GST margin scheme and uncertainty on property subdivisions

The recent Federal Court decision of Brady King Pty Ltd v FCT [2008] FCA 81 has created uncertainty as to the application of the GST margin scheme to the development and subdivision of property for resale.

The decision seems to suggest that the GST margin scheme only applies if the property that is being sold is the ‘same property’ in a legal sense to that originally acquired. Subdivided strata units may not be the ‘same property’ as the land that was originally acquired on which to build them.

Before Brady King – application of the GST margin scheme

Under the GST Act, where the margin scheme applies to a sale of property, the taxpayer will calculate its GST liability on the sale as 1/11th of the margin rather than 1/11th of the sale price of the property.

The margin is usually calculated as the difference between the sale price of the property and cost of the initial acquisition of the property (commonly referred to as the consideration method). However, for a taxpayer who acquired the property before 1 July 2000, the margin is calculated as the difference between the sale price of the property and its valuation on 1 July 2000 (commonly referred to as the valuation method).

The Commissioner of Taxation has accepted that the property that is subsequently sold need not be identical to the property that was originally acquired by the vendor for the margin scheme to apply. Indeed, in the Commissioner’s rulings GSTR 2000/21, GSTR 2006/7 and GSTR 2006/8, it is implicit that a taxpayer is not precluded from applying the margin scheme to sale of a strata unit that has arisen from a subdivision of land originally acquired.

Brady King Pty Ltd v FCT – the decision of Middleton J

The decision throws the application of the margin scheme as outlined above into doubt.

Brady King Pty Ltd was a developer and entered into a contract to purchase an office building before the introduction of GST but did not settle on the purchase until October 2000 (ie after the introduction of GST). The building was converted into strata units and most of these were sold by Brady King in 2001. Brady King self-assessed its GST liability using the margin scheme and the valuation method. The Commissioner however issued assessments to the taxpayer on the basis that the consideration method applied rather than the valuation method.

The court was asked to decide whether or not the taxpayer was entitled to use the valuation method and if it was entitled to, whether the valuation of the taxpayer complied with the requirements of the GST Act. The Commissioner agreed the margin scheme applied – the issue was only how to calculate the margin, given that the purchase was not completed before 1 July, 2000.

The court, however, had its own view and decided that for the valuation method to apply, the property sold by the taxpayer would have to be the same as the property that it originally acquired. In the circumstances of the taxpayer, the strata units that were sold by the taxpayer were not in existence on or before 1 July 2000. Therefore, the valuation method could not have applied to the sale of units by the taxpayer.

Middleton J said that, "the margin scheme can only apply to the same property (in the juridical sense) being acquired and subsequently sold".

This decision seems odd to us as a strata unit may under the law of strata subdivision readily be thought of as part of a ‘parcel of land’. By taking this approach in interpreting the operation of the margin scheme, the court appears, as well as disagreeing with ATO rulings, to have departed from the previous Federal Court decision in Sterling Guardian Pty Limited v FCT [2005] FCA 1166.

After Brady King …

Ironically the Commissioner cannot appeal because he won the case, though not in the way he sought to do. It is our understanding that the Commissioner will encourage the taxpayer to appeal so as to resolve the uncertainty created by the case.

The Commissioner has issued a Decision Impact Statement outlining his position in relation to the outcome of the case. In the Decision Impact Statement the ATO did comment that it "may" follow Middleton J’s decision. Pending the outcome of any appeal, the Commissioner has indicated that he will continue to maintain his view in relation to the application of margin scheme according to the current GST rulings pending the outcome of any appeal. This means that unit developers who comply with all the requirements in the rulings will be able to rely on the Commissioner’s rulings, continue to self assess GST during this period on the basis that the margin scheme is available and the valuation method may be used (for property acquired prior to 1 July 2000), notwithstanding that the strata titles have not issued at the valuation date. The same principle will apply in respect of other subdivisions, such as land subdivisions, where the title to the lots supplied may not have issued at the valuation date. Taxpayers that comply with the current GST rulings should not be subject to retrospective amendment and adjustments.

If the outcome of the appeal is inconsistent with the Commissioner’s view, or if no appeal is lodged, the Commissioner has indicated that he will approach Treasury to seek a legislative amendment to clarify the operation of the margin scheme.

What does it mean for all taxpayers, especially property developers?

Having regard to the Commissioner’s Decision Impact Statement, taxpayers who have previously applied the margin scheme in accordance with the existing GST rulings will not need to review or reassess their GST liability. It will however be prudent for taxpayers who are now venturing into property development to take into consideration the possibility of not being able to apply the margin scheme and keep abreast of developments in the area.