GST and the margin scheme: Some recent observations

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The majority of margin scheme transactions are relatively straightforward. However, various amendments to the margin scheme rules over the years (notably in 2005 and 2008) have seen a range anti-avoidance measures included which add layers of complexity when seeking to determine the two key questions:

  1. Am I eligible to apply the margin scheme? and
  2. How do I calculate the ‘margin’ to determine the GST liability?

In this article we set out a summary of supplies that are eligible for the margin scheme and how to calculate the ‘margin’, and also look at a recent AAT decision which raised some questions on the latter of these aspects.

Eligibility

In its simplest form the margin scheme applies where an entity is selling real property and has entered into a written agreement with the purchaser to apply the margin scheme to that sale. However, the vendor of the real property needs to be eligible to apply the margin scheme. A vendor will be eligible to apply the margin scheme where they have acquired their interest in the real property via a transaction that is either not subject to GST, or is subject to GST but margin scheme has been applied (noting other eligible scenarios exist).

Legislative provisions often use an ‘exclusionary’ approach, setting out the circumstances where an entity (the vendor) cannot apply the margin scheme. Essentially, the vendor cannot apply the margin scheme if the acquisition transaction is ‘ineligible for the margin scheme’. The main transaction falling into this category is if the property was acquired subject to GST (and without the margin scheme having been applied) – i.e. a full taxable supply.

Calculating the Margin

Where the margin scheme applies the GST liability is calculated as 1/11th of the ‘margin’, where the margin is the amount by which the consideration for the supply (i.e. the GST-inclusive sale proceeds) exceeds the consideration for the acquisition of the interest (i.e. the amount paid to acquire the property).

Whilst not referred to in the legislation, we refer to the acquisition component as the ‘margin scheme base’.

There are then various special rules that apply regarding calculating the ‘margin scheme base’ depending on the type of acquisition being made and the timing of that acquisition. For example, if the property was acquired before 1 July 2000 the margin scheme base may be a market valuation as at 1 July 2000 (instead of the actual historical acquisition price of the property).

The ‘margin’ as defined for GST purposes should also not be confused with the ‘profit’ of the transaction. Ignoring GST for a moment, the profit for a typical development would be calculated as:

Sales proceeds,
less (A) land acquisition costs
less (B) development and construction costs
less (C) holding costs
less (D) sales costs
= Profit

For GST purposes the ‘margin’ is simply:

Sales proceeds,
less (A) land acquisition cost
= Margin (for GST purposes)

When determining the consideration for the acquisition of an interest in real property for margin scheme purposes, we note s. 75-14(1) of the GST law, where it expressly states:

To avoid doubt, in working out the consideration for the acquisition disregard:

  • the cost or value of any other acquisitions that have been made by you, or any work that has been performed, in relation to the real property; and
  • the cost or value of any other acquisitions that are intended to be made by you, or any work that is intended to be performed, in relation to the real property, after its acquisition,

including acquisitions or work connected with bringing into existence the interest, unit or lease supplied.

It is generally considered that the above provision applies to exclude costs such as development and construction costs incurred after acquiring the property, and therefore such costs are not included in the ‘margin scheme base’.

Recent AAT Case – ‘Margin Scheme Base’

The issue regarding what amounts are to be included as ‘consideration for the acquisition’ (i.e. included in the ‘margin scheme base’) was one of the issues dealt with in a recent Administrative Appeals Tribunal (AAT) case – WYPF v FCT [2021] AATA 3050. Another issue considered dealt with GST refunds and ‘passing on’ – see further comments below.

This case involved a residential development in the Australian Capital Territory (ACT) where:

  • the developer paid $14m to acquire the land (under a contract of sale subject to GST and on which the margin scheme was applied) from the ACT Land Development Authority (LDA);
  • costs referred to as Preparatory Works of $29.7m inclusive of GST were incurred by the developer; and
  • costs referred to as Building Works of $77m inclusive of GST were incurred by the developer.

By way of summary, there were sequential events as follows:

  1. A Contract of Sale was entered into between the LDA and the developer for $14m where, on completion, a Holding Lease was granted to the developer;
  2. The Holding Lease was granted for a term of 66 months for nominal rent, for the purpose of subdivision and construction works to take place in accordance with the Deed of Agreement;
  3. A Deed of agreement was entered into requiring the land to be developed at the developer’s expense – essentially incurring the Preparatory Works costs – and once this work was competed the developer would be issued Consequent Leases;
  4. The Consequent Leases were granted to the developer for 99 years and required the Building Works to be completed within 48 months.
  5. On completion of the Building Works, the developer entered into agreements selling the completed residential properties to buyers (for the balance of the 99 year lease term remaining).

Having acquired the property under a taxable supply on which the margin scheme was applied, the developer was eligible to apply the margin scheme when selling the properties to buyers.

Despite having applied for private binding rulings and engaging in correspondence with the ATO about the treatment of the Preparatory Works, the developer remained uncertain about the precise value that the ATO would accept as the value of the Preparatory Works. The Taxpayer chose a conservative approach in preparing its GST returns and treated the $14m acquisition price paid as the consideration for the acquisition of the land, but did not include the value of the Preparatory Works or Building Works in the ‘margin scheme base’ when calculating the margin on the sales of the apartments.

