Australia: Input Tax Credits Not So Easy

The current interest rate climate makes borrowing to buy a property harder. The natural consequence to this is that property is getting harder to sell.

Occasionally, a property developer may find it difficult to sell their stock. With rising interest rate cost and falling property prices, some developers can only hope of makinga sale before the holding costs erode their profit margin. Pressure from financiers may exacerbate this need of a quick sale.

A strategy of some developers has been to lease the properties they had built for sale. This could be a short-term strategy, with a view to obtaining an income stream tobear the holding costs, or it couldbe a long-term change on purpose.Either way, there are GST implications which need to be considered as they can significantly affect the developer's cash flow position.

Under the GST Legislation, input tax credits (ITCs) can only be claimed where an acquisition is made for the purposes of making a taxable supply. Selling 'new residential premises' is a taxable supply, therefore, the developer would have claimed the ITCs throughout the development phase for the costs of construction, consultants, marketing and possibly the original land purchase.

The supply of residential rental property, however, is an 'input-taxed supply'. Accordingly, acquisition and the ITCs previously claimed would need to be 'clawed back' by the Australian Taxation Office (ATO).

In assessing the liability to GST, the ATO looks at the actual supply that is being made, not the supply that was contemplated. Thus, if the supply is input-taxed (e.g. because it is residential rent) ITCs would not be allowed and it will be necessary for the developer to calculate an 'increasing adjustment' under the terms of Division 129 of the GST Act. Each acquisition needs to be separately considered.

An 'adjustment period' commencesno sooner than 12 months after the tax period in which the input tax credit was originally claimed and ends on 30 June. For a developer reporting for GST on a monthly basis, the adjustment periods for each month would be as indicated in the following table:

Thus, in the adjustment period ending on 30 June 2008 the developer would have to include any adjustments to be made in respect of input tax credits originally claimed during the period1 June 2006 to 31 May 2007.

The increasing adjustment is calculated as:

Input Tax Credit X (Former creditable percentage - Actual creditable percentage )

In other words, the developer would have an increasing adjustment equal to the input tax credits previously claimed in respect of making the supply, which would include costs attributable to the particular property. As noted above, the requirement to refund the GST to the ATO can be deferred by as much as 23 months, so the cash flow consequence of the change of use may not necessarily be immediate. That in itself could lead to problems if adequate provision is not made to pay the GST adjustment when it becomes due.

If and when the property is ultimately sold, it will be necessary to ascertain whether or not there is a taxable supply for GST purposes at that time. As mentioned above, a sale of residential premises is input taxed unless the premises are 'new residential premises'. A property is considered to be 'new residential premises' unless it has either previously been sold as a taxable supply or has been used for a period of five years for making input taxed supplies.

Therefore, if a property is sold after having been rented out for more than five years, it would not be a taxable supply and no GST would be charged by the developer. No further adjustments would be required.

However, if the property is sold within that five year period, it would stillbe regarded as 'new residential premises' and be subject to GST on sale.This means that it would be appropriate for the developer to reclaim a portion of the input tax credits that had previously been clawed backby the ATO. The same formula as shown above would be applied to calculate the decreasing adjustment. In this instance, the 'Former Creditable Percentage' would be zero percentage (as the property was used for making input taxed (i.e. rental supplies) whilst the 'Actual Creditable Percentage' would have to be determined.

Whilst the legislation indicates that any reasonable apportionment calculation would be acceptable to ascertain the actual creditable percentage, the ATO have stated that in the case of a change in the case of new residential premises that were constructed, an apportionment based on time factors alone would distort the outcome and not be acceptable. To this end, the ATO has published the following formula in their Property and Construction Issues Register, which they will accept as a basis for calculating a new 'actual creditable percentage', apportioning the ITCs on the basis of consideration received.

Consideration for the taxable supply of the premises

(Consideration for the taxable supply of the premises + Total rents received)

The adjustment period for the calculation of this decreasing adjustment would be based on the same time periods as indicated above for increasing adjustments. Thus, there could be a delay (of up to 23 months) before the developer would receive the GST refunds that they may be entitled to.

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.