GST and options over real property

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1 Economos Pty Ltd Chartered Accountants economos.com.au PO Box Q285 QVB Post Office Sydney NSW 1230 Introduction The ATO is very active in conducting desk audits prior to the release of GST refunds. For obvious reasons, this is especially the case in relation to initial activity statements showing significant refunds. From a commercial perspective, developers and their advisers must be aware of the precise tax, duty and GST treatment of future projects so as to conduct robust feasibility studies in order to accurately estimate both viability and the anticipated level of return. In relation to the use of options, this involves not only the GST implications of options themselves but the impact (if any) on the GST ultimately payable on the eventual supply of the underlying end product (e.g. new residential premises or commercial premises). GST first principles GST is levied on taxable supplies, which specifically exclude both GST-free and input taxed supplies. A common GST-free supply is the supply of a going concern. Common input taxed supplies include: 1. the supply of existing (non-new) residential premises (other than commercial residential premises ); and 2. financial supplies. GST and options over real property If the grantor or nominator of an option is not registered or required to be registered for GST, no GST will apply on the grant or nomination of the option. Grant and nomination of options taxable, input taxed or GST-free free? An input taxed financial supply includes the provision (e.g. grant) or disposal (e.g. transfer) of a derivative. An option will be a derivative for GST purposes where it is an agreement or instrument the value of which depends on, or is derived from, the value of assets or liabilities, an index or a rate. Therefore, the supply of an option (whether by grant or nomination) is generally an input taxed financial supply. However, there is a critical exception to the input taxed treatment of derivatives such that the supply of a derivative will not be input taxed and therefore, will be an ordinary taxable supply (subject to the meeting the relevant criteria) where it relates to the making of an underlying taxable supply. Our liability is limited by a scheme approved under professional standards legislation gettingitdone.tv

2 Further, the supply of an option over an underlying supply that will be GST-free is both input taxed and GST-free (and the tie-breaker rules under the GST Act deem it to be GST-free only). Therefore, the underlying GST treatment of the subject-matter of an option informs the GST treatment of the option itself, for example: 1. the grant of an option to acquire a property where the underlying supply will be an input taxed supply of (non-new) residential premises will be an input taxed financial supply of a derivative; 2. the grant of an option to acquire a property where the underlying supply will constitute a GST-free supply will be GST-free; and [Note this very much depends on the facts and the wording of the particular option agreement as to the intention of the parties at the time of entering into the option as, for example, as actual eligibility for the GST-free going concern exemption can only be determined based on all the relevant facts up to and including settlement, the option agreement must reflect the parties intention for the going concern exemption to apply to the underlying supply if the option is exercised] 3. the grant of an option to acquire a property where the underlying supply will be a fully taxable supply will engage the exception outlined above and the option itself will be a taxable supply (again, assuming the relevant criteria are met). Input taxed financial supply is a small developer registered for GST and owns a large suburban block with an old 3 bedroom dwelling on it. The block may be re-zoned but the is tied up with other projects and wishes to sell it off. acquires an option to purchase the block for $1m. pays an option fee of $100,000 which is to be applied against the exercise price in the event that the Option is exercised. The Option is for 12 months and following re-zoning and development approval, the Option is exercised. This may be depicted as follows: Trust etc) Input taxed financial supply of derivative by (Input taxed supply of non-new residential premises) Non-new new residential premises

3 Input taxed financial supplies - nomination Assume the same facts as above except nominates Nominee for a premium of $1.35m (being in the increase in the value of the property following re-zoning of $1.25m plus its original $100k option fee). This may be depicted as follows: Input taxed financial supply by Non-new new residential premises Transfer of $1.35m Nomination Fee Input taxed financial supply by Option Holder Input Taxed Supply of non- new residential premises by Nomination (transfer/novation) Nominee (Individual, Company, GST-free supply Assume the same figures as above but the underlying property will be a GST-free supply. This may be depicted as follows: GST-free supply of option by (GST-free supply) GST-free supply e.g. going concern or farmland

4 Taxable supply Assume the same figures as above but the supply of the underlying property will be a fully taxable supply of vacant land. This may be depicted as follows: * Taxable supply of option by $1m Strike Price ($900k* net payable (Taxable supply of vacant land) Supply of vacant land *GST-exclusive Taxable supplies - nomination Assume same facts as above involving a nomination by the. This may be depicted as follows: $100k* Option Fee Taxable supply of option by Supply of vacant land Transfer of $1m Strike Price ($900k* net payable $1.35m* Nomination Fee Taxable supply by Option Holder Taxable supply by *GST-exclusive Nomination (transfer/novation) Nominee (Individual, Company,

5 Issues under the margin scheme The margin scheme may apply to reduce the GST ultimately payable on a taxable supply from 1/11 th of the value of the supply to 1/11 th of the margin. The margin is determined under the GST Act and, in the context of the acquisition of, say, input taxed residential premises for re-development into a small apartment block, the margin is essentially the difference between the end value of the apartments and the price paid for the property/ies (as apportioned). The cost of the property for margin scheme purposes excludes related expenditure such as stamp duty and legal expenses on acquisition. The Commissioner takes the view that regardless of whether the option fee or extension fee is applied against the strike price of the option from a contractual perspective, they do not form part of the consideration for the purchase of the property but for the separate supply of the option or extension. In addition, in circumstances where a nominee pays an option holder a significant premium for the nomination, the premium does not form part of the consideration for the underlying land for margin scheme purposes. Assume the same facts as above involving the nomination of an option for a nomination fee of $1.35m. The table below provides a simple example of the difference in the margin scheme outcomes between a direct acquisition of the underlying property versus acquisition under the nomination arrangement assuming that the property is developed into 10 apartments of equal end value: Direct Acquisition Nomination Arrangement Contract Price for underlying $2,250,000 $1,000,000 (A) Option Fee - $100,000 Net Strike Price - $900,000 Following DA MV of underlying $2,250,000 $2,250,000 Option Nomination Fee - $1,350,000 End Value of Apartments (B) $7,500,000 $7,500,000 End Value Per Apartment $750,000 $750,000 Margin $5,250,000[(B) (A)] $6,600,000 [(B) - (A)] Margin Per Apartment $525,000 $660,000 Total GST Payable $477,272 $600,000 GST Payable Per Apartment $47,727 $60,000 Difference = $12,273 per apartment or $122,730 in total Conclusion Despite their common usage, options give rise to complex issues from a GST perspective. If you need any assistance, whether you re at the feasibility stage, looking to on-sell or acquire an option or under ATO audit, feel free to contact James Meli, our Director of Tax on (02) or james.meli@economos.com.au.