Who does this affect?

Residential property developers

What do you need to do?

Developers considering undertaking new projects should be aware that there is a risk (albeit low) they may not be able to use the margin scheme on future residential unit sales.

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Peter Fogarty  
Partner
T +61 3 9643 4127

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Melbourne
Frank Brody  
Developers considering undertaking new projects should be aware that there is a risk (albeit low) they may not be able to use the margin scheme on future residential unit sales.

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Justice Middleton of the Federal Court recently handed down his decision in Brady King Pty Ltd v Commissioner of Taxation [2008] FCA 81. This is an important case which throws into question the availability of the margin scheme in the context of residential developments (and other stratum developments).

Summary of facts

Brady King Pty Ltd (“taxpayer”) is a developer who entered into a contract to acquire an office building in King Street, Melbourne, on 22 May 2000. The purchase price was $9,250,000.

The sale was completed after 1 July 2000 (i.e. after the GST start date). The taxpayer redeveloped the property into 158 units and began to sell these under the margin scheme. The taxpayer had obtained a margin scheme valuation which valued the whole property as at 1 July 2000 at $23,232,000. Planning approval for the redevelopment was obtained in June 2000, which may partly explain the significant increase in value.

Questions to be decided

The key question was whether, when applying the margin scheme, the taxpayer was entitled to have regard to the value of the property as at 1 July 2000 (i.e. $23 million+) or whether it had to have regard for the consideration that it had paid to acquire the property, at completion, post 1 July 2000 (i.e. $9,250,000).

There was also a question as to whether the margin scheme valuation was a complying valuation.

Summary of decision

Middleton J held that the taxpayer was not entitled to use the 1 July 2000 valuation. Consequently it was not necessary to consider whether the valuation was a complying valuation.

Other key aspects of the decision

Significantly, Middleton J’s decision would appear to go further and suggests that the taxpayer may not have been entitled to apply the margin scheme at all. In this respect Middleton J stated that “the margin scheme can only apply to the same property (in the juridical sense) being acquired and subsequently sold”.

In other words, because the property acquired by the taxpayer (i.e. title in the office building) was different to the legal interest being supplied (i.e. title in each residential unit), the margin scheme, in Middleton J’s view, was not available.

Middelton J also held that the margin scheme only applies to supplies of legal interests, not equitable interests.

Impact of this decision for residential developers

If Middleton J’s decision is correct, then this throws into serious question the availability of the margin scheme for any residential development (or other stratum development) where the legal interest sold by the developer (i.e. title in each stratum unit) is different to the legal title acquired by the developer (e.g. bare land, or title in an office building, hotel, industrial site etc).

It should be noted that this decision appears to conflict with the decision of the Federal Court (both at first instance and on appeal) in the Sterling Guardian case. That case involved the sale of residential units which had been constructed on what was effectively bare land. The question in that case was whether the construction costs could be included in the margin scheme calculations, or whether the relevant value was the value of the land. It was held (at first instance and unanimously on appeal) that the construction costs could not be taken into account. However, it was not suggested, at any stage, that the margin scheme was not available at all.

Middleton J has sought to distinguish the Sterling Guardian case on the basis that the earlier case concerned different sections of the margin scheme provisions in the A New Tax System (Goods and Services Tax) Act 1999.

Tax Office response - Decision Impact Statement

In response to the decision, the Tax Office has issued a “Decision Impact Statement”. Key points are:

• The Tax Office has noted that “it may follow from [Middleton J’s] view that developers would be precluded from using the margin scheme at all for unit developments”.
• The Tax Office considers the basis on which the Court reached this view to be “contrary to the submissions made by the Commissioner” and to be “contrary to the Tax Office’s longstanding practice in relation to the margin scheme provisions, as reflected in its public rulings”.
• The Tax Office does not currently intend to review its public rulings in light of the decision. If an appeal is lodged, the Tax Office will not review the public rulings until the outcome of the appeal is known.
• Taxpayers that follow the Tax Office’s public rulings will have protection against retrospective adjustments [i.e. adverse GST assessments] under provisions in the Taxation Administration Act.

The Tax Office has stated that “this means that, subject to compliance with all requirements set out in the rulings, developers will be able to continue to self assess GST during this period on the basis that the margin scheme is available for unit developments, and the valuation method may be used, notwithstanding that the strata titles have not issued at the valuation date. The same principle applies in respect of other subdivisions, such as flat land subdivisions, where the title to the lots supplied may not have issued at the valuation date”.

Discussions with the Property Council of Australia (“PCA”)

The Tax Office has also discussed this matter with the PCA. Key points from those discussions are:

• The taxpayer has until 10 March 2008 to lodge a notice of appeal. The Tax Office will encourage an appeal and will try to facilitate early resolution of the matter.
• If the decision is upheld on appeal, or if no appeal is lodged, the Tax Office will approach Treasury seeking legislative amendments which reflect the Tax Office’s current policies.
• If legislative amendments are required, the PCA expects that the Tax Office will encourage the Government to make an early announcement regarding the amendments, to give taxpayers some degree of comfort while the amendments are drafted and passed.

Recommendations for residential developers

In light of the Tax Office’s Decision Impact Statement, developers should not need to do anything for the moment if they have previously sold residential units under the margin scheme (or are currently selling such premises under the margin scheme).

However, developers that are considering undertaking new projects should be aware that there is a risk (albeit low) that they may not be able to use the margin scheme on their future residential unit sales. Whether the margin scheme is available may depend on the outcome of future court decisions or legislative amendments. While we expect that the margin scheme will continue to be available for unit developments, this obviously cannot be guaranteed. Developers may consider it appropriate to undertake two feasibility studies in respect of new projects (one taking the margin scheme into account and another taking GST into account at the full 10% rate).