Relocating to Australia gives rise to myriad potential tax issues from both a pre-departure, pre-arrival and ongoing perspective.

Check out our questionnaire on some of the key issues to consider and understand in making the transition.

Economos Pre-Arrival Questionnnaire

If you or your clients need any assistance in answering these questions and devising a pre-arrival plan, feel free to get in touch!

If you are a small / medium business using contractors, you must make sure they are independent contractors to claim exemption from certain liabilities.

Contractors are a key area of compliance with the Australian Taxation Office.

If your contractors are not independent they will be classified as employees and your business will be liable for their:

• Superannuation
• Workers Compensation
• PAYG Withholding Tax
• Payroll Tax (State based tax)
• Fringe Benefits Tax (where applicable)

The following statutory bodies:

• Australian Taxation Office (superannuation and PAYG WHT),
• Workcover (Workers Compensation), and
• the various Offices of State Revenue (Payroll Tax)

are the bodies authorised to go back 4 years and review payments your business made to your “contractors” to make sure they are independent for liability purposes.

This is especially important in the building and construction industry. This industry is of particular interest to the various authorities.

Two important facts about contractors:

1. Just because a contractor has an ABN does NOT make them an independent contractor.
2. A contractor who uses a PTY LTD company will always be an independent contractor.

The following guide has been provided by the ATO in determining the status of your contractors.

You may have hidden liabilities.

Please contact me if you need assistance in determining the independence of your contractors and assessing any potential hidden liability to these authorities.

Links

The ATO: Employee or Contractor: What’s The Difference?

Principal Contractor Issues: New South Wales Workcover

Contractors: Office of State Revenue NSW

Overview

With limited exceptions (most notably in relation to eligible start-up schemes), the ESS rules are aimed at ensuring that ESS interests (shares or options rights over shares issued by a company employer or the holding company of the relevant employer) are subject to tax as ordinary income rather than concessionally-taxed capital.

The ESS rules achieve this by taxing any discount to the market value of the relevant ESS interest. However, the timing of when the relevant discount is calculated, either up-front or at the deferred taxing point depends on whether or not the particular ESS interests are eligible for deferral.

Preliminary issues

It is important to understand that:

1. the ESS rules can apply to relationships broader than the ordinary employer/employee relationship;

2. the ESS rules apply to the individual employee even if the relevant ESS interest are actually issued to another entity such as a family trust;

3. the ESS rules only apply to shares or options/rights over shares in companies – they do not apply to units in unit trusts;

4. ESS give rise to State/Territory-based payroll taxes;

5. where up-front taxation arises, subject to meeting certain conditions, employees may be able to reduce the amount included in their assessable income by up to $1,000; and

6. in relation to an ESS involving unlisted options (even if over listed shares), employees may be able to take advantage of the concessional ‘Table Valuations’ under the ESS regulations.

Taxed up-front schemes

The starting point under the ESS rules is that any discount is taxed up-front in the income year in which the relevant shares or options/rights are granted.

Where an individual is taxed up-front, the relevant discount is included in their assessable income in the ordinary course subject to the possible $1,000 reduction.

Example 1

 Annabelle is a key employee of Tech Co. Tech Co issues Annabelle with shares in the company worth $25,000 in 2017.

The shares are not subject to any vesting conditions.

Annabelle includes the full $25,000 in her assessable income in 2017.

As you can imagine, this can place a significant cash flow constraint on the employee, who must come up with actual cash in order to pay her tax bill on a potentially illiquid asset (shares in a private company).

It was partly for this reason that the relevant start-up ESS concessions were introduced (see below).

Tax deferred schemes

Subject to meeting relevant deferral conditions, which differ for shares versus options/rights (with some overlap), the employee does not calculate the relevant discount as at the grant date but at the earlier of various deferred taxing points.

The critical conditions for deferred taxation include:

1. the ESS interests must be ordinary shares or options/rights over ordinary shares (and importantly, ordinary shares are effectively any shares other than preference shares);

2. the ESS interests must be subject to a ‘real risk of forfeiture’, that is, they are subject to vesting conditions such as minimum terms of employment, employee or company-specific KPIs or a combination all of them.

