On 26 July 2018, the ATO issued a draft Decision Impact Statement (DIS) on the GST case: MSAUS Pty Ltd v. Commissioner of Taxation [2017] AATA 1408, which defied earlier cases on sale of apartments in the same block, but the Commissioner chose not to appeal.

The background facts and GST decisions (common to all the cases cited below and to MSAUS)

The Sebel Manly Beach Hotel spawned a line of GST cases, including those cited below in the draft DIS, the lead one of which is the Full Federal Court decision in the South Steyne case [2009] FCAFC 155.

The following is a statement of the undisputed facts in the South Steyne Full Federal decision [at par 7].

  1. On 8 December 2000, the first appellant (“South Steyne “), purchased the Sebel Hotel.
  2. On 10 August 2006, each of the 83 individual apartments in the Sebel Hotel, including apartments 111, 304 and 604, together with the management lot, consisting of the reception area, offices and car parking spaces, became separate lots of a strata plan (the Hotel Strata Plan).
  3. On 29 September 2006, South Steyne: (i) transferred the management lot to Mirvac Hotels Pty Ltd (Hotels); and (ii) granted a separate lease to Mirvac Management Pty Ltd (Management) in respect of each of the 83 apartment lots in the Hotel Strata Plan. Under each lease, Management was obliged to operate a scheme whereby each apartment was, together with all other apartments, to be operated as part of a serviced apartment business.
  4. From 29 September 2006 at latest, Hotels had exclusive control of the operation of the serviced apartment business pursuant to an agreement with Management dated 11 January 2006 (the Management Agreement), which conferred upon Hotels the benefit of Management’s rights under the leases.
  5. Between 29 September 2006 and 31 October 2007, South Steyne sold apartments 111, 304 and 604 to the second appellant, MBI Properties Pty Limited (Properties). Each apartment was sold subject to the applicable lease, that had been granted to Management and each contract for sale permitted Properties to participate in a scheme that mirrored the scheme provided for under the leases. Properties elected to participate in that scheme.
  6. On the night of 17-18 October 2007, Ms Emily Young, an employee of the third appellant, Morgan & Banks Investments Pty Ltd (Investments), stayed in apartment 403 and made use of various services available to guests of the Sebel Hotel.

The commercial result was that South Steyne sold the individual apartments, to various purchasers (including Properties, in the South Steyne case, and MSAUS, in this case). Each sale was subject to a lease to the Management company, which bound Management to operate a Serviced Apartment Business. This business involved Management renting the furnished apartments to customers (the GST effect of which was to make taxable supplies of ‘commercial residential premises’ to the customers, like any hotel).

The intended GST result of the sale of the apartments, was as follows.

  • The parties hoped that the sale of the apartment could be GST-free, as a going concern (under s38-325 of the GST Act). This was because each purchaser would be carrying on an ‘enterprise’ (by leasing the apartment to Management). And so, the GST clause, in each contract said that the  ‘sale of a going concern’ provisions would apply to the contract.
  • But the ‘Going Concern’ treatment produced could produce an unwanted increase in overall GST. This would arise if Div 135 applied, to give the purchaser an ‘increasing adjustment’ (which would be as much as the GST saved by the ‘going concern’ exemption). Div 135 would be triggered, if the purchaser was making lease supplies, to Management, of  ‘residential premises (which the apartment could be) and not taxable (leasing) supplies of ‘commercial residential premises’ (which are carved excluded from input taxing leasing supplies of ‘residential premises) under s40-35 of the GST Act. It was clear that Management was making taxable supplies, to its customers, of Commercial Residential Premises (because renting serviced apartments was the commercial equivalent of renting rooms in a ‘hotel’). But the GST treatment of Management’s supply, did not necessarily determine the GST treatment of the the purchaser’s supply, of the same apartment to Management.
  • So, to reduce the GST, the purchaser would then have to bear, the GST clause sought to make the ‘margin scheme’ apply, if the ‘going concern’ treatment, would only result in the immediate claw-back of the GST savings (under Div 135).

