Article: Law & Finance
A GST Trap
With the Auckland rental market heating up, we’re likely to see investments like these promoted around the regions before long. Watch out for variations on this theme.
Here’s Some Background:
Typically property developers are GST registered businesses. They claim GST on the costs of developing land and constructing buildings. And when the finished product (let’s say it’s an apartment) is sold, GST is paid to the IRD on the sale price. That’s an almost $40,000 GST bill on the sale of say a $300,000 apartment.
During the last property boom, many promoters found a clever way to avoid paying GST on the sale of finished apartments. Only trouble is, they passed the GST problem on to the often unsuspecting purchasers – and now we are regularly seeing the fallout from this.
Here’s How The Story Unfolded:
Apartments were promoted to first time property investors – often in rather slick seminars. The properties were sold with a lease and management agreement to a company in the business of letting properties for short term accommodation for example to students or tourists – usually in Auckland or Wellington. The seminars even promoted a friendly lawyer, valuer and mortgage broker to make sure the sale was completed without a hitch.
This was pitched as perfect for the out-of-town investor. The purchaser had a guaranteed income – and no tenant hassles because the management company takes care of everything. All you needed to do was sit back and wait for those big projected capital gains on the property.
The management agreement and lease were structured in such a way that the purchaser was required to register for GST, and the property was purchased on a zero-rated basis for GST. Great for the promoter, who was typically still able to sell the property for the same $300,000 – but zero rated on the basis that the activity was a going concern, saving big money by eliminating their GST obligations on sale. And there was no immediate cash disadvantage to cause alarm to the purchaser, who still paid the same $300,000.
This typically worked fine for a while – and in a few cases continues to work. But often the management company hasn’t lasted the distance – or if it has, the lease has not been renewed after the first term. The property owner is left with no option other than renting the property on a normal residential tenancy or selling up without the management agreement in place.
Here’s The $40,000 Catch:
As soon as the management agreement ends, or the property is sold to a non-GST registered person - or you move in yourself, there is probably GST payable. The lease has ended and there has been a change in the apartment’s use. And if time goes on before this is attended to, penalties and interest will quickly accumulate.
See how the original promoter has pushed their GST obligation onto the often unsuspecting purchaser?
What To Do:
Always consult your Chartered Accountant before committing to any investment property purchase. And if you already own an apartment which was purchased on a zero rated basis for GST, you should stay in close contact with your Chartered Accountant – particularly if the management agreement is close to expiry, if you are considering moving in yourself or if you are considering selling.
