(1)  ATO withholding of BAS refunds curtailed (for now)
(2)  Residential premises draft amendments released
(3)  Adjustments for M&A costs
(4)  GST refund restrictions and the passing-on provision
(5)  Just getting external advice not necessarily reasonable care
(6)  Other developments

(1)  ATO withholding of BAS refunds curtailed (for now)

How many times have I heard taxpayers gripe about net Business Activity Statement (BAS) refunds being held up while the ATO does a ‘refund verification check’? While the case discussed below could be considered an extreme example, it does appear that the ATO’s ability to withhold refunds pending investigations has possibly been severely curtailed, at least for now.

In a very serious loss for the Commissioner, the Federal Court has ruled that the ATO could not continue to withhold the payment of a net GST refund while it investigated suspected fraud by that taxpayer giving rise to the refund.

In Multiflex Pty Ltd v Commissioner of Taxation (link) the taxpayer lodged 5 monthly BASs with net GST refunds due to acquisitions of taxable electronics components in Australia which were then exported under GST-free supplies. The ATO suspected that fraud was involved, in particular that the taxpayer did not actually make most of the acquisitions giving rise to the purported input tax credits. The ATO alleged that there was a track record of sham transactions of similar goods involving related companies of the taxpayer controlled by the same individuals. Following ATO audits these other companies received GST and penalty assessments for some $26 million, and later went into liquidation. The assessed amounts were never recovered by the ATO.

The ATO withheld payment of the net refunds for the 5 periods while it investigated the potential fraud. At the time of the hearing some 3 months had passed since the last of the 5 BASs was lodged, and the ATO advised it expected its investigation to be resolved within another 2 months.

There is a lot of detailed discussion of past and present provisions of the GST legislation and the Taxation Administration Act 1953 which I won’t run through, but essentially what the Court held was that the current provisions required the ATO to pay a net refund amount within such a period as is reasonable to undertake the general administrative tasks of processing, authorising and paying the refund on the BAS, but not encompassing the time taken to undertake an investigation of the accuracy of the BAS itself. Challenging the accuracy of the BAS is to be done through the assessment process. The Court ordered that the refunds be paid. The Commissioner has already appealed the decision to the Full Federal Court, with the hearing to take place on 28 October.

In cases of high possibility of fraud or evasion I have some sympathy with the Commissioner’s position here and the risk to revenue. It is worth noting that the relevant legislation is already slated for amendment from 1 July 2012. The most recent Exposure Draft legislation was issued on 22 August 2011 (link). Amongst the 56 pages of proposed amendments is section 8AAZLGA to be inserted into the Taxation Administration Act, which allows the Commissioner to withhold a refund if he has reason to believe that the BAS contains incorrect information, and retain that amount until he is satisfied that the information is correct or he amends an assessment. An aggrieved taxpayer can object against such a decision, but only after the end of 6 months (!!) after the Commissioner’s decision.

Concerns with this draft provision have already been raised with Treasury. This would give the ATO the power to withhold refunds well beyond situations of suspicion of fraud or evasion. A suspicion of a minor error or a difference of view on an industry-wide technical issue could theoretically allow the ATO to hold up a large refund, with possibly nothing the taxpayer could do about it for 6 months, while those taxpayers in a net payment position may not be adversely affected in the same manner.

Depending upon the outcome of the Full Federal Court appeal legislative amendment could well be rushed through, but hopefully the ATO’s right to withhold refunds longer than a couple of weeks will be restricted to situations of genuine suspicion of fraud or evasion.

(2)  Residential premises draft amendments released

Treasury has released Exposure Draft legislation (link) primarily to deal with development lease scenarios for residential property developments.

The Full Federal Court in the Gloxinia case (link) held that a developer’s sales of newly constructed residential premises (constructed under a ‘development lease’ arrangement) were not ‘new residential premises’ and so were input taxed supplies. The Government has said the outcome of the case was contrary to the policy intent of the GST legislation and therefore amendments to the GST law are required. This is sought to be achieved by ensuring that the ‘wholesale’ supply of the property by the landowner to the developer is disregarded in determining whether the developer’s on-supply is of ‘new residential premises’, i.e. the developer’s supply becomes the first supply as residential premises and so therefore taxable.

One of the contentious issues with development lease arrangements not specifically canvassed in the draft amendments is the GST treatment of the wholesale supply itself, in particular what is the consideration for that supply – the value of the land, or the value of the land and completed building works. This is an important cash flow issue for the parties, and impacts very significantly upon margin scheme calculations. It would appear however that, contrary to the now-withdrawn ATO ruling GSTR 2008/2, in accordance with the Gloxinia decision and the general tenor of the proposed amendments, the consideration for that supply or supplies is the value of the land plus completed building works.

