GST and the problem with leases

Cameron Steele, Special Counsel, Sydney
 
Last week the Australian Taxation Office released two public determinations (GSTD 2012/1 and GSTR 2012/2) dealing with the GST consequences following the sale of leased premises. 
One of the determinations addresses the GST consequences of a vendor selling tenanted residential premises, while the other determination deals with the sale of tenanted commercial properties.  The determinations focus on the nature of the supply (or absence thereof) between the purchaser and a continuing tenant.  In a commercial property scenario, this characterisation is important when determining whether the purchaser is obliged to account for GST on rent received after completion.  However, it is the treatment of rent received by the purchaser of a tenanted residential property that may give rise to more obscure outcomes.
The purchaser of a newly tenanted residential complex (eg, a retirement village) may be charged GST on the land contract as the property is ‘new residential premises’.  The purchaser may wish to claim input tax credits for that acquisition on the basis that it is carrying on an enterprise.  The issue discussed in determination GSTD 2012/1 affects the purchaser’s entitlement to recoup GST on its acquisition costs in these circumstances.
Recent decisions of the Federal Court have cast doubt on whether purchasers of newly tenanted premises make any supplies to continuing tenants.  This is because the lease has already been granted by the previous owner and the covenants of the lease run with the title.  Arguably, this could mean that the purchaser of new residential premises is not denied input tax credits as it may not be making input taxed supplies to the continuing tenants. 
The two new ATO determinations formalise the Commissioner’s response to the Full Federal Court’s decision in South Steyne Hotel Pty Ltd & Ors v Commissioner of Taxation 2009 ATC 20-145. 
In the South Steyne Hotel case, each of the three members of the Full Court (Finn, Emmett and Edmonds JJ) held that the purchaser of leased land did not make any new supply to the existing tenant.  Their honours found that the covenants of the initial lease remained but the benefits of the tenant’s covenants and the burden of the landlord’s covenants “ran” with the reversion. 
The decision of the Full Court is at odds with the court’s earlier decision in Westley Nominees Pty Ltd v Coles Supermarkets Australia Pty Ltd 2006 ATC 4363 where, in a joint judgment by Ryan, Heerey and Edmonds JJ, the court said at [22]:
“While the matter is not entirely free from doubt, we have concluded that when the appellants purchased the reversion they assumed the obligation of [the vendor] to honour the lease according to its terms and in that sense entered into an obligation to tolerate an act or situation and in consequence, made a ‘supply’ by virtue of s 9-10(2)(g). The fact that the obligation arises by operation of law does not, in our view, impede this conclusion; after all, the reference to ‘obligation’ in s 9-10(2)(g) must be a legal obligation, although not necessarily one sourced in contract.”
This approach was not followed in South Steyne Hotel where the issue was reconsidered.  In South Steyne Hotel, Emmett J (with whom Finn J agreed) said:
“The better view is that there was no further supply, merely by reason of the continuation of the leases after the sale of the reversion.  Rather, the situation is provided for by Division 156.” (at [32])
Similarly, Edmonds J states at [76] that there was no new supply by the purchaser to the tenant but merely a continuation of the original supply, namely the grant of the lease.  Edmonds J explained that:
“The attribution provisions of Div 156, specifically s 156-5 and 156-22, the latter dealing with supplies or acquisitions by way of lease, prevent any unintended imbalance as between successive reversionary owners over the term of the lease.”
Division 156 deals with supplies made on a progressive or periodic basis.  Section 156-5 deals with the attribution of GST payable on a taxable supply made for a period or on a progressive basis and section 156-22 confirms that leases fall within the category of a progressive or periodic supply for the purposes of Division 156.  The effect of these provisions is to treat each progressive or periodic component of a taxable supply as if it were a separate supply.  
So, presumably, the Full Court in South Steyne Hotel thought that Division 156 operates to deem there to be a series of supplies, some of which would be made by the purchaser of the reversion.
Importantly, the provisions in Division 156 only deal with taxable supplies.  There are no equivalent deeming provisions for input taxed supplies made on a progressive or periodic basis.
If the view is taken that there is only one supply (ie, the grant of the leasehold interest) then the purchaser of tenanted land does not make any supply to the existing tenant unless deemed to do so under Division 156.  But Division 156 only applies to taxable supplies. 
Therefore, it may be open to a purchaser of lease residential premises to argue that it does not make any input taxed supplies in relation to the continuation of the lease.  As noted earlier, this could affect the entitlement to input tax credits on the acquisition of new residential premises.  For example, the purchaser of a newly tenanted leasehold retirement village may argue that it makes no continuing input taxed supplies to existing residents and it may only make non-incidental supplies of things like meals, laundry, etc.
Despite the lack of any deeming provision in the GST law applying to input taxed supplies made on a progressive or periodic basis, GSTD 2012/1 states that, upon the sale of leased residential premises, there is a continuing supply by way of lease which remains an input taxed supply.
The Commissioner’s view ensures that purchasers of leased residential premises are not entitled to an input tax credits because, according to GSTD 2012/1, the purchaser makes input taxed supplies under the continuing lease.  GSTD 2012/1 asserts that this view is supported by indications in the two cases mentioned above that Division 156 (which only applies to taxable supplies) has a role in avoiding unintended situations in these circumstances.
No legislative amendments have been announced to support the Commissioner’s views in determination GSTD 2012/1.​