Edited version of private ruling

Authorisation Number: 1011573475350

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fac sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: GST and input tax credits

Question 1

Whether XYZ Pty Ltd (XYZ) is entitled to full input tax credits or reduced input tax credits (RITCs) on its acquisition of legal services from LLL Ltd (LLL)?

All legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) unless stated otherwise.

Answer

No, XYZ is not entitled to full input tax credits or RITCs on its acquisition of legal services from LLL.

Question 2

Whether XYZ is entitled to full input tax credits or RITCs on the payment of disbursements incurred by LLL?

Answer

No, XYZ is not entitled to full input tax credits or RITCs on the payment of disbursements incurred by LLL.

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.

XYZ solely carries on an enterprise of share trading which consists of the making of input taxed financial supplies.

XYZ exceeds the financial acquisitions threshold (FAT).

All trades carried out by XYZ were handled by EEE Ltd (EEE).

As advised, XYZ acted on EEE's recommendation and provided its trading stock to Lender Ltd (Lender) as collateral to set up loan facilities with Lender.

Upon the failure of Lender's business XYZ's trading stock was seized in full by the Liquidator of Lender.

XYZ engaged the services of LLL to commence legal proceedings against EEE and to seek damages for the value of the trading stock on the basis that EEE had been negligent and breached its duty of care.

An agreement (Agreement) was entered into between XYZ and LLL.

The Agreement sets out the terms and costs of LLL's services as well as their scope of work.

Under the Agreement, XYZ authorised LLL to transfer trust money from XYZ's matter to any other matter conducted by LLL on XYZ's behalf.

LLL sent a letter to XYZ confirming XYZ's instructions to file an application to commence legal proceedings. Enclosed with the letter was a litigation costs estimate which set out the estimated costs for each step of the proposed litigation and listed items of professional costs separate to its disbursements.

A number of invoices were subsequently issued by LLL to XYZ for the payment of professional fees and disbursements. Items of professional fees were listed separately to items of disbursements in the invoices.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Input taxed financial supplies

Subsection 40-5(1) provides that a financial supply is input taxed.

The provision, acquisition or disposal of something is a financial supply where it satisfies the relevant requirements of regulation 40-5.09 of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations).

The table in subregulation 40-5.09(3) of the GST Regulations contains eleven categories of interest; the provision, acquisition or disposal of which would constitute a financial supply where the requirements of subregulation 40-5.09(1) of the GST Regulations are satisfied.

Of present relevance is item 10 which lists securities. The purchase and sale of shares by XYZ under its share trading enterprise would fall within this item.

In this case, XYZ makes input taxed financial supplies for GST purposes through its share trading activities.

XYZ's acquisitions

Invoices provided by LLL to XYZ show the itemised costings along with descriptions for its professional legal services as well as disbursements.

For GST purposes, an entity may sometimes acquire things in its capacity as an agent of a principal and subsequently seek reimbursement for those acquisitions from the principal. Where this occurs, those acquisitions may be treated as acquisitions of the principal rather than the agent itself.

Paragraphs 48 and 49 of Goods and Services Tax Ruling GSTR 2000/37 Goods and services tax: agency relationships and the application of the law (GSTR 2000/37) provide the GST treatment of acquisitions made by an entity on behalf of, or as an agent of, another entity state that:

Agency relationship and disbursements

48. Agents may incur expenses on a client matter both as an agent of the client and as a principal in the ordinary course of providing their services to the client. For example, in most cases, even though agreements between solicitors and clients may not use the term agent or agency, it is clear that the clients have authorised the solicitors to act on their behalf in the particular matter. When the solicitor acts as an agent for the client, the general law of agency applies so that the solicitor is 'standing in the shoes' of the client.

49. If a disbursement is made by a solicitor and incurred in the solicitor's capacity as a paying agent for a particular client, then no GST is payable by the solicitor on the subsequent reimbursement by the client. This is because the goods or services to which the disbursement relates are supplied to the client, not to the solicitor, by a third party. Also, the reimbursement forms no part of the consideration payable by the client for the supply of services by the solicitor…..

