GST Case: determining the ‘5-year rule’ and ‘passing on’

There are many curiosities within the GST law and a couple of these were considered in a recent Administrative Appeals Tribunal (AAT) decision.

On 23 December 2022, Senior Member R Olding of the AAT handed down the decision in the Dals Property Trust Case (Domestic Property Developments Pty Ltd as trustee for the Dals Property Trust v Commissioner of Taxation [2022] AATA 4436).

This case essentially looks at two issues:

1. The application of what is referred to as the ‘5-year rule’ when it comes to determining whether residential premises are ‘new residential premises’; and
2. Whether GST was ‘passed on’ where property is sold as a taxable supply under the margin scheme and whether this prevents a refund where an overpayment has occurred.

Background

By way of summary, the relevant background facts are:

• The taxpayer developed seven residential units which it intended to sell on completion;
• Two properties, Units 1 and 3, failed to sell on completion and were subsequently rented out;
• Both units were eventually sold and the taxpayer reported the sales in their BASs as taxable supplies (of ‘new residential property’) subject to the margin scheme;
• The GST reported and paid for Unit 1 was $69,582 and for Unit 3 was $96,927;
• The taxpayer argued that the sale of both units were input taxed supplies and there was an error by mistakenly reporting and paying the GST;
• In relation to Unit 1:
  • The Commissioner did not accept that the sale was input taxed as the ‘5-year rule’ was not met; and
  • Even if the Commissioner was wrong and the supply was input taxed, the taxpayer would be denied a refund because any overpaid GST was passed-on to the purchaser;
• In relation to Unit 3:
  • The Commissioner accepted that the sale was an input taxed supply giving rise to an overpayment of GST;
  • However, the Commissioner argued that taxpayer would be denied a refund because any overpaid GST was passed-on to the purchaser;
• Given the above, the taxpayer had the burden of proving the assessments were excessive and to succeed it would need to prove that:
  • Unit 1 had met the ‘5-year rule’ and was therefore an input taxed supply; and
  • The taxpayer had not passed-on the GST in relation to Unit 3 (and Unit 1 if the ‘5-year rule was met and the supply input taxed).
• Dates relevant to the ‘5-year rule’ issue for Unit 1 included:
  • 28 October 2011 – Certificate of occupancy issued;
  • 5 November 2011 – offered for sale at auction (passed-in);
  • 24 February 2012 to 23 July 2016 – leased;
  • 1 August 2016 to at least 5 September 2016 – advertised for lease;
  • 15 October 2016 – marketed for sale;
  • 17 November 2016 – sale contract entered into ; and
  • 1 December 2016 until 28 February 2017 (settlement date) – purchaser granted a licence to occupy Unit 1.

The ‘5-year rule’

Broadly, a sale of ‘new residential premises’ is a taxable supply and subject to GST. However, residential premises are not ‘new residential premises’ if, for the period of at least five years since the premises were last built/substantially renovated or first became residential premises, the premises have only been used for making residential rental supplies.

In the case, the taxpayer would need to prove that Unit 1 had only been used to make residential rental supplies for at least 5 years during the period from 28 October 2011 (certificate of occupancy) until 28 February 2017 (settlement). The parties agreed that premises are used to make residential rental supplies even if there are short periods when the premises are unoccupied, if actively marketed for lease during those periods. However, the parties’ view differed for the period Unit 1 was available for sale.

Ultimately the AAT decided that the term ‘used’ is capable of embracing the holding or application of premises for the purposes of sale, and therefore Unit 1 ceased to be used only for making rental supplies when it was first marketed for sale.

The AAT also stated that the rule requires a continuous period of at least five years.

Accordingly, the decision concluded that as Unit 1 has not been used only for making rental supplies for the period of five years since completion of construction, the ‘5-year rule’ was not met and the sale remained a taxable supply.

The Passing on Issue

The contracts for sale of both Units 1 and 3 were essentially identical in terms of GST, other than a handwritten insertion of the words ‘(inc. of GST)’ besides the sale price on the Unit 1 contract.

In coming to its decision, Senior Member Olding, referred to two previous AAT cases, the WYPF Case, which relied on the High Court decision in the Avon Products Case, and the M3K Services Case, noting the following comments from the Avon Products Case (which were relied upon in the WYPF Case):

“…where the facts disclose that the taxpayer has set prices at a level to ensure they exceed cost (including sales tax), it will be difficult for the taxpayer to satisfy its onus … to show that it has borne the burden itself”.

The AAT decided that, as the taxpayer sold the units at prices that ensured it exceeded their costs, the taxpayer faced a difficult task in proving it had borne the burden of the GST. It also rejected the submission that as the supplies were input taxed and there was no GST payable there could be no excess GST passed on. Ultimately, the AAT concluded that there was nothing in the evidence that proved the excess GST was not recovered in the selling prices, and therefore the taxpayer did not prove that it had not passed-on the GST. As a result, notwithstanding that it was accepted that the sale was input taxed and not subject to GST the taxpayer was not entitled to a refund of the GST on the sale of Unit 3.

Importance of advice before paying GST

In addition to providing analysis on how the ‘5-year rule’ and how the term ‘used’ should be interpreted, the case highlights the importance of seeking advice. This is particularly the case for property transactions which involve higher transaction values and therefore significant amounts of GST.

If advice was sought to clarify the GST treatment, and the taxpayer initially and correctly treated the sale of Unit 3 as being input taxed, then no GST would have been reported paid to the ATO in the first instance, and there would not have been a passing-on issue as there was no GST overpayment and so no refund to be claimed.

We would have also expected that such advice would have identified the issues dealt with in relation to Unit 1.

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