MBI Properties Pty Ltd v Commissioner of Taxation

Federal Court of Australia (Full Court)|2013-10-18|Before: Griffiths J, Davies JJ, Edmonds J

Introduction 1 This is an appeal from orders made by a judge of this Court dismissing an application by way of appeal against an appealable objection decision notified to the appellant ("MBI") by the respondent ("Commissioner") by letter dated 23 April 2012 disallowing in full MBI's objection dated 6 March 2012 against an assessment of the net amount within the meaning of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) ("GST Act") ("Assessment") for the quarterly period 1 October 2007 to 31 December 2007 ("relevant quarter"), the Assessment having been made under s 105-5 of Sch 1 to the Taxation Administration Act 1953 (Cth) and notified to MBI on 29 February 2012. 2 The primary judge held that MBI had an "increasing adjustment" in the amount of $215,000 (representing 10% of the total purchase price for three apartments it purchased from South Steyne Hotel Pty Limited ("South Steyne") in October 2007) within the meaning of Div 135 of the GST Act for the relevant quarter. The only issue on the appeal is whether his Honour was correct in holding that the requirements of s 135-5(1), in particular para 135-5(1)(b), were satisfied in the circumstances.

Statutory Context 3 Section 135-1 provides what Div 135 of the GST Act is about: The recipient of a supply of a going concern has an increasing adjustment to take into account the proportion (if any) of supplies that will be made in running the concern and that will not be taxable supplies or GST-free supplies. Later adjustments are needed if this proportion changes over time. 4 Importantly, s 135-5 provides: 135-5 Initial adjustments for supplies of going concerns (1) You have an increasing adjustment if: (a) you are the *recipient of a *supply of a going concern, or a supply that is *GST-free under section 38-480; and (b) you intend that some or all of the supplies made through the *enterprise to which the supply relates will be supplies that are neither *taxable supplies nor *GST-free supplies. (2) The amount of the increasing adjustment is as follows: 1 x Supply price x Proportion of 10 non-creditable use where: proportion of non-creditable use is the proportion of all the supplies made through the *enterprise that you intend will be supplies that are neither *taxable supplies nor *GST-free supplies, expressed as a percentage worked out on the basis of the *prices of those supplies. supply price means the *price of the supply in relation to which the increasing adjustment arises.

Factual Context 5 The relevant factual context in which the issue on appeal arises has already been ventilated in this Court in South Steyne Hotel Pty Limited v Federal Commissioner of Taxation (2009) 180 FCR 409. Relevantly, those facts are summarised in [54]-[58] of my reasons: 1. The Sebel Manly Beach Hotel ("the Hotel"), which was constructed in or about 1988, is comprised of 83 apartments, a beachfront restaurant, a bar, two swimming pools, outdoor spa and other public areas as well as meeting and conference rooms and related facilities. The Hotel has been operated as a hotel offering short-term accommodation, averaging two to three nights stay per guest, since it was constructed. 2. On or about 8 December 2000, South Steyne purchased the Hotel. 3. On 10 August 2006, each apartment in the Hotel was individually strata-titled. 4. On or about 29 September 2006, South Steyne: 4.1 Sold the "Management Lot", which included the reception area, offices and car parking spaces, to Mirvac Hotels Pty Ltd ("MHL"); and 4.2 leased each of the 83 apartments to Mirvac Management Pty Ltd ("MML") under 83 separate lease agreements. Each lease obliged MML to operate a scheme whereby the apartment was, together with the other apartments, operated as part of a serviced apartment business. 5. Between 29 September 2006 and 31 October 2007, South Steyne sold 15 apartments to various investors, including apartments 111, 304 and 604 to MBI. Each apartment was sold subject to the applicable lease to MML. Each contract for sale permitted the purchaser to participate in a "Management Rights Scheme", which mirrored the scheme provided for under the lease agreements. Each purchaser elected to participate in the scheme.