For options/rights granted before 1 July 2015 (even if un-vested as at 1 July 2015), the taxing point is generally vesting with a maximum deferral period of 7 years from the grant date.

For options/rights granted on or after 1 July 2015, the taxing point is generally exercise with a maximum deferral period of 15 years from the grant date.

The downside of deferred taxation is that the discount is calculated at the deferred taxing point so that any increase in the value of the ESS interests up to that point will be taxed in the employees hands as ordinary income.

Example 2

William is lead engineer in a telecommunications company. The company issues William $10,000 worth of options.

Both the company and William satisfy the relevant conditions for deferred taxation and the options vest at the end of 3 years provided that William is still employed by the company and certain company-based KPIs are met.

At the end of 3 years, the options vest. If the options were granted before 1 July 2015 vesting would generally be the taxing point. If the options were granted on or after 1 July 2015 the subsequent exercise of the options will generally be the taxing point.

Either way, however, the increase in the value of options (based on the underlying increase in the company’s share price) between the grant date and the deferred taxing point is assessed to William at the relevant time. For example, if the options were worth $1m on the relevant date William will be taxed at up 45% on the entire discount (excluding levies)!

Eligible start-up concession

In recognition of the difficulties facing start-up companies and their employees, particularly in relation to the latter and the potential for them to be taxed heavily in relation to ESS interests that are highly illiquid and their valuations highly speculative, new rules with effect from 1 July 2015 operate to ensure that, in relation to the issue of options:

1. eligible start-ups can save the potentially significant costs of:
   1. formal legal advice by adopting the Australian Taxation Office template ESS Plan documentation;
   2. subject to meeting additional criteria – a formal valuation by adopting the safe harbour valuation methodology (which in effect provides a net tangible assets valuation stripping the company of valuable intangibles);

2. eligible employees:
   1. may be able to obtain shares in the company (via exercising the options) at a significant discount to ‘real’ market value which would generally include valuable intangibles ignored under the safe harbour valuation methodology; and
   2. are only taxed on the eventual disposal of the underlying share following vesting and exercise of the relevant options/rights.

In addition, provided that the combined holding period of options and the underlying shares (post-exercise) is more than 12 months, the relevant employee will generally be able to access the general 50% CGT discount (whereas ordinarily, exercising an option ‘re-starts the clock on the 12 month holding period rule in relation to the underlying share).

There are a number of conditions that must be satisfied, however, in order to qualify for an eligible start-up plan, including but not limited to:

1. the strike price of the option must be at least equal to the underlying share price on the grant date (which, subject to separate eligibility criteria, could be determined using the safe harbour valuation methodology);

2. the relevant company and all group entities are under 10 years old;

3. the relevant company and all group members have total turnover of less than $50m;

4. the options must relate to ordinary shares in the relevant company; and

5. the particular employee-participant cannot hold more than 10% of shares in the relevant company on a fully diluted basis.

Other ESS plans

If, for whatever reason, the relevant ESS fails to qualify for the eligible start-up concession or none of the other structuring options under the ESS rules are suitable to all relevant stakeholders, other alternatives include:

1. a limited recourse loan plan – where employees are issued shares in the company but are required to repay the full market value as at the subscription date over time (watch out for deemed dividend and FBT issues);

2. a partly paid share plan – where employees are issued with share partly paid-up to a certain extent and who pay-up the shares to the full market value as at the subscription date over time (generally should not give rise to deemed dividend or FBT issues); and

3. a phantom share plan – which isn’t a share plan at all but a right to a cash payment which usually tracks the increase in value of the shares in the company between set dates.

Conclusion

There are numerous issues to consider in relation to the design and implementation of an ESS.

The starting point is achieving the company’s commercial goals of incentivising key employees to kick major goals by tying business levers to individual KPI’s in a meaningful way so that all stakeholders benefit.

Other things being equal, from a tax perspective the start-up concession is the most beneficial to participating employees in that the relevant increase in value will generally be taxed at only half the rate of ordinary income (max. 22.5% instead of max. 45% excluding levies). However, if this is not available, it is a matter of designing a plan that strikes the right balance between achieving the company’s goals and not creating cash flow problems for participating employees.

