How does GST operate when leased premises are sold?
1. Despite sounding a little complex, most transactions involving the sale of property, even leased property, in reality do not create any great difficulties for GST purposes.
Recent Federal Court decision
2. No great difficulties that is until the recent decision of the Federal Court in the case of MBI Properties Pty Limited v Commissioner of Taxation.3. MBI Properties Pty Ltd ("MBI") acquired three apartments in a hotel complex, each of which was subject to a lease entered into between the vendor, South Steyne Hotel Pty Ltd ("South Steyne"), and the operator of the hotel, Mirvac Management Ltd ("MML"). MBI, on acquiring the rights of the lessor, became the recipient of a "supply of a going concern" within the meaning of the GST Act. The issue in the case concerned the construction and application of s 135-5(1)(b) of the GST Act and whether, by reason of MBI's assumption of the lessor's rights and obligations with respect to MML, it was thereafter making supplies through an enterprise to which the supplies related.
4. In that case the Full Court of the Federal Court held that a purchaser of a property subject to a lease does not make any supply to the tenant following completion of the acquisition. It followed that the purchaser has no GST liability in respect of the ongoing lease.
5. The Federal Court created a wave of uncertainty for GST when it held that the only relevant supply in respect of a lease occurs on its grant (see MBI Properties Pty Ltd v FCT  FCA 56, 2 February 2013, upheld on appeal to the Full Federal Court in MBI Properties Pty Limited v FCT  FCAFC 112, 18 October 2013).
6. The decision raised many questions regarding the correct GST treatment in such circumstances.
Position prior to Federal Court decision in MBI
7. Until the Federal Court decision it was generally understood that a lease is a continuing and periodic supply for GST purposes and as a result, when the freehold is sold, the vendor ceases supplying the property under the lease, and ceases to have any GST liability in respect of the lease. The accepted view was that the purchaser assumed the supply to the tenant of the property under the lease, and therefore the GST liability in respect of the lease.
8. The Australian Taxation Office (ATO) had issued a public ruling confirming that in substance the ATO would administer the GST law in that way when a sale of a rental property occurred.
9. The Federal Court’s decision applied to all leases because the Court held that, under the GST legislation, a lease is supplied in full at the time of grant of the lease and not continually or periodically over time. The Court held that there is no provision in the GST Act that deems continuation of supply during the continuation of a lease. The supply is the grant of the lease and therefore the supply is complete on the lease coming into existence.
Implications from Federal Court decision
10. This finding by the Court raised a number of questions in circumstances where property is sold subject to a lease:
1. Does the vendor remain liable for the GST in respect of the lease after selling a property, even though the vendor is no longer entitled to receipt of the rental payments? Although the Federal Court decision made this a theoretical possibility, vendors were protected by ATO ruling GSTD 2012/2 which states in paragraph 7:
"7. The vendor of the commercial premises is not liable for GST relating to the lease where it is no longer in receipt of or entitled to rent or other consideration for the lease following the sale of the reversion."
2. Should the purchaser of a property subject to a lease continue collecting the GST from the tenant and remitting it to the ATO, even though according to the Full Federal Court decision the purchaser is not making any supply to the tenant?
11. The Full Federal Court in MBI Properties decided that a purchaser who acquired new residential premises subject to existing leases as a GST-free supply of a going concern was not liable for GST under Division 135 of the GST Act. This was because the purchaser was not intending to make any input taxed supplies through the enterprise which the purchaser acquired.
12. Tenants under any lease which is subject to GST where the underlying land has been sold were also potentially impacted by MBI Properties. This is because, in order to claim any input tax credits for GST paid correctly , the tenant also needed to be considered to be making an acquisition and be issued with tax invoices by the entity who makes the supply.
The Commissioner's appeal
13. The Commissioner of Taxation sought (and was granted) leave to appeal to the High Court from the decision of the Full Court of the Federal Court.
The High Court decision
14. The High Court appeal concerned the characterisation, for the purposes of the GST Act, of observance of obligations of lessor and lessee continued by operation of law following the sale and purchase of premises subject to an existing lease.
