Contributed by Andrew Henshaw and Rajan Verma, Directors of Velocity Legal
Ordinarily, vendors pay GST on the value of the taxable supplies that they make. Vendors will sell goods or services for a price that includes a GST component. When it comes time to lodge their BAS, the vendor will then pay that GST component to the ATO. There may be a three or four months delay between a vendor receiving a purchase price (including the GST component), and having to pay the GST to the ATO.
In recent times, the ATO and the government have become increasingly concerned that some property developers collect the GST on a sale, but ultimately do not pay GST. The ATO have also publicly acknowledged that their enforcement and detection methods are not effective.
Refer to CCH Books’ GST guide and legislation titles for more detailed insights.
GST withholding regime
In the 2017/18 Budget, the government announced that it would introduce a GST withholding regime for the residential property industry, effective 1 July 2018 (the GST withholding regime).
The government has released draft legislation for the GST withholding regime. Assuming the draft legislation is passed as is, here are the key takeaways that people involved in the sale or purchase of property need to be aware of.
GST withholding — When does it apply?
From 1 July 2018, all purchasers of new residential premises or new residential subdivisions will be required to pay the GST component of the purchase price directly to the ATO (and not to the vendor).
In particular, proposed s 14-250(1) and (2) of the draft legislation provide that the recipient of a taxable supply that is a supply of either new residential premises or certain potential residential land is required to pay an amount to the Commissioner.
The GST withholding regime will apply if:
- the supply is a taxable supply (in contrast to a GST-free supply, input taxed supply, or where the vendor is not registered for GST nor required to be registered), and
- the property is new residential premises or certain potential residential land (as opposed to existing residential premises, or commercial residential premises).
How much GST to withhold?
The purchaser must withhold 1/11th of the (GST-inclusive) price payable under the sale contract. Plain and simple.
However, the margin scheme will often apply to the sale of new residential premises. This will usually mean that the ultimate GST payable by the vendor is less than 1/11th of the price, sometimes far less.
Despite the unfairness and cash flow issue for vendors having the GST withholding obligations based simply on 1/11th of the price is a sensible approach. Margin scheme calculations can be complex and are often not well-understood. Forcing a vendor to disclose their margin (which is something they will probably not want the purchaser to know) and requiring the parties to agree on the precise application of the margin scheme would be unworkable. Unfortunately, it means that any vendor using the margin scheme will need to seek a refund of the overpaid GST from the ATO. This is discussed below.
The GST withholding amount must be paid by the purchaser on or before the date that the purchaser first provides consideration (other than the deposit). Practically, this will usually mean before or at settlement. However, where consideration is staged (eg an instalment or terms contract), the rules may result in the purchaser paying GST well before settlement.
GST withholding notice — a new requirement
To facilitate the operation of GST withholding by purchasers, the rules will require the vendor to provide the purchaser with a GST withholding notice. Under this notice, the vendor tells the purchaser whether they are required to withhold GST, and if so, how much. The vendor must provide this notification at least 14 days before making a supply (ie settlement).
The GST withholding notice must specify:
- whether the purchaser is required to make a GST withholding payment under proposed s 14-250, and
- if so, the following additional information:
- the vendor’s name and ABN
- the amount of GST that the purchaser will be required to pay
- when the other entity will be required to pay that amount
- if some or all of the consideration is something other than money, what the GST-inclusive market value is of that consideration.
Unlike the withholding obligation, which only applies to new residential premises or new subdivisions of potential residential land, the notification requirement applies to the supply of any residential premises or any potential residential land.
Penalties — vendor
If a vendor fails to provide a GST withholding notice serious penalties apply, with 100 penalty units payable for breach of the strict liability offence (ie $21,000).
The penalties can apply to the supply of any residential premises or any potential residential land, regardless of whether the premises are new residential premises or certain potential residential land. That is, the failure to provide a GST withholding notice, even one which states that no amount of GST needs to be withheld by the purchaser, can still attract serious penalties.
Penalties — purchaser
On the purchaser’s side, the failure to withhold is a strict liability offence which attracts penalties of 10 penalty units (ie $2,100).
