Edited version of your written advice

Authorisation Number: 1051368558802

Date of advice: 20 June 2018

Ruling

Subject: Goods and services tax (GST) and the sale of a going concern and the margin scheme

Question 1

Whether the supply of the properties (the Properties) from Entity A Pty Ltd (Entity A) to Entity B Pty Ltd (Entity B) is a GST-free supply of a going concern under section 38-325 of A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer 1

Yes, the supply of the Properties from Entity A to Entity B is a GST-free supply of a going concern under section 38-325 of the GST Act.

Question 2

When Entity B makes taxable supplies of subdivided lots from the Property, can it use $XXX amount (i.e. the consideration Entity A paid to acquire the property) to calculate its margins under section 75-10 and sub-paragraph 75-11(5)(e)(ii) of the GST Act?

Answer 2

Yes, when Entity B makes taxable supplies of subdivided lots from the Property, Entity B can use $XXX amount (i.e. the consideration Entity A paid to acquire the property) to calculate its margins under section 75-10 and sub-paragraph 75-11(5)(e)(ii) of the GST Act.

Relevant facts and circumstances

Entity A and Entity B are involved in a proposed property transaction.

Entity A’s acquisition of the development property

Entity A purchased the development at the Property from Entity D during year XXXX. The purchase price was $XXX amount. The Property is comprised of approximately XXX hectares.

When Entity A acquired the Property from Entity D, it received:

(a) freehold interest in the Property;

(b) development approvals relating to the Property, in particular a Ministerial development approval for reconfiguration of a lot in stages (development permit) and operational works (preliminary approval) pertaining to a proposed master planned community over part of the Property (Ministerial Approval);

(c) a development application pertaining to the proposed village centre over part of the Property;

(d) the development and marketing materials and various intellectual property in those materials;

(e) the intellectual property;

(f) any operational works permits relating to the Property;

(g) water licences;

(h) key financial schedules as detailed in the contract.

Entity D also assigned Entity A’s rights and obligations under an existing lease to a third party to use the Property, primarily for agisting activities.

Before settlement, Entity D and Entity A had a written agreement that the supply would be a GST-free supply of a going concern. Both Entity D and Entity A were registered for GST at settlement.

By deed of variation signed in year XXXX, the parties agreed to apportion the purchase price as follows:

(a) $XXX amount for the freehold interest in the land; and

(b) $XXX amount for the other components of the enterprise.

(c) continuing development

Entity A acquired the Property as an enterprise during year XXXX. A rebranding exercise for the development was undertaken and marketing conducted.

Since its acquisition of the Property, Entity A has made amendments to the development approvals. This has primarily been motivated by:

(a) the ecologically fragile nature of the area; and

(b) the need to reconfigure the proposed sale lots to match changes in consumer demand following the downturn in the property market.

In particular, Entity A sought to change the development to better reflect the current market and community expectations. Entity A’s application was a movement away from a denser built-form residential development to a less dense residential development of detached dwellings.

Entity A continued to make financial investment in the delivery of this development project through their continued commitment to obtain various necessary operational works approvals.

Entity A engaged consultants to develop a strategy to fulfil the delivery of Stage X to plan sealing in a coordinated manner, requiring the preparation of new and updated management plans required by condition X of the Ministerial Approval as well as the amendment of various related operational works approvals through the permissible change process.

The updated management plans and amendments to the Stage X operational works approvals are close to completion.

The first stage of the development pursuant to the Ministerial Approval must be completed by XX date/XX month/XXXX year.

Entity A’s continuing licence arrangements

Entity A continued the licence arrangements the previous owner Entity D for some time.

The original term of the licence was XX years.

Entity A’s proposed sale of the Property to Entity D

On XX date/XX month/XXXX year, Entity A received an offer from Entity X to purchase the Property.

Entity A and Entity X are currently in the final stages of drafting the contract for the sale of the Property.