South Steyne Hotel Pty Limited v Federal Commissioner of Taxation (2009) 180 FCR 409 6 On 16 January 2009, Stone J dismissed an application brought by several applicants (including South Steyne and MBI) seeking various declaratory orders in relation to the GST treatment of what were described as four "categories of supply" arising from the events described above, as well as a further event (giving rise to the fourth category of supply), not relevant for present purposes: (2009) 71 ATR 228. 7 On appeal to a Full Court, the appeal was allowed in part. 8 The first three categories of supply were referred to as follows: (1) First category of supply: the supply by way of lease from South Steyne to MML of each of 83 apartments: see [5(4)] above. (2) Second category of supply: the supply by sale of apartments by South Steyne to investors, including the sale of apartments 111, 304 and 604 to MBI: see [5(5)] above. (3) Third category of supply: the leases of apartments 111, 304 and 604 by MBI to MML in consequence of the former's purchase of the reversion from South Steyne: see [5(5)] above.

First Category 9 The primary judge concluded that, for the purposes of the GST Act, the apartments in the Hotel were residential premises to be used predominantly for residential accommodation and were not commercial residential premises. As a consequence, her Honour held that their supply by way of lease attracted the operation of s 40-35 such that the supply was input taxed. 10 Her Honour's conclusion was unanimously upheld by the Full Court.

Second Category 11 The primary judge concluded that, for the purposes of the GST Act, the supply by sale of apartments by South Steyne to investors, including the sale of apartments 111, 304 and 604 to MBL, were taxable supplies. 12 The Full Court, by majority, disagreed with her Honour and concluded that the second category of supply was GST-free under s 38-325 of the GST Act as the supply of a going concern, to which all the requirements of s 38-325(1) were met.

Third Category 13 The primary judge concluded that, for the purpose of the GST Act, this category of supply was input taxed. 14 The Full Court unanimously held that there was no supply by MBI. In the words of Finn J (at [2]): [T]he sales of three apartments to MBI Properties subject to their respective leases did not constitute a new or further supply. The covenants of the initial leases remained but the benefit of the respective tenants' covenants and the burden of the landlord's covenant "ran" with the reversion by virtue of real property legislation: see Conveyancing Act 1919 (NSW), ss 117, 118; Real Property Act 1900 (NSW), s 40(3); and not by virtue of a distinct supply agreement or arrangement: see generally Butt P, Land Law (5th ed, Lawbook Co., 2006) at [15159]-[15175]. In the words of Emmett J (at [32]): There is a real question as to whether the Continuation Category involves any supply at all. Properties acquired from South Steyne the legal estate in respect of apartments in the Sebel Hotel, being the reversion after the leases in favour of Management. It is common ground that there was a supply on the grant of the leases. The better view is that there was no further supply, merely by reason of the continuation of the leases after the sale of the reversion… I said (at [76]): I have come to the view that when MBI purchased the reversionary interest in the three apartments there was no new supply by MBI to MML but merely a continuation of the first category of supply and there is no dispute that that supply was "by way of lease". The basis for this view is sourced in the proposition that when MBI purchased its reversionary interest in the three apartments, MML's lease did not come to an end and a new lease commence. Its lease, originally granted by South Steyne, continued uninterrupted by the change in the owner of the reversionary interest. In other words, there is no third category of supply, merely a continuation of the first category of supply… 15 Before the primary judge, and on the appeal in this Court, the Commissioner relied heavily on the language I used at [76] of my reasons that while there was no new supply by MBI to MML, there was a continuing supply by South Steyne to MML. Neither of the other members of the Court referred to a "continuing supply"; Emmett J, with whom Finn J agreed, referred to "the continuation of the leases after the sale of the reversion". I mention this aspect of the Commissioner's case now because of its relevance to the process of reasoning employed by the primary judge, although I return to it again in the context of my analysis, later in these reasons.

