Australia: GST Ruling on Interest-Free Loans Received by the Developer of a Retirement Village

On 9 June 2010, the ATO released a draft public ruling on how GST applies to the development and sale of tenanted retirement villages. This ruling has been long anticipated by the industry and its release and content is likely to cause difficulties for developers and operators in the sector.

The draft ruling addresses the relevance of ingoing contributions in the form of interest free loans received by the owner/operator of a retirement village to determine:

• the consideration for the sale of the retirement village, and
• the extent to which GST included in development costs can be claimed as GST input tax credits by the developer of the retirement village.

Consideration for the sale of a tenanted retirement village

The preliminary view of the Commissioner of Taxation is that the purchaser of a tenanted retirement village provides the vendor with a benefit by assuming responsibility for repaying ingoing contributions. According to the draft ruling, this benefit forms part of the consideration for the supply of the retirement village based on the full face value of any ingoing contributions that have not been repaid to residents.

The consequence of the Commissioner's interpretation is that the GST payable on the sale of a tenanted retirement village may increase very substantially. This additional GST represents a real cost where the purchaser is unable to recover input tax credits on its acquisition of the village. This will apply to all future projects (together with any current projects that are not eligible for the transitional relief discussed below).

However, the problem raised by this draft ruling really only arises where the developer sells the retirement village while the residential apartments in the complex are still treated as "new residential premises". The issue subsides once the apartments have been leased for at least 5 years and the apartments convert to second-hand residential premises. This is because GST is not normally payable on the sale of second-hand residential premises.

The basis for the Commissioner's interpretation in the draft ruling seems questionable. First, the draft ruling states that the obligation to repay the ingoing contribution is a presently existing debt, recoverable as such at law. While this may be true in one sense, it ignores the fact that the ingoing contribution is unlikely to fall due for repayment for many years. If regard is given to the time-value of money, the obligation assumed by the purchaser should be significantly less than the full face value of the ingoing contribution.

Secondly, the draft ruling states that the purchaser's assumption of the obligation to repay the ingoing contribution "represents one of the advantages sought by the developer". This overlooks the commercial reality of the arrangements, as recognised by the Commissioner in Interpretative Decision ATO ID 2001/634. In that Interpretative Decision, the Commissioner explained that:

If ATO ID 2001/634 correctly states that the deferred management fee is consideration for the lease to the resident then the ingoing contribution represents an advance in relation to the resident's prospective liability under the lease, part of which has already been earned by the developer when the purchaser assumes the obligation to repay that ingoing contribution. Therefore, for the Commissioner to be consistent, the obligation assumed by the purchaser should be reduced by the amount of any unpaid deferred management fees accrued when the purchaser assumes the obligation to repay the ingoing contribution.

GST input tax on development costs

The draft ruling sets out a methodology for claiming credits during the development stage of the retirement village. Under the methodology described, the total consideration the developer receives from the residents for the grant of leases includes the benefit of not having to pay interest on the ingoing contributions. That is, the financial benefit of the "interest free" loan is treated as additional consideration for the resident leases (which is a non-creditable activity).

The draft ruling states that this financial benefit can be valued by using a reasonable estimate of the additional financing costs the developer would incur if it borrowed an amount equal to the ingoing contributions under an arm's length interest bearing loan from a commercial lender. The Commissioner will accept an interest rate based on the yield rate for 90-day Bank Accepted Bills published by the Reserve Bank.

The value of the "benefit" needs to be determined for the period from the payment of the ingoing contribution until the retirement village is sold (or the contribution is repaid).

While there may be other "fair and reasonable" methods of apportioning the development costs, the draft ruling states that the Commissioner does not accept an output based method that does not reflect the benefit of the interest-free use of the ingoing contributions.

The result of this view is that the value of the input taxed supplies made by the developer is increased and this will reduce the amount of input tax credits the developer can claim during the development stage of the retirement village.

Transitional arrangements

Statements made by the Commissioner in an earlier GST ruling (GSTR 2004/9) have been interpreted by some developers to mean that a statutory obligation imposed on the purchaser to repay ingoing contributions to residents does not form any part of the consideration for the sale of the village. The current draft ruling acknowledges that those developers should be entitled to rely upon the earlier ruling.

therefore, developers who have previously sold a tenanted retirement village without including the value of unrepaid ingoing contributions should be entitled to rely on the Commissioner's views in GSTR 2004/9. In addition, developers need not include the face value of the ingoing contributions in their sale price for the retirement village where the developer was commercially committed to construct and develop a retirement village before 9 June 2010 (ie, the date of issue of the draft ruling).

However, this transitional concession is only available if the developer determines its entitlement to input tax credits on development costs using a methodology that is consistent with this approach.

Conclusions and the way forward

If the Tax Office adopts the preliminary views stated in the draft ruling:

• the GST payable by a developer on the sale of a retirement village may increase very substantially; and
• the proportion of GST input tax credits developers can claim in relation to the construction of retirement villages will reduce.

The Tax Office will accept comments on the draft ruling until 23 July 2010. In the meantime, developers should take steps to ensure that projects they have already committed to undertake will be eligible for the transitional arrangements permitted under the draft ruling.

Developers proposing to enter into new projects, or considering the sale of their portfolios, should consider alternative holding structures or sale structures that will maximise their input tax credits during the development stage and reduce any potential GST burden on a subsequent sale of the retirement village. Gadens Lawyers can provide advice in relation to GST effective structures for these projects.

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