ATO's 5-Year Rule Clarification: What You Need to Know About GST on Residential Property Sales

In a decision of the Australian Administrative Tribunal, the Member in the Dals Property Trust Case clarified the application of the '5-year rule' used to determine whether residential premises are 'new residential premises' and are therefore subject to GST.

Ordinarily, the sale of 'new residential premises' is subject to GST. However, the sale of new residential premises may not trigger GST if the premises have been leased to residential tenants for a continuous period of at least 5 years prior to the sale. In the Dals Property Trust Case, the Commissioner successfully argued that the 5-year rule was broken when the developer started to actively market the premises for sale.

The ATO has now published its Decision Impact Statement (DIS) which outlines its position on the interpretation of the 5-year rule, including when 'new residential premises' are no longer exclusively used for residential rental purposes, when the 5-year period may commence and when GST mistakenly paid to the Commissioner by a taxpayer can be refunded.

This article will summarise the key facts and findings of the Dals Property Trust Case, provide insights on the DIS and outline what this may mean for you.

Tristram Feder, Maddocks Lawyers

Background and Facts

While generally the sale of ‘new residential premises’ is subject to GST, the sale of such premises will not trigger GST if the premises have only been used for residential leasing purposes for a continuous period of at least 5 years prior to the sale (known as the ‘5-year rule’).

In Domestic Property Developments Pty Ltd as trustee for the Dals Property Trust and Commissioner of Taxation , the developer (Dals) constructed a residential property development, but failed to sell two of the units (Unit 1 and Unit 3). Dals subsequently leased Unit 1 and Unit 3 to residential tenants. Before 5 years passed since the units were constructed, Dals began to actively market Unit 1 for sale. Dals later sold both units and paid GST from the sales to the Commissioner.

However, Dals later took the view that the GST it has paid was excessive, on the basis that:

  • the supplies of Unit 1 and Unit 3 were exempt from GST on the basis of the 5-year rule; and
  • if the supplies were exempt from GST, Dals was eligible for a refund of the GST.

What did the Tribunal find?

The Tribunal decided in favour of the Commissioner, finding that the proceeds received from the sale of Unit 1 were not exempt from GST as the 5-year rule had been broken. The Tribunal was clear that the 5-year rule required that the 5 year lease period must be unbroken but that in the circumstances of the case:

  • Unit 3 was exempt from GST as the 5-year rule had not been broken in respect of those premises;
  • the ‘active marketing’ of Unit 1 for sale by Dals was a ‘use’ of the unit, so that Unit 1 could not be said to have only been used for the purposes of a residential lease (this is discussed further below); and
  • the granting of the ‘certificate of occupancy’ and the date the unit first became residential premises started the 5-year period for both Unit 1 and Unit 3.

Further, the Tribunal held that even if the sales satisfied the 5-year rule and were exempt from GST, Dals was not entitled to a refund as Dals had already ‘passed on’ the GST burden to the purchaser.

Active marketing of Unit 1

The Tribunal decided that Unit 1 was not used only for residential leasing purposes as Dal’s marketing of Unit 1 for sale was also a ‘use’ of those premises. While it was accepted by the Tribunal that actively marketing a property is generally not considered a ‘use’ of land, the Member decided that in the context of a property developer carrying on a property development enterprise, marketing for the sale of premises was an important part of its business operations.

Eligibility for refund

While the parties accepted that Unit 3 had passed the 5-year rule and was exempt from GST, the Tribunal considered that Dals was ineligible for a refund.

If the economic burden of GST is deemed to have been ‘passed on’ to the purchaser, a vendor taxpayer is not eligible for a refund of GST. This is to prevent the vendor from making a windfall gain on GST amounts. To ensure this outcome, the taxpayer bears the burden of proving that it did not pass on the incorrect GST amount.

In this case, the Tribunal found that Dals failed to prove that it did not recover an amount referable to GST from the purchaser. The Member noted that:

  • while the contracts of sale stipulated that Dals would meet any GST payable without any adjustment to the purchase price, they were not convinced that this meant that Dals necessarily bore the economic burden of the excess GST;
  • while it was accepted that the units were sold at ‘market price’, they were not persuaded that the market price in this instance did not include an amount referable to GST;
  • the issue or non-issue of a tax invoice has little weight in proving whether an amount referable to GST was included in the purchase price;
  • the error was not a simple reporting or keying error due to the significant amounts of GST paid to the Commissioner in the context of a small business like Dals; and
  • generally, it will be difficult for a taxpayer to prove that it did not pass on the burden of GST where the taxable supply was made at a price that exceeded the costs.

How will the Commissioner approach sales of new residential premises going forward?

In the DIS, the Commissioner has accepted the Tribunal’s interpretation of the law. In particular, the Commissioner has outlined that it will:

  • interpret a ‘use’ of property in respect of the 5-year rule according to its ordinary meaning in the GST statutory context, and in particular the Commissioner will regard ‘active marketing for sale’ as a use (although the Commissioner does not specify what constitutes as ‘active marketing’, it may mean publishing or advertising a property for sale);
  • consider that a continuous unbroken period of 5 years is required to meet the 5-year rule;
  • continue its current practice of assuming that the 5-year period can start at any time after the completion of construction of new residential premises, as the Tribunal gave no reasoning why it seemed to require the 5-year period to begin when the ‘certificates of occupancy’ were issued. The Commissioner expressed that it will seek to clarify its interpretation of when the 5-year rule commences at the first available opportunity before the Tribunal or Federal Court; and
  • review relevant GST Tax Rulings, namely GSTR 2003/3 (When is a sale of real property a sale of new residential premises?) and GSTR 2009/4 (New residential premises and adjustments for changes in extent of creditable purpose).

What does this mean for me?

On the basis of the Tribunal’s decision and the DIS, you should consider:

  • seeking advice if you wish to rely on the 5-year rule for the sale of your new residential premises;
  • not commencing any marketing activities to sell your new residential premises within the 5-year residential lease period if you intend on selling the premises on a GST exempt basis;
  • objecting to a GST liability in the first instance (instead of paying GST and seeking a refund later on) due to the difficulties for taxpayers in navigating the passing on rules; and
  • maintaining comprehensive records of how the purchase price for the sale of your new residential premises to buyers are determined if you believe that the sale is not subject to GST.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

Related document packages

Last revised on : 31-10-2023

Lawyer in Profile

Jack Coventry
Jack Coventry
Senior Associate
+61 3 9258 3819

Qualifications: BA (Philosophy), Monash University, JD (Juris Doctor), University of Melbourne

Jack is a member of Maddocks Commercial team. He advises a range of corporate and private clients on:

  • M&A transactions,
  • corporate reorganisations, and
  • legal and tax structuring.

Jack acts for clients on both buy-side and sell-side and specialises in founder-owned businesses and Australian subsidiaries of multi-national companies. He works across a number of sectors including information technology, professional services, and property development and management including land lease.

Jack’s structuring work includes assisting multinationals to structure Australian operations, listed companies to achieve regulatory compliance / optimisation and providing general tax structuring. He has also represented clients in tax controversies including before the General Anti-Avoidance Review Panel (GAAR Panel) and the Federal Court of Australia.

Read Our Latest Articles