The Primary Judge 16 It was common ground, both before the primary judge and before this Court on appeal, that MBI was the recipient of a supply of a going concern, such as to satisfy the requirements of s 135-5(1)(a) of the GST Act. The dispute between the parties concerns the proper construction of s 135-5(1)(b) and its application to the facts of the case. 17 In coming to his conclusion, the primary judge considered that MBI's contended construction of s 135-5(1)(b) should be rejected and the Commissioner's contended construction accepted (at [26]), for the following reasons: (1) First, his Honour did not accept that s 135-5(1)(b) should be construed such that the reference "supplies made through the enterprise to which the supply relates" referred only to supplies made by the recipient and not a third party. MBI contended that the provision should be read as though it referred to "supplies made by you [in this case MBI]" through the enterprise. His Honour accepted the Commissioner's contention that there is no basis for reading those words into the provision (at [27]). (2) Secondly, his Honour did not consider that MBI's construction was advanced by the presence in s 135-5(1)(b) of the terms "will be". Even if it were accepted that those terms indicate that the supplies to which the relevant intention relates are supplies made through the enterprise after the supply of the going concern, according to his Honour there is no warrant for construing the provisions as requiring that the supplies have to be made by the acquirer of the enterprise (at [31]). (3) Thirdly, his Honour considered that the terms "will be" are sufficiently broad to cover the situation where supplies continue to be made through an enterprise, as is the case here. His Honour accepted the Commissioner's contention that all s 135-5(1)(b) requires in the circumstances here is that MBI intend that the leases granted by South Steyne to MML in relation to the three apartments (constituting the input taxed supplies of residential premises) would continue to be made through the enterprise of the serviced apartment business which MBI acquired from South Steyne as a going concern (at [32]). (4) Fourthly, to the extent there is any dispute about the matter, his Honour accepted the Commissioner's contention that, for the purposes of s 135-5(1)(b), the issue of MBI's intention is to be determined objectively and by reference to the nature of the enterprise to which the supply of the going concern relates (at [33]). His Honour observed (at [35]): MBI did not dispute that it subjectively intended the leases over the apartments to continue and it accepted that it would be "objectively determined" that it intended those leases to continue. (5) Fifthly, his Honour accepted the Commissioner's contention that the leases are intrinsically linked with the serviced apartment business which constitutes the relevant "enterprise" for the purposes of s 135-5(1)(b) of the GST Act (at [36]). 18 His Honour concluded (at [38]): Having regard to all these matters, I consider that the requirements of [s 135-5(1)(b)] are satisfied in circumstances where there is a supply that is treated as a continuing supply (namely the supply of the residential premises by lease) which continues to be made through the enterprise constituted by the serviced apartment business after its supply as a going concern. Moreover, for reasons given above in [35], I find that MBI as recipient of the going concern intended that that be the case. (Emphasis added.)

