Edited version of private ruling

Authorisation Number: 1011570434448

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Ruling

Subject: GST and derivative in mixed supply

Question 1

Is the supply made under a contract and supplementary agreement (SA) between Entity A and Entity B a mixed supply of taxable and input taxed components?

Answer

Yes, the supply made under a contract and SA between Entity A and Entity B gives rise to a mixed supply - a taxable supply of services and an input taxed financial supply of a derivative. Each of these supplies has a separate aim and economic identity.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

· Entity B tendered for a fixed price contract for an Australian project.

· Entity B's direct parent entity is a non-resident holding company.

· The ultimate parent entity of Entity B is also a non-resident company.

· Entity X won the contract on the basis of the fixed currency amount.

· Amounts payable under the contract are invoiced in a fixed currency amount.

· Under the contract Entity X is to provide services to Entity B.

· Entity X is a non-resident for Australian tax purposes and is not registered for GST nor part of a GST group.

· A novation of the contract for the project was subsequently made from Entity X to its Australian subsidiary (Entity A).

· Entity A is registered for GST but not part of a GST group.

· The contract for the project has numerous stages with a timeframe of several years.

· The contracts confirm all parties are registered for GST and carrying on an enterprise.

· It is also confirmed that the supply of the services are a taxable supply.

· The fixed price contract specifically states that the price for the relevant services shall not be higher than the fixed price and Entity A shall not request an increase to the price for any reason.

· However due to a significant increase in production capacity the contract price was altered from a fixed price in the original contract to a new fixed price in the amending agreement.

· A clause of the original contract stipulated the contract could be amended as long as terms and conditions of the amendment contract were agreed upon by both parties in the original contract.

· An amending agreement was executed by both parties a short time after the original contract was executed.

· A key amendment to the original contract was inserted by way of a clause in the amending agreement and is the only reference to the hedging arrangement in either agreement.

The key amendment clause indicates:

· Entity A provides Entity B with a tax invoice in a fixed currency in accordance with relevant services provided at a specific stage of the project.

· The project is invoiced by Entity A on a regular basis and for GST purposes the fixed currency is converted to AUD at an exchange rate outlined on the tax invoice. The GST amount is then determined from the AUD equivalent amount.

· The hedging agreement is then applied and calculated in accordance with the key amendment clause.

· This means that, in accordance with the key amendment clause, a percentage of the total amount invoiced is subject to the currency hedging agreement, so that that proportion of the total fixed currency is converted to another currency using at mutually agreed rate.

· This rate stays in place until cumulative amounts reach a specific point. When this amount is exceeded the original hedge is completed and a new hedge commences. So when the amounts invoiced are greater than a specific point, the excess amounts are pegged to a different exchange rate.

· When the hedged amount has been converted to the alternative currency under the pegged rate it is then converted back to the original fixed currency at the current rate and the ensuing difference will result as either an exchange loss or gain to the contractual parties.

· On this basis, if the 'Total Invoiced Amount' (that is, the new fixed currency amount after applying the calculation prescribed under the key amendment clause of the amendment contract) is greater than the 'Net Payment Due', (that is, the fixed price contractual amount), in the fixed currency, then Entity B is required to pay Entity A the greater amount - in effect being a (foreign exchange) FX gain to Entity A (and consequently a FX loss to Entity B).

· On the other hand, if the 'Total Invoiced Amount' is less than the 'Net Payment Due' in a foreign currency, Entity B is only required to pay the lesser amount - in effect being a FX loss to Entity A (and consequently a FX gain to Entity B)

· This FX gain or loss will be recorded against the project.

Reasons for Decision

The meaning of 'supply' is given in section 9-10 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). Subsection 9-10(1) of the GST Act provides that a 'supply is any form of supply whatsoever.' Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are included as supplies.

Of relevance to this ruling are paragraphs 9-10(2) (b) and (f) of the GST Act which refer to a supply of services and a financial supply respectively.

As it has been established that the supply of services is a taxable supply, it needs to be determined whether there is a financial supply consisting of a derivative.

Is there a financial supply of a derivative?

Under subsection 40-5(1) of the GST Act, a financial supply is input taxed.

Subsection 40-5(2) of the GST Act provides that financial supply has the meaning given by the GST Regulations.

Subregulation 40-5.09(1) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) provides that the provision, acquisition, or disposal of an interest mentioned under subregulation 40-5.09(3) or 40-5.09(4) of the GST Regulations is a financial supply if:

(a) the provision, acquisition or disposal of that interest is:

· for consideration

· in the course or furtherance of an enterprise

· connected with Australia, and

(b) the supplier is:

· registered or required to be registered for GST, and

· a financial supply provider in relation to the supply of the interest.

