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Ruling

Subject: GST and redeemable preference shares

Questions

1. Are you required to be registered for GST in the course of implementing the proposed scheme of arrangements?

2. Will you make a taxable supply when you issue redeemable preference shares to each of the four trusts before the new strata title apartment and townhouses are built?

3. Will you make a taxable supply when you redeem the redeemable preference shares by transferring the newly completed apartments and townhouse as consideration?

Answers

1. Yes, you are required to be registered for GST in the course of implementing the proposed scheme of arrangements.

2. No, you will not make a taxable supply when you issue the redeemable preference shares to each of the four trusts before the new strata title apartment and townhouses are built?

3. Yes, you will make a taxable supply when you redeem the redeemable preference shares by transferring the newly completed apartment and townhouse as consideration?

Relevant facts and circumstances

An entity (you) purchased an old residential apartment building (property) pre July 2000.

The apartments are currently being leased to residential tenants.

You propose to demolish the apartments and construct several new strata title apartments and townhouses on the land.

Before you start developing the property, you will issue redeemable preference shares to a number of shareholders.

Each of the shareholders will be a related discretionary trust (trust) to you.

§ Each redeemable preference share will give the holder the right to occupy nominated apartments and/or townhouses specified in the terms of issue for that redeemable preference share.

§ The holder of each share will have the right to have the legal title to 'their apartment and /or townhouse' transferred to them on redemption of the share.

§ The redeemable preference shares will be issued by you for an issue price that reflects a proportion of the current market value of the land and building costs (apportioned between each of the trusts),

§ The shareholders will have a right to occupy specified apartments and townhouses. However, a person who has a right to occupy premises also has the right to lease/sublease the premises to a third party. The shareholders will therefore be entitled to then lease the respective apartments and townhouses to third parties under residential tenancy leases.

After construction has been completed, each of the apartments and townhouses will be leased to third parties under residential tenancy leases.

You intend to redeem the preference shares as soon as practical after the new apartments and townhouses have been constructed.

You do not intend to derive any profit from the development. This is because you will not receive any further consideration from the trusts other than payment equal to the sum of:

§ each trust's proportion of the current market value of the land; and

§ each trust's proportion of the associated building and associated costs.

Each of the trusts intends to keep the apartments and townhouses as investment assets, which will be leased to residential tenants.

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 9-15.

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-20(1).

A New Tax System (Goods and Services Tax) Act 1999 section 9-75.

A New Tax System (Goods and Services Tax) Act 1999 section 23-5.

A New Tax System (Goods and Services Tax) Act 1999 section 23-10.

A New Tax System (Goods and Services Tax) Act 1999 subsection 40-5(1).

A New Tax System (Goods and Services Tax) Act 1999 section 40-65.

A New Tax System (Goods and Services Tax) Act 1999 section 40-70.

A New Tax System (Goods and Services Tax) Act 1999 section 72-5.

A New Tax System (Goods and Services Tax) Act 1999 section 72-10.

A New Tax System (Goods and Services Tax) Act 1999 section 72-70.

A New Tax System (Goods and Services Tax) Act 1999 division 129.

A New Tax System (Goods and Services Tax) Act 1999 section 188-25.

A New Tax System (Goods and Services Tax) Act 1999 regulation 40-5.02.

A New Tax System (Goods and Services Tax) Act 1999 regulation 40-5.03.

A New Tax System (Goods and Services Tax) Act 1999 regulation 40-5.04.

A New Tax System (Goods and Services Tax) Act 1999 subregulation 40-5.09(1).

A New Tax System (Goods and Services Tax) Act 1999 subregulation 40-5.09(3).

Reasons for decision

1. Are you required to be registered for GST in the course of implementing the proposed scheme of arrangements?

As defined in subsection 9-20(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) an enterprise includes an activity, or a series of activities, done:

§ in the form of a business, or

§ in the form of an adventure or concern in the nature of trade, or

§ on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property; or…

You are currently leasing your residential apartments to residential tenants. This constitutes a leasing enterprise in accordance with the above definition.

You are not registered for GST; therefore it needs to be determined whether you are required to be registered.

Section 23-5 of the GST Act provides that you are required to be registered for GST if:

§ you are carrying on an enterprise and

§ your annual turnover meets the registration turnover threshold.

The applicable GST registration turnover threshold is $75,000. You have a GST turnover that meets the registration turnover threshold if your current GST turnover is at or above $75,000 and your projected GST turnover is not below $75,000.

In calculating your GST turnover under Division 188 of the GST Act certain supplies are excluded.

Goods and Services Tax Ruling GSTR 2001/7 Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected GST turnover considers the ATO view on the meaning of GST turnover and other related issues.