Analysis of MBI's Appeal 19 On the appeal, MBI identified, as the principal error in the primary judge's judgment below, his Honour's conclusion that South Steyne was "treated" by the GST Act as continuing to make input taxed supplies to MML after it had ceased to have any interest in the units. 20 That this was the critical issue on the appeal was conceded by counsel for the Commissioner in the following terms (T28/26-27): Indeed, if there is no continuing supply there is no basis on which MBI would be liable to an increase adjustment. And a little later (T29/12): Indeed, if that proposition cannot be made good, then the appeal must be allowed. In my view, this concession was correctly made. 21 It was common ground that Div 156 had no application to the present case, only being concerned with the attribution of GST payable on a taxable supply. The "treatment" worked by s 156-22 is therefore not applicable. 22 Counsel for the Commissioner was unable to identify any other provision of the GST Act which "deems continuation of supply" during the continuation of a lease, at least "explicitly" (T31/31-T32/6). 23 In counsel's own words (T29/13-15): The proposition, if one can boil it down as much as possible, is simply this: If there is a continuing lease, there must be a continuing supply. The proposition is, your Honours, as simple as that… 24 With respect, the proposition is flawed. The lease is the subject of the supply, not the "supply"; the "supply" is the grant of the lease: see s 9-10(2)(d) of the GST Act. The act of grant does not continue for the term of the lease; the "supply" is complete on the lease coming into existence. The "supply" constituted by the grant of the lease did not continue beyond the grant; the fact that the lease continued was solely a function of the terms of the grant, not a continuing supply by the grantor. 25 If the "supply" constituted by the grant of the lease did not survive the grant, it certainly did not survive the sale of the reversion from South Steyne to MBI. The idea that South Steyne continued to supply the lease to MML following the sale of the reversion to MBI is self-evidently flawed; as observed by counsel for MBI, following the sale of the reversion, South Steyne may go out of existence, be wound up or, in a case where the original lessor is a natural person, be dead, and yet on the Commissioner's contention, accepted by the primary judge, the original lessor would be deemed or treated as continuing to make a supply. 26 Insofar as the Commissioner sought to gain support for his proposition from what I said in South Steyne at [76] (see [14] above), what I there said concerning "a continuation of the first category of supply" has to be understood as referring to a continuation of the subject of the "first category of supply", namely, the lease, not the grant. The grant was the "supply". So understood, what I there said is totally consistent with what Emmett J (with whom Finn J agreed) said at [32] in South Steyne (see [14] above). 27 The Commissioner also sought to gain support for his proposition from what a Full Court said in Westley Nominees Pty Ltd v Coles Supermarket Australia Pty Ltd (2006) 152 FCR 461 at [20], [21]: It was put to Senior Counsel for the appellants that it would be an odd result if a "supply" by way of lease of real property were to come to an end when the owner of the property and grantor of the lease sold the reversion to a third party purchaser so that, while the third party purchaser of the reversion and the lessee would remain bound in terms of the lease and entitled to enjoy the respective benefits therefrom, there would no longer be a "supply" upon which a liability to GST could be founded. Surely, that could not have been the intention of Parliament. Senior Counsel's response was that it is not an odd result. First, it is entirely revenue neutral; no GST is payable, but then nobody gets an input tax credit. Second, this is new legislation and gaps like this are to be expected; if Parliament intends that the purchaser of a reversion is to be regarded as continuing to make the supply which its predecessor in title contracted to make, then it would be easy enough to enact a deeming provision. As indicated below, we take the view that the existing legislation discloses such an intention. With respect, the revenue neutrality argument does not neutralise the oddness of the result for which Senior Counsel for the appellants contended. At one moment GST would be payable in respect of what is an undoubted taxable supply and, at the next instant, GST would not be payable because the lessee is no longer paying rent to the grantor of the lease, but to the grantor's successor in title, the purchaser of the reversion. True, the lessee will not be entitled to an input tax credit, but that is consistent with the operation of the taxing regime if the rent is not consideration for a supply. The appellants' argument leads to a curious result because it entails that the lease of the real property to the lessee ceases to be a "supply", notwithstanding that the lease is still on foot and the lessee is paying rent, albeit to the purchaser of the reversion, in accordance with the lease. One could understand that result where the lessee purchases the reversion and there is a merger: the lease being absorbed into the reversion and destroyed. But that is not the case here. 28 A number of things may be said about this passage from the Full Court's reasons, among them being that it concerned, inter alia, the operation of A New Tax System (Goods and Services Tax Transition) Act 1999 (Cth), in particular, s 12 of that Act which applied to periodic or progressive supplies beginning before and ending on or after 1 July 2000; and s 12(3) providing that a supply by way of lease was taken to be a supply for the period of the lease; and it concerned "taxable supplies" not, as here, an "input taxed supply". These matters aside, insofar as there is any tension between what was said by the Full Court in this passage from its reasons in Westley Nominees and the foregoing analysis, in particular at [24] and [25] above, the passage is to be explained and understood by reference to what is said in [26] above. 