The margin scheme was introduced as part of the GST regime as a means of determining the GST payable on certain supplies of land, most usually by sales of residential property by property developers. Where the margin scheme applies, GST is calculated as 1/11 of the difference between the sale price of the property and the consideration for the property (or its value as at 1 July 2000).
Where the supplier/developer of the property acquired it prior to 1 July 2000, the supplier/developer may use an ‘approved valuation’ of the land as at 1 July 2000 to determine its value at that date (rather than using the price at which the supplier acquired the property before 1 July 2000). Whether a valuation is ‘approved’ depends on whether it meets the relevant criteria laid down by the Australian Tax Office (ATO) in a series of Tax Determinations (known as Margin Scheme Valuation Requirements Determinations (MSVs)).
There have been an increasing number of disputes concerning the margin scheme, and in particular, whether valuations obtained by the supplier/developer are ‘approved valuations’. Most recently, the Federal Court considered what constitutes an ‘approved valuation’ for the purposes of the margin scheme in Brady King1. This note considers that decision.
Brady King
The latest instalment of Brady King’s dispute with the ATO was decided by the Federal Court in December 2008, the issue coming before Justice Middleton again after the Full Federal Court found for the taxpayer on a preliminary point. In Brady King, Justice Middleton held that the taxpayer’s valuation was not an ‘approved valuation’ for the purposes of the margin scheme.
In considering whether the valuation in Brady King was an approved valuation, Justice Middleton received evidence from both the valuer who had prepared the valuation, as well as an expert valuer called as a witness by the ATO. Having regard to that evidence, Justice Middleton concluded that the valuation did not satisfy the criteria stipulated by the relevant MSV (in this case, MSV 2000/2). (Other MSVs have their own criteria for whether a valuation is ‘approved’.)
Justice Middleton accepted that a mere difference of opinion in the valuation of the property did not mean that the relevant valuation is not an approved valuation. However, Justice Middleton held that the valuation relied on by Brady King failed to comply with the MSV as the valuation contained the following errors:
| Alleged error |
Approach of the court |
| Failure to consider sales that had occurred after 1 July 2000. |
This was a fundamental error affecting the validity of the valuation. Of particular interest is the court’s approach of requiring consideration of sales data after 1 July 2000: this is not consistent with the approach taken by the ATO in other cases, where the ATO has accepted that later sales are not relevant. |
| The valuation excluded the impact of GST (calculated at $2.5 million) in calculating the profit margin. |
Justice Middleton held that ‘profit margin’ component required the valuer to estimate the GST payable. Failure to take into account GST as part of profit margin was a fundamental error. |
| Failure to properly take into account interest on acquisition costs as part of the holding costs. |
The valuation took into account the interest payable by the taxpayer (based on 100 per cent debt funding of the development) by reference to the taxpayer’s actual purchase price. However, Justice Middleton held that the appropriate course was to take into account interest payable (based on 100 per cent debt funding) by reference to the value of the property as at 1 July 2000 (which was higher than the taxpayer’s purchase price). This was a fundamental error. |
| Failure to take into account hypothetical developer’s purchase costs (stamp duty and legal costs) at 1 July 2000. |
Such costs were not minor. Again, the costs should have been calculated by reference to a hypothetical developer’s purchase price. This was a fundamental error. |
| Failure to take into account land tax and rates. |
The impact of both of these may have been minimal. Justice Middleton considered it was unnecessary to decide whether these factors alone invalidated the valuation as the above factors had already determined the valuation was invalid. |
Justice Middleton left open the question of whether a minor valuation error would be sufficient to invalidate a valuation. Justice Middleton also referred to an ATO ‘GST Fact Sheet’ (dated 29 November 2005), noting that it was the ATO’s practice to allow taxpayers the opportunity to fix what the ATO considered to be a non complying valuation with a fresh valuation. A recent GST Fact Sheet (dated 16 December 2008) provides for the following approaches where a valuation is found to be invalid:
- The ATO will allow the taxpayer to fix the actual valuation so that it conforms to the ATO’s requirements
- The taxpayer may substitute another ‘approved valuation’ if completed before the relevant BAS date
- The margin may be recalculated on a supply of completed premises using a valuation made for rating or tax purposes before 1 July 2000, or
- The taxpayer may choose to calculate the margin and the GST using the consideration for the acquisition of the property as the base.
In those cases, the taxpayer may amend its BAS within the relevant statutory time limits. It is not clear what position the ATO will adopt in respect of returns already made by the taxpayer based on an invalid valuation where the taxpayer is out of time to amend its BAS. In that and in other cases, where a different approach leads to a different valuation, then there may be an increased liability for GST (plus penalties and interest).
The taxpayer has filed an appeal against Justice Middleton's decision to be heard in May. Given the status of this decision, its limited application to the particular MSV under consideration, and the fact that each valuation will necessarily have its own considerations, doubt will remain about whether any particular valuation will be an ‘approved valuation’. Accordingly, we expect that there will be continuing disputes between taxpayer developers and the ATO about whether valuations are ‘approved valuations’.
We have prepared a presentation on issues confronting those taxpayers who have obtained a valuation for margin scheme purposes where the status of that valuation as an ‘approved valuation’ is being contested by the ATO. Please contact us if you would like to us to deliver this presentation to you, or would like to discuss the particular circumstances of your position.
Endnotes
1. Brady King Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia (No 2) [2008] FCA 1918.
This article was written by Hugh Paynter, Senior Associate and Wenonah Tenedero, Solicitor, Sydney.
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