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Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

Introduction

This article is relevant for developers, investors and even those looking to break into the first-home buyer’s market at a discount to market value.

In relation to the latter, even at historically low interest rates, many people are simply shut out of the property market as the cost of entry is beyond their financial reach. For some, the problem is exacerbated in boom times where the market may increase in value well beyond the rate of their capacity to save.

Increasingly, as a means of entering the market, friends and family members are pooling their financial resources. Commonly, this involves the straightforward purchase of an existing dwelling to live in or rent out, however, an increasingly popular option is to undertake small-scale development projects, such as a duplex.

Such projects can be attractive in a variety of circumstances, including:

1. parents seeking to acquire an investment property and adult children wanting to enter the first-home buyer’s market (parents take one dwelling and the children take the other(s));

2. parents seeking to down-size and adult children wanting an investment property (parents live in one dwelling and adult children rent out the other(s)); or

3. siblings and/or friends seeking a first-home and/or investment property (one party takes one dwelling and the other party takes the other).

There is no denying that such projects give rise to complexities, however, provided that participants carefully consider all the relevant issues and weigh the particular risks prior to entering into any arrangement, they can be very worthwhile.

Increasingly, project home builders have standardised duplex/triplex/townhouse designs available so as streamline the construction process (and although participants pay a premium for the service compared to project managing themselves, in the writer’s experience, project home building is a very competitive industry with very reasonable base prices and if you can source options and extras from external sources rather than the project builder, there are considerable savings to be made).

For present purposes, assume that by pooling their resources, two parties are able to save $100,000 each, that is, an attached duplex which would cost $850,000 on market costs $750,000 to develop. This may not only be the difference between buying in a preferred suburb or elsewhere, but over the life of the loan this will save a very significant amount of interest.

From a planning perspective, individuals need to be aware of the rules governing the development of a potential property before purchasing. Unfortunately, each local government area is different so it will be a matter of participants either:

1. sifting through the relevant provisions of the applicable Local Environmental Plan, Development Control Plan and any statutory overlays personally; or

2. engaging the services of an experienced town planner in their local government area, who for a small fee will summarise precisely what can and cannot be done with the property prior to you moving forward.

In the writer’s experience, wherever possible, going down the path of ‘complying development’, that is, purchasing a property that is effectively ‘pre-approved’ by the local government authority for the desired project (subject to meeting designated criteria such as minimum lot frontage, minimum lot area, maximum height and maximum floor-space-ratio) effectively eliminates the risk of not getting approval. However, there are also other risks to carefully consider before deciding to proceed, including finance risk and construction risk.

From a tax perspective, these projects give rise to issues as to:

1. the income/capital distinction;

2. income tax;

3. capital gains tax (“CGT”);

4. goods and services tax (“GST”);

5. stamp duty; and

6. the availability of any relevant concessions/exemptions.

Interaction between planning regulations and finance

One critical issue to consider is finance, which is in part a function of valuation. Generally, ordinary residential mortgage lenders will lend 80% of the valuation of the end product without mortgage insurance.

The potential problem with this is that in relation to attached duplexes and triplexes, local council regulations generally dictate that subdivision (whereby a single legal lot is split into two or more separate legal titles) is the very last step in the entire construction process. Therefore, ordinary residential mortgage lenders will often only lend on the value of the amalgamated (un-subdivided) property. Consider the following:

Example

Annabelle and William are siblings and wish to construct two, three-bedroom attached duplexes. Based on comparable sales, the end value of each duplex post-subdivision will be $850,000 ($1,700,000 in total). However, the lender can only value the existing, un-subdivided block based on the plans provided as a single, six bedroom home valued at $1,200,000. Therefore, Annabelle and William can borrow 80% of $1,200,000 ($960,000) without mortgage insurance, not 80% of $1,700,000 ($1,360,000).

Some participants may simply accept that mortgage insurance is the cost of getting started and of course, there may be better financing options out there, although in the writer’s experience, borrowing on the anticipated end value of a project (post-subdivision) involves commercial forms of finance which is generally more expensive. Ultimately, if the numbers work, perhaps commercial forms of finance is the answer to get the project off the ground before re-financing to an ordinary residential mortgage on completion (a finance broker should be able to assist you in this regard).

