Court Clarifies Residential Premises Test

Because rental income derived from residential premises and sales of second hand residential premises are input taxed (ie no GST payable), determining whether real estate qualifies as 'residential premises' is very important.

The Federal Court in South Steyne Hotels Pty Ltd v Commissioner of Taxation [2009] FCA 13 considered the GST characterisation of various supplies involving apartment rooms at the Sebel Manly Beach Hotel complex.

Leasing the residential units

The court adopted the ATO's view that the GST categorisation of a supply of individual strata titled apartments in a hotel complex is determined by the nature of the individual apartments, and the operation of the complex as a whole is not relevant. On this basis, the grant by the former owner of 83 leases of 83 individual strata titled apartments to the incoming manager of the hotel complex was characterised as 83 input taxed supplies of 'residential premises'. The court accepted that the apartments were to be used predominantly for 'residential accommodation'.

The position is different where the supply consists of accommodation provided by the operator of the hotel complex. The incoming manager had acquired interests as lessee in the 83 apartments and had assigned its rights to operate the apartment business together with its rights under the leases to a related entity, the hotel operator, which in turn provided accommodation to guests. The court considered that the supply of accommodation to guests was a taxable supply of 'commercial residential premises'.

Selling the residential units

A number of the strata titled apartments had been sold by the former owner to various investors on the basis that they were second hand residential premises because the hotel rooms had been long established before being strata titled and sold to investors. This, the taxpayers argued, meant that the sales were input taxed because the apartments had been "used for residential accommodation (regardless of the term of occupation) before 2 December 1998" and, consequently were not treated like 'new residential premises'.

However, the court considered that, in this particular context, the phrase 'residential accommodation' should be interpreted to exclude 'commercial residential accommodation' (which is not an expression familiar to the GST law). On this basis, the sales of apartments to the investors were found to be taxable supplies.

This aspect of the decision is surprising given the court's earlier findings that the apartments were 'residential premises' that were predominately for 'residential accommodation'.

The remaining issue determined by the court was whether an investor who purchased an apartment subject to an existing lease to the hotel manager was making a taxable supply in relation to its continuation of the lease. The court held that the supply by an investor to the hotel manager was the supply of 'residential premises' "by way of lease" and, therefore, it was an input taxed supply. This represents an divergence from the view previously expressed by the Full Federal Court in Westley Nominees Pty Ltd v Coles Supermarkets Australia Pty Ltd (2006) 152 FCR 461.

What now?

The decision is unlikely to be the final judicial word on at least some of these issues. In particular, the phrase 'residential accommodation' is likely to be the subject of further judicial interpretation. Simple, isn't it?

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