Mortgagees liable for GST on sales of mortgaged property

A Privy Council decision1 has confirmed that, if a mortgagee sells property (in relation to which the mortgagor would have been liable for GST had it sold the property), then the mortgagee has to pay the GST to the IRD in priority to all amounts due to it and other charge-holders.

Most mortgagees selling mortgaged property had accepted that they were personally liable for GST on sales – irrespective of whether the property was sold above or below the amount that was secured.

This practice was called into question in 2002 when the High Court decided2 that the Commissioner had to take his place in the queue behind secured creditors. The High Court said that the primary question is:

“… whether, on sale by the first mortgagee of land of a mortgagor registered under the Goods and Services [Tax] Act 1985, the Commissioner is entitled to payment of GST out of the proceeds of sale ahead of the debt and expenses of the second mortgagee...the answer is no.”

On appeal, the Court of Appeal found for the Commissioner – that is that the mortgagee is obliged to pay GST to the IRD irrespective of whether the sale generated a surplus. The matter was appealed to the Privy Council and judgment was delivered on 26 July.

The Privy Council dismissed the appeal saying that “although a sale by a mortgagee is deemed to be a supply in the course of a taxable activity carried on by the mortgagor, it is the mortgagee who must pay the tax”.

The effect of this decision is that if a mortgagee sells a property, and GST would have been payable had the mortgagor sold, the mortgagee is liable to pay the GST to the IRD irrespective of the amount raised from the sale. It is clearly now critical that the terms of sale adequately deal with this issue as the mortgagee no longer has priority over the IRD.

This is a substantial change from the High Court decision, in which the court had interpreted this obligation to pay the Commissioner as if it was qualified by the words “if there is any money left over after paying off any charges on the property”. The Court of Appeal rejected this and the Privy Council endorsed that rejection.

The Privy Council also confirmed that, in terms of section 104 of the Land Transfer Act 1952 (which regulates the application of the proceeds of sale arising on a sale by a mortgagee), payment of the GST is an “expense occasioned by the sale” and the mortgagee “is therefore entitled to deduct it from the proceeds before payment of his own debt and is accountable to subsequent encumbrances only for the balance”.

1 Edgewater Motel Limited v Commissioner of Inland Revenue [2004] UKPC 44

2 In Edgewater Motel Ltd & Ors v Commissioner of Inland Revenue (2002) 20 NZTC 17,713

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