There are many Goods and Services Tax (GST) implications for property development businesses and, without a good working knowledge of these implications, developers may find themselves in a tricky situation.

This article outlines the basics of how GST works, whether or not developers need to register for GST, how business losses will affect GST payments, how to avoid the GST pitfalls, and when to consider cancelling GST.

AN INTRODUCTION TO GST

Under the GST Act, an entity is liable to pay GST on ‘taxable supplies’ it makes, and is entitled to input tax credits for ‘creditable acquisitions’. In other words, businesses are entitled to pay GST on income/revenue and are also entitled to a refund of GST on acquisitions/purchases. For each tax period (normally a quarter), the amount of GST paid for the revenue a business has generated is offset against the credits it is entitled to receive based on business purchases. The net amount is the amount must be paid to the ATO, or the ATO must pay, for the period. In some cases, adjustments may be required from prior periods.

Simple enough? Not quite. GST only applies to certain types of revenue and certain types of purchases, rather than all of them, and this must be understood for GST liability. Input taxed supplies are one exception, with the most common example being the lease of a residential property. In this case, no GST is payable on rental income earned. Similarly, no credits are available for any purchases related to earning this income, such as renovations. Additionally, some purchases can be wholly creditable, partly creditable, or not creditable, and this depends on whether the entity has a ‘creditable purpose’, meaning whether, and to what extent, the purchase was made in order for the business to be run.

DO YOU NEED TO REGISTER FOR GST?

When business GST turnover exceeds the turnover threshold, businesses must register for GST. The business does not need to have a great level of sophistication or longevity, it simply needs to have a commercial or business characteristic of providing a product or service for a monetary reward. However, this does not include activities done as a private recreational pursuit or hobby, meaning private dealings among family members, without an expectation of profit and dealings by hobbyists, are likely to fall outside the scope of GST law. When it comes to GST turnover, this is determined by calculating the total value of your sales excluding GST, input-taxed sales (sales where GST does not apply), and sales not connected to Australia.

There are two registration thresholds – the current turnover threshold and the projected turnover threshold. The current turnover threshold counts your GST turnover in the current month and the previous eleven months. The projected turnover threshold counts the turnover in the current month and the turnover likely to be achieved in the next eleven months. The threshold amount for both thresholds is $75,000 per annum. It’s also important to keep in mind two additional categories of supply that are not counted. The first category is any income made, or likely to be made, by way of the transfer of ownership of a capital asset.

Capital assets are structural assets – such as factories, shops or offices – through which a business is run. If you are registered for GST, you are liable for GST if you sell a capital asset in the course of your enterprise. For property developers, properties built for sale and the land on which they are to be built are generally treated as revenue assets, and rental properties and the land on which they are to be built, are generally treated as capital assets. The second category is any income made, or that is likely to be made, as a consequence of ceasing to carry on an enterprise or substantially reducing the size or scale of an enterprise.

For instance, if you purchase vacant land as a potential development site and decide not to proceed with any development activities, you would not be required to include the proceeds of the disposal of the land in your projected turnover. In summary, if running an enterprise and turnover is over $75,000 per annum, then registering for GST is a must, whereas if it’s under the threshold and/not running an enterprise, don’t.

WHAT HAPPENS IF YOU CHANGE THE USE OF YOUR DEVELOPMENT?

What happens if you are a GST-registered property developer who builds apartments exclusively for sale, and later decides to rent them? The typical situation is a developer might start out by correctly claiming input tax credits on all acquisitions relating to the development, including architect’s fees, legal fees, and construction charges. However, when sales are slow or financial pressures arise, they may then rent the apartments for income while still trying to actively sell them. This is a change of use from a fully creditable purpose to a partly creditable application and will lead to a requirement to repay some of the GST credits claimed on the inputs into the development. The adjustment will be an increasing adjustment.

Contrary to popular belief, the increasing adjustment need not be made in the next activity statement due after an apartment is first leased. Nor is the GST repaid in a lump sum. The adjustment is made progressively at the end of an adjustment period, which starts at least 12 months after the end of the tax period during which you started renting out the properties, and ends on 30 June in any year. If reporting on a monthly basis, rental income earned in April 2013 would not have its first adjustment period until 30 June 2014.