The GST cases on the sales, that followed, established the following.

  • The Marana Holdings case [2004] FCAFC 307 established that the lease to Management was input taxed, as the leasing supply of Residential Premises, even though the on-supply of that apartment, by Management (to a customer), was taxable, as a leasing supply of Commercial Residential Premises.
  • That put the conditional nature of GST clause, in each supply to the test. The South Steyne case [2009] FCAFC 155 decided that it was not effective. The Full Federal Court decided that the drafting did not make the ‘going concern’ election conditional on the relevant GST treatment of the leases, to Management. It only put the competing Margin Scheme election, in conflict with the ‘going concern’ election, and it gave precedence to the latter.
  • The High Court’s MBI Properties decision [2014] HCA 49, is only of tangential interest, in that it concluded that the Div135 increasing adjustment did apply. The application of Div 135 depended on the purchaser making supplies to Management, and MBI argued that a leasing supply, is made at the time the lease is entered into (and the owner grants the lessee the leasehold estate). MBI said it bought the land subject to the previously granted leasehold estate, and therefore made no relevant ‘supply’ to Management. The High Court, however, held that by continuing to abide by the terms of the lease, the purchaser had made a relevant supply.

What the Vendor and MSAUS did to meet these problems

How this case was different, from those that preceded it, was that the vendor and purchaser executed Deeds of Rectification’ It was against this background that the AAT made the MSAUS decision.

What the MSAUS case actually decided

The AAT actually decided that the same GST clause, was effective, to achieve the ‘margin scheme’ result – even though the Full Federal Court had reached the opposite conclusion, in the South Steyne case. The following passage, in AAT’s reasons, demonstrates this.

 

[34]   There were shortcomings in the drafting of clause 47.6.6, to be sure. That much was acknowledged in these proceedings by Mr Smith, the solicitor. In fairness, the lawyers were trying to draft a clause that anticipated the risk of events that did not take final shape until the High Court made its decision in MBI Properties. Yet I am satisfied the purpose and effect of that clause as drafted is tolerably clear on its face. It provides for a contingency plan that is activated if something happens that triggers a liability to pay GST. In that event, the parties agreed the margin scheme would apply. It was open to them to reach an agreement to that effect in the contract of sale, and I am satisfied clause 47.6.6 does that. I am ultimately untroubled by the absence of express words of qualification in the clause which spell out how the clause interacts with the other provisions that would, if viewed in isolation, indicate a different result. The contract must be read in its entirety and the relationship between the various terms is clear.

[35]   I accept the conditional agreement in clause 47.6.6 to apply the margin scheme was an agreement made on or before the making of the supplyin accordance with s 75-5(1A)(a). The fact the contingency was not activated until a later event is beside the point: the clause embodying this aspect of the agreement was in place ‘on or before the making of the supply’ in accordance with the requirements of s 75-5(1A)(a).[2]

[36]   The reasoning of the High Court in MBI Propertiesmakes the purpose of clause 47.6.6 apparent in hindsight. In reaching that conclusion, I am not retrospectively supplying a gloss on the contract that suggests the clause meant something that was not intended at the time. On the contrary: the High Court’s reasoning sheds light on what the parties were talking about in the contract because they plainly anticipated at some level what the High Court ultimately decided. Clause 47.6.6, for all the (understandable) awkwardness of its drafting, turns out to be the product of prescient lawyering.

 

The AAT made some observations about the Deeds of Rectification, but the Tribunal Member made it clear these were by way of (obiter dictum) – viz: to what the decision relies on. Again, this is made clear by the following paragraph.

[70]   I do not need to decide the rectification argument given my conclusion with respect to the wording of the contract as originally drafted. But I would venture the following observations.

Having said that, I’ll move to what the Commissioner has said in his draft DIS.

He appears to pin everything on the Deeds of Rectification – as the key to the decision and the key to his decision not to appeal the case. I gave the ATO feedback along these lines, and they pointed out it doesn’t quite say that.