For the purposes of analysing XYZ's entitlement to input tax credits and RITCs it is therefore important to identify the acquisitions that are made by XYZ.

In this case, disbursements incurred by LLL are costs incurred on behalf of XYZ.

The Agreement specifically provides that the legal costs payable will vary depending on factors such as where it is necessary to brief barristers or expert witnesses. Items of disbursements (including costs associated with briefing barristers) were in fact incurred and were separately listed to LLL's professional fees in its invoices and litigation costs estimate.

We also note as part of the Agreement, XYZ has authorised LLL to transfer trust money from XYZ's matter to any other matter conducted by LLL on XYZ's behalf.

Accordingly, for GST purposes, the disbursements incurred by LLL are costs incurred as an agent on behalf of XYZ and are acquisitions of XYZ.

The subject of discussion for the purposes of this ruling is therefore whether XYZ is entitled to input tax credits or RITCs on the acquisition of legal services from LLL as well as the disbursements incurred on behalf of XYZ (subsequently referred to as 'third party acquisitions' in this ruling).

Entitlement to input tax credits

Under the GST Act, an entity is entitled to an input tax credit for any creditable acquisition that it makes.

Section 11-5 provides that:

You make a creditable acquisition if:

(a) you acquire anything solely or partly for a *creditable purpose; and

(b) the supply of the thing to you is a *taxable supply; and

(c) you provide, or are liable to provide, *consideration for the supply; and

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

* denotes a term defined in section 195-1.

Section 11-15 discusses the meaning of creditable purpose and states that:

Meaning of creditable purpose

(1) You acquire a thing for a creditable purpose to the extent that you acquire it in *carrying on your *enterprise.

(2) However, you do not acquire the thing for a creditable purpose to the extent that:

(a) the acquisition relates to making supplies that would be *input taxed; or

(b) the acquisition is of a private or domestic nature.

* denotes a term defined in section 195-1.

Accordingly, the general rule under Division 11 is that no entitlement to input tax credits would arise for acquisitions that relate to the making of input taxed supplies as they are denied creditable purpose under paragraph 11-15(2)(a) of the GST Act.

Acquisitions made in carrying on your enterprise

Goods and Services Tax Ruling GSTR 2008/1 Goods and services tax: when do you acquire anything or import goods solely or partly for a creditable purpose (GSTR 2008/1) sets out the Commissioner's views for determining whether an acquisition is made in carrying on an enterprise and whether an acquisition relates to supplies that would be input taxed.

Part A of GSTR 2008/1 discusses the Commissioner's approach to determining whether an acquisition is made in carrying on an enterprise. Firstly, it is necessary to identify an enterprise that is being carried on and secondly, whether there is a connection between the acquisition and the enterprise being carried on.

As advised, XYZ solely carries on an enterprise of share trading and only makes input taxed financial supplies.

Relevant for discussion for subsection 11-15(1) is whether there is a connection between XYZ's acquisitions and the enterprise it carries on.

In analysing the required connection in the GST context, paragraphs 69 and 70 of GSTR 2008/1 provide that:

69. The Commissioner considers that in the GST context it is necessary to make an objective assessment as to whether there is a connection between the thing acquired and the enterprise, based on all the facts and circumstances. Although the subjective purpose of the entity making the acquisition is relevant, it is not determinative.

70. Whether an acquisition is acquired in carrying on an enterprise is a question of fact and degree, making it impractical to provide an exhaustive list of all the factors that may be relevant to determining whether an acquisition is made in carrying on an enterprise. However, some factors that would suggest that an acquisition is made in carrying on an enterprise include that:

· the acquisition is incidental or relevant to the commencement, continuance or termination of the enterprise;

· the thing acquired is used by the enterprise in making supplies;

· the acquisition secures a real benefit or advantage for the commencement, continuance or termination of the enterprise;

· the acquisition is one which an ordinary business person in the position of the recipient would be likely to make for the enterprise;

· the acquisition does not meet the personal needs of individuals such as partners or directors;

· the acquisition helps to protect or preserve the enterprise entity, structure or organisation; and

· the acquisition is made by the entity in accordance with, or to satisfy, a statutory requirement imposed on the enterprise.

