- Options are always tricky.
- What applies to GST does not necessarily apply to CGT.
- Assumptions can be very dangerous.
Options and hidden tax stings
Tony comes to see you about a ‘too good to refuse’ offer he has received from a developer – $5 million GST inclusive for a property
he bought for $5,000 in 1970.
Tony tells you that he uses the land for his car repair business, which operates out of a building put there soon after purchase. Tony’s family company
pays him rent of $65,000 per year which his accountant advised for tax planning purposes. Also, his accountant told Tony that provided he keeps
the rent under $75,000 he will not be required to register for GST.
Tony tells you that Dan, the developer, plans to build 30 residential units and has told him that the sale must be under the GST margin scheme, because
otherwise Dan will not be able to use the margin scheme when he sells.
Dan has yet to arrange his finance fully so asks Tony for a call option for which he will pay $500,000. If Dan exercises the option the amount paid
will come off the price. If Dan doesn’t exercise the option Tony keeps the $500,000.
Stings and near stings
You explain to Tony that if he agrees to use the margin scheme he will have to register for GST and, if the sale goes ahead, pay GST on the increase
in value since GST was introduced in 2000. “No way” says Tony – “as of 2000 that land would have been worth about $500,000. So I’d have to pay
10 per cent of $4.5 million?”
But Tony calms down when you tell him that Dan has got it wrong: Dan can in fact use the margin scheme because none of the 7 disqualifying conditions
in section 75-5(3) of the GST Act will apply when he buys from Tony.
The only disqualifying condition that could apply would be if the purchase from Tony was a “taxable supply” with normal 10% GST payable. None of the
other six disqualifying events apply to a property first sold after GST commenced on 1 July 2000.
The sale from Tony to Dan will not be a ‘taxable supply’ because not all the 4 positive conditions in section 9-5 of the GST Act that must be met will
Those 4 positive conditions are that:
(i) the sale is for consideration;
(ii) the sale is in the course of furtherance of an enterprise;
(iii) the property is within the “indirect taxation zone” (effectively Australia) and;
(iv) Tony is registered or required to be registered.
The first three of the positive conditions apply but the fourth does not, because Tony is not registered or required to be registered, so the sale
is not a taxable supply.
So, provided you can persuade Dan’s solicitor that Tony need not register for GST and use the margin scheme, Tony saves 10 per cent of $4.5 million
Tony asks: “but don’t I have to register because the $5 million sale proceeds puts me well over the $75,000 threshold?” No, you say, because section
188-25 of the GST Act provides that when working out your likely future turnover you can ignore the proceeds of the sale of a capital asset,
such as business premises.
“Gee, you’re good” says Tony.
But wait, you silently think, what about the $500,000 option price – does that require Tony to register? You ask a mate who tells you that in a private
ruling in the ATO’s register of private binding rulings (Number 1012942530481) the ATO says that ‘For GST purposes we consider that where the supply
is the sale of a capital asset, the proceeds from granting an option to purchase the asset are capital proceeds’.
So you relax but don’t mention this to Tony.
In a later meeting Tony asks about capital gains tax. To which you reply that because he acquired the property before 1985, when CGT was introduced,
the sale will be tax-free.
But then you make the dangerous assumption that because the property is pre-CGT no CGT will be payable on granting the option to buy it, which you
do mention to Tony.
Tony is again impressed but later you find out from the same mate that this time you’re wrong.
Granting an option triggers CGT event D2 (section 104-40 ITAA 1997). It is a new asset so the general 50 per cent discount does not apply. The taxable
amount is the full $500,000 less only the incidental costs of its creation. But not necessarily: if the option is exercised CGT event D2 is disregarded
(section 104-40(5) ITAA 1997). And because the property is pre-CGT, this means nothing to pay on the sale.
But, as it happens, Tony later telephones to say that Dan did not exercise the option but at least he gets to keep $500,000 tax-free, so: “you’re a
You hesitate before telling him the truth about CGT. It wasn’t your fault really (because Tony would have granted the option anyway) but Tony’s good
opinion of you is likely to diminish somewhat when you do.
Author: Jim Main
This article is general information only and should not be relied on without obtaining further specific information.