Introduction

This article discusses the adjustment provisions in Div 129 of the GST Act. These provisions often apply in the context of property developers who lease out stock to generate income to offset holding costs during downturns in the market. Failing to adjust can result in inadvertent shortfalls, penalties and interest. Therefore, it is critical for developers and their advisers to have a working knowledge of the adjustment regime to avoid any nasty surprises.

Background

Where a registered taxpayer makes a wholly creditable acquisition, they are entitled to 100% of the GST embedded in the relevant good or service in the form of input tax credits. The extent to which an acquisition is creditable is based on the taxpayer’s intention as at the acquisition time regarding the use to which that acquisition will be put. That is, if it will be used to make fully taxable supplies, it will be a fully creditable acquisition. Difficulties arise, however, when an acquisition is made which, based on the intention of the taxpayer as at the acquisition time, was fully creditable but, due to a subsequent change of intention/use, the acquisition will no longer be used in making taxable, or fully taxable supplies, such as where the acquisition will now be used to make GST-free supplies.

What is a GST adjustment?

An adjustment for present purposes arises for an acquisition in an “adjustment period” where:

1. there is a difference between the actual application and the planned (or intended) application of the relevant “thing”; or
2. there is a difference between the actual application of the thing up to the end of 1 adjustment period and the actual application of the thing up to the end of the previous adjustment period.

When does a taxpayer have to start adjusting?

A taxpayer’s first adjustment period following a change of intention/use is the first tax period that starts at least 12 months after the end of the tax period to which the acquisition is attributable and ends on 30 June. For example, if a creditable acquisition was made on 30 September 2010, the first adjustment period would be 30 June 2012, that is:

1. the December 2011 Quarter is the first tax period to commence at least 1 year after the end of the September 2010 Quarter; and
2. the June 2012 Quarter is the first tax period to commence after at least 1 year after the end of the September 2010 Quarter that ends on 30 June.

For how long do taxpayers have to adjust?

The number of adjustment periods is determined by reference to the GST-exclusive value of the relevant acquisition to which they relate, that is:

What is the relevant “thing” subject to adjustment?

Division 129 of the GST Act applies in relation to a “thing”, for example, as outlined by the Commissioner in GST Ruling GSTR 2009/4, under a periodic payment contract for building services; this is likely to be the individual instalment payments rather than the underlying items to which they relate (concrete, bricks, trusses, windows, etc).

Example 1

X Co is a property developer. In 2010, X Co acquired a block of land for $100,000 from a private individual (no GST embedded in the sale price and X Co will apply the margin scheme on eventual disposal of the re-developed lots).

X Co incurred $550,000 (incl. GST) in expenses re-developing the property and therefore, claimed 1/11th of the total cost, or $50,000, in GST input tax credits.

The development was completed in September 2010 after which, the original property was subdivided into 2 lots. Each lot was valued at $750,000 each. X Co marketed the properties but due to a downturn in the property market, they sat on the market for 12 months.

To defray the holding costs pending sale, from September 2011, X Co decided to lease out the properties to arm’s length third parties. The properties were continually marketed for sale however, and an agreement was struck with tenants that in return for a lower rent, they required only 10 days notice to vacate if the property was sold. Each lot is leased at $3,500 per month and the market values of the properties have been revised down to $700,000 each.

The progress payments during construction were as follows:

1. 30 May 2010 – $220,000;
2. 30 June 2010 – $110,000
3. 30 July 2010 – $110,000;
4. 30 September 2010 – $110,000

Therefore, the first adjustment period for all payments is 30 June 2012.

Between September 2011 and June 2012, each property derived $35,000 in rent ($70,000 in total). Therefore, the GST adjustments are as follows:

Current market value/(Current market value + Rent)
= $700,000/($700,000 + $35,000)
= 95.24%

This is the actual application of the “thing” (that is, each progress payment). Therefore, X Co has an increasing adjustment as it overclaimed GST originally on account of the actual application of the thing. The increasing adjustment is as follows:

GST paid x (100% – 95.24%)
= $50,000 x (4.76%)
= $2,380

Example 2

Where, unlike in Example 1, X Co decided to take the properties off the market and hold them both long term for rental income. As such, the properties are leased at $4,000 per month each as there is no discounting for the short notice to vacate period as in Example 1.

Where the relevant “thing” was initially acquired for a wholly creditable purpose, but subsequently the thing was put to a wholly non-taxable purpose, it is appropriate to adjust on a time basis. That is:

[Period held for creditable purpose/Total Period] x 100%

On these facts, the first instalment payment was for a creditable purpose from 30 May 2010 to 1 September 2011 (16 months) and the total period between 30 May 2010 and 30 June 2012 is 25 months. Therefore, the adjustment is as follows:

16/25 x 100% = 64%

This is the actual application of the thing resulting in an increasing adjustment as follows:

$20,000 (GST paid on first instalment payment) x (100% – 64%)
= $20,000 x 36%
= $7,200

This process must be repeated in relation to each instalment payment.

Conclusion

The purpose of this article was to highlight the operation of the adjustment regime in Div 129 of the GST Act. The most important thing for developers and their advisers to remember is that whenever a developed lot is held or is being used for any purpose other than for sale, including to derive rental income and whether or not the property is still being marketed for sale, the GST Act operates to claw-back over-claimed input tax credits and the developer must adjust accordingly.

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Note – this article was published in the October 2012 edition of inTax Magazine (a Thomson Reuters publication).

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.