Q&A with Sam Mohammad: Navigating GST Risks in Property and Commercial Deals

When entering into a property transaction, what are the key GST considerations parties need to get right in the contract from the outset?

Firstly, you need to consider what you expect the GST treatment of the transaction to be and what you would like as the optimal outcome. It is important to note that these two outcomes may not be the same thing so having a GST clause that deals with contingencies or different possible outcomes is important.

Secondly, it is important to remember that the purpose of a GST clause in a sale agreement is to allocate the risk and cost of GST as between the parties. For example, what happens if a supply which was expected to be GST-free is assessed as taxable – who should bear the burden of funding the GST liability, when does that GST amount need to be paid, what evidence does the buyer need to obtain from the seller before having to add GST to the sale price, is GST calculated under the margin scheme. These are all matters that should be dealt with in the sale contract for the property.

What are the most common GST issues that arise when deals fall over - including break fees, forfeited deposits and failed settlements?

It is interesting to note that 2 of the first 3 High Court decisions dealing with GST related to transactions that did not proceed as intended. For example, what happens when a property transaction falls over and the seller retains the buyer’s deposit or what if you fail to show up to your flight and the airline retains your airfare – these are all matters that the High Court has now considered.

What these and other cases tell us is that amounts paid in the context of a failed transaction can still have GST consequences. In simple terms, there is usually no such things as a free lunch. Generally, the ATO will take a wide interpretation around what a payment may be for and there is usually a high chance that GST will apply. One of the more common issues and misconceptions around a deal falling over is that parties can sometimes believe that if the intended transaction falls over, that there will be no GST liabilities or obligations – that is clearly not the case in all situations.

In practice, how does GST apply to break fees or liquidated damages, and what misunderstandings do you see most often?

The biggest misunderstanding is that simply by putting a label of “damages” on a payment, that no GST is payable. It is more complicated than that. Potentially, the payment may relate to more than simply making a payment to compensate the other party for a loss – if there has been an earlier or current supply, the payment may still attract GST.

Farm land and going concerns are often assumed to be GST‑free - in your experience, what are the pitfalls or situations where GST does in fact apply?

Often, farm land and going concerns are, in fact, GST-free so it’s probably right to assume that will be the starting point. But simply assuming something to be true does not make it true. With farm land, how does a seller prove that a farming business has been carried on for the preceding five years and that the purchaser intends for the farming business to be carried on? That requires both parties to share some knowledge and information between themselves so making assumptions on either side can be dangerous. Similarly, the application of the going concern provision does require some thought to be given to what the enterprise being transferred is and whether all assets are being transferred to allow that enterprise to be carried on after settlement.

The other great pitfall is not having a fallback when things go wrong – for instance, if you’re the seller and the ATO rejects your claim for a GST-free exemption, will you be able to have recourse to recover the GST from the buyer? If so, under what conditions? These are all matters that need to be dealt with before the contract is executed rather than post-fact.

The margin scheme can be attractive, but not always advisable. What factors should practitioners consider before choosing to apply the margin scheme?

First and foremost, the margin scheme can only be applied to taxable supplies of real property. I’ve experienced many times when parties will tie themselves in knots in working out whether they should apply the margin scheme and, if so, trying to work out the margin scheme cost base, only to have missed the first step of working out whether the supply is even taxable to start with. Quite often, the transaction is an input taxed supply of old residential premises and the application of the margin scheme is a moot point.

The other main item to consider is whether the margin scheme is optimal – generally, if the buyer can recover the GST on the transaction, the margin scheme should not be applied (obviously subject to exceptions). So, with the margin scheme, just because you can, doesn’t mean you should.

When a deal becomes uncertain or starts to unravel, what GST issues should lawyers flag immediately to avoid later disputes or liabilities?

The GST issues that should be flagged is ensuring the GST clause adequately allocates the actual or potential risks. This needs to be while the deal is developing and not trying to deal with things post-completion.

Are there any recent ATO positions or compliance trends that make these GST “deal breakers” more important than ever?

The ATO expects most taxpayers to demonstrate that they have “justified trust” they are paying the right amount of tax at the right time. There are various compliance programs that practitioners will be familiar with (Top, 100, Top 1,000, Next 5,000) but, regardless of the program, the key is that the taxpayer is required to demonstrate they have appropriate people, process and technology resources allocated to managing their GST risks. Part of this is ensuring that significant transactions are properly managed, which includes that GST risk such as the margin scheme, going concern and farm land provisions are applied appropriately.