Private ruling: sale of residential premises
Date of advice: 10 March 2017
Published: March 2018

Ruling: Q1: Is the sale of the Property by the Vendor to the Purchaser pursuant to the Contract a sale of residential premises to be used predominantly for residential accommodation (regardless of the term of occupation) which is input taxed pursuant to section 40-65 of the A New Tax System (Good and Services Tax) Act 1999 (GST Act)? | A1: Yes.

Relevant facts and circumstances: Prior to a subdivision which took place in April 2016 the Property (which comprises a dwelling and appurtenant land) formed part of a larger area of land which included the dwelling and a large workshop plus appurtenant land. Pursuant to a contract which exchanged in October 2013, the Vendor acquired the dwelling, workshop and appurtenant land subject to a Lease of both the dwelling and the workshop to the Lessee. The sale to the Vendor was treated as a supply of a going concern. The Vendor registered for GST with effect from November 2013. The term of the Lease originally commenced in January 2011 and terminated in December 2015, but the entity which sold the Property to the Vendor and the Lessee subsequently executed a Variation of Lease which reduced the term of the Lease so that the Lease expired in July 2014. In March 2014 the Vendor terminated the Lease after the Lessee failed to pay the rent. After the Vendor terminated the Lease the workshop and dwelling remained vacant and the Vendor did not advertise them for lease as the Vendor intended to subdivide and sell the land. The Vendor demolished the workshop in late 2014/early 2015 and by October 2015 the Vendor completed remediation and installation of services in relation to the land formerly occupied by the workshop. The Vendor registered a plan of subdivision in April 2016. The Vendor did not make any improvements to the Property. The Property was used as an office by the Lessee from January 2011 until March 2014 but was described in the ruling request as convertible to a house and it was submitted that two photographs supplied with the ruling request evidenced the residential nature of the Property. The first photograph, taken before the workshop was demolished, is a street view which shows a dwelling adjacent to a large workshop (which appears to be occupied by a car repair business). The second photograph is an aerial view, taken after the workshop was demolished, which shows the dwelling with a large covered porch at its rear adjacent to a large area of vacant land. The Property is zoned Medium Density Residential and has a Development Approval (DA) for construction of a residential duplex. The Contract includes a clause which provides that the Vendor agrees to assign all of the Vendor’s rights, title and interest in the DA to the Purchaser. The Vendor’s adviser confirmed that the Vendor advertised the Property for sale by the Vendor as two bedrooms plus one bathroom with an approved DA.

Relevant legislative provisions: A New System (Goods and Services Tax) Act 1999 section 40-65.

Reasons for decision: Summary: The supply of the Property by the Vendor to the Purchaser pursuant to the Contract is input taxed pursuant to section 40-65 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). The Vendor was required to make an increasing adjustment under Division 135 of the GST Act when the Vendor acquired the workshop, dwelling and appurtenant land in 2013. | Detailed Reasoning - Detailed reasoning: Subsection 40-65(1): Subsection 40-65(1) of the GST Act provides that a sale of real property is input taxed, but only to the extent that the property is residential premises to be used predominantly for residential accommodation (regardless of the term of occupation). Residential premises: ‘Residential premises’ is defined in section 195-1 of the GST Act: residential premises means land or a building that: (a) is occupied as a residence or for residential accommodation; or (b) is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation; (regardless of the term of the occupation or intended occupation) and includes a *floating home. Paragraphs 6 and 7 of Goods and Services Tax Ruling GSTR 2012/5 state: 6. Premises, comprising land or a building, are residential premises under paragraph (a) of the definition of residential premises in section 195-1 where the premises are occupied as a residence or for residential accommodation, regardless of the term of occupation. The actual use of the premises as a residence or for residential accommodation is relevant to satisfying this limb of the definition. 