Canberra, 19 August 2008: Property developers will benefit from the release of ATO ID 2008/114 today that clarifies how GST adjustment events need to be managed when a developer rents out new residential premises that are difficult to sell.

The GST treatment of this issue has been unclear for some time. The prevailing view was that when a client rented out residential premises while trying to sell the property they were required to make an increasing adjustment under Division 129 of the GST Act and effectively re-pay all input tax credits claimed in relation to the property (subject to adjustment periods and the value of acquisitions). As the property had only been used to make input taxed supplies (i.e., rental of residential property), it was arguable that the extent of creditable purpose for the property was 0%. If the client sold the property within 5 years they would then make a decreasing adjustment in order to re-claim some of the input tax credits as the property would have been used to make both a taxable supply and input taxed supplies.

ATO ID 2008/114 clarifies that it may not be necessary to re-pay all of the input tax credits if the client continues to actively market the property for sale while it is rented out. If the client is no longer actively marketing the property for sale they will need to make a full adjustment in order to repay all of the input tax credits claimed. The ATO considers that a property developer still has a creditable purpose in relation to the property if they are actively marketing the property for sale as a taxable supply. The simple example below demonstrates how the ATO’s interpretation would apply in practice:

Bob acquires a block of land in 2005 for $100,000. Bob’s intention is to build a house and sell the property for a profit. Bob spends a further $120,000 in 2006 constructing a house on the land. Bob claims input tax credits of $20,000 in relation to the acquisition and construction costs.

Following completion of construction, Bob lists the property for sale with a local real estate agent for $300,000. Due to a downturn in the property market Bob is unable to obtain a buyer for the property. Bob decides to rent the property to tenants while he continues to seek a buyer. The tenants move in on 1 July 2007 and pay rent of $20,800 during the year ended 30 June 2008.

As Bob is using the property to make input taxed supplies an increasing adjustment will be required. The extent of creditable purpose can be calculated as follows:

Estimated consideration for the taxable supply of the premises when sold/ Estimated consideration for the taxable supply of the premises when sold + consideration for input taxed supplies of residential rent

The extent of Bob’s creditable purpose at 30 June 2008 would be:

$300,000 / ($300,000 + $20,800) = 93.5%

Bob would need to make an increasing adjustment of $1,300 in the June 2008 BAS (ie, $20,000 x 6.5%).

While the net GST result for the client should effectively be the same, adoption of the ATO’s interpretation should provide a cash flow benefit to clients who find themselves in this situation. Practitioners should remember that ATO IDs are neither legally nor administratively binding on the Commissioner. However, taxpayers relying on a current ATO ID where the circumstances are not materially different from those described in the ATO ID may be protected from shortfall penalties and interest charges if the ATO ID is later found to be incorrect.