What happens on subdivision?

If two participants acquire a property as tenants-in-common in equal shares and intend to construct a duplex, whether as developers, investors or a private arrangement with the duplexes to serve as their respective main residences, then returning to the example above, on subdivision:

1. Annabelle owns 50% of Lot A and 50% Lot B; and

2. William owns 50% of Lot A and 50% Lot B.

The purpose of the project is to ensure that Annabelle owns 100% of Lot A and William owns 100% of Lot B. This is critical as to the extent that one party wishes to use their dwelling as their main residence, they must hold 100% of the property in order to claim the full main residence CGT exemption on disposal. Separately, a partition is critical if the parties are seeking to carry out a joint venture as opposed to a partnership (and therefore avoid joint and several liability), as the hallmark of a joint venture is the sharing of product rather than profit.

Returning to the example above, if Annabelle treated Lot A as her main residence and there was no partition, the eventual disposal of Lot A would only be exempt as to 50%, with the remaining 50% assessed in the usual manner in the hands of William (who will be ineligible to claim the main residence CGT exemption in relation to Lot A as his main residence is Lot B).

In order to achieve the desired result:

1. Annabelle will need to transfer her 50% share of Lot B to William; and

2. William will need to transfer his 50% share of Lot A to Annabelle.

This is known as a ‘partition’.

As outlined below, depending on whether the relevant participant holds their interest on capital account, trading stock or otherwise on revenue account, various tax consequences arise on partition.

Tax issues for participants

The income/capital distinction

Participants must consider their intention or purpose in entering into the project. If participants intend to live in their dwelling as their main residence, or to rent out one of the dwellings, they are likely to be taken to hold the property as a capital asset. Conversely, if a participant is entering into the project to sell one or more of the dwellings, they will be taken to hold the relevant “for sale” dwelling(s) as trading stock (or otherwise on revenue account).

So what is the difference?

If a participant holds the property on capital account, they will be subject to the CGT regime. Capital assets give rise to capital gains or losses and for individuals (or individual beneficiaries of a trust), the maximum tax payable on a long-term capital gain (a gain on an asset held for at last 12 months) is 22.5% (excluding levies).

This is known as the “50% CGT discount”.

Further, in the present context, special exemptions may apply in the context of partitions (see below).

If participants hold the property as trading stock (or otherwise on revenue account), they will be subject to tax at their ordinary marginal tax rates on disposal (currently up to 45% excluding levies).

Note, the income/capital distinction can be a very grey area and the ATO is certainly alive to the pointy practice of taxpayers purporting to hold assets on capital account rather than as trading stock (or otherwise on revenue account) and claiming the 50% CGT discount on disposal soon after the 12 month holding period ticks over.

In the context of an ATO review, it is insufficient to highlight the taxpayer’s subjective intention or purpose in entering into the project unless such intention is corroborated by objective evidence and as recent case law highlights, this extends to evidence as to:

1. what participants told their lender(s) when seeking finance as to their purpose;

2. what participants told any real estate(s) agent as to their purpose and whether they were engaged to generate pre-sales;

3. what participants told the local government area as to their purpose in seeking approvals (if applicable); and

4. whether and how the property/ies were marketed (i.e. for sale, for rent or ‘for sale or rent’).

At the risk of over-simplifying, all objective evidence must support the taxpayer’s stated subjective purpose and participants can expect that, in the absence of specific circumstances (such as serious illness, unexpected relocation etc), the shorter the time period between completion of the project and disposal, the higher the scrutiny they are likely to come under from the ATO in seeking to claim discount CGT treatment.

This article assumes that participants are on capital account.

CGT issues

A partition gives rise to a partial disposal, that is, returning to the example above, Annabelle disposes of her 50% interest in Lot B to William as consideration for the transfer of William’s 50% interest in Lot A.

The disposal of a CGT asset generally gives rise to a capital gain or loss. However, a special exemption applies where:

1. you own land on which there is a building; and

2. you subdivide the building into stratum units; and

3. you transfer each unit to the entity who had the right to occupy it just before the subdivision,

a capital gain or loss you make from transferring the unit is disregarded.