Paragraph 14 of GSTR 2001/7 summarises the types of supplies that are excluded from the calculation of current and project GST turnover:

§ supplies that are input taxed;

§ supplies that are not for consideration (and not taxable supplies under section 72-5);

§ supplies not made in connection with an enterprise that you carry on;

§ supplies that are not connected with Australia; and

§ supplies made from one member of a GST group to another member of that GST group.

Further, section 188-25 excludes certain supplies made when working out your projected annual turnover. Paragraph 29 of GSTR 2001/7 states:

Section188-25 requires you to disregard the following when calculating your projected annual turnover.

(a) any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; and

(b) any supply made, or likely to be made, by you solely as a consequence of:

(i) ceasing to carry on an enterprise; or

(ii) substantially and permanently reducing the size or scale of an enterprise.

The meaning of capital assets is not defined in the GST Act. Capital assets are often referred to as structure assets and may be described as the business entity, structure or organisation set up or established for the earning of profits. It can include tangible assets such as your factory, shop or office, your land on which they stand.

It is to be distinguished from revenue assets which are assets whose realisations are inherent in or incidental to, the carrying on of a business.

Where your annual turnover meets the registration turnover threshold you will be required to be registered for GST.

In your case, you only derive rental income from your old residential apartments at present. This will be input taxed and hence will be excluded in calculating the current and projected GST turnover. Consequently, your turnover will be less than $75,000.

As such, you will not be required to be registered for GST when you only derived rental income from old residential apartment. However, you may be registered as you are carrying on an enterprise under subsection 23-10(1) of the GST Act.

Upon the subsequent demolition of old building, the issuing of redeemable preference shares to the shareholders, the construction of six new strata title apartments and three townhouses, the entry of a construction and partitioning agreement with the shareholder trusts and the final disposal of the new residential premises through the redemption of the redeemable preference shares represent the commencement of a new enterprise of building and 'supplying' new residential premises.

At the time when you issue redeemable preference shares prior to the construction of new residential premises, you are not required to be registered because the provision of shares (please refer to question 2 below for more details) does not impact on your GST turnover. Accordingly, your registration turnover threshold is not met under section 23-5 of the GST Act.

As from the completion of the new residential premises to the redemption of the redeemable preference shares whereby you will transfer the newly completed apartments and townhouses as consideration to the shareholders, you will be required to be registered for GST because you will be making a taxable supply of new residential premises. More precisely, you will be required to be registered 11 months prior to the redemption of these shares to the shareholder trusts when the taxable supply of new residential premises is made. This is because your projected GST turnover will be at or above the registration turnover threshold of $75,000 when you transfer those newly built residential premises to shareholders upon redemption of the redeemable preference shares (please refer to question 3 below for more details).

2. Will you make a taxable supply when you issue the redeemable preference shares to each of the four trusts before the new strata title apartment and townhouses are built?

Subdivision 40-A of the GST Act is about financial supplies. Central to the operation of this subdivision is the concept of an interest, which is defined at regulation 40-5.02 the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) as anything that is recognised at law or in equity as property in any form.

A supply of an interest (a financial interest) mentioned at subregulation 40-5.09(3) of the GST Regulations is a financial supply if the supply satisfies the requirements set out in subregulation 40-5.09(1) of the GST Regulations.

Part 8 of Schedule 7 of the GST Regulations provides examples of interests in securities for item 10 (listed in subregulation 40-5.09(3) of the GST Regulations) purposes. Item 2 in Part 8 is shares in, or debentures or convertible notes of, a body. Thus, a supply of a share is a financial supply where the supply satisfies the requirements of subregulation 40-5.09(1) of the GST Regulations.

In addition, the glossary attached to Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions adopts the following meaning of a share:

A share in the capital of a company and includes stock except where a distinction between stock and share is expressed or implied. The main types of shares are: ordinary shares, which confer a right to vote and a right to share in the surplus assets of the company on dissolution, plus (usually) a right to a dividend; and preference shares, which give the holder a preference, generally in the form of priority in the payment of a declared dividend, or in the distribution of capital.

In your case, redeemable preference share is a share within the definition of securities under item 10 in subregulation 40-5.09(3) of the GST Regulations

Furthermore, subsection 40-5(1) of the GST Act provides that a financial supply is input taxed.

However, a supply can only be a financial supply where the requirements of subregulation 40-5.09(1) of the GST Regulations are also satisfied. Subregulation 40-5.09(1) of the GST Regulations provides that the provision, acquisition or disposal of an interest mentioned in subregulation 40-5.09(3) of the GST Regulations is a financial supply if:

(a) the provision, acquisition or disposal is:

(i) for consideration; and

(ii) in the course or furtherance of an enterprise; and

(iii) connected with Australia; and

(b) the supplier is:

(i) registered or required to be registered; and

(ii) a financial supply provider in relation to supply of the interest.

