The Government has raised a number of GST discussion papers proposing major amendments across broad areas of the GST law. One of the more interesting and controversial proposals is to remove the GST going concern and farm land exemptions and replace them with an optional reverse charge mechanism. In this tax update, we analyse this proposal in some detail. Taxpayers should seek their own advice as to how the proposals affect them
While the publicity and media surrounding the Budget focused on the super, personal tax and corporate tax changes, the Budget contained significant GST announcements. The proposed GST amendments and announced reviews potentially represent the most significant changes to the GST law since GST was introduced almost 10 years ago, including substantive GST reviews in relation to the margin scheme, the GST cross border rules and the financial supply provisions.
One of the more interesting recommendations is to remove the going concern and farm land exemptions and replace them with an optional reverse charge provision. The proposal is of particular relevance to the property industry and to taxpayers that sell their businesses or farm land. The start date for this proposal is 1 July 2010.
The existing law - going concern and farm land
The going concern GST exemption allows the sale of the assets of an enterprise to be sold as GST-free where certain requirements are met. Similarly, under the farm land GST exemption, the sale of farm land is GST-free where certain requirements are met, including that the purchaser intends to carry on a farming business on the land. The going concern exemption is used by businesses across various industries for the sale of their enterprises, including for the sale of tenanted commercial property and property development enterprises in relation to new residential property (recent legislative amendments were made to the margin scheme that impact on these latter arrangements).
The going concern and farm land exemptions are primarily used for the cash flow benefit and, particularly in the property sector, because they reduce the stamp duty payable on the sale of land / assets by the purchaser (since stamp duty is calculated on the GST-inclusive purchase price). However, there have been a number of practical problems with the going concern provisions:
- The provisions are highly technical with the consequence that many transactions considered to be commercial going concerns by the parties do not meet the technical requirements. An example is where the purchaser already has its own premises and therefore the vendor does not transfer or assign the business premises to the purchaser. This would normally preclude the transaction from being a GST going concern. Where the vendor incorrectly classifies a taxable transaction as a GST-free going concern, it will normally have a significant GST exposure, including interest and penalties.
- The benefits of a going concern are primarily benefits for the purchaser, not the vendor. However, the vendor ordinarily bears the risk that the transaction will be incorrectly classified as a GST-free going concern. The lack of alignment concerning GST risk and benefit often leads to disputes between the parties.
- The GST law contains complex adjustment provisions that apply to some going concern transactions. These provisions are not well understood by taxpayers and are often ignored, once again leading to significant GST exposures, including interest and penalties.
Optional reverse charge mechanism proposal
The Treasury discussion paper proposes removing the GST going concern and farm land exemptions from the GST law. The proposal has a number of elements:
- Normally, the vendor remits the GST on a taxable transaction. Under the proposal, the parties can instead agree to reverse charge the GST on a supply of a going concern or farm land. Under the reverse charge agreement, the purchaser becomes responsible for remitting GST that would otherwise be the responsibility of the vendor. The purchaser is often entitled to claim an input tax credit on the transaction, normally resulting in zero net GST payable by the purchaser.
- The definition of a going concern will be expanded so that it is easier to meet the criteria. This will more closely align the going concern test with the commercial understanding of a going concern and is intended to reduce the technical complexities highlighted above.
- A number of consequential amendments will need to be made to the GST law, including amendments to deal with the amount of GST reverse charged, the agreement to reverse charge, supplies between associates, the adjustment provisions, tax invoices and adjustment notes.
- There will also be a carve-out for the sale of real property to be sold under the margin scheme. The vendor will continue to have the GST liability on the sale of real property that forms part of a going concern transaction where the parties so agree in writing.
The reverse charge mechanism is represented diagrammatically below.
There are a number of potential problems with implementing the reverse charge proposal:
- It has been suggested that stamp duty is payable on the GST component of the transaction. This is on the basis that the obligation to remit GST has been assumed by the purchaser and therefore forms part of the dutiable value for stamp duty purposes. Given that the primary benefit of the going concern exemption is the favourable stamp duty outcome, it is likely that industry would strongly object if the reverse charge mechanism gave an adverse stamp duty outcome.
- While the expanded definition of the going concern test is welcome, it will remain a technical test. This means that vendors will continue to bear some GST risk. For example, where the parties agree to apply the reverse charge mechanism to the sale of assets, but the sale does not meet the technical requirements of a going concern, the vendor, not the purchaser, will continue to have a GST liability on the sale. This will expose the vendor to a potentially significant GST exposure, including interest and penalties.
- The Tax Office takes the view that the assumption of any liabilities by the purchaser in a sale of business assets (such as employee entitlements) will often be treated as an adjustment to the purchase price. This leads to complexities in calculating the GST payable on the sale, which may expose the purchaser to a GST exposure, including interest and penalties. This will particularly be an issue where the purchaser is not entitled to claim a GST credit (for example, the purchaser is a financial institution).
Many taxpayers and industry bodies have questioned the need to introduce the reverse charge mechanism, particularly given the likely adverse stamp duty consequences. Instead, there would appear to be other solutions to the problems that currently afflict the going concern exemption and that will not create further concerns. As discussed above, a significant problem arises where the vendor incorrectly classifies a taxable transaction as a GST-free going concern, as it would normally have a significant GST exposure. Instead of the reverse charge mechanism, it would be possible to resolve this problem by amending the GST law so that the transaction is still GST-free where the parties have treated the sale as a GST-free going concern in good faith and there is no revenue loss to the Government.
There are also strong arguments that the going concern exemption should be extended to apply to the sale of high value capital assets to reduce both the compliance burden for the parties and the cash flow consequences for the purchaser.
Nevertheless, since the Government has agreed to these proposals in principle, it highly likely they will proceed. If implemented as intended, both vendors and purchasers that propose to use the reverse charge agreement will need specific provisions in their agreements to protect their GST positions.
Submissions in response to the Treasury discussion paper were due in by 10 June 2009 and we expect draft legislation to be released shortly. The proposals in the various reports and reviews are likely to have a significant impact on all taxpayers and we recommend all clients seek specific advice as to how these changes will affect them.
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