7. Premises, comprising land or a building, are also residential premises under paragraph (b) of the definition of residential premises if the premises are intended to be occupied, and are capable of being occupied, as a residence or for residential accommodation, regardless of the term of the intended occupation. This limb of the definition refers to premises that are designed, built or modified so as to be suitable to be occupied, and capable of being occupied, as a residence or for residential accommodation. This is demonstrated through the physical characteristics of the premises. A footnote to paragraph 6 of GSTR 2012/5 states that ‘premises’ refers to whatever is supplied, whether it is the whole or any part of land or a building. In the present case the Vendor is supplying the Property (i.e. the subdivided land with a two bedroom plus one bathroom dwelling on it) plus the DA. The Property was leased to the Lessee and used by the Lessee as an office until March 2014 and then left vacant because the Vendor intended to subdivide the larger area of land and sell each subdivided parcel separately. That suggests that the Property does not satisfy paragraph (a) of the ‘residential premises’ definition as the premises are not currently being occupied as a residence. However the statement in the ruling request that the dwelling on the Property is convertible to a house, the fact that the Vendor advertised the Property for sale as two bedroom and one bathroom with an approved DA plus the photographs supplied with the ruling indicate that the Property does satisfy paragraph (b) of the ‘residential premises’ definition, i.e. the premises are intended to be occupied, and are capable of being occupied, as a residence or for residential accommodation. Paragraph 7 of GSTR 2012/5 provides that whether premises satisfy paragraph (b) of the ‘residential premises’ definition is demonstrated through the physical characteristics of the premises. To be used predominantly for residential accommodation: Subsection 40-65(1) requires that the residential premises are ‘to be used predominantly for residential accommodation (regardless of the term of occupation). Paragraphs 9 and 10 of GSTR 2012/5 state: 9. The requirement in sections 40-35, 40-65 and 40-70 that premises be 'residential premises to be used predominantly for residential accommodation (regardless of the term of occupation)' is to be interpreted as a single test that looks to the physical characteristics of the property to determine the premises' suitability and capability for residential accommodation. 10. The requirement for residential premises to be used predominantly for residential accommodation does not require an examination of the subjective intention of, or use by, any particular person. Premises that display physical characteristics evidencing their suitability and capability to provide residential accommodation are residential premises even if they are used for a purpose other than to provide residential accommodation (for example, where the premises are used as a business office). The fact that the DA allows the Purchaser to demolish the dwelling on the Property and erect a duplex does not mean that each Property is not to be used predominantly for residential accommodation. This is explained in Example 1 in paragraphs 12 and 13 of GSTR 2012/5: Example 1 - purchaser's intention not to use premises for residential accommodation 12. John carries on an enterprise which involves leasing a house on property which he owns. Based on the physical characteristics of the house it is residential premises to be used predominantly for residential accommodation. The area in which the house is located has recently been rezoned by the local Council to permit higher density residential apartments. Following the rezoning, a developer, Knock Them Down Co, approaches John and offers to purchase his property. Knock Them Down Co intends to demolish the house, redevelop the property into a new apartment building, and sell the apartments . 13. The fact that Knock Them Down Co does not intend to use the house to provide residential accommodation does not mean that the house is not residential premises to be used predominantly for residential accommodation. Knock Them Down Co's intention is not a relevant factor in determining the character of the premises. Based on its physical characteristics, the house is residential premises to be used predominantly for residential accommodation. The sale of the house by John to Knock Them Down Co is an input taxed supply under section 40-65 . In Toyama Pty Ltd v Landmark Building Developments Pty Ltd 2006 ATC 4160 ( Toyama ) the NSW Supreme Court held that the sale of land on which a dwelling was situated and in respect of which a DA for the construction of 14 apartments had been granted was a taxable supply, notwithstanding that the Commissioner had issued a private ruling which confirmed that the sale of the property was an input taxed supply. The issue in that proceeding was whether the trustees appointed to sell the property had failed to exercise the requisite standard of care where they stated in the contract for sale that the sale was a taxable supply. White