There is a corresponding CGT exemption for the receipt of the relevant strata unit in these circumstances. However, specific advice should be sought and the relevant partition agreement between the parties must be appropriately documented so as to ensure that each participant has a right to occupy a particular dwelling so as to fall within the particular exemptions.

Note that this only applies to strata title properties and does not apply to other forms of land title, including Torrens title.

In relation to Torrens title land (and other forms of land title), the ATO takes the view that a partition agreement, even if entered into at the very outset between the relevant parties, will trigger an ordinary disposal for CGT purposes.

Some commentators take the view that if the relevant parties enter into an arrangement at the outset whereby Annabelle acquires half of her 50% legal interest in the property as trustee for William and vice versa that the subsequent transfers of those shares by the respective trustees on partition are ignored for CGT purposes under the absolute entitlement rules.

However, the ATO takes the view (in a draft Taxation Ruling that has remained in draft form for near 12 years now) that two or more individuals cannot be absolutely entitled to a single parcel of real property and therefore, the absolute entitlement rules do not apply to prevent triggering CGT in these circumstances.

At the very least, this differential treatment for Torrens title versus strata title property appears to infringe the principle of horizontal equity, in so far as taxpayers with similar assets (although clearly legally distinct) being subject to different tax rules, that is, partitions of Torrens title property triggers liability to CGT whilst partitions of strata title property being disregarded for CGT purposes. However, the CGT concession for strata title property has its genesis in the conversion of older systems of title to strata title following its introduction. The question remains, however, as to why there is not a broad-based CGT rollover for partitions of all real property, regardless of its system of title as it only serves to trigger liability to tax in the absence of the actual receipt of funds with which to pay it (unless the relevant asset is liquidated).

Stamp duty issues

Ordinarily, transfers pursuant to a partition would trigger liability to duty. However, in NSW (and other States/Territories), special concessions may apply to limit duty to the extent of any ‘overs’. Returning to the example above, in NSW, if Annabelle and William have an interest in the post subdivision (pre-partition) dwellings worth $850,000 each, and post-partition they each hold 100% of a single property worth $850,000, concessional duty of only $50 is payable.

However, if the post subdivision (pre-partition) value was $850,000 each, but Lot A was worth $900,000 based on superior fixtures, fittings and aspect, then Annabelle, as transferee, would be subject to duty on her $50,000 up-interest, or approximately $765.

Please note that other States/Territories offer various partition concessions however, they can operate differently to the NSW provisions and specific advice should be sought in this regard.

GST issues

Generally, the supply of residential premises is input taxed, meaning that the supplier (vendor) does not charge GST on the supply and cannot claim any GST credits on expenses in relation to the property.

There is an exception to the general rule, however, in relation to the supply of ‘new residential premises’. Broadly, new residential premises are residential premises that:

1. have not previously been sold as residential premises (other than commercial residential premises) or the subject of a long-term lease (generally 50 years);

2. have been credited through substantial renovations; or

3. have been built, or contain a building that has been built, to replace demolished premises on the same land).

New residential premises are subject to GST if all the relevant conditions of a ‘taxable supply’ are met.

An entity makes a taxable supply where, among other things, they carry on an ‘enterprise’ and they are registered, or required to be registered for GST.

The term, ‘enterprise’ is broader than that of ‘business’ and includes, for example, an enterprise of leasing residential property. However, activities of a private or domestic nature fall outside the scope of an enterprise.

Broadly, if a participant is seeking to construct a dwelling to act as their main residence, it will be considered private or domestic and therefore, they will not be required to be registered for GST (and if they are registered for required to be registered for other reasons, for example, they are a sole trader, then these activities would fall outside the scope of their enterprise).

However, if a participant is seeking to rent out their dwelling, they will be carrying on an enterprise of residential leasing and therefore, they will be required to be registered if they will have turnover of more than $75,000.

Returning to the example above, if Annabelle intended to use Lot A as her main residence and William wanted to rent out Lot B, then as the value of William’s supply of 50% of Lot A to Annabelle on partition will exceed the $75,000 registration threshold, William will be subject to GST on the partial disposal of new residential premises.

