The Australian Taxation Office has at last finalised its GST public ruling on retirement villages (GSTR 2011/1). The ruling maintains the position that taxable sales of retirement villages must include GST based on the value of resident loans. In a second 'hit' to developers, it also requires them to reduce their input tax credit claims by allowing for a 'deemed' interest component in the calculation of their input tax credit recovery ratios.
On the positive side, the ATO has extended the scope of transitional relief so that these rules will, in the majority of cases, only apply to new developments.
While the extension of transitional relief is welcome, we remain of the view that there are significant technical difficulties with various aspects of the ATO's legal reasoning. Based on feedback from the industry, we expect that the ruling will have a significant effect on the viability of a number of new retirement village projects.
Transitional relief has been expanded so that the new rules will not apply to any development where the developer was commercially committed before the date of the ruling. Furthermore, transitional relief has also been extended so that 'deemed' interest will not need to be incorporated into input tax credit apportionment methodologies for existing developments.
While the expanded scope of the transitional relief is welcome, there are still potential pitfalls for existing village developments. For example, in relation to the sale of a village as a GST-free going concern, the scope of transitional relief has been restricted. In particular, the transitional provisions will not apply to a purchaser's exposure to a Division 135 adjustment unless the purchaser has already commercially committed to purchase the village. This will effectively deny the 'going concern' exemption for many future sales of retirement villages even though they would otherwise fall within the scope of the transitional provisions. We see no compelling policy justification for limiting the scope of the transitional relief in this manner.
GST on sales - including the value of assumed liabilities
The ruling confirms that from the ATO's perspective, GST on the taxable sales of villages should be calculated by including the value of resident loans. So, for example, a village that is sold for $20 million, but also has resident loans of $100 million, will attract GST of $12 million (ie 10% of $120 million). Thus, the GST on a sale for $20 million will be $12 million (so much for GST being charged at 10%!).
In our view, there is considerable doubt as to whether the courts would accept a blanket rule that the assumption of resident loans by a purchaser of a village (the transfer of which is otherwise addressed in different legislative contexts across each of the states) could correctly be treated as separately identifiable, valuable consideration on which GST is payable when a village is sold. This is exacerbated by the suggestion that these liabilities could be assumed pursuant to an implied term rather than anything specific in the sale contract.
Of significant additional concern is the potential for the various state revenue offices around Australia to also adopt this approach when calculating the stamp duty payable on the acquisition of retirement village businesses - which would further significantly increase the overall tax cost.
Input tax credits - deemed interest to be included in apportionment methodologies
The second significant aspect of the ruling is that developers must allow for a 'deemed' interest component when calculating the amount of input tax credits they can claim for the GST incurred during the development phase. This 'deemed' interest arises from the fact that most resident loans are interest-free, so from the ATO's perspective, developers realise the benefit of not having to pay interest to residents while retaining this money. However, the commercial reality is that in the vast majority of developments this money is used to fund construction and is not simply generating 'free' revenue for developers.
In our view, it is far from clear that the courts would accept the suggestion that deemed interest, on an otherwise interest-free loan, should be treated as consideration or some other benefit derived by an operator for the purposes of applying an apportionment methodology.
Ultimately, given such amounts are never derived, and at best exist in theory, it is difficult to understand why they should universally be recognised in the methodology so as to reduce the credits available to retirement village developers. Furthermore, it is not clear why the retirement village industry should be treated differently to other industries - for example rulings for other industries (see GSTR 2006/3) only require the use of 'actual' revenues or consideration - there is no suggestion in these rulings that 'deemed' or 'notional' amounts must be included.
Looking forward, any new retirement village developments will need to take extreme care calculating the GST cost that is likely to be incurred over the course of the development. It may be that the position adopted by the Commissioner forces a change of approach in how such developments are structured.
Furthermore, although the scope of the transitional relief has been extended, those considering the sale of an existing development will need to carefully consider the best way to sell their village in response to the position adopted by the ATO.