If reporting quarterly and receive rental income in April 2013, the first adjustment period for the acquisition would be June 2015. The reason for this is that the quarterly reporter’s tax period ends on 30 June 2013 and the adjustment period must end on a 30 June that is at least twelve months after 30 June 2013. It can be seen, that 30 June 2014 does not fit this description as it falls within 12 months, not after 12 months.

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. Developers are often in this position and may be required to defend themselves by objecting to the assessments issued and cancellation action taken by the ATO. This is not overly difficult where a development has been planned, as the project will likely be costed and research undertaken to determine a potential profit is likely at completion and sale.

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 variable costs directly related to the development would be treated as trading stock and/or work-inprogress, and therefore not have an impact on profit or loss. Trading stock is added back at the end of the financial year if land is not sold. 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.

WHAT CONCESSIONS ARE THERE FOR GST?

There are two key concessions for GST that apply to property developers: the margin scheme, and how GST applies to ‘going concerns’.

GOING CONCERN

A sale of business where all necessary to operate the business is transferred to the purchaser is known as the supply of a ‘going concern’. In simple terms, the business has the ability to continue to function, as was the case immediately prior to sale. The revenue generated is GST-free if it is in exchange for money or some other benefit, if the recipient is registered for GST, or required to be, and if the parties have agreed in writing the business will continue to operate effectively. There are two farm land concessions. The more common concession arises where:

1. There is a sale of land on which a farming business has been carried on for five years or more preceding the sale.
2. The purchaser intends a farming business continues to be carried out on the land.

There is no defined time limit for the second criteria. However, there would be an adjustment if trying to exit the GST system with the land or to make input taxed supplies. A less commonly used concession is available where:

1. Potential residential land is subdivided from land on which a farming business has been carried on for at least five years.
2. The sale is made to an associate of the seller without consideration or for consideration below the GST-inclusive market value of the supply.

This concession allows potential residential land (land that it is permissible to use for residential purposes, but that does not contain any residential buildings) to be sold to a family member for development or for resale to a developer. What does this all mean in real life situations? If the intention is to undertake a development in a business-like manner constituting an enterprise, developers should consider becoming registered for GST as soon as the enterprise commences. Identifying the commencement of the enterprise is a difficult task. The commencement usually coincides with the first significant expense incurred once the decision to proceed with a specific development has been made.

Developers are not required to be registered until sales in excess of the GST turnover threshold are made, or are likely to be made. However, delaying registration in these circumstances is only going to be an inconvenience and potentially cause cash flow pressures. If likely to exceed the GST turnover threshold, the best advice is to register from the beginning to claim any GST expenses, so as not to be out of pocket. However, if undertaking a residential development and holding the developed residential properties for rent, the best advice is to not apply to become registered or cancelling existing registration.

With most property developments, the acquisitions and input tax credits typically precede the payment of GST arising from sales. This timing difference usually sparks an interest and hence response from the ATO. Developed should ensure input tax credit claims are creditable acquisitions and supported by tax invoices before making the credit claims.

MARGIN SCHEME

The margin scheme is a way of working out the GST payable when selling a property that is a part of a business. Where the margin scheme does not apply, calculate the GST as one-eleventh of the sale price. Where the margin scheme does apply, calculate the GST as one-eleventh of the ‘margin’. The margin is the difference between the sale price and the purchase price of the property. For property purchased prior to 1 July 2000, there is a choice to use the original purchase price or an approved valuation as of 1 July 2000.

It is important to note the margin is not the profit made on the property sale, as it does not take into account costs to develop the property or costs to subdivide the land. If the property is sold as part of the business and is registered for GST, developers may be able to use the margin scheme to work out how much GST is payable. For example, if a property is purchased for $500,000 and sold for $830,000 and the margin scheme applied, the total GST would be $30,000 (one-eleventh of the margin of $330,000), rather than $75,454 (which would be based on the sale price without the margin, or one-eleventh of $830,000).

