Edited version of private advice

Authorisation Number: 1051753239141

Date of advice: 15 September 2020

Ruling

Subject: GST and input tax credits on development costs

Question

Are you entitled to claim GST credits on acquisitions relating to the development of the Lots at the Property?

Answer

No.

Relevant facts

You run a repair business. You are registered for GST.

You purchased the Property in Year 1, a number of years ago.

The Property has a particular land size and from the time of purchase contains a number of lots.

The Property contained a residential building on the land. At the time of purchase, you intended to demolish the residence and build on the Property. The purchase was funded by personal savings.

Since the purchase, the Property was treated as a rental property whereby each financial year's net rental profit or loss were recorded in your income tax return.

You decided to develop the property in Year 2, a few years ago. At the time of deciding to develop the Property, you intended to sell one of the lots to your child and the remaining lots to be rented out.

You engaged the services of a building company to obtain development approval from the Council.

You sold Lot X to your child in early Year 2.

The building was demolished later in Year 2.

A demolition company was contracted for the demolition work. The demolition costs were funded out of private funds.

The building consent was issued in the middle of Year 2 for the development of a number of Torrens titled townhouses.

A construction company was engaged as project managers and builders for the townhouses. The development costs for each lot was over $XXX. The development costs are funded by loans from the bank.

You provided floor plans showing that the townhouses each provide a sleeping area and facilities for daily living such as a bathroom, toilet, laundry and kitchen.

Due to Covid-19, the current plan is to rent the Lots. However, the sale of the Lots in the future could be an option.

The development activities are expected to be completed in a month and you intend to advertise the townhouses for lease in a month and a half.

None of the development costs or interest on loans have been claimed as income tax deductions.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 11-5.

A New Tax System (Goods and Services Tax) Act 1999 paragraph 11-5(a).

A New Tax System (Goods and Services Tax) Act 1999 section 11-15.

A New Tax System (Goods and Services Tax) Act 1999 subsection 11-15(1).

A New Tax System (Goods and Services Tax) Act 1999 paragraph 11-15(2)(a).

A New Tax System (Goods and Services Tax) Act 1999 section 11-20.

A New Tax System (Goods and Services Tax) Act 1999 section 40-35.

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

Reasons for decision

Section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you are entitled to the input tax credit for any creditable acquisition that you make.

You make a creditable acquisition if all of the requirements of section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) are met. Section 11-5 of the GST Act states:

You make a creditable acquisition if:

(a)  you acquire anything solely or partly for a *creditable purpose; and

(b)  the supply of the thing to you is a *taxable supply; and

(c)  you provide, or are liable to provide, *consideration for the supply; and

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

(* denotes a term defined in section 195-1 of the GST Act)

As listed in paragraph 11-5(a) of the GST Act, to make a creditable acquisition you must acquire the thing solely or partly for a creditable purpose.

Section 11-15 of the GST Act provides that you acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise. However, you do not acquire the thing for a creditable purpose to the extent that the acquisition relates to making input taxed supplies or the acquisition is of a private or domestic nature.

The acquisitions relating to the development of the Lots are made in carrying on your enterprise. However, we need to determine if these acquisitions relate to making supplies that would be input taxed.

Goods and Services Tax Ruling GSTR 2008/1 explains some factors that provide guidance in determining whether an acquisition is for a creditable purpose. GSTR 2008/1 notes that paragraph 11-15(2)(a) of the GST Act specifically focuses on the relationship between an acquisition and the making of supplies. The ruling goes on to state at Paragraph 106:

106. Paragraph 11-15(2)(a) does not require tracing to a specific supply. Nevertheless, unlike subsection 11-15(1), it requires some form of connection to the supplies that the entity makes, made or intends to make.

Paragraph 118 of GSTR 2008/1 deals with the principles that should be applied in determining whether an acquisition relates to making supplies that would be input taxed and includes:

The words 'relates to' are wide words signifying some connection between two subject matters. There must be a connection between an acquisition and the making of input taxed supplies. The connection or association signified by the words may be direct, or indirect, substantial or real. It must be relevant and usually a remote connection would not suffice.

Paragraphs 121 to 123 of GSTR 2008/1 deal with the situation where acquisitions are used or consumed in making input taxed supplies and they state:

121. Subsection 11-15(2) specifically focuses on the relationship between an acquisition and particular supplies. When viewed in the context of the adjustment provisions such as Division 129, it can be seen that, when an acquisition precedes a supply, the purpose of subsection 11-15(2) is to focus on the intended usage of the acquisition.

122. If the intended usage of the acquisition relates to supplies that would be input taxed, paragraph 11-15(2)(a) precludes it from being for a creditable purpose. Division 129 then focuses on the actual usage of the acquisition and adjusts accordingly, depending on whether the actual usage relates to input taxed supplies.

123. If the acquisition is used or consumed in making an input taxed supply, there is a direct connection between the acquisition and the input taxed supply. For example, acquisitions made in constructing or maintaining residential premises that are supplied by way of an input taxed supply of a lease or licence relate to making that supply and consequently are not for a creditable purpose.

Under paragraph 40-35(1)(a) of the GST Act, the supply of premises by way of lease, hire or licence is input taxed where the supply is of residential premises.

Section 195-1 of the GST Act defines residential premises to mean land or a building that:

(a)  is occupied as a residence or for residential accommodation; or

(b)  is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation;

(regardless of the term of the occupation or intended occupation) and includes a *floating home.

Goods and Services Tax Ruling GSTR 2012/5 provides guidance on the application of GST to supply of residential premises.

Paragraph 9 of GSTR 2012/5 explains that the requirement in sections 40-35, 40-65 and 40-70 that premises be 'residential premises to be used predominately for residential accommodation' is to be interpreted as a single test that looks to the physical characteristics of the property to determine the premises' suitability and capability for residential accommodation. Further, paragraph 15 of GSTR 2012/5 states that to satisfy the definition of residential premises, premises must provide shelter and basic living facilities. Paragraph 20 of GSTR 2012/5 further explains that the premises must be fit for human habitation in order to be suitable for, or capable of, being occupied as a residence or for residential accommodation.

In your case, you are constructing townhouses on the Lots. According to the floor plans you provided, the townhouses each provide a sleeping area and facilities for daily living such as a bathroom, toilet, laundry and kitchen. The townhouses possess the physical characteristics which satisfy the definition of residential premises.

You advised that due to Covid-19, your current plan is to rent the Lots.

Accordingly, as the physical characteristics of the townhouses are those of residential premises and the premises will be used for residential accommodation, the leasing of the townhouses is an input taxed supply under paragraph 40-35(1)(a) of the GST Act.

The acquisitions for the development of the Lots relate solely to the making supplies that would be input taxed and are not made for a creditable purpose. Accordingly, the requirement of paragraph 11-5(a) of the GST Act is not met.

As one of the requirements in section 11-5 of the GST Act is not satisfied, you are not making creditable acquisitions when you acquire things for the development of the Lots. Therefore, you are not entitled to the input tax credits in relation to the acquisitions.

Other information

You advised that the sale of the Lots in the future could be an option.

Although the acquisitions in developing the Lots are not creditable acquisitions, adjustments can still arise under Division 129 of the GST Act if you subsequently apply the residential premises for a creditable purpose.

Goods and Services Tax Ruling GSTR 2009/4 Goods and services tax: new residential premises and adjustments for changes in extent of creditable purpose explains the Commissioner's view of when an adjustment for a change in creditable purpose arises under Division 129 of the GST Act in relation to acquisitions made in constructing new residential premises.