Edited version of private ruling

Authorisation Number: 1011611750583

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Ruling

Subject: GST and adjustments

1. Is XYZ Pty Ltd's (XYZ) calculation of decreasing adjustments with respect to the termination of its Commercial Hire Purchase (CHP) agreements correct?

Yes, XYZ's calculation of decreasing adjustments with respect to the termination of its CHP agreements is correct.

2. Given that XYZ issued adjustment notes on 30 July 2010 with respect to the termination of its CHP agreements, is XYZ entitled to claim in their current Business Activity Statement (BAS) the total amount of decreasing adjustments which have not been claimed prior to July 2010 and within the past four years?

Yes, XYZ is entitled to claim the total amount of decreasing adjustments which have not been claimed prior to July 2010 and within the past four years in the tax period for which it holds the adjustment notes when it lodges its BAS.

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

Relevant facts and circumstances

XYZ intends to claim decreasing adjustments for GST in relation to early terminations and defaults of a CHP arrangement which occurred within four years from the end of the tax period to which the entitlement relates.

XYZ is a finance company and provides financing to purchasers of new and used commercial vehicles.

XYZ is wholly owned a parent company which manufactures and distributes vehicles in Australia.

XYZ accounts for GST monthly on a non-cash basis and its annual turnover is more than $2 million.

Financial products offered by XYZ include commercial hire purchase (CHP) agreements which are a form of asset financing.

CHP agreements require XYZ to purchase the asset concerned and let it to the customer (the hirer) in return for instalments of principal and interest for a fixed term. At the end of the term the hirer has the option of purchasing the asset for a lump sum (balloon payment).

XYZ attributes and remits the GST on CHP agreements at the commencement of the contract when an invoice is issued or when a payment is received, whichever is earlier.

The credit component in XYZ's CHP agreements is provided separately and disclosed to the recipient and is understood to meet the requirements of a financial supply under the GST Act.

In respect of early terminations and defaults on CHP agreements:

· Up until July 2010, XYZ did not issue adjustment notes to customers who early terminated or defaulted.

· Up until July 2010, XYZ did not claim any decreasing adjustments for GST on adjustment events which occurred in the relevant tax periods (i.e. The periods in which early termination or default occurred).

Where the vehicle is resold, the normal GST rules for a taxable supply are applied.

It is understood that XYZ holds adjustment notes in respect of its terminated CHP agreements from when it issues those adjustment notes on 30 July 2010.

XYZ intends to claim decreasing adjustments arising from termination of CHP agreements which have not been claimed prior to July 2010 and within the past four years, in their current BAS.

XYZ has identified all early terminated and defaulted CHP agreements from four years back and have extracted all principal amounts outstanding at the time of early termination or default which includes any residual value/balloon amount.

XYZ is not claiming decreasing adjustments for any interest components as they are understood by XYZ to be financial supplies and are not subject to GST.

XYZ has calculated the decreasing adjustment in relation to the outstanding principal component of all its terminated CHP agreements for the past four years up till 30 July 2010 to be $X. This was calculated according to the following formula:

(outstanding principal) / 11

For the purposes of this ruling, the 'outstanding principal' is an amount which represents all outstanding principal amounts of a particular CHP agreement at termination date and includes the balloon amount but not any non-taxable components such as interest, registration costs, stamp duty and so on).

The example below illustrates the approach adopted by XYZ up to 30/7/2010 with respect to claiming decreasing adjustments on the termination of CHP agreements:

On 1/1/2007 XYZ purchases a vehicle (vehicle A) for $110,000 inclusive of GST.

XYZ claims input tax credits of $10,000 in their January 2007 BAS.

On 1/1/2007, XYZ enters into a CHP arrangement with a customer (ABC) for the hire of vehicle A. The principal and interest amount is disclosed separately to ABC.

The principal amount is $110,000 (including GST) and constitutes a taxable supply and XYZ remits $10,000 in their January 2007 BAS.

The interest component is understood to be a financial supply and therefore not subject to GST.

On 1/1/2009, the CHP contract with ABC is terminated due to default of principal and interest payment by ABC. At this point, outstanding amounts are no longer payable to XYZ.

The outstanding principal on the terminated CHP agreement is $44,000 and the interest component outstanding is $3000 (the outstanding principal is calculated using an actuarial approach).

On 30/7/2010, XYZ issues an adjustment note to ABC which complies with the requirements of Goods and Service Tax Ruling GSTR 2000/1 Goods and Services Tax: adjustment notes (GSTR 2000/1).

The amount on the adjustment note is the amount of the outstanding principal of $44,000 (being $40,000 plus GST of $4000).

The termination of the original CHP agreement gives rise to a change in the consideration from $110,000 to $66,000. XYZ proposes that this results in a decreasing adjustment of $4,000 (being the outstanding principal / 11).

Hence, for the current BAS, XYZ intends to submit a decreasing adjustment claim for $4000.

As advised, under the actuarial method, the effective interest rate is used to calculate the interest and principal component of each instalment payment. This is achieved by multiplying the interest rate applicable to the instalment period by the outstanding balance at the time of each instalment. Over the life of the CHP agreement, the interest component of each instalment decreases as the principal repayments increase and the outstanding principal reduces.

The actuarial approach has been adopted and used throughout the life of XYZ's CHP agreements.

