils, statutory corporations and statutory authorities would make voluntary notional payments of GST as if they were subject to GST.3

The 1999 intergovernmental agreement also stated that the Commonwealth would pass legislation requiring the states to withhold from grant funding paid to a local council by the Commonwealth (via the state) any amount of unpaid notional payments of GST. The Commonwealth subsequently passed such legislation,4 while the states passed legislation permitting or requiring their entities to make these payments of notional GST.5

The creation of notional GST by these intergovernmental agreements and implementing legislation is mirrored by provisions of the GST law that effectively confer upon the recipients of supplies subject to notional GST a right to an input tax credit for the notional GST (by deeming the supply to be taxable and deeming the notional GST to be actual GST).6

Challenged from both sides

Given the complexity involved in implementing notional GST, it was perhaps inevitable that its validity would be challenged by affected parties. Interestingly, however, it ended up being challenged both by a taxpayer and the Commissioner.

In Hornsby Shire Council v Commonwealth,7 the Council argued that notional GST was invalid pursuant to s114 of the Constitution because it was a tax on state property (given that the Council formed part of the State of New South Wales) that the Council was legally and practically compelled to pay.

Conversely, in Landcom v Commissioner of Taxation,8 the Commissioner argued that the Federal Court had no jurisdiction to hear an appeal by a taxpayer against an adverse objection decision made by the Commissioner regarding Landcom's notional GST because notional GST was not legally enforceable.

Both challenges were ultimately unsuccessful.

Hornsby Shire Council v Commonwealth

A simple test case

The facts which gave rise to this dispute may be the simplest ever seen in a tax case: Hornsby Shire Council, a local council in NSW, sold a car.

The notional GST on that sale was included in the Council's GST return/Business Activity Statement (BAS), which resulted in a deemed assessment creating a liability to pay the notional GST.

The Council paid that notional GST under protest before seeking to recover the payment on the basis it was a tax on state property contrary to s114 of the Constitution.

Notional GST upheld

The High Court unanimously found that notional GST was not a tax on state property prohibited by s114 of the Constitution because the Council's inclusion of notional GST in its BAS was a voluntary act that it was neither legally nor practically compelled to do.9

The Court held that, for the purposes of s114 of the Constitution, a tax is a compulsory exaction of money by a public authority for public purposes, enforceable by law, that is not a payment for services rendered, a charge for the use of property or in the nature of a penalty.

Notional GST was not a compulsory exaction enforceable by law because no law compelled the Council to pay notional GST and the Council could choose not to do so. This was because:

  • the intergovernmental agreements were purely political arrangements that were not legally enforceable
  • the GST imposition Acts expressly provided that actual GST was not imposed upon supplies of property belonging to a state (including the Council)
  • the New South Wales Act authorising notional GST payments to the Commissioner was merely permissive and did not create an obligation to pay notional GST
  • the Commonwealth Act imposing an obligation on NSW to withhold from Commonwealth grants to the Council (via the state) the amount of any notional GST not paid by the Council did not impose any obligation upon the Council and, in any event, was only enlivened if NSW accepted Commonwealth grant funding for its councils, which it was free to reject.

The Court held the Council was not practically compelled to pay notional GST due to this withholding mechanism because the Council had no pre-existing right to receive grant funding unreduced by unpaid notional GST and the withholding mechanism was a poor inducement to pay notional GST considering it still gives the Council the time value of money (ie the Council would have the benefit of any notional GST it chose not to pay until the time at which the same amount was deducted from subsequent grant funding).

Conditional grants also upheld

In upholding the validity of notional GST, the High Court also reaffirmed that section 96 of the Constitution permits the Commonwealth Parliament to grant financial assist to states on terms and conditions consistent with the Constitution, and that states are free to reject any such grants.

The Court held that s96 authorises Commonwealth Acts providing for:

  • the GST revenue to be distributed to the states
  • additional local council grant funding provided to the states on the conditions that:
    • it be distributed to local councils in proportions determined by the Commonwealth; and
    • any notional GST not paid by a local council be deducted by the state and remitted to the Commonwealth.

Landcom v Commissioner of Taxation

When is a ruling not a ruling?

Landcom was decided before Hornsby, and considered whether the administrative framework of private rulings, objections, reviews and appeals that applies to actual GST also applies to notional GST. While this required the Federal Court to consider similar issues to Hornsby, the High Court made no reference to the Federal Court's earlier decision.

Landcom is a statutory corporation responsible for land development in NSW. It contracted to sell land and sought a private ruling from the Commissioner in advance of the sale because there was a technical issue around the application of the margin scheme in calculating its notional GST. The ruling was unfavourable to Landcom, Landcom objected, and the Commissioner disallowed the objection.

Landcom sought to appeal that objection decision to the Federal Court, but the Commissioner argued the court had no jurisdiction given that notional GST was unenforceable.