Item 11 in the table in subregulation 40-5.09(3) of the GST Regulations lists an interest in or under a derivative.

The Dictionary to the GST Regulations defines derivative as 'an agreement or instrument the value of which depends on, or is derived from, the value of assets or liabilities, an index or a rate'.

Schedule 1 to Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2), further provides that a derivative includes financial instruments such as options, forwards, futures, swaps where the value is tied to or derived from an underlying security, commodity, currency, liability or index. Entities usually use derivatives to hedge against changes in interest rates and foreign exchange risks or to minimise business risks.

In our view, the effect of the key amendment clause is to provide a currency hedge in a form similar to the financial instruments mentioned above.

The parties have in place a host agreement for the provision and acquisition of services. We agree that the value for the supply of these services is negotiated by the parties and in a fixed currency.

The key amendment clause operates to firstly convert a proportion of any payment amount from one fixed currency into another fixed currency (using the exchange rate at the relevant agreement date). The next step is to reconvert the amount of the second fixed currency back to the first fixed currency at the current exchange rate.

Notwithstanding the fixed currency price however, through the key amendment clause the parties have embedded a foreign currency hedge into the host agreement. The value of the currency hedge changes in accordance with the fixed currency exchange rate. That value is derived from 'a rate' being the underlying foreign currency exchange rates. In our view this currency hedge is a 'derivative' as defined in the Dictionary to the GST Regulations.

Accordingly, by the key amendment clause in their agreement, the parties to the contract have provided each other with an interest in a derivative, within the meaning of item 11 of the table under subregulation 40-5.09(3). This is consistent with the view explained in GST Determination GSTD 2005/3: are contracts for difference and financial spread betting contracts financial supplies? (GSTD 2005/3).

GSTD 2005/3 states:

'Each party to the contract supplies an interest under a derivative at the time of entry into the contract. That is, each party both makes a supply of the interest and provides non-monetary consideration to the other entity in the form of an interest under the derivative. The payment, which may be payable by either party, that arises from the operation of the contracts is additional consideration for the supply of the interests under the financial spread betting contract or the contract of difference.'

Consistent with the explanation in GSTD 2005/3, the amounts that arise from the operation of the key amendment clause in this case, which may be owing by either party, are additional consideration for the supply of the interest under the derivative.

In accordance with regulation 40-5.06, Entity A is the financial supply provider in relation to the provision of the interest in the derivative. The provision of the interest by Entity A is for consideration. In accordance with the facts provided, Entity A is registered for GST and provides the interest in the course or furtherance of an enterprise. It is not in dispute that the provision of the interest by Entity A is connected with Australia.

It follows that the provision of the interest by Entity A satisfies all the requirements in subregulation 40-5.09(1) of a financial supply. It remains to be determined if the supply of the interest in the derivative by Entity A is part of an overall composite supply of taxable services or if it is a separate financial supply component of a mixed supply.

Is the financial supply of a derivative part of an overall composite taxable supply?

Section 9-5 of the GST Act provides that:

'You make a taxable supply if:

(a) you make the supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with Australia; and

(d) you are registered, or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.'

Section 9-80 deals with supplies that are partly taxable and partly GST-free or input taxed. It describes how to calculate the value of that part of a supply that is a taxable supply.

Goods and Services Tax Ruling: GSTR 2001/8: Goods and services tax: apportioning the consideration for a supply that includes taxable and non-taxable parts (GSTR 2001/8) discusses how to determine whether a supply, containing more than one part, is a mixed or composite supply.

Paragraphs 19 to 22 and paragraphs 40 to 44 of GSTR 2001/8 discuss the differentiation between mixed and composite supplies. Further these paragraphs of GSTR 2001/8 state that one should take an overall view of the circumstances of a transaction comprising a bundle of features and acts in order to ascertain its essential character. In analysing the circumstances of a transaction, it is necessary to take a commonsense approach to determine if the supply is essentially the provision of one thing.

Paragraphs 43-44 of GSTR 2001/8 discuss mixed and composite supplies as follows:

'43. A mixed supply contains separately identifiable parts where one or more of the parts is taxable and one or more of the parts is non-taxable. None of these parts is integral, ancillary or incidental in relation to the whole supply. On the other hand, a composite supply is a supply of one dominant part that has other parts that are not treated as having a separate identity as they are integral, ancillary or incidental to the dominant part of the supply.

44. In working out whether you are making a mixed or composite supply, the key question is whether the supply should be regarded as having more than one separately identifiable part, or whether it is essentially a supply of one dominant part with one or more integral, ancillary or incidental parts.'

