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The ATO has informed us about a growing trend that may be hitting many Mum and Dad investors in coastal units and apartments with an unexpected bill.

Basically, whilst they may think they are acquiring the unit or apartment GST-free, they are later hit with a GST bill, not the vendor.

The vendor is left untouched, counting his money!

This is due to a little-known part of the GST law providing for increasing adjustments to purchasers – Div. 135 of the GST Act.

Common arrangements

The ATO says that it is seeing and acting on instances similar to the following:

• a developer builds a high rise holiday complex at a popular coastal holiday destination;
• they then rent out the units to the public under a lease arrangement; and then
• sell the units to individual ‘Mum and Dad’ type investors whilst claiming to be carrying on an enterprise of leasing, and use the ‘supply of a going concern’ provision to make a GST-free supply to the Mum and Dad investors.

This is all legitimate from the vendor’s point of view, and provided they meet all of the requirements of S.38-325 of the GST Act, they do not need to remit any GST on the sale.

The GST consequences down the track

If Mum and Dad are registered for GST (as they would need to be in order for the seller to make a GST-free supply of a going concern under S.38-325) and they continue to rent out the unit, Mum and Dad will be making an input taxed supply.

However, Div.135 provides that the recipient of a supply pf a going concern may have an increasing adjustment to take into account the proportion (if any) of supplies that (a) will be made in running the concern and (b) will not be taxable supplies or GST-free supplies.

Because Mum and Dad will not be making any GST-free or taxable supplies, Mum and Dad will now have an increasing adjustment under S.135-5 of the GST Act.

In this typical example, as all the supplies are input taxed, the increasing adjustment would be equal to 10% of the purchase price.

It doesn’t matter whether the unit was new residential premises or not. There will be an increasing adjustment under Div.135.

The ATO’s approach

The Tax Office has published an ATOID that covers a similar scenario to this example (ATOID 2002/710 – GST and increasing adjustment for the purchase of a block of residential flats with leases intact as a going concern).

They have recently seen instances where vendors are requiring purchasers to register for GST prior to settlement, on the pretence that if they are registered they won’t have to pay the GST on the new residential premises.

What, or course, isn’t disclosed is the Div.135 increasing adjustments.

The vendor is in the clear, so the ATO has no choice but to pursue the purchaser.

According to the ATO, it’s a “classic case of buyer beware”, and the ATO recommends that all parties to a contract should seek independent legal advice to protect their interests before signing.