Full Federal Court upsets position
However, the Full Federal Court threw the practice about GST on rent into turmoil in MBI Properties Pty Ltd v Commissioner of Taxation  FCAFC 112. The case involved MBI Properties Pty Ltd’s (“MBI”) purchase of three commercial residential apartments in a hotel complex, each of which was subject to an existing residential lease between the vendor South Steyne Hotel Pty Ltd (“SS”) and the hotel operator, Mirvac Management Ltd (“MML”). MBI objected to the Commissioner’s subsequent issue of a GST assessment which included an “increasing adjustment” for GST under section 135-5 of the GST Act, so making MBI liable to pay GST equal to 10% of the price it paid.
Section 135-5 requires the recipient purchaser of a supply (sale) of a going concern that intends to make supplies (leasing) which are neither taxable nor GST-free, to make an “increasing adjustment”. The increasing adjustment is calculated by taking 1/10th of the price of the supply in relation to which the increasing adjustment arises and multiplying it by “the proportion of all the supplies made through the enterprise that you intend will be supplies that are neither taxable supplies nor GST-free supplies, expressed as a percentage worked out on the basis of the prices of those supplies”.
The Full Federal Court decided that a purchaser of commercial residential premises subject to an existing lease as a going concern was not liable for GST, basing its decision on the finding that a lease involved the lessor making only one “supply”, being the time at which the lease is granted. That finding presented practical difficulties and created considerable confusion for purchasers of properties subject to an existing lease or leases.
High Court restores position
Thankfully, the High Court, on 3 December 2014, has restored the previously held view that a lease involves a landlord making at least two supplies: a supply at the time of entering into the contract (entering into the lease) and a continuing supply at the time of performance (observing the covenant of quiet enjoyment). The court unanimously confirmed that the continuation of the lease after sale involved a “continuing supply” of residential premises to the tenant which remains input taxed. So, MBI as the purchaser landlord was not liable for GST on the rent it continued to receive from the residential (input taxed) lease after the purchase. It follows that if the lease was commercial and so MBI was making a taxable supply, that MBI would have been liable for GST on the rent.
But the High Court also held that:
- the purchase by MBI of commercial residential was the purchase of a going concern
- as MBI intended to continue to make only input taxed supplies through the continuing residential leases, those supplies are neither taxable nor GST-free
- MBI’s assumption of SS’s rights and obligations with respect to MML constituted the making of supplies through an enterprise to which the supply was related and
- MBI was subject to assessment under the “increasing adjustment” provision and so liable to pay GST equal to one-tenth of the purchase price of the property.
What does this mean?
A purchaser landlord will have to pay GST on rental received under a commercial lease previously entered into by the vendor or a predecessor of the vendor.
The purchaser may have an “increasing adjustment” if acquiring the property as a GST-free going concern and then making input taxed supplies of residential premises.
If contemplating the sale or purchase of leased commercial residential premises, contact us for advice about the impact of the above decision on the proposed transaction.