Edited version of private ruling

Authorisation Number: 1011624179458

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Ruling

Subject: GST and retirement villages and apportionment issues

Question 1

Is the proposed indirect outputs based methodology appropriate for the purposes of calculating the increasing adjustment under Division 135 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer 1:

No. An output based indirect method compares the projected economic benefits between the different revenue from input taxed and other supplies and relies on the proper characterisation of the transactions and calculation of amounts that are factored into the equation. We consider that there are some inconsistencies which will affect the accuracy/appropriateness of the proposed methodology. Therefore, the proposed methodology is not appropriate.

Question 2:

Should the increasing adjustment under Division 135 of the GST Act be attributed to the specified tax period?

Answer 2:

Yes, it is appropriate to attribute the increasing adjustment arising from your change of extent of creditable purpose, to the specified tax period provided your intention changed at that time and not at an earlier time. However, the initial adjustment that you were required to make under section 135-5 of the GST Act (in relation to the rental property) would be attributable to the tax period in which you acquired the GST-free supply of the going-concern.

Question 3:

Can the methodology proposed to calculate the Division 135 of the GST Act adjustment also be used to calculate your entitlement to future input tax credits under Division 11 of the GST Act?

Answer 3:

No. As there are inconsistencies in the proposed methodology, we consider that it is not fair or reasonable to calculate future input tax credits under Division 11 of the GST Act. Further, the Division 135 adjustment pertains to your acquisition of the enterprise that was supplied GST-free. For the purposes of Division 11 of the GST Act you will need to consider your extent of creditable purpose for the relevant acquisitions made.

Question 4:

Can the proposed methodology be used to calculate your GST credits relating to the acquisition of things that are used to make taxable, GST-free and input taxed supplies?

Answer 4:

No. The proposed methodology cannot be used to calculate your GST credits relating to the acquisition of things that are used to make taxable, GST-free and input taxed supplies.

Where the acquisitions can be directly allocated, then we consider that this would be more appropriate.

Note: It should be noted that this ruling does not consider whether the supply of the retirement village enterprise to you, was correctly characterised as a GST-free supply of a going-concern.

Relevant facts and circumstances

You are registered for GST and report on a quarterly basis.

You entered into a contract for the sale of land with a third party to acquire:

· land located in Australia (the Village);

· particular shares that confers certain rights; and

· a rental property located on the land.

You also entered into a second contract to acquire the business activities of another entity which relate to the retirement village enterprise.

The total consideration was:

· $X for the sale of the business; and

· $X for the sale of the land.

The 'additional clauses' to the contract for sale includes the following further defined terms:

Business sale contract;

Inclusions;

Property means the land comprising the titles referred to in Annexure A, the improvements, the Inclusions, any [X] licenses held in respect of the land but not the Sold Units.

Clause X of the 'additional clauses to the contract for sale provides that on completion the vendor will execute and deliver such documents as are reasonably required to transfer to the purchaser specified rights attaching to the property.

Annexure X is an Annexure to the Contract for the sale of land and outlines the 'warranties'. The relevant clauses for the purposes of this private ruling are:

Particulars of Properties

The particulars of the property set out in Annexure X will be true and correct in all respects at completion.

Property all land used

The property, the Sold Units, the [rental property] and the Community Centre are the only land and buildings owned used or occupied in connection with the operation of the Village;

The two contracts were entered into on a specified date with a completion date of XX.

The two contracts were supplied under an arrangement treated as a GST-free supply of a going-concern.

The development of the Village was not complete when it was acquired by you. The development is expected to be comprised of:

· X independent living units (ILUs);

· X serviced apartments (SAs); and

· a community centre.

The Village enterprise (operated by the previous owners) was operating under a particular model. You acquired the Village with the intention of continuing to operate the Village enterprise under that model. However, on a specified date you decided to complete the development for the purpose of operating and maintaining the Village using a loan/lease model.

As a result of changing your operating model, you changed your intention from making only taxable supplies to making mixed supplies.

At the time of this private ruling application, the development was partly completed.

Under the loan/lease model, you will offer the resident a lease to reside in either an ILU or a SA and the right to use all communal facilities within the Village. When the resident enters into the lease agreement, they will also enter into a loan agreement providing for the advancement of an interest free loan to you.

The resident will pay a variety of charges to you including:

(a) a departure fee

Clause X of the Loan/lease agreement requires the resident to pay a departure fee when they exit the Village.