Thus, when determining the connection between an acquisition and an enterprise, the Commissioner considers that an objective assessment of the connection is necessary based on factual circumstances.

Applying the Commissioner's views as outlined in the above paragraphs of GSTR 2008/1 would mean that XYZ's acquisition of legal services and third party acquisitions are acquired in carrying on XYZ's share trading enterprise as it is incidental or relevant to the continuance or termination of its enterprise and thus would satisfy the requirements of subsection 11-15(1).

XYZ has submitted that an entitlement to input tax credits on their acquisition of legal services arises on the grounds that those acquisitions were necessarily incurred in attempting to recover the market value of the trading stock or necessarily incurred in recovering the funds to enable XYZ to carry on its primary business as a share trader.

We understand XYZ's submission but do not agree with this view, on the basis that an entitlement to input tax credits arises through the making of creditable acquisitions which require, amongst other things, that the acquisition is made for a creditable purpose.

As mentioned above, for an acquisition to be made for a creditable purpose, it must satisfy the requirements of the positive limb of subsection 11-15(1) and not be caught under the negative limbs of subsection 11-15(2) (more relevantly to this case, paragraph 11-15(2)(a)) of the GST Act..

The negative limb test at paragraph 11-15(2)(a)

The Commissioner's view is that the negative limb at paragraph 11-15(2)(a) has an independent operation to subsection 11-15(1) of the GST Act. The principles used to establish a connection between an acquisition and an input taxed supply are different to the principles used to establish a connection between an acquisition and an enterprise.

Paragraphs 102 and 103 of GSTR 2008/1 provide for those circumstances where an entity needs to or not consider whether paragraph 11-15(2)(a) applies:

102. If an entity does not make, has never made, and does not intend to make, supplies that would be input taxed, there is no need to consider whether paragraph 11-15(2)(a) applies. Instead, to establish whether an acquisition is for a creditable purpose, it is only necessary to ascertain whether the acquisition is made in carrying on the enterprise (see Part A at paragraph 54 of this Ruling).

103. However, if an entity makes, has made, or intends to make, input taxed supplies, it needs to consider whether paragraph 11-15(2)(a) applies to its acquisitions. Paragraph 11-15(2)(a) applies if acquisitions relate solely or partly to supplies that would be input taxed.

In XYZ's case, XYZ would need to consider whether paragraph 11-15(2)(a) applies to its acquisitions as it has made input taxed financial supplies.

The relationship between an acquisition and the making of a supply that would be input taxed

When discussing the negative test of 11-15(2)(a), the Commissioner stated at paragraph 104 of GSTR 2008/1 that

104. Unlike subsection 11-15(1), paragraph 11-15(2)(a) specifically focuses on the relationship between an acquisition and the making of supplies. …

Hill J in HP Mercantile Pty Limited v. Commissioner of Taxation [2005] FCAFC 126 (HP Mercantile) considered the connection required between an acquisition and the making of supplies that would be input taxed.

The principles found in HP Mercantile have been adopted by the Commissioner for the purposes of determining whether an acquisition relates to making supplies that would be input taxed. Those principles are provided at paragraph 118 of GSTR 2008/1 which relevantly states that:

118. The decision in HP Mercantile established the following principles that should be applied in determining whether an acquisition relates to making supplies that would be input taxed:

…

There is no requirement for an acquisition to precede a supply before it can be said that the acquisition is connected to the making of that supply. Therefore an acquisition can relate to the entity making past, current or future supplies.

The words 'relates to' are wide words signifying some connection between two subject matters. There must be a connection between an acquisition and the making of input taxed supplies. The connection or association signified by the words may be direct, or indirect, substantial or real. It must be relevant and usually a remote connection would not suffice.

…

Accordingly, a relationship between an acquisition and the making of a supply that would be input taxed can be either a direct or indirect one.

