Edited version of private ruling

Authorisation Number: 1011734528494

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: GST and sale of property

Question 1

Will you be liable to pay the goods and services tax (GST) when you grant the call option to an entity (entity A)?

Answer

Yes.

Question 2

Will you be liable to pay GST when you subsequently sell the property to the option holder, entity A?

Answer

Yes.

Relevant facts and circumstances

You are a legal practitioner and are registered for the GST.

Years ago you purchased a property to use it in connection with your legal practice. The property at the time of purchase was in a dilapidated condition and was zoned business.

The property was previously used by the former owner as their residence for many years. You acquired this property because it satisfied many characteristics convenient to your business, including location, visibility, storage and advertising potential. Work was carried out on this property to enable you to use it as your business well before you have settled for the purchase of the property.

You use this property to provide your legal services and store all your files and documents related to your legal practice. You also utilise the property to promote your business by means of banners placed at the front and on the western side of the property.

The ground level of the property consists of a large room at the front of the house which is used as reception and main office. It also has a second room that can be used as an office, kitchen, bathroom and backyard. In addition the property has 2 rooms on a second storey dedicated to storage of complete files and other documentation required to be kept by your legal firm.

You state that the house is not used for residential accommodation and nobody lives at the premise. Nevertheless, if used for residential purposes it would be described as a 3 bedroom property.

You intend to retire and are currently contemplating granting a call option and subsequently sell the property to the option holder, entity A. However, whether or not the property is sold to the option holder is dependent on the option being exercised within the period of validity of the option and in accordance with the terms of the option. The option holder by paying a fee for the call option is entitled to decide whether or not to purchase the property.

You have stated that entity A owns several properties close by and intends to develop another property. Depending on the result of discussions that entity A has with the local council, entity A may exercise the option to acquire your property. As to the intention of entity A, your limited understanding is that if your property is not included in its development application, it may be sold, rented out or kept by entity A for its own purpose.

You advised the following concerning the call option:

§ in law a call option merely entitles a party (the option holder) to exercise the option within the period during which the option is open for exercise. In the present case the option holder has proposed to pay you an option fee for an entitlement to purchase your property and then to have until the expiry date of the call option to decide whether or not to exercise the option.

§ the call option would be in the form of a confidential Deed of Call Option that provides the names of the parties to the call option, grantor and grantee, the consideration payable, the period of the option, the method of exercising option which is by written notice to you before the expiry date specified in the Deed of Call Option.

§ the call option also provides the following:

o if the option holder exercises the option they will be entitled to purchase the property within the period specified in the option and in accordance with the terms and conditions;

o if the option holder fails to exercise before the expiry date of the call option the option would lapse and you would be entitled to keep the option fee and will not be required to sell the property to the option holder;

o if the option is granted and subsequently exercised, and you fail to sell the property to the option holder, the option holder would be entitled to recover the option fee from you and could sue you for additional charges.

§ unless and until such time as the option is exercised and the property acquired pursuant to the terms of the option, you will continue to operate your legal practice at the property. During the time when the option is open for execution, in law and in fact, the property will remain under your sole ownership. If the option is exercised a normal contract for sale of the property will be entered and the contract will provide for completion before the expiry date of the call option.

Question 1

Detailed reasoning

GST is payable on a taxable supply. Under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) you make a taxable supply if:

a) you make the supply for consideration;

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

c) the supply is connected with Australia; and

d) you are registered or required to be registered for GST.

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

All the requirements in section 9-5 of the GST Act need to be satisfied for a supply to be a taxable supply.

We will now determine whether the fee for the call option gives rise to a taxable supply under section 9-5 of the GST Act.

Applying the facts to section 9-5 of the GST Act

Paragraph 9-5 (a) of the GST Act

A supply is defined widely in section 9-10 of the GST Act and includes an entry into or release from an obligation:

o to do anything; or

o to refrain from an act; or

o to tolerate an act or situation.

From the information received, the purpose of the call option is for you to refrain from selling your property while the option holder decides whether or not to purchase the property. Accordingly, when you provide the call option to the option holder you have made a supply to them under section 9-10 of the GST Act.

Further the supply is made for consideration since you receive a fee from the option holder when you provide the call option to them. Paragraph 9-5(a) of the GST Act is therefore satisfied.

Paragraph 9-5(b) of the GST Act

From the information received, you use this property to provide your legal services. This property is therefore in connection to the legal business activity that you carry on as it is the premise from where you carry on your legal business.

Accordingly, when you supply the call option, this supply is made in the course of an enterprise (business) that you carry on. Paragraph 9-5(b) of the GST Act is satisfied.

Paragraph 9-5(c) of the GST Act

Under subsection 9-25(5) of the GST Act, a supply of anything other than goods or real property is connected with Australia if:

(a) the thing is done in Australia; or

(b) the supplier makes the supply through an enterprise that the supplier carries on in Australia; or

(c) all of the following apply:

(i) neither paragraph (a) nor (b) applies in respect of the thing;

(ii) the thing is a right or option to acquire another thing;

(iii) the supply of the other thing would be connected with Australia.

From the information received, the supply of the call option is connected with Australia as:

o the grant of the call option is done in Australia;

o you make the supply through a business that you carry on in Australia.

Paragraph 9-5 (c) of the GST Act is therefore satisfied.

Paragraph 9-5(d) of the GST Act

Paragraph (d) of the GST Act is satisfied as you are registered for GST.

Summary

As the supply of the call option satisfies paragraphs 9-5(a) to 9-5(d) of the GST Act, the supply is a taxable supply except to the extent that it is GST-free or input taxed.

There is no provision under the GST Act that makes the supply of the call option to the option holder in Australia GST-free or input taxed.