Notional GST administered like actual GST

Justice Thawley held that the Federal Court did have jurisdiction to hear the appeal. In order for the court to have jurisdiction, sections 75-77 of the Constitution require that there be a 'matter', which involves a justiciable controversy over real and non-hypothetical rights and obligations. The court held that it had jurisdiction on two separate grounds.10

First, the court held that all entities registered for GST must lodge GST returns (ie BAS) and the inclusion of notional GST in a BAS gives rise to a debt to the Commonwealth enforceable by the Commissioner unless it is subsequently disputed by the taxpayer. As such, Landcom had a real and not hypothetical interest in determining the correct amount of notional GST to include in its BAS.

The ability to obtain a private ruling on the tax consequences of a proposed scheme to be entered into in the future does not render a dispute between the Commissioner and a taxpayer over any such ruling hypothetical. Consequently, an appeal against an objection decision on a private ruling involves a matter, regardless of whether the subject of the ruling is actual or notional GST.

Second, the court held that there was a matter over which it had jurisdiction because:

  • the subject matter of Landcom's private ruling, section 75-10(3)(item 4) of the GST Act dealing with supplies of real property by the Commonwealth, a state or territory, expressly applied to Landcom
  • Landcom has a statutory right to seek a private ruling from the Commissioner about how that provision applies to it, and the Commissioner is obliged to give such a ruling
  • Landcom was dissatisfied with the ruling because there was a controversy between it and the Commissioner as to how the GST Act applied to it.

On that basis, the court proceeded to hear Landcom's appeal.

Implications for government entities and developers

Reasoning applies to notional GST generally

The High Court in Hornsby emphasised that its reasoning, despite being focused on the sale of just one car by one part of one state, would apply more broadly to any local government body choosing to include notional GST in its BAS.11

Given the consistency in reasoning between Hornsby and Landcom, it should also apply more broadly to any state or state entity. There seems to be no reason why it should not also apply even more broadly to the Commonwealth or any Commonwealth entity.

Standard GST clauses should deal with notional GST

Government entities should ensure their standard GST clauses confer upon them a right to receive a gross-up from their counterparty for both actual GST and notional GST.

Failure to do so might result in the government entity being (politically) required to remit notional GST, but with the counterparty being under no obligation to gross-up the entity for that amount, whilst simultaneously being entitled to an input tax credit.12 In such cases, the notional GST exclusive price will effectively become the notional GST inclusive price, to the benefit of the counterparty and to the cost of the government entity.

Parties dealing with government entities, in particular developers, should clarify how any notional GST liability (and associated input tax credit entitlement) operates under their contract with the government entity. If there is any doubt, a private ruling can be obtained.13

Enforcement of notional GST by Commissioner

The Federal Court in Landcom held that the Commissioner's duty to administer GST includes a duty to administer notional GST, including a duty to collect notional GST, accept payments of notional GST, pursue non-payment of notional GST and issue private rulings about notional GST.14

Practically speaking, this means the Commissioner is required to act in relation to notional GST in the same way as in relation to actual GST. Accordingly, government entities should ensure their compliance with notional GST is subsumed within their compliance with actual GST.

If there is any uncertainty regarding how notional GST applies to a government entity, Landcom clearly establishes that the entity is entitled to obtain a private ruling from the Commissioner on that point (subject to the normal limits on obtaining rulings).

If the Commissioner did seek to pursue payment of notional GST from a government entity, the government entity would be required to either pay, or dispute its liability for, such notional GST.

The Commissioner is precluded from imposing penalties upon government entities that form part of the Crown and has made a public ruling stating that penalties and interest do not apply to Commonwealth entities at all, while penalties and interest do not apply to state entities in relation to notional GST.15

Disputes regarding notional GST

Shortly before Justice Thawley handed down judgment in Landcom, the ATO published a Dispute Resolution Process for Notional GST Matters. The document set out an internal ATO process that assumed notional GST taxpayers did not have regular rights of objection, review and appeal.

That assumption is now clearly incorrect. Justice Thawley held that a state that included notional GST in its BAS could:16

  • lodge an objection with the Commissioner against its deemed assessment on the basis of s114 of the Constitution; and, if the objection was rejected by the Commissioner,
  • seek review of the assessment in the Administrative Appeals Tribunal or appeal to the Federal Court, either of which could find the assessment excessive on the basis of s114.

Presumably a Commonwealth entity could similarly object and seek review or appeal on the basis of section 177-1(1) of the GST Act, which provides that Commonwealth entities are not liable to pay GST.

Since Landcom, the ATO has added a note to its process document stating it is under review. The ATO has also issued a decision impact statement on Landcom which states that it intends to consult with the states and territories on the process document (including on any appropriate updates).17

Intriguingly, the decision impact statement asserts that as the reasoning in Landcom does not deal with the dispute resolution process that applies to objections against assessments, as opposed to objections against private rulings as was the case in Landcom, the ATO intends to issue further guidance on that matter. This statement is difficult to reconcile with the reasoning of Justice Thawley that objections could be made against assessments and not just private rulings.