However, in my opinion, it would be much better if there were a clear statement that the AAT differed, from the Full Federal Court, on the effectiveness of exactly the same (unrectified) GST clause and then provide reasons as to why it was not in the public interest to appeal.

I’ll let you be the judge – the draft DIS appears below.

The Draft Decision Impact Statement in the MSAUS case

Brief summary of facts

MSAUS bought residential premises subject to an existing lease, agreeing the supply was GST-free as a going concern. If the lease was input taxed however, special conditions in the contract sought to apply the margin scheme.

  • The Full Federal Court and the High Court had previously considered the GST consequences surrounding the sale of other leased residential premises in the same development.
    • In South Steyne, the Full Federal Court held that identical conditions were ineffective to apply the margin scheme ([2009] FCAFC 155 (at [3, 50]).
    • The AAT had also reached a similar conclusion in the Hotel Apartment Purchaser case ([2013] AATA 567). 
    • In MBI Properties, the High Court found that a different purchaser in the same circumstances made an input taxed supply and was subject to an increasing adjustment ([2014] HCA 49 (at [46]).[3]
  • Unlike the other decided cases, MSAUS and the vendor later entered into ‘deeds of rectification’ to remove retrospectively the going concern clause from their sale contract.

Issues decided by the tribunal

The AAT decided it wasn’t bound by South Steyne. It held that the special conditions were effective to apply the margin scheme, and that there was no increasing adjustment. Incidental comments were made about the ‘deeds of rectification’.

  • Rectification by order – McCabe DP commented on a 2016 deed seeking to rectify the sale contract made 10 years earlier. He said it ‘would have been preferable’ had MSAUS sought orders from the Supreme Court. Orders of this kind would rectify the sale contract retrospectively, ‘bind third parties’, and avoid the ‘current uncertainty’.[4]However, McCabe DP accepted there was no certainty a court would have ordered rectification in the circumstances of the MSAUS case, ‘especially if the Commissioner opposed that outcome’.[5]
  • Rectification by deed – McCabe DP said that, even if the contract could be rectified by deed, it was an ‘interesting question’ as to how margin scheme requirements could be met in any case.[6]

ATO View of Decision

Despite the tension between this case on the one hand and South Steyne and Hotel Apartment Purchaser on the other,[7] the broader public interest is not served by an appeal seeking clarification of how the special conditions in the sale contract at issue in MSAUS operated.

Further, as the Commissioner understands it, ‘rectification by deed’ for the purpose of changing how the tax law has applied to an earlier transaction is not established as a general principle.[8] Accordingly, the Commissioner is not bound to accept at face value a deed of this kind executed by private parties. In the absence of court orders, the public interest does not compel the Commissioner unilaterally agreeing to change how the tax law has already applied to an earlier transaction.

ATO seeks COMMENTS by 23 August 2018.

FJM 16.8.18

[ATO website: MSAUS draft DIS; LTN 142, 26/7/18; Tax Month – July 2018]

 

Comprehension questions (answers given)

  1. Did MSAUS decide that the sale to MSAUS was made under the ‘margin scheme’, when South Steyne decided the opposite (on the same property and the same sale contracts, to the same purchaser, who was bound to use the relevant apartment, in the same way, under the same lease)?
  2. Did this turn on the construction and effectiveness of of the GST clause, in the sale contract (the same clause as in the South Steyne case)?
  3. Does the Commissioner put this different result down to the deeds of rectification (not present in the earlier South Steyne case)?
  4. Does the AAT (in this case) rely on the deeds of rectification?
  5. Does the ATO give any reasons for saying an appeal is not in the ‘public interest’?

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Category: Tax Month - July 2018

Author: John Morgan

John Morgan is a tax specialist lawyer of more than three decades experience now practicing at the Victorian Bar - w: www.FJMtax.com e: f.john.morgan@vicbar.com.au