Whether the margin scheme is used depends on how and when the property is first purchased. Use the margin scheme if the property was purchased before 1 July 2000 or if it was purchased after 1 July 2000 from someone who:

• Was not registered or required to be registered for GST;
• Who sold an existing residential premises;
• Who sold the property as part of a GST-free going concern; or
• Who sold the property using the margin scheme.

Developers cannot use the margin scheme if, when the property was first purchased, the sale was fully taxable and the margin scheme was not used. In this case, the amount of GST included in the price paid is one-eleventh of the full purchase price. The rules regarding the application of the margin scheme to a sale are very useful to understand, as they provide mainly for situations in which the acquisition of a property to be developed makes the subsequent sale ineligible for the margin scheme. The most common of these situations is where the entire interest in the property is acquired as fully taxable income on which GST is calculated without using the margin scheme. Another common situation is where the entire interest in the property was acquired as a going concern from a vendor who had acquired the property as a fully taxable supply on which GST was calculated without using the margin scheme.

Where the property is acquired as a going concern from a vendor who was entitled to use the margin scheme, but didn’t, calculate the margin by deducting the vendor’s purchase price (or the market value when the vendor purchased the property) from the sale price. For example, a property is purchased from a vendor as a going concern for $500,000. The vendor originally purchased the property for $400,000, and you sell the property three years later for $600,000. Calculate the margin on the vendor’s original purchase price of $400,000, therefore margin would be $200,000 and GST is payable of one-eleventh of $200,000, or $18,182. If the margin scheme is not applied, GST is payable on the $600,000 sale price, or $54,545.

The best outcome is to purchase a property that is either an existing residence (on which no GST is payable) or a non-taxable supply (such as a commercial property sold by a vendor who is neither registered nor required to be). Developers can then deduct the entire purchase price when calculating the taxable margin. As a property developer, acquiring property as a going concern, or as farm land, is more attractive than acquiring it as a fully taxable supply, on which GST is worked out without applying the margin scheme. As long as eligible to use the margin scheme, developers will save GST payable on the sale of the developed properties – generally one-eleventh of the acquisition value that can be used to calculate the taxable margin.

WHEN SHOULD YOU CONSIDER CANCELLING YOUR GST REGISTRATION?

Just as not being registered for GST can be an effective defence against an accusation of a taxable income, legitimately cancelling registration before the income is made can prevent the income from being taxable. The cancellation process involves applying for the cancellation with the ATO. You are required to have done one of two things before you apply to cancel GST registration:

1. Ceased trading or now trading under the GST turnover threshold.
2. Sold the business to another party.

Upon leaving the GST system, there is the requirement to make an increasing adjustment in the final return. If the application for cancellation is more than 12 months after becoming registered, and the ATO is satisfied there is not a requirement to be registered, the ATO must cancel the registration. Note developers are not required to have ceased operations. However, the ATO must be satisfied annual turnover is below the current and projected registration thresholds. If operations have ceased, the ATO can cancel registration upon becoming satisfied the operator is not carrying on an enterprise, and registration is not likely to be required for at least 12 months.

The ATO may also cancel registration if the operation has been registered for less than 12 months and they are satisfied it is not required to be registered. This is important because there will be times when the best outcome is to purchase or sell property as a non-taxable source of revenue. One scenario would be if the current and projected GST turnover is below the threshold and you wish to sell a capital asset without paying GST. In making this decision, consider whether current and projected GST turnover are below the threshold and the size of any increasing adjustment that may be required to make upon cancellation.

SUMMARY

As a property developer, it’s essential to be aware of the complexities of dealing in real property and the GST implications of this. In simple terms, developers are required to pay GST on income/revenue once GST turnover crosses the $75,000 threshold. Developers are also entitled to a refund on the GST paid for relevant purchases. Keep in mind the reality is more complex, particularly when it comes to changing development intentions, making the most of concessions and avoiding the pitfalls, so professional advice is essential.

 

This article was first published in the ANZPJ May 2019 edition. Visit the ANZPJ library to read past publications.