A supply is mixed where it contains parts that are separately identifiable as taxable and non-taxable or have an aim in themselves. A composite supply is one whereby its several parts may objectively be treated as if they are simply a supply of a single thing.

Paragraphs 45 and 46 of GSTR 2001/8 discuss the UK case of Sea Containers Ltd v. Customs and Excise Commissioners [2000] BVC 60 (Sea Containers). That case involved the provision of luxury train travel that included 'fine wining and dining'.

The issue was whether there was a composite supply of transport services or a mixed supply of transport services and catering. The Court held that the catering element was significant in its own right and constituted for customers a separate aim in itself - going well beyond the point where it could be seen merely as a way of better enjoying the transport element.

The question of separate identity was also considered in the case of Customs and Excise Commissioners v. Wellington Private Hospital Ltd, [1997] BVC 251, (Wellington) and discussed in paragraphs 51 and 52 of GSTR 2001/8. In that case Millett LJ stated at 266:

'The proper inquiry is whether one element of the transaction is so dominated by another element as to lose any separate identity as a supply for fiscal purposes, leaving the latter, the dominant element of the transaction, as the only supply. If the elements of the transaction are not in this relationship with each other, each remains as a supply in its own right with its own separate fiscal consequences.'

Paragraph 52 of GSTR 2001/8 states that a supply has separately identifiable parts where the parts require individual recognition and retention as separate parts, due to their relative significance in the supply.

On the other hand, a supply is composite where its subordinate parts are integral, ancillary or incidental to a dominant part of the supply. What these terms mean in effect is that, as per paragraph 55 of GSTR 2001/8, in a composite supply, the dominant part of the supply has subordinate parts that complement the dominant part.

Examples of composite supplies given in GSTR 2001/8 and by the UK courts include:

· where delivery of new cars was considered to be ancillary or incidental to a supply of cars (Customs and Excise Commissioners v. British Telecommunications plc [1999] BVC 306)

· a plan for holders of credit cards to be protected against loss or theft of their cards, together with a card registration service, was considered to be a composite supply of an exempt (input taxed) supply of insurance services (Card Protection Plan Ltd v. Customs and Excise Commissioners [2001] BVC 158)

Card Protection Plan is considered to be a seminal case. Paragraphs 29 and 30 of the ECJ judgment (Case C-349/96, [1999] BVC 155) are particularly relevant in stating that:

the essential features of the transaction must be ascertained in order to determine whether the taxable person is supplying several distinct principal services or a single service; and

a service must be regarded as ancillary to a principal service if it does not constitute for customers an aim in itself but a means of better enjoying the principal service supplied.

The case of British Airways plc v. Customs and Excise Commissioners, (1990) 5 BVC 97, (British Airways) can be contrasted with Sea Containers discussed earlier. The issue was whether an in-flight catering service involved a separate supply of catering or whether it was merely integral or ancillary to a composite supply of air transport. The case is discussed in paragraphs 47 to 49 of GSTR 2001/8.

The Court found that the in-flight catering was, in substance and reality, an integral part of the supply of air transportation - contributing to a degree of comfort which was commercially appropriate and necessary to attract passengers. One of the factors supporting this finding was that the airline had no contractual obligation to supply meals even though meals were expected as part of the service.

In looking at the features of the transaction in the present case, we are of the view that the part of the supply relating to the derivative is not integral, ancillary or incidental. This is so for a number of reasons.

· The supply of services would stand by itself without the derivative part of the supply.

· That supply originally did stand by itself until the scope of the project was extended and currency hedging was considered necessary.

· For each of the parties to the contract, there was a separate aim in entering into the currency hedge.

· From the recipient's perspective, the benefit of the currency hedge went beyond being a means of better enjoying the supply of services. Addressing its currency risk was an economic aim separate to its receipt of services.

· From the supplier's perspective, its interest in the currency hedge enabled it to address, at least partially, a likely currency risk that one currency would appreciate against another currency. If one currency appreciates against another currency, the supplier will receive less of one currency in the event that the first currency receipts are ultimately converted back to the second currency receipts.

· On an objective weighing up of all the factors involved, there is not such a close coupling which indicates that the currency hedge is integral, ancillary or incidental to the supply of services. Certainly not in the same manner as a free in-flight meal (British Airways) or delivery services associated with the supply of new cars (British Telecommunications), or the incidental benefits provided with credit card insurance (Card Protection Plan). The present facts point more clearly to the words of Millett LJ in Wellington being apt - so that the currency hedge is not so dominated by the services as to lose its separate identity as a supply.

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