J held that the sale was a taxable supply and that the trustees did not fail to exercise the requisite standard of care. The Commissioner was not a party to the proceedings and White J stated that the court’s decision on the GST issue did not bind the Commissioner. White J held that the phrase ‘to be used predominantly for residential accommodation’ in subsection 40-65(1) required a prediction of the use of the property based on the subjective intention of the purchaser. The ATO considers that requiring the GST liability of a vendor to be determined by the subjective intention of a purchaser (which the vendor may not know) would cause difficulty for vendors generally. Further, in Marana Holdings Pty Ltd v Commissioner of Taxation [2004] 141FCR 299, 313 the Full Federal Court held that the words ‘intended to be occupied…as a residence’ in paragraph (b) of the ‘residential premises’ definition in section 195-1 of the GST Act does not refer to the subjective intention of any person but the objective intention with which the particular premises are designed or built. Similarly, in Sunchen Pty Ltd v FCT [2010] FCAFC 138 Edmonds and Gilmour JJ held ‘to be used predominantly for residential accommodation’ to be concerned with the physical characteristics of the property rather than the intended use by any person. We therefore consider that the phrase ‘to be used predominantly for residential accommodation’ in subsection 40-65(1) requires an objective approach rather than the subjective approach taken in Toyama . Subsection 40-65(2): Subsection 40-65(1) of the GST Act is qualified by subsection 40-65(2) which states: (2) However, the sale is not input taxed to the extent that the *residential premises are: (a) *commercial residential premises; or (b) * new residential premises other than those used for residential accommodation (regardless of the term of occupation) before 2 December 1998. Commercial residential premises: The Property does not fall within the definition of ‘commercial residential premises’ in section 195-1 of the GST Act (which refers to a hotel, motel, inn, hostel or boarding house or anything similar). New residential premises: ‘New residential premises’ is defined in section 40-75 of the GST Act: (1) *Residential premises are new residential premises if they: (a) have not previously been sold as residential premises (other than *commercial residential premises) and have not previously been the subject of a *long term lease; or (b) have been created through *substantial renovations of a building; or (c) have been built, or contain a building that has been built, to replace demolished premises on the same land. Paragraphs (b) and (c) have effect subject to paragraph (a). | Detailed Reasoning - Note 1:: For example, residential premises will be new residential premises if they are created as described in paragraph (b) or (c) to replace earlier premises that had ceased to be new residential premises because of paragraph (a). | Detailed Reasoning - Note 2:: However, premises that are new residential premises because of paragraph (b) or (c) will cease to be new residential premises once they are sold, or supplied by way of long-term lease, as residential premises (see paragraph (a)). | Detailed Reasoning - Note 3:: Premises created because of the registration of, for example, a strata title plan, or a plan to subdivide land, may not become new residential premises (see subsection (2AA)). The Property is not ‘new residential premises’ pursuant to paragraph (a) of subsection 40-75(1) because the Property (albeit as part of the larger area of land) was sold to the Vendor as residential premises, i.e. notwithstanding that the supply to the Vendor was treated as a supply of a going concern and the dwelling was being used as an office, the part of that supply comprising the dwelling satisfied paragraph (b) of the ‘residential premises’ definition in section 195-1 of the GST Act, i.e. land or a building that is intended to be occupied, and is capable of being occupied, as a residence. Nor does the Property satisfy paragraphs (b) or (c) of subsection 40-75(1) as the Property was not created through substantial renovations of a building or built to replace demolished premises on the same land. As the sale of the Property by the Vendor to the Purchaser satisfies subsection 40-65(1) and neither exception in subsection 40-65(2) applies, that supply of the Property by the Vendor is input taxed. Supply of DA: We do not consider that the assignment by the Vendor to the Purchaser of the Vendor’s rights, title and interest in the DA is a separate taxable supply. The DA is stated to be in respect of the Property and will transfer to the purchaser as a consequence of the sale of the Property by the Vendor. Consequently the Vendor will not transfer to the Purchaser anything that was not already transferred to that Purchaser as a consequence