So, what happened to the margin scheme?

Land transactions have been some of the most contentious transactions within the Australian GST system. Of the cases considered by the courts, the vast majority relate to real property transactions. There are many possible reasons for this. Real property cases often involve transactions of significant value. However, Reliance Carpet [2008] HCA 22, a dispute arising from the sale of property and as yet the only GST dispute to have been considered by the High Court, involved the princely sum of $30,000 in GST.

Another reason for the frequency of disputes in the real property context is the fact real property transactions can be input taxed, GST-free or taxable. Even once it is decided that the sale of the real property is a taxable supply, the GST can be calculated in accordance with general principles or the GST may be able to be calculated under the margin scheme.

In its original conception, the margin scheme must have appeared deceptively simple. If land was held as at 1 July 2000, the margin scheme would allow GST to be imposed only in the increase in the value of the land after that date. Where land was acquired after that date, a subsequent application of the margin scheme would ensure that the pre-1 July 2000 value of the land was always excluded from the tax base. If land entered the GST system after 1 July 2000 (because, for example, the land owner became registered after that date) the margin scheme would exclude the value of land prior to that date from the tax base.

As with all things in tax, the reality has proved significantly more complex.

If the margin scheme were to be seen as merely a transitional measure, it could be argued that more than eight years into the operation of the Australian GST the margin scheme has served its purpose. This would be a mistake. Firstly, the design of the margin scheme necessitates its continued operation in order to continue to exclude the pre-1 July 2000 value from the tax base. Secondly, the margin scheme has anticipated that land owned by government and owned by entities not carrying on enterprises will enter the GST system after 1 July 2000. As Justice Stone noted, the margin scheme has a broader operation "to correct what would otherwise be an anomaly in the legislative scheme arising where GST is attracted on the supply of land but no input tax credit is available" (Sterling Guardian Pty Limited v Commissioner of Taxation [2005] FCA 1166).

Thus it is important that we ensure that the margin scheme continues to be a viable and useful part of the GST law. In this context it is useful to consider two of the recent developments in the law relating to the margin scheme:

• the decision of the Full Federal Court in Brady King Pty Limited v Commissioner of Taxation [2008] FCAFC 118 in which the Full Court unanimously rejected the approach taken by Justice Middleton at first instance; and
• the amendments currently before the Senate and proposed by Tax Laws Amendment (2008 Measures No.5) Bill 2008 regarding the interaction of the margin scheme with various GST-free supplies, including supplies as a going concern and supplies of farm land for farming.

Brady King

The case involved the purchase of an existing office building for subsequent redevelopment and eventual sale as strata titled residential units. The contract was entered into before 1 July 2000 (the commencement of GST) and was completed after 1 July 2000. The parties to the dispute (the Commissioner of Taxation and the developer) thought that the matter in contention was whether in applying the margin scheme the developer could say that as at 1 July 2000 the uncompleted contract for sale provided the developer with a sufficient interest in the land to say that the developer "held" the land at 1 July 2000.

To the surprise of both parties (and the property development industry generally) Justice Middleton held that "the margin scheme can only apply to the same property (in the juridical sense) being acquire and subsequently sold" ([2008] FCA 81). Therefore, because the developer had bought an office block and sold stratum units, he held that the developer could not apply the margin scheme at all. This would have had a devastating impact on the application of the margin scheme.

The developer appealed to the Full Federal Court and in a decision handed down on 26 June 2008, the Court overturned the decision of Justice Middleton - much to the relief of the property development industry (and the Commissioner). The Court noted that the margin scheme is "directed towards developers" and that the "beneficial purpose of the Margin Scheme would be frustrated if such a commonplace transaction as the present one were held to be outside" it. This line of thinking is significant. The Court identified the margin scheme as an important concession in the legislation and thus in construing the language of the provisions the Court adopted an interpretation that gave it a "practical and fair business operation" where such an interpretation was "reasonably open" and "conforms to the legislative intent".

Thus it is not necessary to have identity in the interest that was acquired and the interest that was sold in order to be able to apply the margin scheme to the subsequent sale. However, the Court went further than this and accepted the developer's argument that interest under the uncompleted contract for the purchase of the office block entitled the developer to say that it "held" the relevant interest as at 1 July 2000.

The practical impact of the Court's view may be limited to transactions with land entering the GST system after 1 July 2000. The Commissioner's Decision Impact Statement on the Brady King decision notes the Commissioner's view that although the developer "held" and interest in the land from the date the contract was entered into, no taxable supply or creditable acquisition occurred as of that date. Rather "in the case of a completed contract for the sale of real property, there is only one taxable supply and that it occurs at completion of the contract". Therefore, somewhat at variance with the Full Court's decision, the date of supply of the interest in land is the date on which the contract is completed.