Conversely, this means that William will be entitled to GST input tax credits equal to 50% of the GST component of his eligible input costs in carrying out the project. In this regard, specific advice should be sought as to the availability of the margin scheme.

Conclusion

Partitioning is common amongst developers engaged in joint ventures (whether between arm’s length third parties or ‘internal’ joint ventures between a company [intending to sell] and a trust [intending to hold for investment] within a single family group).

Increasingly, partitioning is being used by family and friends to break into the property market or deliver an instant ‘equity boost’ to the participant’s respective property portfolios.

Of course, there are myriad issues to consider and costs to factor in in conducting a feasibility study so as to determine whether it is worthwhile and what participants can expect to save compared to buying equivalent end-product ‘on market’.

Any feasibility study must include as relevant expenses the tax, duty and GST implications of the proposed transaction so as to get an accurate idea of the relevant savings, which will ultimately assist in determining whether the project is worth the effort.

Again, specific advice is absolutely critical in this regard as generalisations are apt to mislead, however, as a rough ‘ready reckoner’, please see the table below:

Many people are surprised by the fact that tax and GST issues can arise on partition as they are not ‘cashing out’ but rather, taking a preliminary step in putting the properties in the individual names of the relevant participants so as to facilitate, for example, access to the CGT main residence exemption on eventual disposal. However, in the absence of any specific concession, the general tax rules apply to assess participants as outlined above (except insofar as a specific concession or exemption applies) and these costs must be factored into any meaningful feasibility study.

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Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

Developers often use options as a means of mitigating risk by optioning a property so as to lock in a property at a set price whilst giving them give them time within which to obtain the necessary approvals  without having to actually acquire the property – saving carrying costs such as interest as well as delaying stamp duty.

The GST implications of options broadly follow the GST treatment of the underlying property/ies subject to the option, that is, if the supply of the underlying property on exercise of the option would be an input taxed supply of (non-new) residential premises, then the option itself will not be subject to GST.

It is common for some option holders to acquire the option with a view to obtaining the necessary approvals before effectively ‘on-selling’ the option rather than exercising it and carrying out the development itself. This is done by way of nomination under the option agreement. However, developers acquiring an option by way of nomination, whereby they pay a premium representing the difference between the amount payable for the property under the option and the market value of the underlying property following the development approval process must understand the GST implications this will have downstream when it subsequently re-develops the property and seeks to sell-off individual titles. Specifically, how acquiring property in this way, as opposed to purchasing land directly, impacts on the calculation of the margin scheme on eventual disposal.

These issues should be carefully determined as part of any meaningful feasibility study from the outset.

For a detailed explanation and helpful diagrams, see GST on Options over Real Property

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Disclaimer – this article and the contents of any links herein do not constitute specific advice and cannot be relied upon as such.

Introduction

This article discusses the adjustment provisions in Div 129 of the GST Act. These provisions often apply in the context of property developers who lease out stock to generate income to offset holding costs during downturns in the market. Failing to adjust can result in inadvertent shortfalls, penalties and interest. Therefore, it is critical for developers and their advisers to have a working knowledge of the adjustment regime to avoid any nasty surprises.

Background

Where a registered taxpayer makes a wholly creditable acquisition, they are entitled to 100% of the GST embedded in the relevant good or service in the form of input tax credits. The extent to which an acquisition is creditable is based on the taxpayer’s intention as at the acquisition time regarding the use to which that acquisition will be put. That is, if it will be used to make fully taxable supplies, it will be a fully creditable acquisition. Difficulties arise, however, when an acquisition is made which, based on the intention of the taxpayer as at the acquisition time, was fully creditable but, due to a subsequent change of intention/use, the acquisition will no longer be used in making taxable, or fully taxable supplies, such as where the acquisition will now be used to make GST-free supplies.

What is a GST adjustment?

An adjustment for present purposes arises for an acquisition in an “adjustment period” where:

1. there is a difference between the actual application and the planned (or intended) application of the relevant “thing”; or
2. there is a difference between the actual application of the thing up to the end of 1 adjustment period and the actual application of the thing up to the end of the previous adjustment period.

