Archive for January 25, 2012

Valuations and the GST Margin Scheme – the current state of play

January 25, 2012 / Damian / No comments

On 17 January 2012 the Australian Taxation Office published a “Valuation Issues Paper” in collaboration with the Australian Property Institute and the Australian Valuation Office (link).  In light of this it is worthwhile recapping on the current requirements for approved valuations for GST margin scheme calculations, and considering what this Issues Paper may add.

There are several situations in which calculations of GST payable under the margin scheme for supplies of real property under Division 75 of the A New Tax System (Goods and Services Tax) Act 1999 require an “approved valuation” of a property interest as at 1 July 2000 or some later date when a particular event occurs (eg the date of GST registration).

Section 75-35 allows the Commissioner to determine in writing the requirements for making such a valuation, and has issued a number of legislative determinations in this regard.  The latest is MSV 2009/1 (link) applying to sales of real property from 1 March 2010.  Typically a taxpayer will adopt Method 1 of engaging a professional valuer.

Paragraph 13 of MSV 2009/1 lists various requirements for a valuation by a professional valuer to be an approved valuation for the purposes of Division 75.  Essentially the valuation must determine the market value of the property interest as at the applicable valuation date and must be made in a manner that is not contrary to the professional standards recognised in Australia for the making of real property valuations.  It also must satisfy certain procedural requirements, including a certificate specifying certain things (including the valuation approach and the valuation calculation) and when the valuation must be made.

The decision of the Federal Court in the Brady King case (link) is authority for the Commissioner being able to challenge margin scheme valuations (ie where the Commissioner considers the valuation is too high so the GST payable is too low) where the terms of the applicable legislative determination have not been complied with.

To successfully challenge a professional valuation the Commissioner would need to show that it did not comply with the requirements of MSV 2009/1.  Provided the signed certificate sets out the requisite matters and other procedural matters are followed, the Commissioner would need to argue that as a matter of fact the valuation was not a market value determination made in accordance with the professional standards recognised in Australia for the making of real property valuations.

While MSV 2009/1 is not all that descriptive about what factors need to considered or disregarded in undertaking the valuation, the need to set out in the valuation certificate the valuation approach and the valuation calculation gives the ATO and AVO potential nits to pick.

The Federal Court in the Brady King case acknowledged that within any valuation there will be matters of subjective judgement undertaken by the professional valuer based upon his or her expertise and experience.  The Court commented that just because another valuer may come to a different valuation figure does not mean that the valuation relied on may not be compliant, and indicated that only where there was a fundamental error would the valuation be invalid (such as in that case ignoring post 1 July 2000 sales data), and that minor errors would not be sufficient.

The ATO in the recent Valuation Issues Paper now talks about valuations falling within a “reasonable range”.  This at least appears to be a step forward from the more pedantic and inflexible ATO/AVO approach that taxpayers have experienced in the past, although the Issues Paper does discuss a number of recurring issues which the ATO says have been appearing in non-complying valuations.  I won’t run through all of these in detail, but broadly they relate to:

  • using profit and risk ratios well below what it considered reasonable
  • not using open market interest rates
  • unrealistic project timelines
  • not including important development costs in a hypothetical development valuation
  • assuming nil contamination where evidence indicates a probability the property is contaminated
  • unreasonably assuming nil or minimal risk associated with site characteristics
  • comparable sales data not withstanding objective scrutiny of their comparability
  • not using pre-sale prices if determining a gross realisation value (particularly when property prices have risen)
  • the impact of post valuation date knowledge or events
  • valuing the real property interest that is being sold rather than the interest that existed at the valuation date.

In respect of post valuation date knowledge or events, the Issues Paper states that post valuation information which clarifies the state of the property as at the valuation date may be considered in the valuation as it is expected that a prudent purchaser would undertake appropriate investigation to limit their risk.

However, where post valuation date information changes the state of what existed as at the valuation date then this information should not be used, eg a development application has been lodged and approved, although the ATO does appear to leave the door open to including post valuation date knowledge and events which can enhance values as long as relevant risk weightings or other reasonable adjustments are included. Risk-adjusted rezoning potential as at the valuation date may therefore still be able to be taken into account.

Where there is possible contamination the ATO comments that the valuer may provide a qualified valuation excluding the impact of contamination and revise their valuation once the full extent of contamination is known. In most cases the full contamination reports and remediation costs should be available before the property is sold, and the ATO would expect a revised valuation be issued and then used for the GST calculations. However in some cases the property will be sold and GST accounted for before the full financial impact of contamination is known, where indemnity issues may be important.

Time will tell, but it does appear that the ATO may have become a little more relaxed about complying margin scheme valuations.  Ten recurring errors have been identified in the Issues Paper, but whether they are errors in each specific circumstance could be arguable on the facts and it will be their effect on the “reasonable range” that is important.  Material assumptions may need to be justified, and preferably should be explained properly upfront in the valuation certificate to avoid drawn-out and costly disputes with the ATO.  Copies of instructions and supporting documents must be maintained.  But clearly taxpayers also should not just roll over if challenged by the ATO where they think that the approach used is reasonable and justifiable.