The developer contended that the acquisition price, and both the Preparatory Works and Building Works costs were to be included in the ‘margin scheme base’.

The Commissioner accepted that the acquisition price and the Preparatory Works costs were included in the ‘margin scheme base’ but not the Building Works costs.

The AAT decided that the Building Works costs were excluded from the ‘margin scheme base’ as they did not form part of the consideration for the developer’s acquisition of the property. While the Building Works and the Consequent Lease were connected, the degree of connection was not sufficient for the building works to constitute consideration to obtain the Consequent Leases. The Consequent Leases were granted before the Building Works were completed, and therefore the developer did not carry out the Building Works to obtain the Consequent Leases.

Curiously, s. 75-14 was not addressed in the body of the decision. However, the following comments were included by way of footnote, along with the sentences in the body of the decision for context:

    1. It has been held that consideration is what is given ‘in order to obtain’ a supply.[6] In other contexts, it has been said that the consideration for real property is the thing that ‘moves’ the conveyance or transaction.[7] I see no relevant distinction between these two formulations. Both are consistent with ‘consideration’ being defined, not as a stand-alone concept, but as consideration ‘for’ a supply or acquisition.[8]
    2. Hence, the question for determination is whether the Building Works were undertaken for the applicant to obtain the Consequent Leases or ‘moved’ the supply of the leases to the applicant.[9]

Footnotes [6], [7], and [8] not included.

Footnote [9]: After reserving my decision, it occurred to me that s 75-14(1) was, depending on the view of connection considered to be required by the provision, potentially capable of applying in this matter. I therefore asked the parties for a short note regarding the relevance, if any, of s 75-14 and, in particular, the basis on which it is considered the Preparatory Works and Building Works are not required to be disregarded by this provision. Both parties responded with submissions that s 75-14 does not apply in the current circumstances. Since the position adopted by the parties is at least arguable, it is appropriate to proceed on the basis of their agreed position that s 75-14 does not apply.

GST Refunds and ‘passing on’

The other interesting issue dealt with in the case relates to GST refunds and the concept of ‘passing on’.

Broadly, the ATO describes this issue in its public ruling GSTR 2015/1 as follows:

    1. The object of Division 142 is to ensure that excess GST is not refunded if this would give an entity a windfall gain. Generally, the Division operates so that a supplier is not entitled to a refund of an amount of excess GST where the supplier has passed on the GST to another entity (the recipient), and has not reimbursed that other entity for the passed-on GST. Where a supplier is uncertain whether it has passed on the GST or reimbursed, it may apply for a private ruling.

The contentions of both parties were described as follows in the AAT case:

    1. By not taking into account the value of the Preparatory Works and the Building Works, the applicant says it overpaid GST and is entitled to a refund of the overpaid amount. The Commissioner says the applicant passed on any overpaid GST to the purchasers of the apartments. Under s 142-10 of the A New Tax System (Goods and Services Tax) Act 1999 (‘GST Act’), amounts overpaid as GST (called ‘excess GST’), but passed onto the recipient of the relevant supply, are treated as payable. In effect, such amounts are not refundable unless the taxpayer reimburses the recipient of the supply for the excess GST that it passed on.
    2. The applicant disputes that it passed on the excess GST. Even if it did pass on excess GST, the applicant says s 142-10 should be treated as not applying in accordance with s 142-15(1).

In addressing this issue, the Tribunal member noted that ‘it will be a rare case in which GST is not passed on to a customer’. However, referring to a number of factors including:

  • that the developer applied for a private ruling regarding whether the Preparatory Works costs were to be included the ‘margin scheme base’ and took this into account when pricing the apartments;
  • the developer sought clarification of the amount of Preparatory Works costs to be so included and also sought clarification of whether the Building Works costs would also be included.

Ultimately the Tribunal member decided that:

    1. For these reasons, having regard to the particular circumstances of this case, I am satisfied this is one of the rare instances in which a taxpayer has (to the extent of the excess GST referable to the failure to deduct the Preparatory Works from the margin) paid excess GST that it did not pass on to the recipients of its supplies.

Given that the developer had not passed on the ‘excess GST’ to the buyers (i.e. the GST to be refunded to the developer after it correctly calculated the ‘margin scheme base’ by including the amount of the Preparatory Works costs), the developer was entitled to a refund of the excess GST amount and was not required to pay this to the buyers.

Conclusion

The margin scheme is generally a relatively straightforward concept and calculation. However there are many transactions where the more complex aspects of the margin scheme rules need to be applied. For this reason care should be taken to understand and confirm the background facts of each transaction and then methodically work through the margin scheme provisions.

As we noted at the outset, the two questions that must be successfully navigated are:

  1. Am I eligible to apply the margin scheme? and
  2. How do I calculate the ‘margin’ to determine the GST liability?
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. It is not intended to be, nor should it be relied upon as, a substitute for professional advice. TaxEd Pty Ltd and any person connected with its production disclaim any liability in connection with any use.