Going Concern Leases

A.             Leases granted to an associate shortly before completion of a sale

A vendor selling an untenanted building or parcel of land may be asked by a prospective purchaser to grant a lease to an associate (of the vendor or purchaser) shortly before settlement.  There may be commercial reasons for this, but often it is done to ensure the sale of the leased property will qualify as the GST-free supply of a going concern, providing a transfer duty saving to the purchaser.

These requests, often made via e-mail from a purchaser’s solicitor or agent enquiring about a “going concern lease”, create GST risks for the vendor that need to be managed.  They may also create risks for the purchaser (or their solicitor / agent), especially in New South Wales which introduced its own tax promoter penalty regime in May 2022.

B.             Going Concern Benefits

The benefits of acquiring a property (other than a residential premises) as a GST-free supply of a going concern include:

• Cash flow savings.  No need for the purchaser to pay GST to the vendor before waiting for an input tax credit (GST credit).

• Transfer duty savings.  All Australian States and Territories calculate transfer duty on the total consideration for a transfer of land (including GST).  A GST-free supply can save 1/11th of the transfer duty.

• Potential margin scheme benefits.  The purchaser may be entitled to apply the margin scheme to future sales of the property, benefitting residential developers if the vendor acquired the property through an eligible supply. 

The benefits directly favour the purchaser, but the vendor may indirectly benefit if the going concern exemption enhances sale prospects or the purchase price.

C.             ATO Investigations

The ATO’s Next 5000 private groups program has increased the review of GST going concern transactions.  If the ATO investigates a transaction where a lease was granted shortly before settlement, they may request:

• Explanation of the commercial rationale for the lease.

• Details on early termination rights and their exercise.

• Information on who suggested the lease arrangement.

• Evidence of rent payment under the lease.

• Evidence that keys or access passes were provided to the lessee.

• Evidence of the lessee occupying the property.

• Notice of attornment issued to the lessee upon sale.

• Evidence of the return of keys / access passes to the new owner.

• The basis for setting the rent and permitted use under the lease.

D.            Who bears the GST risk?

If the ATO determines the sale was not a GST-free supply, the vendor will be assessed for the GST shortfall, plus penalties and interest.

To mitigate this risk, vendors will typically include a GST indemnity clause in the contract.  However, this is an imperfect solution due to:

• Credit risk.  The ATO has up to four years to audit the transaction.  By then, the purchaser may have on-sold the property or been wound up.

• Public policy.  Courts may void contractual indemnities for statutory penalties on public policy grounds.

The best protection a vendor can obtain is a favourable ATO private ruling, confirming the sale is GST-free and that the general anti-avoidance provisions will not apply. The Commissioner is legally bound by a favourable private ruling if all material facts are fully disclosed, and the completed transaction conforms to those facts.

E.            Are there any risks for the purchaser?

While the vendor bears the GST risk, the purchaser should consider the risk of state revenue offices applying general anti-avoidance provisions if a lease is granted solely to reduce their transfer duty liability. In New South Wales, there is also the risk of Revenue NSW applying tax promoter penalty rules introduced in May 2022, particularly if:

• The lease is implemented shortly before settlement to ensure the sale is GST-free for transfer duty savings.

• The lease is proposed by the purchaser or their solicitor / agent.

New South Wales is the only state with a tax promoter penalty regime.

F.             Concluding remarks

There are legitimate commercial reasons for a purchaser to request a vendor grant a lease to an associate shortly before completion of a sale.  Documenting legitimate reasons for the lease and retaining this documentation is in both parties’ interests, especially in the event of an ATO or state revenue office audit.  If timing permits, the vendor should consider applying for an ATO private ruling.