Entity X has nominated Entity B, a wholly owned subsidiary of Entity X, as the purchasing entity and the details are as per below:

● The proposed purchase price is $XXX amount.

● The proposed settlement date is XX date/XX month/XXXX year.

The sale to Entity B will include:

(a) the Property (freehold title);

(b) development approvals (including the Ministerial Approval and all operational works approvals) relating to the Property and materials relating to the same;

(c) development applications relating to the Property and materials relating to the same;

(d) the development and marketing materials including transfer of the business names;

(e) an assignment of rights and obligations under the Occupation Licence.

Entity B is currently registered for GST and has an ABN.

Until settlement, Entity A will continue to undertake activities in relation to the development of the Property. For example, Entity A will continue to:

(a) contract with professional consultants in relation to how conditions of approval can be satisfied;

(b) engage consultants to finalise the updated management plans and amendments to the operational works approvals; and

(c) engage with Council to confirm the fees required for lodgement of the relevant documentation, and then lodge the applications and monitor and respond to any council requests in respect of the applications.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-20

A New Tax System (Goods and Services Tax) Act 1999 Section 75-10

A New Tax System (Goods and Services Tax) Act 1999 Subsection 75-10(1)

A New Tax System (Goods and Services Tax) Act 1999 Subsection 75-10(2)

A New Tax System (Goods and Services Tax) Act 1999 Subsection 75-11(5)

A New Tax System (Goods and Services Tax) Act 1999 Section 75-14

A New Tax System (Goods and Services Tax) Act 1999 Sub-paragraph 75-11(5)(e)(ii)

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

A New Tax System (Goods and Services Tax) Act 1999 Section 38-325

A New Tax System (Goods and Services Tax) Act 1999 Subsection 38-325(1)

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 38-325(2)(a)

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 38-325(2)(b)

Reasons for decision

Summary

The two key issues in this case are in relation to the sale of a GST-free going concern and the margin scheme.

1. We consider that the supply of the Property from Entity A to Entity B is a GST-free supply of a going concern under section 38-325 of the GST Act.

2. We consider that when Entity B makes taxable supplies of subdivided lots from the Property, Entity B can use $XXX amount (i.e. the consideration Entity A) paid to acquire the property) to calculate its margins under section 75-10 and sub-paragraph 75-11(5)(e)(ii) of the GST Act.

Detailed reasoning

In the reasoning unless otherwise stated,

● all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

● all reference materials referred to are available on the Australian Taxation Office (ATO) website www.ato.gov.au

● all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act

1. The supply of a going concern

You must pay the GST payable on any taxable supply that you make.

Section 9-5 states that you make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that you *carry on;

and

(c) the supply is *connected with the indirect tax zone; and

(d) you are *registered, or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

A supply is a GST-free supply of a going concern when all of the requirements of section 38-325 are satisfied.

Section 38-325 states:

(1) The *supply of a going concern is GST-free if:

(a) the supply is for *consideration; and

(b) the *recipient is *registered or *required to be registered; and

(c) the supplier and the recipient have agreed in writing that the supply is of a going concern.

(2) A supply of a going concern is a supply under an arrangement under which:

(a) the supplier supplies to the *recipient all of the things that are necessary for the continued operation of an *enterprise; and

(b) the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as a part of a larger enterprise carried on by the supplier).

Enterprise’ is relevantly defined in section 9-20:

Enterprises

(1) An enterprise is an activity, or series of activities, done:

(a) in the form of a *business; or

(b) in the form of an adventure or concern in the nature of trade; or

(c) on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property; or

…

‘Carrying on’ an enterprise includes doing anything in the course of the commencement or termination of the enterprise pursuant to section 195-1.

A two-step approach is required to determine firstly, whether the supply is a supply of a going concern and if it is, whether the supply of the going concern is GST-free.

Goods and Services Tax Ruling GSTR 2002/5 Goods and services tax: when is a ‘supply of a going concern’ GST-free? explains what is a ‘supply of a going concern’ and also when the ‘supply of a going concern’ is GST-free.

