GST Article ‘ I choose going concern but if … then I want the margin scheme to apply
A recent Administrative Appeals Tribunal had to consider how GST applies where the parties to a sale contract had agreed to treat the supply as a ‘going concern’ but if the purchaser was subject to Div. 135 of the GST Act, the margin scheme was to apply to the sale.
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The recent (31 August 2017) AAT decision MSAUS Pty Ltd as the Trustee for Melissa Trust v Commissioner of Taxation considered a contract for sale of land which consisted of standard NSW contract for the sale of land with special clauses. The Commissioner was demanding the purchaser (MSAUS Pty Ltd) pay GST in accordance with Division 135 of the GST Act.
Nature of the Contract
The contract related to the sale of a strata title apartment in a hotel complex. The vendor had leased the apartment to a serviced apartment operator (Operator) and was selling the apartment to the purchaser (Purchaser) subject to the lease. At the time the contract was entered into, it was unclear whether the relationship between the Purchaser and the Operator after settlement entailed the Purchaser making an input taxed supply to the Operator.
In these uncertain circumstances, the vendor and the Purchaser wanted to treat the supply of the apartment as a going concern if the Purchaser would not make an input taxed supply to the Operator. However, the vendor and Purchaser wanted to treat the sale as subject to the margin scheme if the Purchaser made input taxed supplies to the Operator. The rationale for their desire for different treatment depending on whether the Purchaser did, or did not, make an input taxed supply to the Operator following settlement was their desire to prevent Division 135 applying to the Purchaser.
Basically, Division 135 provides that where:
- a person makes a supply of a going concern (in this case, the vendor was supplying an enterprise in the form of a lease); and
- the recipient of the supply (in this case, the Purchaser) intends that some or all of the supplies which the recipient will make through the enterprise (in this case, the supply of the benefit of the lease to the Operator) will be supplies that are neither taxable supplies nor GST-free supplies,
then the recipient (i.e. the Purchaser) has an increasing adjustment.
The amount of the increasing adjustment is 1/10th of part of the price of the supply of the going concern. The relevant part of the price is determined by the extent to which the recipient will make supplies through the enterprise that are neither taxable supplies nor GST-free supplies. Put simply, if Division 135 applied to the Purchaser and the Purchaser only made input taxed supplies to the Operator, then the increasing adjustment would be 1/10th of 100% of the price which the Purchaser had paid for the apartment.
As noted earlier, the parties wanted to avoid Division 135 applying. They wanted the sale of the apartment only to be a going concern if Division 135 would not in fact apply. If Division 135 would apply to the Purchaser, they wanted the margin scheme to apply to the sale of the apartment.
How the parties sought to avoid Division 135 applying
You will recall that in order for a supply to be made as a going concern, one of the requirements is that the supplier and the recipient must ‘have agreed in writing that the supply is a supply of a going concern’ – see s. 38-325 (1)(c) of the GST Act.
You will also recall that in order for the margin scheme to apply to a supply of land, the parties to the supplier and recipient of the supply must:
- have agreed in writing that the margin scheme is to apply (s. 75-5(1)) GST Act; and
- the written agreement must have been made ‘on or before the making of the supply’ or ‘within such further period as the Commissioner allows’ – s. 75-5(1A).
The parties sought to comply with these provisions by:
(a) completing the standard land contract by, on the first page of the contract, checking the boxes which signified (i) that sale was not a taxable supply, (ii) the sale was made a GST-free supply because it was going concern and (iii) the margin scheme did not apply; and
(b) inserting a special condition which provided that the sale was a taxable supply and the parties agreed that the margin scheme applied to the sale in certain circumstances. Those circumstances were: (i) the first page of the contract stated the supply is GST-free because the sale is the supply of a going concern; (ii) the supply of the apartment under the lease to the Operator is a supply of residential premises (but not a supply of commercial residential premises), and (iii) the apartment is to be used predominantly for residential accommodation (regardless of the term of accommodation). The clause confirmed that if the margin scheme applied the price specified in the contract was the price inclusive of GST.
It will be noted that requirements (ii) and (iii) of subparagraph (b) identify that the lease of the apartment constitutes the Purchaser making input taxed supplies (i.e. lease of residential premises – s. 40-35 GST Act) to the Operator. Requirement (ii) reflects application of s. 40-35(1)(a) and requirement (iii) reflects application of s. 40-35(2)(a).
The issue the Tribunal had to determine is less interesting (more limited in its relevance) than the Tribunal’s incidental comments.
The issue was whether the way in which the parties had structured their contract amounted:
(a) solely to an agreement that the supply was going concern – this was the Commissioner’s view, or
(b) was an agreement that the supply was only a going concern in certain circumstances and in other circumstances was a supply to which the margin scheme applied and, in the circumstances which occurred, was in fact a supply to which the parties had agreed the margin scheme applied – this was the Purchaser’s position.
The issue was essentially one of contractual interpretation. The Tribunal took notice of the High Court’s decision in Commissioner of Taxation v MBI Properties Pty Ltd  HCA 49. That case demonstrated the uncertainty which the parties faced when making their contract in 2006.
The Tribunal considered the Purchaser’s interpretation of the contract was correct. The parties had effectively agreed that the margin scheme applied to the sale. The Commissioner was not entitled to only consider the manner in which the parties had completed the check boxes on the first page and to disregard the special clause as an inconsistent agreement. The special clause was not inconsistent with what was said on the first page when the contract was read in the context of the issue which had been determined by the High Court in the MBI Properties Case.
The Interesting Point
The interesting point of the Tribunal’s decision is the remark (at paragraph 35):
I accept the conditional agreement in clause 47.6.6 [i.e. the special clause] to apply the margin scheme was an agreement made on or before the making of the supply in accordance with s 75-5(1A)(a). The fact the contingency was not activated until a later event is beside the point: the clause embodying this aspect of the agreement was in place ‘on or before the making of the supply’ in accordance with the requirements of s 75-5(1A)(a). (text in brackets added)
Contracts which provide for supplies to be made as going concerns need to deal with the possibility that the supply will not meet the test for a supply to be GST-free as a going concern (s. 38-325). The events of failure are either:
- the purchasers are not registered or required to be registered for GST at the time the supply is made; or
- the supplier has failed to carry on the relevant enterprise ‘until the day of the supply’.
A third, less common circumstance, is that the parties belatedly realise that the supplier is not supplying the recipient ‘with all of the things that are necessary for the continued operation of the enterprise’.
The usual contractual fall back position is that contract provides for the consideration to be grossed-up for GST and for the supplier to provide a tax invoice to the recipient of the supply.
The Tribunal’s comment indicates that there is scope for an alternate fall back position. It is anticipated that by careful drafting of the contract, in a case where the margin scheme can apply, the parties can provide for its default application.
Whether this is a commercially realistic alternative (including the extent of any gross up for the margin amount of GST) will depend on the negotiating strengths of the parties and the commercial context in which the supply is being made. One might anticipate it would be a rare circumstance.
However, the readiness of the Tribunal to take a broad view of the circumstances in which the timing requirement for agreeing to use the margin scheme is met, should be mentally filed away to be brought out when some situation calls for flexibility, as it did in the MSAUS case.
Disclaimer: This article is based upon information available as at the time of publishing and may be subject to change.