15. In Commissioner of Taxation v MBI Properties Pty Ltd,  HCA 49 the High Court (French CJ, Hayne, Kiefel, Gageler and Keane JJ) unanimously decided in a joint judgment that the assumption by a taxpayer of a lessor's rights and obligations following its purchase of premises subject to an existing lease involved the making of supplies for GST purposes – that is, the supply of a lease involves a continuing supply in addition to the grant itself and the GST legislation does not require the consideration (i.e. the rent) to be attributed exclusively to one or other supply. It is sufficient, and double taxation is avoided, by the attribution of the rent to specific tax periods.
16. The High Court held:
36. … There will in general be a supply which occurs at the time of entering into the lease. That supply will involve a grant within the scope of s 9–10(2)(d) combined (as contemplated by s 9–10(2)(h)) with the creation of contractual rights within the scope of s 9–10(2)(e) and with the entry into contractual obligations within the scope of s 9–10(2)(g). There will then be at least one further supply which occurs progressively throughout the term of the lease. That supply will occur by means of the lessor observing and continuing to observe the express or implied covenant of quiet enjoyment under the lease. The thing of value which the lessee thereby receives is continuing use and occupation of the leased premises. The special attribution rule in s 156–5, made applicable to a supply by way of lease by s 156–22, does not alter those aspects of the general operation of the GST Act.
37. In observing and continuing to observe the express or implied covenant of quiet enjoyment under the lease, the lessor is appropriately characterised, for the purposes of the GST Act, as engaging in an "activity" done "on a regular or continuous basis, in the form of a lease". The result is that, whether or not the lessor might also be engaged in some other form of enterprise, the lessor makes the supply of use and occupation of the leased premises in the course of the lessor carrying on an enterprise as defined in s 9-20(1)(c).
38. Once the general operation of the GST Act is understood in that way, it is apparent that there is no warrant in the text or policy of the GST Act for reading the reference in the special rule in s 40-35 to a supply of "residential premises" that is a supply "by way of lease" as referring to the supply which occurs at the time of entering into the lease but not as referring to the further supply which occurs by means of the lessor observing and continuing to observe the express or implied covenant of quiet enjoyment under the lease. The reference encompasses both, and both are therefore input taxed.
40. In the circumstances which gave rise to the present appeal, there was an input taxed supply of residential premises by way of lease which occurred at the time of the grant of each apartment lease by South Steyne to MML. There was then a further input taxed supply of residential premises by way of lease which occurred by means of South Steyne observing its express obligation under the lease to provide MML with use and occupation of the leased premises. MBI's assumption of that express obligation by operation of law on its purchase of the premises from South Steyne resulted in MBI becoming obliged to continue to make the same further input taxed supply of residential premises by way of lease to MML throughout the remaining term of the lease. MBI intended at the time of purchase to observe that ongoing obligation. MBI intended to do so through an enterprise which was the same enterprise as that in which South Steyne had previously engaged and which MBI, by purchasing the premises subject to the lease, had acquired from South Steyne as a going concern.
45. MBI's intended supply of residential premises by way of lease to MML was for a price: the rent to be paid to MBI by MML in observance of MML's continuing obligation under the apartment lease. That is so whether or not that rent can be said also to have been payable in connection with South Steyne's grant of the apartment lease to MML.
Amended GST Ruling
17. As a result of the High Court decision, the Australian Taxation Office issued Addendum to GSTD 2012/1 regarding the GST consequences following the sale of residential premises that are subject to a lease.
18. As a result, it seems that the general understanding has now been restored.
19. A lease is a continuing and periodic supply for GST purposes and as a result, when the freehold is sold, the vendor ceases supplying the property under the lease, and ceases to have any GST liability in respect of the lease.
20. The purchaser assumes the supply to the tenant of the property under the lease, and therefore the GST liability in respect of the lease.
W G Stark
Hayden Starke Chambers
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