'Provision' is defined in regulation 40-5.03 of the GST Regulations as 'provision of an interest [that] includes allotment, creation, grant and issue of the interest'.

Consequently, as you are not registered nor required to be registered for GST at the time of the issuance of these shares (refer to question 1 above for more details), the requirements of paragraph 40-5.09(1)(b) of the GST Regulations are not met. The provision of shares is not a financial supply. Neither will it be a taxable supply as not all of the requirements of section 9-5 of the GST Act are satisfied.

However, if you are registered for GST, the provision of shares will be a financial supply and will be input taxed under subsection 40-5(1) of the GST Act.

Accordingly, you will not make a taxable supply when you issue the redeemable preference shares to each of the four trusts before the new strata title apartment and townhouses are built.

3. Will you make a taxable supply when you redeem the redeemable preference shares by transferring the newly completed apartments and townhouse as consideration?

Regulation 40-5.04 of the GST Regulations provides that disposal of an interest includes assignment, cancellation, redemption, transfer and surrender of the interest.

Consequently, if you are not registered nor required to be registered for GST, the requirements of paragraph 40-5.09(1)(b) of the GST Regulations are not met. The redemption of the preference share is not a financial supply.

However, if you are registered for GST, the redemption of the preference shares will be a financial supply as it represents a disposal of an interest in or under securities under item 10 listed in subregulation 40-5.09(3) of the GST Regulations and will be input taxed under subsection 40-5(1) of the GST Act.

In your case, you are redeeming the preference shares for non-monetary consideration in the form of transferring real properties to the shareholders.

Paragraphs 14 to 16 of Goods and Services Tax Ruling GSTR 2001/6 Goods and services tax: non-monetary consideration state:

14. In some transactions, particularly those involving money only, the consideration is readily apparent. However, where there is monetary consideration for a supply, it does not necessarily follow that there is no other consideration for that supply. If you receive any non-monetary consideration for a supply, the price includes the GST inclusive market value of that consideration.

15. Many transactions involve parties entering into multiple obligations. The question arises as to whether those obligations are consideration (or additional consideration) for a taxable supply.

16. By providing non-monetary consideration for a supply, you are in turn making a supply. Where this happens, you need to determine the GST consequences of the supply you make. If it is a taxable supply, you need to determine the GST inclusive market value of the consideration you receive for this supply to account for the GST payable. You may also be entitled to claim input tax credits for the supply made to you.

As indicated in GSTR 2001/6 above, something that is non-monetary consideration can itself be a taxable supply. If all of the requirements of section 9-5 of the GST Act are met when you supply the real property to the shareholders, then you have made a taxable supply and are liable to GST.

Section 9-5 of the GST Act provides:

You make a taxable supply if:

(a) the supply is made 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 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.

In your case, you will have made a supply connected to Australia in the course or furtherance of your enterprise, the requirement that is of particular relevance to this case is that the supply of the real property will be for consideration.

Consideration is broadly defined at subsection 9-15(1) of the GST Act to include any payment, act or forbearance in connection with, or in response to, or for the inducement of a supply of anything. It includes both monetary and non-monetary payments.

Section 195-1 of the GST Act defines the term 'money' to include the crediting or debiting of an account. The consideration received when you debit the share capital account is therefore a monetary payment for GST purposes.

The consideration received by you for the real property is the amount with which the shareholder's capital account is debited. That is the shareholders agree to apply its share of the return of its capital to secure an in specie supply of the property.

Next we need to consider whether you are required to be registered for GST.

The supply of the property will be made in the course of your enterprise. It is a new residential property. Such supply is not input taxed as provided under paragraph 40-70(2)(b) of the GST Act. Therefore, your GST turnover meets the registration turnover threshold for the purposes of section 23-5 of the GST Act.

Hence, you will be required to be registered for GST.

As all of the requirements of section 9-5 of the GST Act will be met, you are making a taxable supply when you supply the real property to the shareholders.

Generally, GST liability is 10 per cent of the value of the supply with value being determined according to the formula contained in section 9-75 of the GST Act.

Value = Price x 10/11

This means that GST is calculated on the basis of the GST inclusive price of the taxable supply and is 1/11^th of this amount.

However, the shareholder is an associate of you for GST purposes. This may impact on the calculation of your GST liability if the consideration received is less than the GST inclusive market value of the real property.

Section 72-70 of the GST Act provides that where a supply has been made to an associate and the consideration received for that supply is less than the GST inclusive market value of the supply, the value of the supply is not determined by the consideration received, but by its GST exclusive market value. This applies to all taxable supplies made to associates unless:

§ the associate is registered or required to be registered for GST; and

§ the associate has acquired the thing supplied solely for a creditable purpose.

If section 72-70 of the GST Act applies, your GST liability would not be calculated as 1/11^th of GST inclusive price of the real property but would be 10 per cent of the GST exclusive market value of the real property in question.