Revised Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 5 - Financial supplies
5.1 The amendments in Schedule 5 to this Bill change the de minimis test for financial supplies. Under the new test, a registered entity can obtain input tax credits for acquisitions related to making financial supplies if the total amount of those credits does not exceed the lesser of either $50,000 or 10% of the total input tax credits of the entity.
5.2 The amendments further allow registered businesses to claim input tax credits for borrowing related expenses unless the borrowing relates to making other input taxed supplies.
5.3 The amendments also clarify that reduced input tax credits can only be claimed where an entity is not otherwise entitled to an input tax credit for a particular acquisition.
5.4 The amendments also deny input tax credits for goods and services acquired or imported for the purpose of providing fringe benefits to employees of a financial supplier that is wholly or partially denied input tax credits on its acquisitions.
5.5 The amendments will apply from 1 July 2000.
De minimis threshold and input tax credits
5.6 Under section 11-15 of the GST Act, an entity acquires a thing for a creditable purpose to the extent it is acquired in carrying on an enterprise of that entity. An acquisition is not made for a creditable purpose to the extent that it relates to making supplies that would be input taxed or is of a private or domestic nature.
5.7 Subsection 11-15(4) provides that an acquisition is not treated as relating to supplies that would be input taxed if:
- the only reason it would be input taxed is because it relates to making financial supplies; and
- the entity does not make financial supplies in excess of a de minimis threshold.
5.8 The de minimis threshold is reached if an entity's turnover of financial supplies does not exceed the lesser of either $50,000, or 5% of its annual turnover. If an entity meets the threshold, it is denied input tax credits to the extent its acquisitions are not acquired for a creditable purpose.
5.9 The current de minimis threshold has the effect that many entities making only a small number of financial supplies are denied input tax credits for acquisitions that relate to making those supplies.
Financial acquisitions threshold
5.10 The amendments will allow businesses to make a higher level of financial supplies before they are denied input tax credits for acquisitions that relate to making those supplies.
5.11 Item 1 amends subsection 11-15(4) so that if the only reason the acquisition would be input taxed is because it relates to making financial supplies then it will not be treated as input taxed provided that the entity does not exceed the financial acquisitions threshold . [Paragraph 11-15(4)(b)]
5.12 Item 7 inserts new Division 189 which sets out when an entity will exceed the financial acquisitions threshold . An entity would exceed the threshold if it has made, or is likely to make, financial acquisitions where the input tax credits related to making those acquisitions would exceed the lesser of either:
- $50,000 or such other amount as specified in the regulations; or
- 10% of the total amount of input tax credits to which the entity would be entitled.
If either or both of these levels are met, an entity will have exceeded the financial acquisitions threshold.
Example 5.1 MoneyLender calculates that over a 12 month period it will have spent a total of $220,000 on acquisitions in carrying on its enterprise. Moneylender calculates that $44,000 of that $220,000 was spent on acquiring new computers, software and labour hire services for processing, recording and tracking loans it makes to other businesses. MoneyLender's total input tax credits for the 12 month period would be $20,000. Its input tax credits related to making financial supplies amount to $4,000, which is 20% of its total input tax credits. MoneyLender will be required to treat those acquisitions as relating to making input taxed supplies and is denied those input tax credits to that extent.
Example 5.2 Najbout Corporation calculates that it will have spent a total of $2,200,000 on acquisitions in carrying on its enterprise. Najbout Corporation calculates that $660,000 of that $2,200,000 was spent on acquiring new computers, software and labour hire services for processing, recording and tracking loans it makes to other businesses. Najbout's total input tax credits for the 12 month period would be $200,000. Its input tax credits related to making financial supplies amount to $60,000. As this is more than $50,000 Najbout Corporation will be required to treat those acquisitions as relating to making input taxed supplies and is denied input tax credits to that extent.
5.13 An entity will determine whether it exceeds the financial acquisitions threshold in a way similar to how it determines whether it meets the annual turnover threshold under Division 188. That is, the entity will determine whether it exceeds the financial acquisitions threshold in a given month based on its acquisitions in:
- that month and the previous 11 months; and
- that month and the next 11 months.
The new term 'exceed the financial acquisitions threshold' replaces the definition of 'annual turnover of financial supplies' in section 195-1 . [Items 8 and 9, section 189-1, subsections 189-5(1) and 189-10(1)]
5.14 Under new section 189-15 a financial acquisition is an acquisition that relates to the making of a financial supply (other than a financial supply consisting of a borrowing). The Dictionary in section 195-1 is amended to include a reference to this new definition. [Item 10]
5.15 For members of a GST group, the de minimis threshold is a combined threshold. That is, the threshold for the whole group is the same as if they were a single entity. Therefore, if one member of the group makes financial acquisitions exceeding the threshold, then the GST group as a whole will exceed the financial acquisitions threshold. [New subsections 189-5(2) and 189-10(2)]
5.16 Item 3 amends paragraph 15-10(4)(b) so that, if the only reason an importation would be input taxed is because it relates to making financial supplies, then it will not be so treated provided that the entity making the supply does not exceed the financial acquisitions threshold .
Change in extent of creditable purpose
5.17 Item 6 amends subsection 129-5(2) to reflect the change to the de minimis test (in relation to how to calculate whether an adjustment arises under Division 129).
