GST and rental guarantees - A new ATO Determination (Australia)

by DLA Piper

The Australian Taxation Office (ATO) has today issued a new GST determination, GSTD 2014/3, relating to GST and rental guarantee arrangements. The new Determination replaces an earlier draft which had been released in April of this year. The Determination confirms that the ATO's view in relation to qualifying rental guarantee payments is as follows:

• the payments, which may be made by a vendor to a purchaser following a sale of a property, are a reduction in the purchase price for the property

• the purchaser does not make a supply to the vendor in consideration of the payments and is not liable for GST

• if the sale of the property was a taxable supply and subject to GST, the vendor should be entitled to a "decreasing adjustment", which is effectively a refund of the GST previously paid on the reduced part of the purchase price

• if the sale of the property was a taxable supply, the purchaser may be liable for an "increasing adjustment", which is effectively a payment to the ATO for input tax credits (GST credits) previously claimed on the reduced part of the purchase price

Our comments on the new Determination are set out below, together with some worked examples.

1. What is a "rental guarantee"?

Generally speaking, a "rental guarantee" refers to an arrangement whereby the vendor of a property agrees to make payments to the purchaser if the rent received from the property post-sale is below an agreed rental yield.

From the perspective of a vendor, a rental guarantee may provide an effective sales incentive, whilst maintaining a high face price for the property. From the perspective of a purchaser, a rental guarantee may assist in ensuring that the property delivers at least a certain minimum yield during the rental guarantee period.

Rental guarantees may be offered by vendors of residential premises and commercial premises (including for commercial, industrial, retail, office or other premises).

2. Example One - Residential Premises

Developer Co is selling a new apartment to an investor for AU$550,000. The sale is a taxable supply and the purchase price includes GST of AU$50,000. Developer Co agrees to "guarantee" that the rent the purchaser will obtain on leasing the apartment is at least AU$2,500 per month for the first 12 months, with any shortfall payable as a lump sum at the end of that period. It subsequently turns out that the rent received is only AU$2,000 per month. Consequently, Developer Co is obliged to pay AU$6,000 (i.e. AU$500 x 12) to the purchaser after 12 months.

Based on the Determination, the purchaser (if GST registered) will not be liable for GST on the rental guarantee payment. Further, the AU$6,000 payment is a reduction to the purchase price of AU$550,000, meaning the price is reduced to AU$546,000.

As a result of the price reduction, the vendor would be entitled to a decreasing adjustment, which is effectively a GST refund, of approximately AU$545 (i.e. 1/11th of AU$6,000).

Note: AU$545 may seem a trivial benefit, however, the cumulative benefit can be material if numerous payments are made in the context of a large development project.

3. Example Two - Commercial Premises

Office Trust is selling a tenanted office tower to a purchaser for AU$110 million, including GST of AU$10 million. Office Trust guarantees the purchaser that the rent received in the first 12 months will be at least AU$5 million.

As a result of a large tenant defaulting post-sale, the rent received is only AU$4.12 million. At the end of 12 months Office Trust makes a payment of AU$880,000 to the purchaser pursuant to the rental guarantee arrangements.

Based on the Determination, the purchaser is not liable for GST on the AU$880,000. Further, the payment is a reduction to the purchase price, which is reduced to AU$109,120,000. This should trigger a decreasing adjustment of AU$80,000 for the vendor (i.e. 1/11th of AU$880,000). The purchaser may have an equivalent AU$80,000 increasing adjustment.

4. GST-free going concern sales

The Determination does not deal with rental guarantee payments made in the context of GST-free going concern sales. Nonetheless, based on the principles set out in the Determination, it is likely that a purchaser will not be liable for GST on a rental guarantee payment made in respect of a property which is sold on a GST-free basis. However, the vendor and purchaser should not have to make any decreasing or increasing adjustments as a result of the reduction to the purchase price.

To illustrate, assume that Office Trust's sale of the office tower in Example Two was a GST-free supply for AU$100 million, instead of a taxable supply for AU$110 million. The purchaser should not be liable for GST on the AU$880,000 rental guarantee payment. However, no adjustments would arise for either party as a result of the purchase price reduction.

5. Does the Determination apply to all rental guarantee payments?

The Determination only applies to rental guarantee arrangements which meet all of the criteria listed in paragraph 1 of the Determination. While the criteria listed will cover most bilateral rental guarantee arrangements between a vendor and purchaser, some arrangements may not be covered.

In particular, the Determination does not apply to rental guarantees that may be supplied by a third party (such as a parent company of the vendor). Further, the Determination does not deal with rental guarantee arrangements that may be structured as a sale and lease back of the premises.

Where a rental guarantee arrangement is not covered by the Determination, the GST treatment will need to be considered further having regard to all relevant facts and circumstances.

6. Does the Determination apply if a rental guarantee is assigned to a third party?

The previous draft Determination stated that the Determination would not apply if the rental guarantee is assigned to a third party. Following consultation, that statement has been deleted and is not contained in the final version. However, it will be necessary to carefully consider whether the Determination still applies following an assignment.

For example, assume that the purchaser of the office tower from Office Trust in Example Two decided to on-sell the building during the 12 month rental guarantee period. As a part of that on-sale, the rental guarantee is assigned. At the time that Office Trust is required to pay the AU$880,000 rental guarantee amount, Office Trust is directed to make the payment to the new owner of the building.

In this example, the rental guarantee payment may still be seen as a reduction to the purchase price for Office Trust's sale. If that sale was a taxable supply, Office Trust may continue to be entitled to a decreasing adjustment of AU$80,000, while the purchaser from Office Trust may continue to have an AU$80,000 increasing adjustment. However, the outcome will ultimately depend on all of the surrounding facts and circumstances.

7. Does the Determination apply to property sold under the margin scheme?

Yes, the Determination will apply to qualifying rental guarantee payments, even if the GST on the sale of the premises is calculated under the margin scheme.

It should be noted if the purchase price is reduced as a result of a rental guarantee payment, this may reduce the margin scheme cost base for future margin scheme sales of the same property by a corresponding amount.

The Determination will provide welcome certainty to both vendors and purchasers on the GST treatment of rental guarantee arrangements. A copy of the Determination is available from the ATO's website here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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