Posted on March 9, 2017 by Tom Francis
For our clients in the building and construction industry times are tough; the State Government is forecasting a 26% decline in project commencements compared to last year and prices in some suburbs have decreased sharply. For many this means projects can’t be sold for the price they need to make a profit or break even on their project and as a result many are looking to rent out houses over the short to medium term.
However, it is important to factor in the GST consequences before doing so. The legislation covering GST and property developments is complex but broadly speaking a change of intent from ‘build and sell’ to ‘build and rent’ means the developer is no longer entitled to claim back all of the GST on the costs. The entitlement to GST credits reduces each year for five years or until the property is sold, whichever is shorter, and each year the developer must remit the difference to the ATO. The majority of the GST remitted is paid back in the first year meaning short term rentals also incur a significant adjustment.
On a large scale development this can involve paying tens of thousands of dollars to the ATO each year, sometimes leaving clients worse off than if they had sold the property at a discounted price.
Let us consider the following example:
- Tim and Monica have just finished a three-unit development in their trust, TM Property Trust. The trust is registered for GST
- The land cost them $450,000 including duties and legal fees and they have elected to apply the margin scheme
- The build cost was $550,000 and they claimed $50,000 in GST credits over the 12 months it took to finish construction, bringing their total outlay to $950,000
- A recent valuation by an agent suggested an average sale price of $330,000 per unit
- After paying GST of $16,364 on each unit and agent selling costs, Tim and Monica would receive approximately $305,000 per unit and make a loss of $35,000
- Instead they choose to rent the properties and receive $360 per week for each unit as this will cover their loan repayments.
Over the years the ATO have released a substantial number of rulings on how to reasonably calculate your adjusted GST entitlement, with different methods applicable to different circumstances. In Tim & Monica’s case the most appropriate method is based on how long the intention was to ‘build and sell’ vs how long the intention is to “build and rent”, resulting in over $32,744 being remitted to the ATO after the first year and $44,583 being remitted over the full five years. After 1 year of renting Tim & Monica would need to achieve a sale price of $341,000 per unit to be better off than they would have been selling immediately and $352,581 to break even on the development.
Once a property has been leased it is too late to avoid making an adjustment to GST, even where it is only rented for a short time, and as you can see from the above example the consequences of doing so are complex and costly. We therefore strongly encourage any of our clients who are considering a decision like the above to contact us beforehand to discuss your situation.
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Posted on March 10, 2017 by Chris Grieve
The recent cooling in the WA economy coupled with the increased availability of commercial space has seen many of our clients considering relocating their businesses to take advantage of the favourable market conditions. One of the multitude of things to consider when exiting and negotiating a new lease is the implications of what is commonly referred to as the “Make Good Clause”.
“Make Good” refers to the provision in a commercial lease that stipulates how a property should be left at the end of the lease term. When negotiating a lease many other issues tend to take the precedent such as lease term, rent reviews, incentives, etc leaving make good clauses as an often forgotten generic, poorly worded afterthought.
Even if a make good clause doesn’t appear in the lease agreement, a landlord may be able to take common law action against you if you don’t return the premises in line with its original condition (except for fair wear and tear).
While it is usually accepted by the tenant that the premises be returned in the state it was given, some tenants (and landlords) fail to include adequate detail on the condition and quality of the property at the commencement of the tenancy. This can leave an area of dispute and surprise costs at the end of a lease, consider the following:
- A business signs a lease agreement, substantially fitouts the premises and moves in. The make good clause is a generic clause devoid of detail. At the exit of the lease the landlord requests a refurbishment using different or superior products than was the case at the commencement of the lease. As none of this detail was included in the lease the new business owners have no point of reference to question the landlord’s request.
- Similar to the above a landlord may have purchased a property with the lease intact and have no point of comparison when undertaking final inspection.
- Under an assignment of lease arrangement the new tenant inherits the conditions of the existing lease which can include the make good clause. A prudent assignee can make provision for this in negotiating the assignment so that it doesn’t get burdened with any surprise make good costs. Equally a landlord may seek to recover some of the make good prior to assignment from the assignor as part of it’s negotiations.
Cash settlements in lieu of make good are a popular way of satisfying the make good requirement at the end of the lease. This allows a tenant to vacate the building (providing it is left clean and tidy) and not have to organise the removal of the fitout. From a landlords point of view it gives them the option to find a tenant willing to take on the existing fitout or use the money to fit it out to the incoming tenant specifications.
With the current market place in WA being one favourable to tenants, we are seeing many incentives being offered by landlords including, but not limited to, a “no make good” clause, effectively allowing the tenant to vacate without any obligation to return it to original condition.
It is therefore important for both parties to ensure that they agree on a detailed make good arrangement at the commencement of the lease which is well documented (including photographs) to minimise any disagreement and expense when it comes time to move on.
Should you have any questions or concerns about make good clauses in your lease agreements, please contact our office on (08) 9316 7000 and we can put you in touch with a legal expert in our network who can assist.
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