Enforcement of conditional grants by Commonwealth

While the High Court in Hornsby accepted as a 'basal principle' that constitutional prohibitions like s114 cannot be contravened directly, indirectly or by circuitous device, it held that there was no such device in this case.18

As a result, the Commonwealth can effectively circumvent constitutional prohibitions protecting states by paying the states not to enforce them. Vertical fiscal imbalance and the power to make conditional grants provide the practical means for the Commonwealth to, in effect, do what it otherwise cannot (eg taxing state property).

Despite upholding the constitutional validity of conditional grants, the High Court specifically refused to decide whether such conditions are legally enforceable by the Commonwealth against a state. It also refused to resolve the relationship between the grant power in s96 of the Constitution and the prohibition on Commonwealth taxes on state property in s114.19

If the conditions attached to Commonwealth grant funding are not legally enforceable, then notional GST would effectively become unenforceable, as states could simply ignore any conditions regarding notional GST attached to grants. Enforcement could then only be by political means (eg refusing to grant funding).

Notional income tax arguably different

Commonwealth income tax is generally only imposed upon individuals, companies and trustees;20 it is not imposed on the states and territories.21 However, the states and territories may establish companies and trustees, which would be subject to income tax unless an exception applied.

Local councils, public authorities (including the Future Fund), constitutionally protected funds, wholly owned Australian subsidiaries of the Future Fund and certain state and territory bodies are exempt from income tax.22

The same intergovernmental agreement that first provided for notional GST also provided for state and territory government-owned enterprises to pay notional income tax under the NTER for essentially the same reason: to promote competitive neutrality.23

However, the NTER is an entirely administrative arrangement administered by the Commissioner with payments made to each entity's relevant state or territory revenue office.24 Unlike notional GST, NTER liabilities have not been incorporated into the Income Tax Assessment Acts.

Consequently, the reasoning in Landcom arguably should not apply to the NTER.


  1. Territories are not states and so are liable for actual GST on all supplies they make (except the Australian Capital Territory where it acts as agent for the Commonwealth).

  2. See, eg, A New Tax System (Goods and Services Tax Imposition – General) Act 1999 (Cth) s5; A New Tax System (Goods and Services Tax) Act 1999 (Cth) ss2-1, 177-1(1).

  3. Intergovernmental Agreement on the Reform of Commonwealth-State Financial Relations (June 1999) cll17-8; Intergovernmental Agreement on Federal Financial Relations (December 2008) schA clA28.

  4. Local Government (Financial Assistance) Act 1995 (Cth) s15(aa).

  5. See, eg, Intergovernmental Agreement Implementation (GST) Act 2000 (NSW) s5; cf National Tax Reform (State Provisions) Act 2000 (SA) s4(1).

  6. A New Tax System (Goods and Services Tax) Act 1999 (Cth) ss177-1(4), 177-3.

  7. [2023] HCA 19 (14 June 2023).

  8. [2022] FCA 510 (9 May 2022). The Commissioner subsequently appealed this decision in relation to the substantive issue regarding the margin scheme, but did not appeal against the finding the court had jurisdiction: Commissioner of Taxation v Landcom [2022] FCAFC 204 (22 December 2022) [5].

  9. [2023] HCA 19 (14 June 2023) [4].

  10. [2022] FCA 510 (9 May 2022) [142], [184].

  11. [2023] HCA 19 (14 June 2023) [5].

  12. A New Tax System (Goods and Services Tax) Act 1999 (Cth) ss177-1(4), 177-3; Supplementary Explanatory Memorandum, A New Tax System (Goods and Services Tax) Bill 1999 (Amendments and Requests for Amendments) (Cth) [1.125]-[1.128].

  13. [2022] FCA 510 (9 May 2022) [181].

  14. Ibid [158], [170], [176].

  15. Taxation Administration Act 1953 (Cth) s2B; Australian Taxation Office, Miscellaneous taxes: application of penalties and interest charges to the Commonwealth, States, Northern Territory and Australian Capital Territory, MT 2011/1, 29 June 2011, 9-10 (MT 2011/1); Australian Taxation Office, Administration of penalties and interest charges in relation to the notional liabilities of the States, PS LA 2011/26, 29 June 2011 (PS LA 2011/26).

  16. [2022] FCA 510 (9 May 2022) [132]-[136]. Justice Thawley refused to determine whether the court could declare such an assessment invalid on the basis of s114 in addition to the grounds for invalidity recognised by the High Court in Commissioner of Taxation (Cth) v Futuris Corp Ltd (2008) 237 CLR 146, 157: [136].

  17. Australian Taxation Office, Decision impact statement: Commissioner of Taxation v Landcom, 15 March 2023.

  18. [2023] HCA 19 (14 June 2023) [43].

  19. Ibid [13], [32].

  20. Income Tax Assessment Act 1997 (Cth) s9-1.

  21. MT 2011/1, 8.

  22. Income Tax Assessment Act 1997 (Cth) s50-25; Income Tax Assessment Act 1936 (Cth) s24AM; Future Fund Act 2006 (Cth) s84A(1).

  23. Australian Taxation Office, Manual for the National Tax Equivalent Regime (January 2022) [2], [8].

  24. Ibid [6], [18], [71]. See also MT 2011/1, 8; PS LA 2011/26, [7].