Accordingly, your supply of the call option is a taxable supply under section 9-5 of the GST Act and you will be liable to pay GST on that supply

Question 2

Detailed reasoning

As explained in response to question 1, a supply is a taxable supply under section 9-5 of the GST Act to the extent that it is not GST-free or input taxed.

Based on the information received, when you sell the property to the option holder, you will satisfy paragraphs 9-5(a) to 9-5(d) of the GST Act as:

a) you make the supply for consideration;

b) you make the supply through an enterprise (business) that you carry on;

c) the supply is connected with Australia as the property is located in Australia; and

d) you are registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed. There is no provision under the GST Act that makes the supply of your property GST-free.

What needs to be determined is whether your supply of property is input taxed.

Input taxed

Subsection 40-65(1) of the GST Act provides that a supply 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).

A residential premise is defined in section 195-1 of the GST Act. It states that residential premises means land or a building that is occupied as a residence; or is intended to be occupied, and is capable of being occupied, as a residence.

Goods and Services Tax Ruling GSTR 2000/20 (available at www.ato.gov.au) provides the Australian Taxation Office (ATO) view on the meaning of residential premises.

Paragraph 19 of GSTR 2000/20 states that the requirement in paragraph 40-35(2)(a) and subsection 40-65(1) of the GST Act that input taxing only applies to the extent that the premises are to be used predominantly for residential accommodation. This indicates that premises that are residential premises are capable of use for purposes other than residential accommodation. It is their physical characteristics that mark them out as a residence. In turn, these characteristics determine when the use or proposed use is for residential accommodation.

The function of subsection 40-65(1) of the GST Act is to differentiate the GST treatment of any portions of residential premises that are commercial. This would apply for example to a house that has been partly converted for use as a doctor's surgery. Several parts of the houses may still be used predominantly for residential accommodation, such as bedrooms, bathroom, kitchen, living rooms and gardens, while other areas are not, being turned over to office and consulting space, and storage for the surgery. In this case subsection 40-65(1) of the GST Act operates to exclude these commercial parts from the input taxed treatment of the rest of the property (paragraph 22 of GSTR 2000/20).

Paragraphs 24 to 27 of GSTR 2000/20 describe the characteristics of residential premises as follows:

The definition of residential premises in section 195-1 refers to land or a building that is occupied as a residence or for residential accommodation or is intended and capable of being occupied as a residence for residential accommodation.

The definition requires that land must have a building affixed to it and that the building must have the physical characteristics that enable it to be occupied or be capable of occupation as a residence or for residential accommodation. Vacant land of itself can never have sufficient physical characteristics to mark it out as being able to be or intended to be occupied as a residence or for residential accommodation.

The physical characteristics common to residential premises that provide accommodation are:

(i)  The premises provide the occupants with the sleeping accommodation and at least some basic facilities for day to day living.

(ii)  The premises may be in any form, including detached buildings, semidetached buildings, strata-like apartments, single rooms or suites or rooms within larger premises.

In addition to the physical characteristics, there are other factors which may be of use in determining whether premises are to be used for residential accommodation or accommodation of another kind. These characteristics would usually be present in residential premises that have the physical characteristics given in paragraph 26. These often, but not always, include:

(i)  The purpose or context of the premises use is for personal accommodation, rather than another purpose, such as for a business.

(ii)  The tasks of day to day living, such as, preparing food, cleaning and laundering, are performed by the occupant, or by others under private arrangements.

(iii) The status of the occupant is most commonly that of owner, tenant or lessee. Any boarders, lodgers or guests occupy the premises by private arrangement with the owner, tenant or lessee.

(iv) The premises will be in an area zoned by council or Shire regulations as suitable for human habitation

From the information received, the property has the physical characteristics common to residential premises that provide accommodation. However, despite these characteristics, the purpose of the use of the property is not for personal accommodation. Rather, the premise is predominantly used for business (carrying on of your legal business). Hence, it is considered that the property is not being predominantly used for residential accommodation.

Accordingly, based on an objective analysis of the facts and circumstances surrounding the sale of the property, you are not making a supply of residential premises. Rather, you are making a supply of a commercial property to the option holder. The requirement in subsection 40-65(1) is therefore not satisfied and your supply of the commercial property will not be input taxed.

Summary

Your supply of the commercial property to the option holder will be a taxable supply under section 9-5 of the GST Act and you will be liable to pay GST on the supply.

Additional information

Margin Scheme

If you make a taxable supply of real property, the GST payable under the basic rule in section 9-70 of the GST Act is 1/11^th of the price.

However, under subsection 75-5(1) of the GST Act, you may be able to apply the margin scheme, if you and the recipient have agreed in writing that the margin scheme is to apply and if you make a taxable supply of real property by:

a) selling a freehold interest in land;

b) selling a stratum unit; or

c) granting or selling a long-term lease

Under the margin scheme, the GST payable on the supply of real property is 1/11^th of the margin for the supply. 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 unless subsection 75-10(3) or section 75-11 of the GST Act applies. Section 75-11 of the GST Act applies to supplies made on or after 17 March 2005.

The GST payable under the margin scheme is usually lower than when the GST is worked out

under the basic rule in section 9-70 of the GST Act. Because of this, the margin scheme is used particularly if the recipient of the supply is not entitled to an input tax credit for the acquisition. The most common example is residential land or residential premises supplied to private owners for their own use or for investment purposes. However, the supplier can calculate GST under the margin scheme for supplies of all types of real property including residential, commercial, retail and industrial property.

For more information on 'Margin Scheme' please refer to the Goods and Services Tax Ruling GSTR 2006/8 which is available at www.ato.gov.au

Further, the Goods and Services Tax Determination GSTD 2006/3 are settlements adjustments taken into account to determine the consideration for the supply or acquisition of real property may be of assistance to you. This determination is available at www.ato.gov.au