GST is ever-present and (mostly) unavoidable. However, provided that certain conditions are met, GST on the sale of property can be reduced by calculating GST using the method known as the "margin method".
Developers often use the margin method when selling brand new residential property. By using the margin method, the GST on the supply of the brand new residential property will be less than if the ordinary method was employed. This increases the proportion of the price that the vendor retains and increases available profit.
On 18 February 2008, the Federal Court delivered a judgment in Brady King Pty Ltd v Commissioner of Taxation (Brady King) regarding the application of the margin method. The Court adopted an interpretation drastically limiting the applicability of the margin method in a manner contrary to the practice adopted by the ATO, developers and their lawyers since the introduction of GST in 2000.
The Position Prior To Brady King
Prior to the recent decision, the position was that the margin method could be applied where the title details of the property changed between the date of the acquisition of development land and the sale of subdivided land or buildings. This occurs in most residential development projects as they generally involve changing title by subdividing land or strata subdividing a newly constructed building.
Assume a developer acquires land using the margin method for $10,000,000 (inclusive of GST). The developer then constructs 100 brand new residential units on the land. In order to sell the units, the land is strata-subdivided into 100 units. Each unit is sold for $400,000 (inclusive of GST).
The original title to the property acquired by the developer no longer exists because after subdivision into 100 individual strata units the building has a new strata title.
It was generally thought that the margin method could still be applied on the sale of the strata units. The GST margin on the sale of each unit was calculated by adopting a "fair and reasonable" method of apportionment of the original acquisition price.
Where each unit is assumed to be of equal value, a fair and reasonable apportionment would be an acquisition price of $100,000 per unit (inclusive of GST). The GST, using the margin method for each unit, would be $27,273 (being 1/11th of the difference between the sale price of $400,000 and the apportioned purchase price of $100,000).
In this case, of the $40,000,000 received from purchasers, the developer remits $2,727,300 in GST to the ATO and retains the balance, being $37,272,700.
In Brady King, the Court held that it was no longer possible to apply the margin method on sales of land where the title to the property sold differs from the title to the property acquired. The reason is that the property at the time the margin method supply occurs is not the same property (in a judicial sense) as the property originally acquired by the vendor.
The impact of the decision is that the margin method can no longer be used whenever the title to the property sold is different to the title of the property originally acquired. This has the potential to affect the sale of property whenever a subdivision, consolidation or redefinition of title occurs. Where feasibilities have been prepared on the assumption of the margin method being applied, this could have serious consequences for developers and their financiers.
The ATO has issued public rulings indicating that where the real property that you buy differs from the property that you eventually sell (e.g. where you subdivide land or construct stratum units), the margin scheme applies to the interest created by registering the subdivision or stratum unit and the consideration for that new interest (when calculating the margin) is the corresponding proportion of the consideration provided for the original land or premises.
The ATO has not withdrawn these public rulings and their statement in response to the Brady King decision indicates that they have no immediate intention to change their current approach. Taxpayers are generally protected where they rely upon current ATO public rulings. However, any protection offered by the rulings will be lost if the ATO withdraws them before completion of the relevant sale contracts and this should be factored into future feasibility studies.
Using the facts set out in example 1, if because of the Brady King decision the 100 brand new residential units cannot be sold using the margin method (because the property has been strata subdivided), the only option open to the developer is to sell the units using the ordinary method.
The GST inclusive sale price for the 100 units is $40,000,000. The developer remits 1/11th of the price being $3,636,363 as GST to the ATO and retains the balance, being $36,363,637.
The difference in the GST component of the price between the two methods is $909,063. This means that with the margin method no longer being available to the developer, in this example, the developer has $909,063 less profit at the end of the project.
Although the ATO was successful in the Brady King case (but not on the grounds submitted by the Commissioner), it has issued a decision impact statement which confirms that the judgment was not consistent with their submissions or their long-held views and, although they are still considering their position, they have indicated that the ATO will continue to adopt their existing practices until the decision is confirmed or overturned (if the taxpayer appeals). The ATO cannot appeal as it was successful in the case. An appeal from the decision in Brady King would need to be filed by the taxpayer by 10 March 2008.
If you have any questions about the applicability of the margin method to your project please contact our office for advice on your particular situation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.