(b) A recurrent fee, which is a contribution towards the operating costs and maintenance of the Village, including:

Audit fees; insurance; rates and taxes; electricity, gas and water; care attendants; cleaning; laundry; repairs and maintenance; security; administrative costs; management fees; general wages; gardening and restaurant service- including provision of three meals per day to SA residents.

(c) A contribution to the capital replacement fund (CRF)

o Clause X of the Loan/lease agreement requires a portion of the departure fee to be contributed to a capital replacement fund when the residents exit the Village; and

o the repair cost of any damage (other than wear and tear) to the unit caused by the resident or their guests will be the responsibility of the resident and will not be paid from the CRF.

Clause X states:

X The Operator will conduct a capital replacement fund (CRF) in accordance with the Act from time to time and the CRF shall be maintained at the sole and absolute discretion of the Operator, subject to the following:

(a) the Operator shall contribute a portion of departure fees from outgoing residents to the CRF as follows (unless and until the Operator discloses otherwise):

(i) For ILUs

(A) for the first X days after the Commencement date, X;

(B) for the X day after the Commencement date until the first anniversary date of the Commencement date, X% of the resale price; plus

(C) For each year from the first anniversary of the Commencement Date until the X anniversary of the Commencement date, X% for each year to a maximum of X%.

Included with the assets acquired by you, were shares in a company which controls certain rights. By acquiring these shares, you have certain entitlements.

The vendor is said to have previously derived passive income from the investment. The value of the shares has been determined to be approximately $X based on information from recent sales of related shares.

Also included within the assets acquired by you and pursuant to the land contract was a rental property located within the Village. The rental property was tenanted at the time of acquisition and continues to be tenanted.

The value of the rental property is approximately $X based on the amount of rent derived and the value of sales of similar properties in the area.

Your tax agent made certain contentions in relation to your proposed apportionment methodology:

Assumption

That the supply of the retirement village enterprise to you, met the requirements of section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 and was properly characterised as a GST-free supply.

Reasoning

You acquired a retirement village enterprise as a going-concern that was supplied under an arrangement that was treated as being GST-free. At the time that you acquired the enterprise, your intention was to make taxable supplies. However, in XX you decided to change to a loan/lease model. As a consequence, this will give rise to an increasing adjustment under Division 135 of the GST Act.

You are seeking advice regarding the operation of Division 135 of the GST Act, specifically to which tax period the adjustment is attributable and whether your proposed methodology is acceptable for calculating that adjustment.

To which tax period is the adjustment attributable?

You consider that as you acquired the enterprise with the intention of making only taxable supplies, section 135-5 of the GST Act does not apply and as you only changed your intention in XX and report on a quarterly basis, the adjustment should be reported in your XX BAS.

Under subsection 135-5(1) of the GST Act 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.

Division 135 of the GST Act does not contain any rules concerning the attribution of increasing adjustments that arise under section 135-5 of the GST Act. However, guidance is found in ATO ID 2007/72 which explains that an adjustment that arises under section 135-5 is attributable to the tax period in which the entity acquired the enterprise. This is because the intention of the recipient is determined at the time that the acquisition is made. As a consequence, an entity would attribute the increasing adjustment under section 135-5 to the tax period in which it acquired the enterprise as a going-concern.

One of the things supplied as part of the contract for sale, was a rental property. You consider that this property should be excluded from the calculation of the increasing adjustment under Division 135 of the GST Act as it was not part of the retirement village enterprise.

While you contend that this property was merely held as a passive investment, Annexure X to the contract for sale states that the rental property is part of the 'land and buildings owned used or occupied in connection with operation of the Village'. You advised that the rental property was tenanted when supplied and continued to be tenanted.

As you intended to (and did) use the rental property to make input taxed supplies of 'residential rent', and as the rental property was supplied to you GST-free (as a going-concern) then you would have an increasing adjustment under section 135-5 of the GST Act. This is irrespective of whether the rental property was part of the wider arrangement forming the retirement village enterprise, or if it was supplied separately.

Relevantly, Goods and Services Tax Ruling GSTR 2002/5 (which explains when a supply of a going-concern will be GST-free) states:

Supply of things in addition to those necessary for the continued operation of an enterprise

166. Supplies made under an arrangement, under which all of the things that are necessary for the continued operation of the 'identified enterprise' are supplied to the recipient, may each be the 'supply of a going concern' for the purposes of subsection 38-325(2). The arrangement to which the provision refers is the arrangement under which all of the things that are necessary for the continued operation of an enterprise is supplied (paragraph 38-325(2)(a)). It may include the supply of those things which, while not essential to the continued operation of the business, are utilised in the enterprise carried on by the supplier until the day of the supply (paragraph 38-325(2)(b)).