Subsection 38-325(2) requires:

● an arrangement

● an identified enterprise

● that the supplier supplies all things necessary for the continued operation of the enterprise, and

● the supplier carries on, or will carry the enterprise until the day of the supply.

Supply under an arrangement

It is not a supply itself that must satisfy the requirements of paragraphs 38-325(2)(a) and (b), but the arrangement under which the supply is made.

Paragraphs 19 and 20 of GSTR 2002/5 state:

19. A supply is defined in section 9-10. The term 'supply under an arrangement' includes a supply under a single contract or supplies under multiple contracts which comprise a single arrangement. However, the things supplied under the arrangement must relate to the same enterprise, that is, the enterprise referred to in paragraphs 38-325(2)(a)and (b) (the 'identified enterprise').

20. The supplier and the recipient may identify the arrangement and the supplies under the arrangement, which in aggregate, may comprise the 'supply of a going concern', in the written agreement which is required under paragraph 38-325(1)(c) or in any other written agreement that relates to the arrangement entered into on or prior to the day of the supply. (…). However, an arrangement between a supplier and a recipient is characterised not merely by the description which both parties give to the arrangement, but by objectively examining all of the transactions entered into and the circumstances in which the transactions are made…

Leasing enterprise

In relation to the issue of leasing enterprise, GSTR 2002/5 relevantly states:

Supply of Right to Occupy Premises

58. Many enterprises operate from leased premises. The supplier may supply the lease either by assignment or by surrendering the lease and facilitating the entry by the recipient into a lease or agreement to lease the same premises by the day of the supply.

…

Periodic Tenancies and Tenancies at Will Circumstances

64. Where a supplier occupies premises pursuant to a mere tenancy at will, e.g., during a brief holding over upon expiration of a lease and pays no rent, the supplier is unable to supply those premises because a tenancy at will is not capable of assignment. If the premises occupied under a tenancy at will are a thing necessary for the continued operation of the relevant enterprise, the supplier is not able to make a supply of a going concern.

65. However, if upon expiration of a lease, the tenant is allowed to continue in possession pursuant to a short term periodic tenancy, the new periodic tenancy may be capable of assignment. A periodic tenancy means that the tenant pays rent to the landlord with reference to a period and therefore has a legally enforceable right to occupy the premises for the period.

…

Example 9: Leasing enterprise without written lease agreement

69. DiggerCo owns a parcel of land from which a car yard is operated by Beaut Cars Co (BCC). The two companies have common directors. BCC occupies the premises on a periodic basis with rent paid monthly in advance. Because of the commonality of directors, no formal lease agreement for occupation was ever entered into. BCC pays a commercial rate of rent on a monthly basis in advance.

70. RE Pty Ltd wishes to buy the property and will allow BCC to continue to occupy the premises under the same tenancy arrangements currently in existence. DiggerCo can supply the enterprise of leasing of this property to RE Pty Ltd as a going concern, provided the current periodic tenancy has not terminated and will continue.

From the information that you provided, Entity A is carrying on two separate enterprises that relate to the Property.

1. Entity A is carrying on a property development enterprise, which is ‘a series of activities, done… in the form of a business’

2. Entity A is also carrying on ‘an activity, or series of activities, done… on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property’

The two separate enterprises as described respectively per above satisfy section 9-20.

From the information that you provided, the requirements in subsection 38-325(1) are met for the reasons below:

a) the supply of the Property is for consideration, the purchase price of $XXX amount

b) the recipient Entity B, is registered for GST

c) the supplier Entity A and Entity B of the Property have agreed in the terms of the draft contract that the supply is of a going concern.

Identified enterprise

Paragraph 29 of GSTR 2002/5 provides that subsection 38-325(2) requires the identification of an enterprise that is being carried on by the supplier (the ‘identified enterprise’). This is the enterprise for which the supplier must supply all of the things that are necessary for its continued operation. The supplier must also carry on this enterprise until the day of the supply, whether or not as part of a larger enterprise.