When does a taxpayer have to start adjusting?

A taxpayer’s first adjustment period following a change of intention/use is the first tax period that starts at least 12 months after the end of the tax period to which the acquisition is attributable and ends on 30 June. For example, if a creditable acquisition was made on 30 September 2010, the first adjustment period would be 30 June 2012, that is:

1. the December 2011 Quarter is the first tax period to commence at least 1 year after the end of the September 2010 Quarter; and
2. the June 2012 Quarter is the first tax period to commence after at least 1 year after the end of the September 2010 Quarter that ends on 30 June.

For how long do taxpayers have to adjust?

The number of adjustment periods is determined by reference to the GST-exclusive value of the relevant acquisition to which they relate, that is:

What is the relevant “thing” subject to adjustment?

Division 129 of the GST Act applies in relation to a “thing”, for example, as outlined by the Commissioner in GST Ruling GSTR 2009/4, under a periodic payment contract for building services; this is likely to be the individual instalment payments rather than the underlying items to which they relate (concrete, bricks, trusses, windows, etc).

Example 1

X Co is a property developer. In 2010, X Co acquired a block of land for $100,000 from a private individual (no GST embedded in the sale price and X Co will apply the margin scheme on eventual disposal of the re-developed lots).

X Co incurred $550,000 (incl. GST) in expenses re-developing the property and therefore, claimed 1/11th of the total cost, or $50,000, in GST input tax credits.

The development was completed in September 2010 after which, the original property was subdivided into 2 lots. Each lot was valued at $750,000 each. X Co marketed the properties but due to a downturn in the property market, they sat on the market for 12 months.

To defray the holding costs pending sale, from September 2011, X Co decided to lease out the properties to arm’s length third parties. The properties were continually marketed for sale however, and an agreement was struck with tenants that in return for a lower rent, they required only 10 days notice to vacate if the property was sold. Each lot is leased at $3,500 per month and the market values of the properties have been revised down to $700,000 each.

The progress payments during construction were as follows:

1. 30 May 2010 – $220,000;
2. 30 June 2010 – $110,000
3. 30 July 2010 – $110,000;
4. 30 September 2010 – $110,000

Therefore, the first adjustment period for all payments is 30 June 2012.

Between September 2011 and June 2012, each property derived $35,000 in rent ($70,000 in total). Therefore, the GST adjustments are as follows:

Current market value/(Current market value + Rent)
= $700,000/($700,000 + $35,000)
= 95.24%

This is the actual application of the “thing” (that is, each progress payment). Therefore, X Co has an increasing adjustment as it overclaimed GST originally on account of the actual application of the thing. The increasing adjustment is as follows:

GST paid x (100% – 95.24%)
= $50,000 x (4.76%)
= $2,380

Example 2

Where, unlike in Example 1, X Co decided to take the properties off the market and hold them both long term for rental income. As such, the properties are leased at $4,000 per month each as there is no discounting for the short notice to vacate period as in Example 1.

Where the relevant “thing” was initially acquired for a wholly creditable purpose, but subsequently the thing was put to a wholly non-taxable purpose, it is appropriate to adjust on a time basis. That is:

[Period held for creditable purpose/Total Period] x 100%

On these facts, the first instalment payment was for a creditable purpose from 30 May 2010 to 1 September 2011 (16 months) and the total period between 30 May 2010 and 30 June 2012 is 25 months. Therefore, the adjustment is as follows:

16/25 x 100% = 64%

This is the actual application of the thing resulting in an increasing adjustment as follows:

$20,000 (GST paid on first instalment payment) x (100% – 64%)
= $20,000 x 36%
= $7,200

This process must be repeated in relation to each instalment payment.

Conclusion

The purpose of this article was to highlight the operation of the adjustment regime in Div 129 of the GST Act. The most important thing for developers and their advisers to remember is that whenever a developed lot is held or is being used for any purpose other than for sale, including to derive rental income and whether or not the property is still being marketed for sale, the GST Act operates to claw-back over-claimed input tax credits and the developer must adjust accordingly.

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Note – this article was published in the October 2012 edition of inTax Magazine (a Thomson Reuters publication).

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.