GST Traps For Mortgages

A mortgagee's LVR can be instantly increased 10% by incorrect treatment of GST. In some circumstances the ATO effectively becomes a secured creditor ranking ahead of the mortgagee.

Fundamental to a mortgagee's credit assessment is the mortgagee's position as secured creditor. For example, if a mortgagee's credit policy requires loans not to exceed 80% LVR, it is fundamental to the transaction that the mortgagee ranks as first mortgagee for that amount.

Normally, the ATO ranks after the mortgagee for collection of GST on the sale of the secured property. However, there are situations when the ATO effectively ranks before a mortgagee.

While it is not strictly correct to say that the ATO ranks ahead of the secured creditor, the commercial effect is the same. The mortgagee or its representative becomes obliged to pay GST and so the mortgagee's recovery is reduced by the GST.

The actual amount of GST payable may be reduced if the margin scheme can be applied. Also, in some cases there may be no GST on the sale if the sale of the property is exempt from GST (for example, the sale of second hand residences or the sale of a going concern)

When does the ATO rank ahead of a secured creditor for GST?

The mortgagee or its representative is obliged to pay GST if the mortgagee is in control of the sale of the asset.

The mortgagee will be deemed to be in control if a sale is made in any of the following ways:

• mortgagee exercising power sale

• mortgagee using a power of attorney to sell the mortgagor's property

• mortgagee's receiver or receiver and manager sells.

Even where a mortgagee is not in control, representatives personally liable for GST will only sell in circumstances where the secured creditor has agreed to accept the proceeds after payment of GST. These include a liquidator or administrator of a company, and a trustee in bankruptcy for a bankrupt individual.

gadens lawyers proposes to lobby so that this unusual and possible unintended result does not occur. It is simply inappropriate that:

• a mortgagee's security suddenly reduced in a default situation

• the ATO receives what is effectively a windfall.

On a practical level unless a mortgagee is certain that a property can be sold without GST, a mortgagee should think carefully before taking control of a property and explore arrangements for a sale by the mortgagor.

What is the position of a second mortgagee?

If a first mortgagee or a receiver appointed by the first mortgagee sells the property, the first mortgagee will be obliged to pay the GST to the ATO on the total sale price.

The second mortgagee only receives payment after the first mortgagee's debt is satisfied and the GST is paid.

Usually sale proceeds are to be applied in the following order:

• first, in payment of expenses of the sale

• second, to the mortgagee

• third, to any supplement mortgagees

• finally, any surplus to the mortgagor.

GST will form part of the expenses of the sale. This has been recently confirmed in the case of the Health Pit II Pty Limited v Lowe [2007] NSW SC67.

The table below gives an overview of the GST treatment of sales by mortgagees and representatives of insolvent or incapacity entities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.