Reasons for decision

1. Is XYZ's calculation of decreasing adjustments with respect to the termination of its CHP agreements correct?

Section 19-40 provides that:

You have an adjustment for a supply for which you are liable to pay GST (or would be liable to pay GST if it were a *taxable supply) if:

(a) in relation to the supply, one or more *adjustment events occur during a tax period; and

(b) GST on the supply was attributable to an earlier tax period (or, if the supply was not a taxable supply, would have been attributable to an earlier tax period had the supply been a taxable supply); and

(c) as a result of those adjustment events, the *previously attributed GST amount for the supply (if any) no longer correctly reflects the amount of GST (if any) on the supply (the corrected GST amount), taking into account any change of circumstances that has given rise to an adjustment for the supply under this Subdivision or Division 21 or 134.

Furthermore, section 19-55 provides that:

If the *corrected GST amount is less than the *previously attributed GST amount, you have a decreasing adjustment equal to the difference between the previously attributed GST amount and the corrected GST amount.

Adjustment event

Paragraph 19-10(1)(b) provides that an adjustment event is an event that has the effect of changing the consideration for a supply.

Paragraph 216 of Goods and Services Tax Ruling GSTR 2000/29 Goods and services tax: attributing GST payable, input tax credits and adjustments and particular attribution rules made under section 29-25 (GSTR 2000/29) provides that the repossession of goods under a hire purchase agreement is an adjustment event and adjustments may be required under Division 19.

When a hire purchase agreement is terminated the supplier is no longer entitled to the future instalments that would have become due and payable after the termination date. As such, the consideration for the supply of goods made under the hire purchase has been reduced as the future instalments are no longer consideration for the supply of goods. This is an adjustment event as per paragraph 19-10(1)(b). The consideration for the supply of goods under the hire purchase agreement will be the total of all taxable components for instalments that are due and payable before the termination date.

In XYZ's case, the GST on the taxable supply of goods under their CHP agreements was attributed to an earlier tax period.

Additionally, as a result of the adjustment event which has had the effect of changing the consideration, the previous attributed GST no longer reflects the amount of GST on the taxable supply.

Accordingly, XYZ is entitled to a decreasing adjustment pursuant to section 19-40.

Method of calculating the taxable component

For GST purposes, hire purchase agreements are treated as a sale of goods and a separate supply of finance. When the hirer makes repayments in the form of instalments, those repayments may contain taxable as well as non-taxable components.

Paragraph 92 of 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) provides that:

92. Where there is no legislative provision specifying a basis for apportionment you may use any reasonable method to apportion the consideration to the parts of a mixed supply. However, the apportionment must be supportable by the facts in the particular circumstances.

In addition, paragraph 19 of Goods and Services Tax Ruling GSTR 2000/19 Goods and services tax: making adjustments under Division 19 for adjustment events (GSTR 2000/19) states that:

19. A single payment or amount may be for more than one purpose, that is, part of the amount may have the effect of changing the consideration…and part of the amount may be consideration of a separate supply. Where this is the case, you need to apportion that part of the payment or amount relates to each purpose using a reasonable basis.

…

In this case XYZ has provided an example of how it intends to calculate its decreasing adjustments arising from the termination of its CHP agreements which incorporates the use of the actuarial approach. The actuarial approach uses the effective interest rate to determine the interest and principal components of each instalment payment by multiplying the interest rate applicable to the instalment period by the outstanding balance at the time of each instalment.

XYZ has also advised that the actuarial approach has been adopted and used throughout the life of XYZ's CHP agreements.

In our opinion, XYZ's example of calculating Division 19 decreasing adjustments with respect the termination of its CHP agreements is correct because:

1. the method consistently applies the actuarial approach throughout the life of XYZ's CHP agreements

2. the method is used towards the calculation of the termination value, and

3. the method is consistent with the methods recommended for hirers in Question 1.15 of the Financial services - questions and answers available on the Tax Office website (www.ato.gov.au).

2. Given that XYZ issued adjustment notes on 30 July 2010 with respect to the termination of its CHP agreements, is XYZ entitled to claim in their current BAS the total amount of decreasing adjustments which have not been claimed prior to July 2010 and within the past four years?

Section 29-20 relevantly provides that:

(1) An *adjustment that you have is attributable to the tax period in which you become aware of the adjustment.

…

(3) If:

(a) you have a *decreasing adjustment arising from an *adjustment event; and

(b) you do not hold an *adjustment note for the adjustment when you give to the Commissioner a *GST return for the tax period to which the adjustment (or any part of the adjustment) would otherwise be attributable;

then:

(c) the adjustment (including any part of the adjustment) is not attributable to that tax period; and

(d) the adjustment (or part) is attributable to the first tax period for which you give to the Commissioner a GST return at a time when you hold that adjustment note.

However, this subsection does not apply in circumstances of a kind determined in writing by the Commissioner to be circumstances in which the requirement for an adjustment note does not apply.

For entities that do not account for GST on a cash basis, paragraph 40 of GSTR 2000/29 also provides that:

40. Adjustments can arise because of adjustment events (refer to paragraph 27 above). Adjustments for adjustment events are attributed to the tax period in which you become aware of the adjustment. However, an adjustment for a decreasing adjustment arising from an adjustment event is not attributable to a tax period if you do not have an adjustment note when you lodge your BAS for that tax period. You attribute the adjustment to the first tax period for which you have an adjustment note when you lodge your BAS.

It is understood that XYZ holds adjustment notes in respect of its terminated CHP agreements from when it issues those adjustment notes on 30 July 2010.

Accordingly, our view is that XYZ is entitled to claim the total amount of decreasing adjustments which have not been claimed prior to July 2010 and within the past four years in the tax period for which it holds the adjustment notes when it lodges its BAS.

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