Property Update - February 2006

in this issue:

• New grab for revenue revealed: more land tax
  
In what has come as a shock to many in the property industry, a unit trust holding property in a special trust now incurs an extra $5,884 of land tax.

• Watch out for GST traps in a slow market

When the sale market is slow, it is not uncommon for developers to refrain from selling, and instead rent out a property until the market improves. Developers who go down this route should be wary of a potential clawback in input tax credits.

• Large deposit
s and GST
Most sales proceed on the basis of a 10% deposit. But be wary of a deposit greater than 10%.

In what has come as a shock to many in the property industry, a unit trust holding property in a special trust now incurs an extra $5,884 of land tax.

As a result of a recent High Court decision concerning the taxation of unit trusts under the Victorian Land Tax Act 1958, most unit trusts in NSW will now be assessed as "special trusts" under s 3A of the New South Wales Land Tax Management Act 1956 ("Act").

Special trusts are under a disadvantage compared to other entities or individuals. With special trusts, land tax is assessed at the rate of 1.7% on the taxable value of land, without the $352,000 threshold afforded to others. A unit trust holding property which is a special trust therefore incurs an additional $5,884 of land tax per year.

In many cases, unit trusts were selected as an appropriate vehicle to hold property in for this very reason.

Until this High Court decision, the NSW Office of State Revenue ("OSR") regarded most discretionary trusts as special trusts under the Act but unit trusts had enjoyed the benefit of the threshold and, therefore, a lower land tax bill.

Note the land tax threshold existed until the 2005 tax year when it was abolished but was subsequently re-introduced for the 2006 tax year, so it has resumed its normal significance to taxpayers.

The High Court ruled that the holders of units in the relevant trust were not the owners of land held by the trust.

The outcome of the case turned upon the definition of "owner" under the Victorian legislation. The NSW equivalent definition is almost identical.

The court held that a unitholder at the relevant date was not the owner of the land within the meaning of the statutory definition.

This was because the trust deed gave power to the trustee to do such things as make provision for future and contingent liabilities, and to apply the income to the purchase of any property or business. The only right of the unitholder was to receive a proportionate share of the income of the fund for the year. In other words, the unitholder may, but would not necessarily, receive all of the income of the trust.

Trustees and managers will need to analyse their trust deed to determine whether the trustee or the unitholders are considered to be the "owner" within the meaning of the statutory definition.

Where a trust deed provides that the unitholders do have an ownership interest in land held by the trust, an objection should be made to any assessment for land tax levied on the trustee.

Great care should be exercised before amending the trust deed as this could trigger an unwanted and costly capital gain.

Trustees and managers should also review leases to determine whether the additional land tax liability can be passed onto tenants under the terms of a lease. If the lease is a net lease and outgoings payable by a tenant include land tax, it will be necessary to determine whether the land tax is recoverable on as paid basis; or, as is often the case, is only recoverable to the extent the landlord is not a special trust within the meaning in the Act.
By Stephen Healy and Cameron Steele

When the sale market is slow, it is not uncommon for developers to refrain from selling, and instead rent out a property until the market improves. Developers who go down this route should be wary of a potential clawback in input tax credits.

Developers constructing new residential property are generally entitled to input tax credits for GST paid on all development costs (for example, costs of consultants and construction costs) but must pay GST on the sale price (normally on the margin method). Division 129 of the GST Act can apply with the effect that some or all of the input tax credits may have to be handed back, possibly creating a massive cashflow problem.

Division 129 applies where the actual use of the property may be different from the use intended when the development began.

Where the intention of the developer is to sell new residential property, the developer is entitled to claim input tax credits but must pay GST on the sale proceeds.

However when a new residential property is leased the rent is not liable to GST. Accordingly the "inputs" or costs of making that supply of a lease may not be claimed as input tax credits. Those costs are the costs of developing the new residential property.

Once a developer changes his mind from an intended sale to leasing of the property, then the input tax credits must be refunded on a whole or proportionate basis.

The input tax credits will need to be repaid in full if the property is leased for five years, but no GST is then payable on its sale.
By Stephen Healy and Cameron Steele

Large deposits and GST

Most sales proceed on the basis of a 10% deposit. But be wary of a deposit greater than 10%.

Division 99 of the GST Act states that the giving of a deposit as security does not constitute consideration for supply until it is forfeited or applied as part of the consideration.

A draft GST public ruling GSTR 2005/D1 regarding division 99 deposits raises some surprising matters in relation to deposits including:

• for GST purposes the deposit must be only 10%, unless the taxpayer can justify a higher deposit on reasonable grounds. It is likely that a deposit greater than 10% will be considered by the ATO to be part of the payment of consideration, therefore triggering GST on the full amount of the price even though that full amount has not been received. This could create a significant problem for a vendor who cannot fund the GST prior to receiving the proceeds of sale.

• forfeited deposits are always consideration for a taxable supply even if the underlying supply would have been GST free.

For example, if a commercial property were sold on the going concern method, there is no GST payable by the vendor on the supply of the property.

However a forfeited deposit would be liable to GST. This raises the issue of whether a deposit plus GST ought to be sought from the purchaser. This may create a "catch 22 situation" – if the vendor receives a 10% deposit plus GST, effectively the vendor receives 11% of the purchase price and creates the very GST problem it is trying to avoid.

If 10% only is received, it will be necessary to ensure that a GST clause in a contract is drafted, to allow GST to be recovered by a vendor from a defaulting purchaser on a forfeited deposit.

This publication is provided to clients and correspondents for their information on a complimentary basis. It represents a brief summary of the law applicable as at the date of publication and should not be relied on as a definitive or complete statement of the relevant laws.