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Category: Property / Tags: , , ,

New proposed RITC rate for trustee services

January 17, 2012 / Damian / No comments

The ATO has for some time been unhappy with the manner in which many trusts have been claiming 75% reduced input tax credits (RITCs) for GST incurred on services acquired through their trustee or responsible entity by “inappropriate bundling”. The Government announced in the May 2010 Budget that the law would be changed from 1 July 2012, and the proposed changes to the GST regulations were released on 13 January 2012 in an Exposure Draft (link).

Investment trusts are generally unable to claim input tax credits for GST incurred as they make input taxed financial supplies, although they can claim RITCs for 75% of the GST incurred on acquisitions listed in items in regulation 70-5.02(2) of the A New Tax System (Goods and Services Tax) Regulations 1999.  Many trusts have been claiming RITCs of 75% of the GST on every cost they incur, on the basis that they are part of “trustee services” within item 29 or “single responsible entity services” within item 31. Trusts can of course also claim normal input tax credits to the extent costs relate to their making taxable or GST-free supplies (if any).

While a trust is not a legal entity, it is effectively treated as an entity for GST purposes, being the trustee acting in its capacity as trustee of the trust (ie separate to its corporate/individual capacity). The trustee therefore acts in two separate capacities for GST purposes, and may make supplies and acquisitions in either of those two capacities.

Remuneration for trustees for their services and cost recovery arrangements can take many different forms depending upon the precise wording of the trust deed and associated documents. This could include:

  1. reimbursement out of the trust fund for expenses incurred, with or without an additional specific trustee fee
  2. trustee remuneration on a full cost recovery basis, with or without a mark-up
  3. a single amount (eg a fixed fee or a percentage of funds under management) covering both recovery of expenses and trustee remuneration.

What is the consideration for the acquisition of RITC-eligible “trustee services” by the trust in these scenarios?  In which of the two capacities is the trustee incurring external costs?

In the first scenario only the specific trustee fee would likely be consideration for supplying trustee services and covered by item 29, and the individual expenses would need to be separately examined for RITC-eligibility pursuant to other items in regulation 70-5.02(2).  Some of these expenses, eg advertising, tax compliance and audit expenses, would not by themselves be RITC-eligible.

However, arguably the expenses in the second and third scenarios above are effectively bundled into the trustee’s consideration for supplying RITC-eligible trustee services and so become RITC-eligible for the trust.  This is the distortion the proposed amendments are trying to redress.

The initial Government announcement was that the law would be changed to “unbundle” the trustee acquisitions in the bundled scenarios referred to above.  The Exposure Draft legislation now released however proposes an alternative option “favoured for simplicity and clarity” which introduces a new lower 55% RITC rate for trustee services.

New item 32 is proposed to be inserted into regulation 70-5.02(2) for services acquired by a “recognised trust scheme”, to the extent the services are performed on or after 1 July 2012. The services covered by item 32 are the acquisitions qualifying for the 55% RITCs.

Item 32 will only apply if the trustee carries on an enterprise in its own capacity that includes making taxable supplies to the recognised trust scheme, eg it will not apply where the trustee is not GST-registered in its corporate capacity. It also may not then apply if the trustee does not itself receive any remuneration for trustee services, eg in the first scenario above but where there is no specific trustee fee.

Also, specified services covered by other items will remain eligible for 75% RITCs, including:

  • brokerage services
  • investment portfolio management functions
  • certain administrative functions, and
  • custody services.

The 55% RITCs would appear to be available to the trust regardless of which of the two capacities the trustee originally incurred external costs in, although the need to determine the capacity in which the trustee incurs a cost is not completely removed by these proposals. For example, the trustee needs to know what to report on the Business Activity Statements prepared in its corporate capacity. Also, when a cost is incurred from overseas, the capacity in which the trustee incurs the cost may dictate whether the trust needs to reverse charge GST or the trustee needs to charge GST to the trust instead.

The result should then be that all GST-bearing services acquired the trust are eligible for either 75% or 55% RITCs, but there will still be some work to do to allocate costs between these two GST recovery buckets.

Note also that proposed item 32 only applies to a “recognised trust scheme”.  This is defined to be a managed investment scheme under section 9 of the Corporations Act 2001, or an approved deposit fund, pooled superannuation trust, public sector superannuation scheme or regulated superannuation fund (other than a self managed superannuation fund) within the meaning of the Superannuation Industry (Supervision) Act 1993.  Other types of trusts will still be subject to the existing rules.

While it will cover unregistered managed investment schemes as well as registered ones, there could be an issue as to whether all of the trusts (eg sub-trusts) in an investment trust hierarchy satisfy the Corporations Act definition and are therefore covered by item 32 as currently drafted.

Comments on these proposals close on 24 February 2012. Investment funds should closely examine the impact of these proposals, including how particular acquisitions would be classified from 1 July 2012 under these proposals, the potential financial impact, what system changes would be needed, and whether they wish to participate in the consultation process.

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Category: Financial services, Input tax credit recovery / Tags: , , , , ,
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