Other amendments to the residential premises rules were also included in the Exposure Draft, namely ensuring that:

The proposed amendments are generally to be effective from 27 January 2011, although there are a number of transitional rules which affected developers need to closely consider.

(3)  Adjustments for M&A costs

The 7 July 2011 edition of The GiST mentioned the fact sheet the ATO issued in relation to input tax credits for M&A costs (eg due diligence and advisory costs), and that it specifically did not deal with the possibility of Division 129 ‘change of use’ adjustments. The ATO has now issued a draft Determination, GSTD 2011/D3 (link), dealing with the adjustment issue.

The draft Determination poses the question: “does an adjustment for a change in extent of creditable purpose necessarily arise for services acquired in relation to a proposed merger and acquisition transaction that does not eventuate, or that does not proceed in the manner contemplated at the time the services were acquired?”.

Paragraph 1 of the draft Determination somewhat unhelpfully simply says “No”.

Thankfully subsequent paragraphs give some guidance on the ATO views, including three examples of aborted share acquisitions. Essentially, according to the ATO, the issue is whether the services are applied only at their time of acquisition, or whether they are applied or reapplied at a later time after the change of purpose.

In the examples given the only one in which the taxpayer can claw back the input tax credits through a change of use adjustment is where the mining taxpayer obtains a geologist’s report on the target’s mineral reserves, but later acquires the target’s assets rather than its shares. In that case the geologist’s costs provided the basis for the valuation of the assets, so the services were “reapplied” for a creditable purpose. Simply failing to proceed with a share acquisition is however not in the ATO’s view a change of application of the services acquired, so legal costs for drafting a share sale agreement or advice specific to a share transaction remain not creditable.

Disappointingly, the draft Determination provides no specific comment about the common scenario where costs are incurred before it is known whether the proposed transaction will be a share or asset transaction, e.g. investment bank advice, valuation or due diligence services. According to the fact sheet the costs should generally be apportioned when incurred, but given that (unlike the costs specifically relating to the aborted share acquisition in the examples) the costs would remain relevant to the ultimate form of the transaction does Division 129 then allow or require a partial true-up of the input tax credit claim once the form of transaction is known?

The practical application of the ATO’s views in this draft Determination and the fact sheet needs to be carefully considered in determining input tax credit entitlements for M&A activities.

(4)  GST refund restrictions and the passing-on provision

Net refunds on BASs were discussed earlier. There are different provisions dealing with seeking a GST refund after a BAS has been lodged. In this regard the ATO has issued a Decision Impact Statement (link) in relation to the International All Sports case referred to in the 6 September 2011 edition of The GiST.

You may recall that in that case the Federal Court rejected the Commissioner’s submission that he was not required to refund amounts to a gambling supplier under section 105-65 of Schedule 1 to the Taxation Administration Act 1953 (known as the ‘passing-on’ provision) as this was not a case where a supply was incorrectly treated as taxable. The Commissioner has decided not to appeal the decision.

Furthermore, in response to an issue that had been raised by industry/professional bodies, the ATO has also changed its view from MT 2010/1 so that the ATO will not restrict refunds pursuant to section 105-65 for overpayments of GST resulting from failing to apply, or miscalculating the GST payable under, the Division 75 margin scheme.

We can however expect plenty more disputes between the ATO and taxpayers relating to the passing-on provision, including in respect of refund requests lodged following the Qantas decision.

(5)  Just getting external advice not necessarily reasonable care

The 15 April 2011 edition of The GiST referred to the Federal Court decision in the Aurora Developments case (link), where the Court held that GST-free going concern treatment was not available as the vendor did not supply all things necessary for the continued operation of an enterprise nor did it carry on the enterprise of developing the land until settlement. The Federal Court has now further considered the 25% penalty imposed upon the vendor for failure to exercise reasonable care.

In Aurora Developments Pty Ltd v Commissioner of Taxation (No. 2) (link) the vendor taxpayer argued that it had exercised reasonable care by seeking external GST advice from an accounting firm. The Court however found that material matters had not been disclosed to the adviser, and so the taxpayer had failed to exercise reasonable care by failing to communicate all material matters and obtain an advice based on all material facts.

It may sound obvious, but this case is a salutary lesson for taxpayers to check carefully the facts upon which external advice is given, particularly when facts change, but also for advisers themselves to ensure that clients understand what facts may be relevant and possibly determinative.

(6)  Other developments

If you would like further information or assistance with any of the issues highlighted above or any other GST issues, please contact Damian Welshe on 0415 477 099 or at dwelshe@gstconsulting.com.au.

The GiST 7 October 2011 Edition © Damian Welshe & Associates Pty Ltd

The information in this newsletter is general in nature and does not constitute tax advice. It does not take account of your individual circumstances, for which you should seek specific professional advice.