The Assistant Treasurer has announced that the current GST-free treatment of going concerns and farmland will be abolished ‘sometime in 2014’. In its place, a reverse charge mechanism will apply.
GST-free going concerns and farmland
Currently, a supply of an enterprise can be GST-free if the vendor supplies to the purchaser ‘all of the things necessary for the continued operation of the enterprise’. This means that sales of businesses (or parts of businesses capable of operating independently) and commercial buildings leased to tenants are often able to qualify as GST-free if the parties agree in writing.
A sale of farmland will be GST-free if a farming business has been conducted on the land for the last five years and the purchaser also intends that the land will be used for a farming business.
The two principal benefits of the current GST-free treatment stem from a GST-exclusive purchase price, which means:
- a lower financing cost for the purchaser as it does not need to fund the GST amount; and
- duty is payable on the GST-exclusive purchase price (rather than a GST-inclusive price).
The provisions have always created some tensions in negotiating contracts, as the GST-free treatment usually benefits the purchaser but, if the parties get the GST treatment wrong, the vendor has the risk of paying the GST and interest and penalties.
How does a reverse charge work?
Reverse charge means that the purchaser is liable to account for the GST on the sale, rather than the vendor. If the purchaser is registered for GST and able to claim full input tax credits in relation to its purchase, the transaction should be revenue neutral for the purchaser from a GST perspective.
As a result, the purchaser should still retain the benefit of only having to fund a GST-exclusive purchase price.
It is not clear what position the state revenue authorities will take with respect to the duty base but there is a risk that their position may be that duty should be calculated on a GST-inclusive price under a reverse charge arrangement.
What devil is in the detail?
For land owners
The amendments will not fix the current problems.
If the parties mischaracterise a supply as eligible for the reverse charge, the supply will default back to being a taxable supply, and the vendor will bear the risk of unpaid GST, interest and penalties.
GST clauses will need to be specifically drafted to deal with the reverse charge. It will be important for vendors to have a fall-back position, which is that if the supply is taxable and not eligible for the reverse charge, the vendor is still able to recover the GST amount (and possibly interest and penalties) from the purchaser.
Parties should not assume that all of a transaction will qualify for the reverse charge. It may be that part of the supply will qualify for a reverse charge, which will need to be specifically dealt with in the contract, but that other parts of the supply will need to be governed by a usual GST gross-up clause: for example, the sale of a commercial building that is partly leased to tenants.
Complex issues are likely to arise for developers, particularly in the interaction with the margin scheme provisions.
For example, if a developer acquires a property under the new reverse charge mechanism, will the developer then be eligible to sell developed lots under the margin scheme, and if so, what will be the developer’s acquisition cost for calculating the margin?
Further, what happens to existing developments currently eligible for the margin scheme but where sales are not expected until ‘sometime’ after 2014?
These types of issues will need to be addressed by Treasury in preparing an exposure draft. Please contact us if you would like to discuss the proposed reverse charge rules.