The Commissioner recognises that in some cases an acquisition can be acquired in relation to the whole of an enterprise carried on by an entity and thus have an indirect relationship to all the supplies that the entity makes in carrying on that enterprise.

Conversely, the Commissioner has also provided that where an acquisition is used or consumed in making an input taxed supply, there is a direct connection between the acquisition and the input taxed supply.

In the context of making acquisitions for promoting, marketing or advertising the making of input taxed supplies, the Commissioner provides at paragraph 126 of GSTR 2008/1 that:

126. An entity may make an acquisition to promote, market or advertise some particular aspect of the entity's enterprise. In some instances, the acquisitions will promote specific supplies and will relate to these supplies. In other circumstances, the acquisitions are to promote the entity as a whole, by increasing public awareness of the entity and the types of products that it supplies. If the entity makes input taxed supplies as well as taxable supplies or GST-free supplies, acquisitions must be apportioned on a fair and reasonable basis.

The principles discussed above are relevant to the case of XYZ.

In XYZ's case, the acquisition of legal services and third party acquisitions are acquired for the purposes of seeking damages from EEE who allegedly breached its duty of care to XYZ in the course of providing its professional services to XYZ.

Those damages which are sought from EEE are for the value of the trading stock seized by the Liquidator of Lender.

Accordingly, our view is that XYZ's acquisition of legal services and third party acquisitions are made directly in relation to the trading stock (shares) purchased and to be traded by XYZ rather than being indirectly related to the whole of XYZ's enterprise for the upkeep or preservation of its enterprise.

Consequently, XYZ's acquisitions are made in relation to the making of supplies that would be input taxed and by virtue of section 11-15 of the GST Act would be denied creditable purpose under the general rule.

The financial acquisitions threshold

One of the exceptions to the general rule is where the FAT is not exceeded. This exception is provided under subsection 11-15(4) of the GST Act.

However, in this case XYZ exceeds the FAT and therefore this exception does not apply.

As no other exception rules apply, XYZ is therefore not entitled to full input tax credits on its acquisition of legal services and third party acquisitions.

Entitlement to reduced input taxed credits on acquisitions related to making financial supplies

Division 70 of the GST Act provides special rules for the claiming of RITCs on certain acquisitions where those acquisitions are denied creditable purpose because they are made in relation to the making of financial supplies.

Subsection 70-5(1) states that an entitlement to a RITC may arise for acquisitions of a specified kind relating to making financial supplies known as 'reduced credit acquisitions' (RCAs).

The table in subregulation 70-5.02(2) of the GST Regulations provides an exhaustive list of acquisitions that are RCAs within the meaning of subsection 70-5(1) of the GST Act.

XYZ has contended that the purpose of its litigation was solely to recover a debt and therefore its acquisition of legal services from LLL would be a RCA.

The exhaustive list of RCAs in the table in subregulation 70-5.02(2) of the GST Regulations does not contain any items which cover acquisition of legal services in relation to the recovery of damages or acquisitions which are of the nature of XYZ's third party acquisitions.

Relevant for discussion to XYZs contention would be item 17 which concerns debt collection services and is in the following terms:

Debt collection services

17. The following debt collection services:


(a) debt recovery;

(b) litigation;

(c) lodgment of documents;

(d) by financial supply facilitator, managing the recovery of sums due by borrowers

However, the Commissioner's view is provided at paragraph 425 of Goods and Services Tax Ruling GSTR 2004/1 Goods and services tax: reduced credit acquisitions (GSTR 2004/1) which states that:

425. Item 17 provides an exhaustive list of debt collection services, the acquisition of which may be reduced credit acquisitions under that item. Debt collection in this context, refers to taking action to recover overdue debts. The acquisition of services not mentioned in items 17(a) to 17(d) is not a reduced credit acquisition unless it is covered by another item in subregulation 70-5.02(2).

As there are no overdue debts in XYZ's case, our opinion is that XYZ's acquisition of legal services and third party acquisitions do not fall within item 17. As such, XYZ is not entitled to RITCs on its acquisition of legal services from LLL or its third party acquisitions.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).