of the sale of the Property. The Vendor is not making a separate supply of the DA but is making a single supply of the Property which includes the DA Increasing adjustment under Division 135: Following the acquisition of the larger area of land by the Vendor in late 2013 the Vendor leased both the workshop and the dwelling to the Lessee until the Vendor terminated the Lease in March 2014. To the extent that the Vendor leased the dwelling to the Lessee the Vendor made a supply which is input taxed under section 40-35 of the GST Act, i.e. a supply of premises that is by way of lease where the supply is of residential premises (subsection 40-35(1)) to the extent that the premises are to be used predominantly for residential accommodation (regardless of the term of occupation) (paragraph 40-35(2)(a)). The use of the Property as offices by the Lessee does not mean that the supply of the Property by the Vendor to the Lessee was not a supply of residential premises to be used predominantly for residential accommodation. Paragraph 10 of GSTR 2012/5 states: 10. The requirement for residential premises to be used predominantly for residential accommodation does not require an examination of the subjective intention of, or use by, any particular person. Premises that display physical characteristics evidencing their suitability and capability to provide residential accommodation are residential premises even if they are used for a purpose other than to provide residential accommodation (for example, where the premises are used as a business office). Division 135 of the GST Act deals with initial adjustments and later adjustments for supplies of going concerns. The effect of those provisions is summarised in paragraphs 13 and 14 of Goods and Services Tax Ruling GSTR 2002/5: 13. A recipient of a 'supply of a going concern' that intends to make supplies which are neither taxable nor GST-free may be required by section 135-5 to make an initial increasing adjustment. 14. The recipient of a 'supply of a going concern' is required to make a further increasing or decreasing adjustment under section 135-10 where the proportion of the supplies made through the enterprise which are neither taxable nor GST-free has changed from the proportion of intended supplies. Section 135-10 requires that, in these circumstances, an increasing or decreasing adjustment is to be made using the method contained in Division 129. Subsection 135-5(1) of the GST Act deals with an initial increasing adjustment: (1) You have an increasing adjustment if: (a) you are the *recipient of a *supply of a going concern, or a supply that is *GST-free under section 38-480; and (b) you intend that some or all of the supplies made through the *enterprise to which the supply relates will be supplies that are neither *taxable supplies nor *GST-free supplies. In FCT v MBI Properties P ty Ltd [2014] HCA 49 French CJ, Hayne, Keifel, Gageler, Keane JJ the High Court held that an entity which acquired premises subject to a lease was required to make an initial increasing adjustment because the recipient’s assumption of the lessor’s obligations resulted in the recipient making supplies which were neither taxable nor GST-free. The High Court explained the rationale for the initial increasing adjustment under section 135-5 (Para 13): The purpose of s 135-5 was explained in the Explanatory Memorandum to the Bill for the GST Act as being "to ensure that you account for GST in proportion to the ... input taxed use of a going concern that you acquire" by being subjected to an adjustment which "increases your net amount by an amount equal to the GST you would bear on the acquisition if it had been a taxable supply to you", with the result that "you only get a going concern GST-free to the extent that you intend to make taxable supplies with it. Subsection 135-5(2) sets out the method for calculating the initial increasing adjustment: 1/10th x supply price x proportion of non-creditable use A 1/10 th fraction is used (rather than 1/11 th ) because no GST was included in the sale price of the workshop, dwelling and appurtenant land to the Vendor. The supply price is the price for which the workshop, dwelling and appurtenant land was supplied to the Vendor. The proportion of non-creditable use is defined in subsection 135-5(2) as the proportion of all the supplies made through the enterprise that the Vendor intends will be neither taxable supplies nor GST-free supplies and is expressed as a percentage. In the present case that proportion would be calculated as: rent for the dwelling/rent for the dwelling + rent for the workshop. Under the general attribution rules for adjustments in subsection 29-20(1) of the GST Act the Vendor was required to attribute the increasing adjustment under section 135-5 to the tax period in 2013 in which the Vendor acquired the dwelling, workshop and appurtenant land.