Borrowing related expenses
5.18 Section 40-5 of the GST Act provides that a financial supply has the meaning given by the GST Regulations. Provided the other elements of regulation 40-13 are met, borrowing is a financial supply under item 2 of those regulations. If an entity exceeds the de minimis threshold and incurs borrowing related expenses, they are denied input tax credits for those expenses as they relate to making a financial supply.
5.19 Borrowing related expenses would be included in the calculation of a de minimis test based on denied input tax credits. This would impact negatively on many businesses that borrow funds in making taxable and GST-free supplies.
5.20 In addition to the cost imposed by the denial of input tax credits, non-financial institutions have expressed concern about the compliance costs associated with attributing their inputs to their borrowing activities.
5.21 New subsections 11-15(5) and 15-10(5) provide that a borrowing related acquisition or importation is not treated as relating to making input taxed supplies provided the borrowing itself does not relate to making input taxed supplies [items 2 and 4] . Therefore, if an entity borrows money and uses it in making taxable or GST-free supplies, it will be entitled to input tax credits for its borrowing related expenses.
Example 5.3 Usha Ultimate Properties (UUP) owns several residential and commercial rental properties. It borrows $5,000 to renovate the bathroom of one of its rental properties and $20,000 to refurbish one of its commercial properties. In borrowing the 2 sums of money, UUP pays $3,300 for legal and investment advice.UUP would not be entitled to input tax credits in relation to the borrowing expenses to the extent they relate to the supply of the residential rental premises. However, it would be entitled to input tax credits for the borrowing related expenses incurred in relation to the commercial premises.
Example 5.4 Monolith Enterprises borrows $250,000 from AmberCo for the purchase of a warehouse. Monolith pays a valuation fee of $1,100 to an independent valuer and also pays Lefal Solicitors $5,500 in legal fees for negotiating the loan contract. Monolith would be entitled to an input tax credit of $600 (1/11 of $6,600) for those expenses provided that the money borrowed does not relate to making input taxed supplies.
Interaction of GST and FBT
5.22 The Government announced on 22 December 1999 that 2 different FBT gross-up rates would apply. A GST-inclusive FBT gross-up rate will apply to a situation where input tax credits have been allowed on the acquisition of the fringe benefit and the existing FBT gross-up rate will apply where no GST is payable or no input tax credits are claimable on the acquisitions.
5.23 It is acknowledged that this measure does not specifically deal with entities that make input taxed supplies but where partial input tax credits are allowed (i.e. for fringe benefits). In the absence of any change, they would be subject to the higher gross-up rate on purchases even where only a small proportion of the input tax credit is claimable. Conceptually, they should be subject to the higher gross-up on that part of the fringe benefit that they could claim an input tax credit for. However, it will be difficult to determine the extent of input tax credit entitlement for the goods and services acquired for the purpose of the fringe benefit.
5.24 To address this issue, item 5A inserts new Division 71 into the GST Act to deny input tax credits for goods and services acquired or imported for the purpose of providing fringe benefits to employees of a financial supplier that is wholly or partially denied input tax credits on its acquisitions. The input tax credits are only denied under this Division where the supplier exceeds the financial acquisitions threshold contained in Division 189. [New subsections 71-5(2) and 71-10(2)]
5.25 Where suppliers are denied input tax credits under new Division 71 , the existing (i.e. the lower) FBT gross-up rate will apply to the fringe benefit.
5.26 Items 2A, 4A and 4B insert references to new Division 71 in the GST Act.
Reduced input tax credits
5.27 Division 70 allows for reduced input tax credits to be claimed for certain prescribed acquisitions, known as reduced credit acquisitions. Reduced input tax credits should only be available where an input tax credit would otherwise not be available for an acquisition. Item 5 inserts new subsection 70-5(1A) to clarify that reduced input tax credits can only be claimed if an entity is not otherwise entitled to an input tax credit for a particular acquisition.
5.28 The objective is to provide input tax credits for expenses related to borrowing except where the borrowing is undertaken by a financial institution or where the borrowing is undertaken by the corporate treasury of a large business for the purposes of making other input taxed supplies.
5.29 Two implementation options were considered.
5.30 The first was to list financial institutions that would be denied input tax credits for borrowing expenses, and to allow input tax credits for borrowing expenses for businesses above the de minimus levels except where the borrowing is related to making input taxed supplies.
5.31 The second option considered was to exclude borrowing related expenses from the de minimis provision, and to allow input tax credits for borrowing expenses for businesses above the de minimus levels where the borrowing is not related to making an input taxed supply. Businesses that exceed the de minimis would be allowed to claim input tax credits for borrowing expenses where the borrowing is not related to making an input taxed supply. For example, where a large sum is borrowed to make a physical investment.
Assessment of impacts
5.32 The first option would have required the listing of financial institutions. The Government is not attracted to this option as it is against the basic design of the GST, which is to identify the nature of supplies made rather than the entity making them. In addition, it would be administratively complex as such lists would have to be initially compiled and then regularly updated.
5.33 The second option allows businesses falling above the de minimis levels to claim full input tax credits for borrowing expenses provided the borrowing is not related to making an input taxed supply. This approach reduces the compliance costs of affected businesses. Businesses required to apportion input tax credits will be able to use their required record keeping to claim input tax credits for borrowing expenses not related to making input taxed supplies.
5.34 There has been extensive consultation with representatives of business and the financial sector. There has been general support for the proposal.
Conclusion and recommended option
5.35 The second option provides the most benefits to businesses and is administratively more simple, whilst ensuring the correct policy objective is achieved.