167. The relevant arrangement may be narrower than the arrangement entered into by the supplier and recipient. The arrangement may include a single supply, multiple supplies or part of a supply. What the relevant arrangement is will be a question of fact in each case and will depend upon what is the 'identified enterprise'.

168. The supplies made under the relevant arrangement are those which are capable of being GST-free. Supplies which are not made under the relevant arrangement, even if made under the wider arrangement, are not GST-free as supplies of going concerns.

169. If part of a supply is under the relevant arrangement and part is not, section 9-80 provides a method of apportionment of the GST-free part and the taxable part.

Example 29: supply of things not under the relevant arrangement

170. A motor mechanic contracts to sell his motor repair business, including the building from which it operates, and a residence located on an adjoining block in which he lives. The supply of the business and any related buildings is a supply under the relevant arrangement. The supply of the residential premises is neither the supply of a thing which is necessary to the continued operation of the 'identified enterprise', nor the supply of a thing used in carrying on the enterprise until the day of the supply. Therefore it is not a supply under the relevant arrangement.

We consider that the rental property can be distinguished from the above example, as according to the contract for sale, it was property that was 'owned, used or occupied in connection with the operation of the Village' and therefore was held as part of the 'relevant enterprise' that was supplied as a going-concern. Consequently, it is not appropriate to exclude the rental property from the calculation of the Division 135 of the GST Act adjustment.

Even if we were to accept your contention that the rental property was separate from the retirement village enterprise, the activity of renting the property is still an activity that falls within the definition of 'enterprise' as it is done on a regular or continuous basis in the form of a lease, licence or other grant of an interest in property (paragraph 9-20(1)(b) of the GST Act). As the rental property was supplied tenanted, it is an enterprise that was capable of being supplied as a separate enterprise. As this 'rental' enterprise is something that could be and was supplied as a GST-free supply of a going-concern and as you acquired the enterprise with the intention of making input taxed supplies (that is, supplies that are neither GST-free or taxable), then this would give rise to an initial adjustment under section 135-5 of the GST Act to this extent.

Therefore, you were required to make an increasing adjustment under section 135-5 of the GST Act in relation to the rental property and the adjustment would be attributable to the tax period in which you acquired the enterprise GST-free.

We acknowledge that at the time that you acquired the retirement village enterprise, your intention was to continue to make taxable supplies.

Under section 135-10 of the GST Act, further adjustments may be required during the period that would be permitted under Division 129 of the GST Act for changes in the extent of creditable purpose.

Section 135-10 of the GST Act provides that the recipient of a supply of a going concern which is GST-free would have such an adjustment to the extent that their application of the enterprise relates to supplies that are neither taxable nor GST-free.

As you changed your intention when you moved to the loan/lease model, your supplies of the residential premises would be input taxed under section 40-35 of the GST Act. As a consequence, an increasing adjustment would arise under subsection 135-10 of the GST Act to account for the change in your 'extent of creditable purpose'.

On the understanding that your intention only changed in XX and as you report on a quarterly basis, then we agree that the section 135-10 of the GST Act adjustment is attributable to the quarterly tax period ending XX.

Is your proposed methodology for calculating the adjustment acceptable?

Subsection 135-10(1) of the GST Act provides that:

If you are the recipient of a supply of a going concern, or supply that is GST-free under section 38-480, Division 129 (which is about changes in the extent of creditable purpose) applies to that acquisition in relation to:

(a) the proportion of all the supplies made through the enterprise that you intend will be supplies that are neither taxable supplies nor GST-free supplies; and

(b) the proportion of all the supplies made through the enterprise that are supplies that are neither taxable supplies nor GST-free supplies.

Subsection 135-10(2) of the GST Act provides that for the purpose of applying Division 129 of the GST Act, the proportions referred to in paragraphs 135-10(1)(a) and 135-10(1)(b) of the GST Act are to be expressed as percentages worked out on the basis of the prices of the supplies in question.

Your tax agent proposes that the calculation should be:

1/10 x $X x (X% -X%)= $X

In determining the purchase price, your tax agent has added together the two amounts in the sale of business contracts ($X) and the sale of land contract ($X) and deducted the value of the rights ($X) and the rental property ($X).

The Contract for sale of land shows that the property was sold for a price of $X. The Additional Clauses to the Contract define the 'property' to include [specified] licences held in respect of the land but not the sold units'. Clause X provides that on completion, the vendor will execute the transfer of the specified rights attaching to the property. Annexure X states that the rental property is part of the land and buildings owned, used or occupied in connection with the operation of the Village. These facts support that the specified rights and the rental property was part of the arrangement that was supplied as a going-concern. Consequently, for the purposes of calculating the section 135-10 of the GST Act adjustment it would not be appropriate to exclude the part of the purchase price pertaining to the rental property from the calculation.