29 In my view, the primary judge erred in concluding that, following the sale of the reversion from South Steyne to MBI, there was a continuing supply by South Steyne to MML; there was no continuing supply, merely a continuation of the lease, the subject of the supply made by South Steyne to MML by the grant. 30 The Commissioner did not contend that there was any other supply and, as indicated in [20] above, conceded, in those circumstances, that the appeal must be allowed. 31 The primary judge's conclusion that the requirements of s 135-5(1)(b) were satisfied in the circumstances of the case was challenged by MBI on a second basis, and while it is not necessary on the view I take of the first issue to deal with this second basis, in deference to the arguments of the parties, I shall do so. 32 As indicated in [17] above, his Honour concluded that the "supplies" to which s 135-5(1)(b) refers may be supplies made by a person other than the person to whom the section speaks. That is, his Honour held that the section may apply where a person who acquires an enterprise intends that some "third party" will make supplies through that enterprise. His Honour was of the view that there was "nothing in the text, context or apparent policy relating to the provisions" (at [27]) to support the conclusion that the intention must be as to supplies made by the person who has acquired the enterprise. 33 To the contrary, MBI contended that there were quite powerful indications in s 135-5 and in its wider statutory context that the relevant "supplies" are those which the purchaser of the enterprise intends to make in carrying on that enterprise. I agree. Apart from anything else, his Honour's conclusion involves the startling proposition that someone other than the person making the supply, indeed a person which is not even the recipient of the supply, is liable to pay GST on the supply. 34 The proper construction of s 135-5(1)(b) must be approached with an appreciation of its wider setting and the architecture of the GST Act as a whole: HP Mercantile Pty Ltd v Commissioner of Taxation (2005) 143 FCR 553. 35 First, s 38-325 ensures that a person who purchases an enterprise as a going concern is not required to pay to the vendor the amount of GST that would otherwise be payable by the vendor to the Commissioner in respect of the supply. A purchaser of a going concern is thus relieved of the burden of having to fund GST in circumstances where it will be entitled to a full input tax credit and the outcome would, from the Commissioner's perspective, be revenue neutral: see para 5.108 of the Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Bill 1998 (Cth). 36 However, if, in the absence of applying s 38-325, the purchaser would not have been entitled to a full input tax credit in respect of the GST paid to the vendor for the acquisition, the outcome would not be revenue neutral. This would be the case, to the extent that the purchaser makes acquisitions that relate to making supplies that would be input taxed and so would not be entitled to a full input tax credit (ss 7-1(2), 11-5 and 11-15(1) and (2(a)). Division 135 therefore provides a mechanism whereby a person who acquires a GST-free supply of a going concern may become liable to an increasing adjustment, but only to the extent of the proportion of non-creditable use. 37 Thirdly, and this goes to the architecture of the GST act as a whole, s 9-40 imposes a general liability to pay the GST on the supplier of a taxable supply. Section 9-40 operates subject to provisions that allocate responsibility for the payment of GST in the case of GST groups and GST joint ventures. It also operates subject to Divs 83 and 84, which impose liability to pay GST on the recipient of the supply as opposed to the supplier. Here, it is conceded, MBI is neither the supplier nor the recipient. 38 It is not in dispute that MBI makes no supplies, input taxed or otherwise, in leasing the units to MML. In other words, it makes no supplies in carrying on its enterprise which could be regarded as being made "through" its enterprise. So much is recognised by the Commissioner in his "increasing adjustment" under s 135-5(2) included in MBI's Assessment: the proportion of non-creditable use, used by the Commissioner is 100%, wholly and solely referable to the input taxed supply by South Steyne to MML. 39 But on the construction of s 135-5(1)(b) adopted by the primary judge, MBI has been made liable for GST in any event. That is not an outcome that can be reconciled with the stated purpose of Div 135, nor the architecture of the GST Act as a whole. 40 In my view, both the direct statutory context and the wider architecture of the GST Act suggest that the relevant supplies for the purposes of s 135-5 are those made by MBI and not by some other entity. The section only applies where "all of the things that are necessary for the continued operation" of the supplied enterprise (s 38-325(2)(a)) have first been supplied to the taxpayer. The section also only applies where "you intend" that certain supplies "will be made" and does not apply to supplies that have previously been made by another entity. 41 MBI further contended that the construction adopted by the primary judge also gives rise to practical difficulties. On the construction adopted by his Honour, a taxpayer's liability depends upon the extent to which some other person will make, or be "treated" as making, input taxed supplies "through" the taxpayer's enterprise. On that construction, the GST liability on acquisition of leased real property depends upon knowing whether the original grant of the lease (which may not have been made by the vendor) was taxable or input taxed. This matter was seen in the Court below to be an insignificant "theoretical" practical difficulty: at [28]. The difficulty, however, is neither theoretical nor insignificant. 42 A consideration of these difficulties, together with the other textual and contextual matters identified above, leads me to the conclusion that reference to "supplies made through the enterprise" in s 135-5(l)(b) is to supplies to be made by the acquirer of that enterprise. That construction confines liability for the "increasing adjustment" to the supplier consistent with the general liability for GST under s 9-40 of the GST Act. 43 The appeal must be allowed with costs. I certify that the preceding forty-three (43) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Edmonds.

