Margin Scheme Strategy

Question

Have client purchased residential property with house December 1997 for around $180,000 (using Company Structure, in business code “on tax returns” of rental/lease of no residential properties ie owns 3 other commercial properties leased).
Property (land) price now valued around $600,000
Rented the Residential House on and off most of the period up to 2019.
Had property listed with real estate agents for last few years without success.
House was run down so no rental interest and no sale offers.
Decided to demolish home and start construction of initially 2 units and then 2 more units once first 2 sell to recoup investment in the current climate.
Put in application to shire but no change in title until construction complete.

Have now been offered by a GST registered buyer:
1) To take over construction contract in full $899,000 (contractor will refund progress payments to date)
2) Purchase property at agreed market value $600,000 using margin scheme
3) Buyer will pay via Tax invoice to Seller (Company ) initial startup costs like application fee, architect fee, project management etc to compensate for these costs (around $100,000) plus GST.

Do you see any complications or adverse tax scenarios playing out with this type of arrangement of breaking the components in 3 separate transactions up like outlined or should an alternative method be considered?


Answer

I assume buyer and seller are not associates.

Got distracted seeing if no GST could possibly apply to the sale

Subsection 9-30(4) of the GST Act states:

A supply is taken to be a supply that is input taxed if it is a supply of anything (other than new residential premises) that you have used solely in connection with your supplies that are input taxed but are not financial supplies.

This has potential to cover vacant land and is discussed in ID 2009/20 https://www.ato.gov.au/law/view/document?LocID=%22AID%2FAID200920%22&PiT=99991231235958 and ID 2009/19 https://www.ato.gov.au/law/view/document?Mode=type&TOC=%2205%3AATO%20interpretative%20decisions%3ABy%20year%3A2009%3A1-99%3A%230019%23ATO%20ID%202009%2F19%20-%20GST%20and%20sale%20of%20vacant%20land%20used%20in%20connection%20with%20input%20taxed%20supplies%20and%20property%20development%20activities%3B%22&DOCID=%22AID%2FAID200919%2F00001%22
Your client is ahead of these examples because they were not in the business of development originally but the problem is that they have done something more than just disconnect the services and let someone else remove the house. There is also a big gap between it being used for input taxed purposes and they did dabble in the development process, they would have to argue that the council approval was merely to enhance the value for sale. All in all I agree with your conclusion already, that GST does apply to this sale.

Regarding using the margin scheme.

On pre 2000 properties you need to set the amount that is the base ie the GST exempt portion, the difference between this and the selling price is the margin. This is the value of it at 30th June, 2000 or when your client first became registered for GST, whichever is the latter. GSTR 2000/21 details how to set the value as at 30th June, 2000 or when you first became registered.

I can see that there is an advantage as the developer would be selling to home owners who will not be entitled to claim the GST back. Keeping the figures really simple

Value in 2000$200,000
Sale Price$640,000
Margin$440,000
GST Payable$40,000

Developer can’t claim that GST Back

When developer sells each of the 4 units for say $710,000

Base $640/4 $160,000
Sale Price$710,000
Margin $550,000
GST Payable$50,000

but also paid $10,000 more for land ($40,000 GST/4) originally because didn’t claim GST back. So under this process $60,000 in GST paid to ATO that cannot be claimed back by anyone on each of the units.

Alternatively GST charged as normal ie no margin scheme which means developer can’t use margin scheme

Sale Price$660,000
GST Payable$60,000

Buyer gets GST back so only pays $600,000 and seller ends up with $600,000 the same amount as they would have under the margin scheme for $640,000

When developer sells for $710,000 because that is what the market will bear. Home owners will pay the same price regardless of whether seller pays GST or not.

GST on $710,000 is $64,545 that no one can claim back

Constructions costs etc GST can be claimed back.

There would also be a stamp duty saving for the developer because the margin scheme will mean a lower contract price.

So some savings simply because the developer gets to use the margin scheme. I can see why they want to pay for as much as they can separate from the land so they get the best of both worlds. Using the margin scheme and still getting the GST back on initial development costs.

You need to be very careful to make sure your client effectively recovers the GST they are paying else they would be better off charging GST and the developer claiming it back.

The developer will get the ability to use the margin scheme when they sell but in the meantime the land has tied up more cash than would be if full GST is charged and claimed back. This is the developers concern not yours. In your client’s case I would quote two prices after working out exactly how much GST is involved in the margin scheme. Set the cash your client is to put in their pocket after the sale. Then increase it by 10% if the developer decides they are happy to pay GST and claim it back. If the developer wants to use the margin scheme then the price needs to increase by the GST on the margin.

Initially I was a bit uncomfortable with this arrangement, it minimises taxes and that is the only justification. I doubt your client could be seen to be doing the wrong thing anyway, they are not the one subject to stamp duty and they are paying their GST.

Working through all this just looking at it from your clients point of view and the fact that they are selling to someone who is registered for GST, can claim it and understands the process so there is no opportunity to get a better price. GST is just going to be an add in. The only wriggle room is the calculation of the value of the property at 30th June 2000 or when they registered.

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