The term ‘enterprise’ is defined in section 9-20 and includes amongst other things, an activity, or series of activities, done on a regular or continuous basis, in the form of a business.

All things necessary

The meaning of the phrase ‘all of the things that are necessary for the continued operation of an enterprise’ is considered in paragraphs 74 and 75 of GSTR 2002/5, which state:

74. The supplier is required to supply to the recipient all of the things that are necessary to carry on the 'identified enterprise' so that the recipient is put in a position to carry on the enterprise if it chooses.

75. Two elements are essential for the continued operation of an enterprise:

● the assets necessary for the continued operation of the enterprise including, where appropriate, premises, plant and equipment, stock-in-trade and intangible assets such as goodwill, contracts, licences and quotas; and

● the operating structure and process of the enterprise consisting of the commercial or economic activity relevant to the type of enterprise being conducted, for example, ongoing advertising and promotion.

Paragraphs 90 through 99 of GSTR 2002/5 provide that where premises are necessary for the continued operation of an enterprise, these premises, or a right to occupy these premises must be supplied for the supply to qualify as a GST-free supply of a going concern

Nature of the first identified enterprise and all of the things that are necessary for the continued operation of the property development enterprise

From the information you have provided, the first ‘identified enterprise’ is a property development enterprise; specifically, the development of the Property into a master planned residential subdivision.

Entity A acquired the Property from Entity D as a property development enterprise

Entity A’s development activities have a significant commercial purpose and character as:

● they have been undertaken by Entity A with the intention to make a profit, even though it would take some time for this to occur due to the scale of the project; and

● Entity A has invested significant time and funds in the process of planning the development, consulting with professionals and amending development approvals to better reflect current market and community expectations with a view to maximising its return from the development;

● developing the Property into a new master planned community in an area of significant population growth in the area had strong prospects of profit for Entity A;

● the activities involved in obtaining approvals and planning the development have been carried out in a similar manner to the activities of other large-scale property developments;

● Entity A’ s development activities have been planned, organised and carried on in a business-like manner – they have been undertaken in a systematic and organised way rather than on an ad hoc basis; and

● the development activities are on a very large scale to produce a community of XXX dwellings.

Although operational works have not yet commenced, ‘carrying on’ an enterprise includes activities involved in the commencement of the enterprise. Entity A’s preparatory activities in relation to obtaining development plans and approvals (which are essential before construction can begin) are therefore part of carrying on Entity A’s property development enterprise.

The sale to Entity B will include:

● the Property (freehold title);

● development approvals (including the Ministerial Approval and all operational works approvals) relating to the Property and materials relating to the same;

● development applications relating to the Property and materials relating to the same;

● the development and marketing materials including transfer of the business names;

● an assignment of Entity A’s rights and obligations under the Occupation Licence.

● Our view is that the ‘things that are necessary’ for the continued operation of the property development enterprise include:

● the freehold title to the Property;

● the development plans, approvals and applications, including the benefit of all of the professional reports held by Entity A; and

● the benefit of the marketing materials that have already been developed.

● The ‘day of the supply’ is the settlement date (XX date/XX month/XXXX year). On this date, Entity B will assume effective control of the Property and all of the materials necessary for the continued operation of the enterprise.

● Entity A will continue to carry on the enterprise by contracting with professional consultants up until the day of supply. It will not merely be waiting for settlement of the contract – it will continue to actively pursue the completion of the pre-construction stage of the development process until the settlement date.

From the information you provided, the requirement under paragraph 38-325(2)(b) will therefore be satisfied in relation to the first identified property development enterprise.

Nature of the second identified enterprise and all of the things that are necessary for the continued operation of the licensing enterprise

From the information you have provided, the second ‘identified enterprise’ is the licencing enterprise in relation to the Property.