Defences to penalties
The penalties are strict and hefty and the defences are very limited. According to the Explanatory Memorandum to the draft legislation, it is a defence if an honest and reasonable mistake is made about whether the property in question is new residential premises or existing premises, and consequently there was a failure to provide the correct notice. However, there does not appear to be any such defence if an honest and reasonable mistake is made about other matters (eg whether a supply is a taxable supply).
Practically speaking, this means that before a vendor sells any property, they should consider and document whether the property is a taxable supply of a residential premises. If it is, they need to further consider and document whether it is a new residential premises, or some other type of residential premises.
When too much GST has been withheld (eg because the margin scheme applies, or the purchaser has withheld in error), a vendor has two options to recover the overpaid GST:
- claim a refund as part of their BAS for the relevant period, or
- apply for a refund from the ATO, using the new refund mechanism (explained below).
The new refund mechanism addresses the potential timing issue which could apply to quarterly BAS lodgers who make a supply of new residential premises early in the BAS period. In the absence of a special refund mechanism, a vendor in that situation could be out-of-pocket for the excess GST for several months before they can lodge their BAS and obtain a refund in the usual way. However, the refund scheme is complex. In essence, to obtain a refund the vendor needs to prove that they are entitled to a refund. This may include providing detailed margin scheme calculations to the ATO.
Taxpayers that are monthly BAS lodgers cannot make use of the special refund scheme and will need to wait until they lodge their BAS to obtain a refund.
For other property developers, particularly “mum and dad” developers, they may wish to make an earlier GST refund claim, to ensure that their cash-flow impact is minimised. To minimise any loss of time, the refund application should be prepared in advance and ready to lodge as soon as settlement is completed.
Contractual GST disputes
In our experience, disputes often arise between purchasers and vendors regarding the following matters:
- whether a premises is new residential premises or residential premises (eg whether renovation they had undertaken amounted to substantial renovations that would make the property new residential premises)
- whether a supply is a taxable supply or GST-free (eg is a going concern or farm land)
- whether the vendor is required to be registered for GST.
Given that the penalties for failing to withhold are high, we would expect purchasers to act cautiously and to withhold GST if there is any doubt about whether or not GST applies. Accordingly, we expect to see an increase in the number of private ruling applications made by vendors to resolve any GST disputes they may have with purchasers.
Land development agreements
Land development agreements are common arrangements between land owners and property developers, where the developer agrees to develop the property for a share of the proceeds from sale of that developed property.
Such development agreements typically set out an agreed distribution or “waterfall” payment arrangement, which provides for how the consideration will be distributed among the parties. Generally, a portion of the funds will be distributed to the land owner for the purposes of discharging their GST liability to the Commissioner.
These arrangements will need to change under the GST withholding regime, as the purchaser (not the land owner) will be required to pay GST directly to the ATO. Thus, land development agreements will need to be properly tailored to address that the purchaser will generally pay GST.
Special consideration will also need to be given to who will be responsible for applying for refunds when the margin scheme applies, and how that refund will be disbursed among the land owner and the developer.
The GST withholding regime applies to all contracts entered on or after 1 July 2018. However, the rules may apply to a contract entered before 1 July 2018, if the first consideration for the supply is provided on 1 July 2020 or later. This may affect many contracts already signed with long settlement terms (eg large residential apartment buildings which remain to be constructed).
Curiously, there is no requirement to provide a GST withholding notice for any contract entered before 1 July 2018.
With respect to development agreements entered into before 1 July 2018, transitional rules will apply to ensure that no windfall gain is made as a result of a party receiving a GST component under a development agreement which has already been paid under the withholding regime.
The GST withholding regime is a significant shift from the usual way in which the GST law applies to residential property transactions. The penalties for non-compliance are steep. For that reason, property owners and developers should ensure they are across the new rules. If there is any doubt about the characterisation of a transaction, advice should be sought as early as possible.
Special issues arise for long-term contracts and land development agreements under the withholding regime. Going forward, land development agreements will need to be tailored to address the new rules.