On 3 December 2014 the High Court handed down its decision of Commissioner of Taxation v MBI Properties.
The earlier decision of the Full Federal Court had created significant confusion within the property industry. Pleasingly however, the High Court’s decision has removed this confusion and resulted in a return to the generally accepted GST consequences for sellers and purchasers of properties sold subject to a lease (known as a reversionary interest).
Generally, a taxpayer may not claim GST credits on costs that relate to the making of input taxed supplies, such as the leasing of residential premises, but may claim GST credits on costs that relate to the making of GST-free supplies, such as selling residential premises as a going concern.
However, pursuant to Division 135 of the GST Act, if a taxpayer acquires a GST-free going concern and then makes input taxed supplies through that going concern (for example the lease of residential premises), the taxpayer will have an increasing adjustment, resulting in a GST cost.
An increasing adjustment is an amendment to a taxpayer’s BAS that increases GST payable. The GST cost referred to in the previous paragraph would be the GST payable on the sale of the going concern.
The MBI properties case dealt with a dispute about whether an increasing adjustment would apply where a taxpayer, MBI, acquired 3 serviced apartments as a going concern, that were subject to an existing lease to a hotel operator, MML.
The Full Federal Court had previously decided that no supply was made by MBI to MML; accordingly, there was no supply to which the Division 135 increasing adjustment could relate to. The Full Federal Court reached this decision on the basis that a supply by way of lease is when the lease is granted, and no subsequent supply is made when the reversionary interest is acquired.
The High Court disagreed with this approach and stated that, in regard to leases, generally at least two supplies are made – the first at the time of granting the lease, and the second throughout the course of the lease, by continually observing the tenant’s entitlement to quiet enjoyment of the property. The second supply can be made by an entity different to the one that originally granted the lease.
Therefore, the High Court found that MBI was making an input taxed supply of residential premises, by allowing MML quiet enjoyment of the property, and accordingly MBI had an increasing adjustment under Division 135.
What does this mean for you?
You may need to make a Division 135 increasing adjustment.
Commonly, property developers buy old hotels or apartment blocks, refurbish the rooms, and then lease out these new “apartments” to hotel operators to manage the apartments.
Investors who buy such apartments as going concerns should be aware of the various GST pitfalls if these apartments are acquired subject to leases.
Commissioner of Taxation v MBI Properties Pty Ltd  HCA 49