The Property has been licenced on a regular and continuous basis since XX date/XX month/XXXX year.

In your case, the existing licence is a periodic licence capable of assignment, will be assigned by Entity A to Entity B at settlement. This is achieved by the clause in the contract requiring Entity A to execute a covenant under which it will become bound by the Occupation Licence upon settlement (consistent with the terms of the Occupation Licence itself).

At that time, Entity B will acquire all the rights and obligations that Entity A held under the licence. It will therefore hold all of the things necessary for the continued operation of the licencing enterprise on the Property. The existing Occupation Licence will be assigned to Entity B at settlement. Further, Entity A will not terminate the licence prior to that date. It will therefore carry on the licencing enterprise up until the day of supply.

From the information you have provided, the second identified licencing enterprise will satisfy the requirements under both paragraph 38-325(2)(a) and paragraph 38-325(2)(b) respectively.

Paragraph 18A GSTR 2002/5 provides:

18A. Paragraph 9-10(2)(h) contemplates that two or more things listed in paragraphs 9-10(2)(a) to 9-10(2)(g) can be a single supply. This lends contextual support to the view that a number of things supplied under an arrangement that satisfies the requirements of subsection 38-325(2) can be characterised as one ‘supply of a going concern’.

Consequently, upon settlement, the supply of the first identified ‘property development enterprise’ and the supply of the second ‘identified licensing enterprise’ will both meet the requirements for a GST-free supply of a going concern for the purposes of section 38-325. However, for the purposes of the going concern under section 38-325, you can aggregate the property development enterprise supply and the licencing enterprise supply, that is 2 supplies and treat them as one supply of a going concern.

2. The margin scheme

Section 75-10 provides the general rule for calculating the margin using the margin scheme.

(1) If a *taxable supply of *real property is under the *margin scheme, the amount of GST on the supply is 1/11 of the *margin for the supply.

(2) Subject to subsection (3) and section 75-11, the margin for the supply is the amount by which the *consideration for the supply exceeds the consideration for your acquisition of the interest, unit or lease in question.

Relevantly, subsection 75-10(1) provides that the amount of GST on a taxable supply of real property made under the margin scheme is 1/11th of the margin for the supply.

In circumstances where subsection 75-10(2) applies, the margin for the supply is the amount by which the consideration for the supply exceeds the consideration for the acquisition of the real property in question.

In relation to the GST-free going concern which applies to your case, subsection 75-11(5) relevantly states:

(5) If:

(a) you acquired the interest, unit or lease in question from an entity as, or as part of:

(i) a *supply of a going concern to you that was *GST-free under Subdivision 38-J; or

(ii) a supply to you that was GST-free under Subdivision 38-O; and

(b) the entity was *registered or *required to be registered, at the time of the acquisition; and

(c) none of subsections (1) to (4) applies;

the margin for the supply you make is the amount by which the *consideration for the supply exceeds:

…

(e) if that entity had acquired the interest, unit or lease on or after 1 July 2000 and had been registered or required to be registered at the time of the acquisition:

(i) if the entity's acquisition was for consideration and you choose to apply an approved valuation to work out the margin for the supply--an approved valuation of the interest, unit or lease as at the day on which the entity had acquired it; or

(ii) if the entity's acquisition was for consideration and subparagraph (i) does not apply--that consideration; or

(iii) if the entity's acquisition was without consideration--the GST inclusive market value of the interest, unit or lease as at the time of the acquisition…

(Emphasis added)

The effect of subparagraph 75-11(5)(e)(ii) is that, when the purchaser of a property as a GST-free going concern later supplies the property to a third party, the margin for the margin scheme is calculated as follows:

Margin = consideration for supply – consideration for vendor’s acquisition

From the information you have provided, we consider that Entity A’s supply of the Property to Entity B is a GST-free supply of a going concern for:

(1) the supply of the property development enterprise

(2) the supply of the licencing enterprise

The Goods and Services Tax Ruling 2006/8: Goods and services tax: the margin scheme for supplies of real property acquired on or after 1 July 2000 explains how the GST Act applies to a supply of freehold interest, stratum unit, or long term-lease acquired on or after 1 July 2000. Paragraphs 54-58 of GSTR 2006/8 have been reproduced below:

The effect of section 75-14 on supplies made on or after 17 March 2005

54. The treatment of excluding costs incurred in developing real property from the calculation of the margin for the supply is confirmed by section 75-14. Section 75-14 is effective from 17 March 2005.