With respect to the specified rights, you contend that these were held as a passive investment. However, the shares are more than just a passive investment as you secure the use of things through those shares. This supports that the specified rights form part of the 'relevant arrangement' that was supplied as a GST-free supply of a going-concern. Therefore, it is not appropriate to exclude the specified rights when calculating the section 135-10 of the GST Act adjustment.

We will now consider whether the basis of the proposed methodology is acceptable.

Should the advancement of the interest-free loan be excluded from the calculations?

An entity may choose its own apportionment method but the method must be fair and reasonable in the circumstances of the enterprise (paragraph 32 of GSTR 2006/4).

GSTR 2010/D1 proposes that the following formula represents a fair and reasonable method of calculating the extent of a developer's creditable purpose for development acquisitions.

Estimated taxable or GST-free consideration

Estimated taxable or GST-free consideration + estimated input taxed consideration

This method, as outlined in GSTR 2010/D1, is an output based indirect method and compares projected economic benefits obtained from leasing activities with projected economic benefits from sale.

While the above formula refers to development acquisitions and sale of a Village, the underlying principles in GSTR 2010/D1 for determining the extent of creditable purpose are equally relevant to this case.

Face value of ingoing contribution

In circumstances where a village is being sold, the purchaser provides the vendor with a benefit of assuming responsibility for repaying ingoing contributions received by the vendor which have not been repaid before the time of sale. As the vendor is not required to repay the ingoing contributions that it has received, there is a direct and economic benefit for the vendor. For this reason, paragraph 24 of GSTR 2010/D1 concludes that the face value of the ingoing contributions should be included in the apportionment calculation (provided that consistent with that approach, they are to be included in the calculation for the supply of the village). Effectively, the selling price for the Village is 'grossed up' to include the ingoing contributions that are held and retained by the vendor.

However, in this case the Village is not being held for sale, rather it is being held and operated under a loan/lease model. We consider that in these circumstances it is not appropriate to include the face value of the ingoing contributions in the calculations. As the formula is aimed at determining the proportion of taxable or GST-free supplies as a proportion of the total supplies made by the operator of the retirement village in running/operating the Village, including the face value of the ingoing contributions would artificially inflate the consideration for 'input taxed supplies'. As this would be a distorting factor, we consider that the face value of the ingoing contributions should not be included in the calculation of the consideration for input taxed supplies in your circumstances.

Benefit of ingoing contribution interest-free

Paragraph 25 and 26 of GSTR 2010/D1 explain that the consideration for input taxed supplies includes the value of all benefits a developer obtains from input taxed leasing of the Village before sale. This includes the benefit of having the ingoing-contributions interest-free.

Paragraph 30 of GSTR 2010/D1 states:

An output based method which disregards the advantage of having interest-free loans is not fair and reasonable because it does not take into account all significant economic benefits obtained by the developer as a direct result of making input taxed supplies.

Where the entry contribution is provided either interest-free or at an interest rate less than the market value, the operator receives a direct benefit from the use of that money, and this should be taken into account for the purposes of the apportionment formula.

Similarly, there is a significant economic benefit that you gain from having the use of the interest-free loan in the operation of the retirement village under the loan/lease model. Consequently, when calculating the consideration for input taxed supplies you will need to include the benefit of having access to the ingoing contributions amounts interest-free.

This benefit can be valued using a reasonable estimate of the additional financing costs you would incur over the relevant period if you borrowed an amount equal to the ingoing contribution at arm's length. The Commissioner will accept a calculation that relies on the base interest rate used to calculate the general interest charge (see paragraphs 25 and 26 of GSTR 2010/D1.)

Deferred management fees payable by a resident on exit

The Tax Office considers that the deferred management fees form part of the consideration payable by residents for the premises. In a freehold situation, where the supply to the resident was a taxable supply of new residential premises, then the DMF would form part of the consideration for that taxable supply. This is irrespective of the fact that the requirement to pay the DMF crystalises at a future point in time. As subsequent sales of the unit would be an input taxed supply of residential premises, it follows that the DMFs payable by the subsequent residents of that unit would not be subject to GST.

In a leasehold situation, the deferred management fees form part of the consideration for the lease of the ILUs to the residents. It follows that under a loan/lease model the DMF would form part of the consideration for 'input taxed' supplies.

It is only the DMFs that have crystalised that should be included in the formula.