Associate: Dated: 18 October 2013 IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSW 329 of 2013

JUDGES: EDMONDS, FARRELL AND DAVIES JJ DATE: 18 OCTOBER 2013 PLACE: SYDNEY

REASONS FOR JUDGMENT FARRELL J: 44 I have had the benefit of reading drafts of the reasons for judgment of Edmonds J and Davies J and I agree with their reasons and conclusions. I certify that the preceding one (1) numbered paragraph is a true copy of the Reasons for Judgment herein of the Honourable Justice Farrell.

Associate: Dated: 18 October 2013 IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY GENERAL DIVISION NSD 329 of 2013

JUDGES: EDMONDS, FARRELL AND DAVIES JJ DATE: 18 OCTOBER 2013 PLACE: SYDNEY

REASONS FOR JUDGMENT DAVIES J: 45 I have had the advantage of reading a draft of the judgment of Edmonds J and agree with his reasons and conclusions. 46 The Commissioner's case rested on the proposition that the "supply" by way of lease that results from the grant of lease does not come to an end if the reversion is sold. I agree with Edmonds J that the passages from Westley Nominees Pty Ltd v Coles Supermarkets Australia Pty Ltd (2006) 152 FCR 461 ("Westley") on which Commissioner relied cannot be adopted in support of that submission. 47 Westley concerned transitional provisions. The appellant in that case had, before the introduction of A New Tax System (Goods and Services Tax) Act 1999 (Cth) (the "GST Act"), purchased a property subject to an existing lease. The periodical or progressive supply rule in s 12(3) of the A New Tax System (Goods and Services Tax Transition) Act 1999 (Cth) ("the Transition Act") applied to the grant of lease because it spanned 1 July 2000 so that the grant of lease was taken to be a "supply" for the period of the lease. The question that the Full Court addressed was whether there was a "supply by way of lease" following the sale of the reversion to which the transitional provisions applied. The Full Court accepted that the lease of the property did not cease to be a "supply" on the sale of the reversion because: section 12(3) of the Transition Act included a "supply" by way of lease otherwise by grant; and the appellant had made a "supply" within the meaning of s 9-10(2)(g)(iii) of the GST Act in that the appellant had "entered into an obligation to tolerate an act or situation" because it had assumed the obligation of the vendor to honour the lease according to its terms when it purchased the reversion. 48 Westley turned on the question of whether there was a "supply" by the appellant on which s 12 of the Transition Act operated, and the passages from Westley at [20] and [21] on which the Commissioner relied are to be understood in that statutory context. The "continued supply" by way of lease that resulted from the grant depended in that case on the treatment of the relevant supply as a progressive or periodical supply within s 12(3) of the Transition Act. 49 Division 156 of the GST Act is the counterpart of s 12 of the Transition Act in that, if applicable, the supply by way of lease will be taken to be supplied progressively or periodically over the whole of the period of the lease. However, Division 156 does not assist the Commissioner because Division 156 only applies to taxable supplies by way of lease: s 156-5 and s 156-22 of the GST Act. Division 156 does not apply in the present case because the supply by way of lease by South Steyne to MML was held by the Full Court in South Steyne Hotel Pty Ltd v Federal Commissioner of Taxation (2009) 180 FCR 409 ("South Steyne") to be an input taxed supply. No continuing supply by way of lease can therefore be attributed and Westley provides no support for the proposition advanced by the Commissioner in this case. 50 As the Full Court in South Steyne held that the acquisition by MBI of the reversion did not constitute a new or further supply to MML, the only relevant "supply" was the grant of lease by South Steyne to MML. That "supply" by the grant of lease was complete on the lease coming into existence because it was an input taxed supply. Whilst there appears to be some tension between Westley and South Steyne as to whether there is a further "supply by way of lease" by reason of the continuation of the leases after the sale of the reversion, that tension need not be resolved here. Either way, there was no continuing "supply by way of lease" here, whether by grant or by the acquisition of the reversion, because Division 156 does not apply to an input taxed supply. As there was no continuing supply, the terms of s 135-5(1) of the GST Act are not met. I certify that the preceding six (6) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Davies.

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