55. Section 75-14 makes it clear that in working out the consideration for the acquisition the following are disregarded:

(a)

the cost or value of any other acquisitions that have been made by you, or any work that has been performed in relation to the real property; and

(b)

the cost or value of any other acquisitions that are intended to be made by you, or any work that is intended to be performed after you have acquired the real property,

including acquisitions or work connected with bringing the real property into existence.

Example 3: section 75-14

56. Bob is a builder. He purchases a block of vacant land for $180,000 and then constructs a house on the land. The cost of constructing the house is $100,000. Bob sells the house and land package for $400,000.

57. The margin for the supply is $220,000 ($400,000 - $180,000). The cost of constructing the house is not part of the consideration for the acquisition of the land. Instead, Bob is entitled to input tax credits for any construction acquisitions (for example, building materials and subcontractors' services) that are creditable acquisitions.

Apportionment methods

58. To ascertain the proportion of the purchase price that relates to the subdivided allotment or stratum unit, you may use any fair and reasonable method of apportionment. The method of apportionment used must result in the sum of the proportionate amount of the purchase price that relates to each subdivided allotment or stratum unit equalling in total, the actual consideration for the acquisition. You cannot change the method of apportionment after sales of allotments or stratum units have been made unless the changed method is applied to calculate the margin for all the sales.

In your case, there is a need to exclude costs incurred in developing real property from the calculation of the margin for the supply under section 75-14. A fair and reasonable method of apportionment is acceptable in calculating the portion of the consideration for the acquisition of the Property and the costs relating to the development of the Property.

We consider that subparagraph 75-11(5)(e)(ii) will apply to Entity B’s subsequent supplies of subdivided lots from the Property for the reasons below:

● Entity B will have acquired the Property from Entity A as a GST-free supply of a going concern under Subdivision 38-J;

● Entity A will continue to be registered for GST at the time it supplies the Property to Entity B;

● none of subsections (1) to (4) apply (as these relate to acquiring a property from another member of a GST group, from a GST joint venture or from a deceased estate);

● Entity A acquired the Property after 1 July 2000 and was registered for GST at the time of the acquisition; and

● Entity A provided consideration when it acquired the Property from Entity X ($XXX amount).

As a result, when Entity B calculates the margin on its subsequent sales of subdivided lots from the Property to third parties, it is required to apply the consideration amount, that being $XXX amount, pursuant to subparagraph 75-11(5)(e)(ii) for margin scheme purposes.

Conclusion

Consequently, upon settlement, the supply of the first identified ‘property development enterprise’ and the supply of the second ‘identified licensing enterprise’ will both meet the requirements for a GST-free supply of a going concern for the purposes of section 38-325. However, for the purposes of the going concern under section 38-325, you can aggregate the property development enterprise supply and the licencing enterprise supply, that is two supplies and treat them as one supply of a going concern.

As a result, when Entity B calculates the margin on its subsequent sales of subdivided lots from the Property to third parties, it is required to apply the consideration amount, that being $XXX amount, pursuant to section 75-10 and subparagraph 75-11(5)(e)(ii) for margin scheme purposes.

ATO view documents:

Goods and Services Tax Ruling 2002/5: Goods and services tax: when is a ‘supply of a going concern’ GST-free?

Miscellaneous Tax Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number

Goods and Services Tax Ruling 2006/8: Goods and services tax: the margin scheme for supplies of real property acquired on or after 1 July 2000

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