However, while the courts have been restoring access to the margin scheme, Parliament is seeking to limit it.

Tax Laws Amendment (2008 Measures No.5) Bill 2008

This Bill was introduced into Parliament on 25 September 2008. Schedule 1 of the Bill fulfills the long-held desire of Commonwealth Treasury to change the interaction of the margin scheme with supplies of land as a "GST-free going concern" and land supply as "GST-free farming land". The focus here is on the "going concern" provisions although the same comments could also be made about supplies which are GST-free under the farming land provisions.

These proposed amendments were originally suggested in 2005 when a raft of other reforms to the margin scheme, including the interaction with the grouping provisions, the joint venture provisions and the associate rules were introduced. A gap was even left in the legislation just for these provisions - section 75-11 of the GST Act currently goes from subsection (4) straight to subsection (7). These amendments will fill that gap.

Originally, the margin scheme provisions were drafted simply to prevent the application of the margin scheme to a subsequent sale of land wherever the land had been acquired under a taxable supply the GST on which was calculated other than under the margin scheme. Thus, if a developer was to acquire land under a taxable supply, the margin scheme had to be applied on the sale of that land to the developer of the developer would be unable to apply the margin scheme to the sale of the developed lots. The corollary of this was that if the developer acquired the land under any non-taxable supply – such as a GST-free supply of a going concern – there was no impediment to the developer supplying the developed land under the margin scheme.

The perceived mischief arising from the interaction between the "supply of a going concern provisions" and the margin scheme is twofold. Firstly, by selling land to a developer as a GST-free supply of a going concern, the application of the margin scheme to that land could be "refreshed". For example, A sold land to B under a normal taxable supply on which GST was paid at 10 percent and for which B claimed an input tax credit. Such a supply would ordinarily have prevented B or any subsequent landowner from applying the margin scheme to a sale of that land. B sells the land to C as a supply of a going concern. As such, no GST is paid by B and the land has entered C's hands without any GST being embedded in the price of the land. As C has acquired the land under a non-taxable supply, C is at liberty to sell the land or lots developed out of that land under the margin scheme. The application of the margin scheme to the land has been "refreshed". TLAB No.5 2008 will add a new paragraph to the definition of supplies "ineligible for the margin scheme" to prevent developers like C from being able to apply the margin scheme in this context.

Secondly, even where land has remained eligible for the application of the margin scheme, the supply of a going concern provisions can have an important effect. For example, D held land at 1 July 2000. As at that date, the land was worth $1 million. A sale today of that land under the margin scheme would tax the increase in the value of the land since that time. If D sold to E under the margin scheme at $3.2m, D would be liable for GST of $200,000 (1/11 x $3,200,000 - $1,000,000). Therefore, the cost to E would involve $200,000 of GST which is unrecoverable as an input tax credit[1]. If however, D sold the land to E as a GST-free supply of a going concern under the current provisions, D could sell for $3,000,000 (resulting in no net difference in the amount D retains after meeting D's GST liabilities), E's cost of the land would be reduced by $200,000 and E would nonetheless be able to apply the margin scheme on subsequent sale of the developed land. The increase in value from $1,000,000 as at 1 July 2000 to $3,000,000 has been "shielded" from tax as a result of the GST-free sale.

Again, the amendments proposed by TLAB No. 5 2008 propose to counter this result. The proposed amendments will require E to ignore the consideration provided for the interest in land under a supply of a going concern and instead E's margin on a subsequent sale would be calculated on the difference between the consideration received by E on sale and the value of the land at 1 July 2000. In this way, the amendments will bring the increase in value from 1 July 2000 back into the tax base.

The proposed amendments also contain flexibility dealing with transactions entered into with entities not required to be registered for GST purposes at 1 July 2000 and some specific anti-avoidance measures for transactions between associates.

Clearly the proposed reforms are intended to restrict availability to the margin scheme. However, it is difficult to characterise the reforms as being inconsistent with the intended operation of the margin scheme. In many ways, they bolster the policy intent – to shield the value of land from GST as at the date that interest enters the GST system.

It is equally important that it be recognised that the margin scheme is not merely a transitional measure that has served its purpose. The margin scheme must be preserved as a vital part of the GST Act. To do otherwise would be to undermine the original policy intention of the legislation.