Capital replacement fund

According to the terms of the Residents' Agreement, the operator is required to contribute a proportion of the departure fees received from outgoing residents to the CRF. The operator may use this fund for the replacement of all items of capital in the Village for which the operator is responsible under the retirement village Act, for structural repairs and alterations, unplanned maintenance, installation of new items of capital, for the maintenance of gardens of the units in the Village (apart from rear gardens which are the resident's responsibility), and to refurbish units in the Village upon the permanent vacation of a unit by a resident.

According to the relevant regulatory requirements in your State it is the responsibility of the operator to pay for the cost of replacing capital items for which they are responsible and to pay for the replacement of such items out of its own funds. Proposed annual budgets cannot include an allowance for replacing such items, either directly or through depreciation (with only one exception).

In this case, according to clause X of the Residents' Agreement, the operator is required to contribute a portion of the departure fees from outgoing residents to the CRF. We understand that there is no separate fee that is payable by the resident as a contribution to the CRF. Consequently, we consider that the contributions to the CRF are not consideration for separate supply, as it is a portion of an amount already received from the resident that is simply put into a separate account to fund future capital expenditure. We consider that this amount is not additional consideration for the residential premises or the services and facilities provided to residents. Therefore, it should not be separately accounted for in the formula (as it has already been factored into the calculations).

Recurrent fees

The recurrent fee is a contribution towards the operating costs and maintenance of the Village. According to the Loan and Lease Agreement, the term 'recurrent charges' is the total amount paid by the resident as the resident's proportion of the Village expenditure under Part X.

Clause X outlines what is included in the Village Expenditure. These include (amongst other things) insurance premiums for insurance of the Village, its buildings etc.; rates and taxes payable by the owner; payroll tax; any costs incurred by the operator in connection with the maintenance, repair, cleaning and operation and upkeep of any premises in the Village which is the responsibility of the operator under the Act.

Therefore, the recurrent fees represent consideration for various supplies that you make in operating the Village.

Where the recurrent fees relate solely to making to input, GST-free or taxable supplies, then they should be allocated directly.

However, to the extent that the recurrent fees represent consideration for both input taxed and GST-free or taxable supplies then we agree that it is appropriate to apportion the consideration. You propose to use a 'variety of methods' but have not provided any detail regarding the basis of these methods. Consequently, we cannot confirm whether your proposed method of calculating these amounts is correct.

Reinstatement costs

The reinstatement costs relate to the refurbishment or repair of units to restore them to a suitable condition prior to being leased to an incoming resident. You propose to allocate the reinstatement costs for the ILUs to 'input taxed' and the reinstatement costs for SAs to GST-free.

If you elect to use an outputs based method, then we agree with the proposed allocation as the reinstatement costs form part of the costs you incur and on-charge as part of the supply of the units. However, for the reasons already stated, we consider that it is not appropriate to include the SAs in the calculation of the Division 135 of the GST Act adjustment as there are currently no SAs within the Village.

Irrespective, we consider that the reinstatement costs should be readily allocated to the different accommodation types (ILUs and SAs). Where these amounts can be directly allocated, then we consider that this is a more appropriate method as it will provide a result that is more proximate to the actual supplies made than your proposed method of dividing the average turnover of ILUs by the total average turnover and multiplying by the total reinstatement costs.

Water rights and rental property

Please refer to earlier discussion.

Apportionment methodology for future acquisitions

You asked whether the proposed methodology can also be used to calculate your GST credits relating to the acquisition of things that are used to make taxable, GST-free and input taxed supplies.

We consider that it is not appropriate to use the proposed methodology to calculate your extent of creditable purpose for Division 11 or Division 129 of the GST Act purposes.

In addition to the reasons already provided as to why the proposed methodology is not appropriate, we provide the following comments.

While section 135-10 of the GST Act provides that Division 129 of the GST Act will apply where there is a subsequent change in the extent of creditable purpose, the adjustment arises in respect of the thing that was acquired, which is the enterprise (together with all the things supplied under that arrangement) that was supplied as a going-concern.

For Division 11 of the GST Act purposes it is necessary to consider the intended use of each acquisition that you make to determine the extent of creditable purpose. Division 129 of the GST Act then accounts for any change in extent of creditable purpose.

Further, as the Village is still under development and as you are currently operating under two different models and you are moving towards a single loan/lease model, this will affect the extent to which your acquisitions are made for a creditable purpose.

Also, as there are no SAs currently in the Village, nor is there any immediate plan to develop the SAs, it is arguable that your acquisitions would relate to making GST-free supplies to any extent.

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