Edited version of private ruling

Authorisation Number: 1011782400656

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Ruling

Subject: Commission payment

Question 1

Is a Vendor shareholder entitled to a reduced input tax credit on the final commission payment to Entity H pursuant to item 27 listed in subregulation 70-5.02(2) of the A New Tax System (Goods and Services Tax) Regulations 1999 in relation to their supply and acquisition supply of shares in Entity B and Entity C respectively?

Answer

No. The Vendor shareholder will not be entitled to a reduced input tax credit on the final commission payment to Entity H.

Question 2

If the answer to question 1 is 'no', is the commission payment made by the Vendor shareholder to Entity H consideration for an input taxed supply pursuant to section 40-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) and subregulation 40-5.09(3) of the GST Regulations?

Answer

No. The commission payment by the Vendor shareholder is not consideration for an input taxed supply pursuant to section 40-5 of the GST Act and subregulation 40-5.09(3) of the GST Regulations.

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.

Background

· Entity A is an entity that provided rental and financing facilities to retail and business consumers.

· Entity A entered into an Operating Agreement with Entity H.

· Under the Operating Agreement, Entity H agreed to exclusively promote and provide certain leasing, rental and credit facilities of Entity A in retail outlets.

· In consideration for Entity H's commitment to Entity A, the Operating Agreement set out that Entity A agreed to grant Entity H three different entitlements which are:

1. the immediate entitlement to a certain share of the profits of Entity A;

2. the receipt of fees based on the value of sales made through Entity H retail outlets; and

3. the grant of ordinary shares when Entity A or its business is sold.

· In respect to the third entitlement, the Operating Agreement provided that Entity A undertook to procure the delivery to Entity H 10% of the equity in Entity A when Entity A is sold by way of trade sale or IPO.

· Entity A and Entity H later agreed to terminate the original Operating Agreement and entered into a second agreement (the Restated Agreement).

· The Restated Agreement was identical in all material respects to the Operating Agreement as described above, including that it continued to set out Entity H's entitlement to the equity in Entity A.

· The Restated Agreement was subsequently amended by an Amending Deed where the Vendor shareholder and Entity B, which is the parent company to Entity A, were added as party to the Restated Agreement.

· In addition to changing the entities which were party to the Restated Agreement, the Amending Deed changed the equity clause of the Restated Agreement to "Commission". The underlying agreement for services to be provided by Entity H to Entity A (not the Vendor shareholder) was not altered.

· Under the Amending Deed, clauses of the Restated Agreement (i.e. the equity provisions) would be deleted on the occurrence of a "Liquidity Event" which was defined to include the sale of Entity A by way of Initial Public Offering (IPO).

Relevant facts

· The Vendor later entered into a Participation Deed with Entity H.

· The Participation Deed governs the manner in which Entity H entitlements under the Restated Agreement and Amending Deed would be discharged.

· Under the Participation Deed, the Vendor agreed to pay or procure payment to Entity H of the amount described as "Final Commission".

· The amount of the "Final Commission" was to be calculated in accordance with the equity provisions of the Restated Agreement. Essentially, it is contended that the amount of the "Final Commission" was to be equal to the value of shares that Entity H would have received had it retained its entitlements under the equity provisions in both the Operating Agreement and the Restated Agreement.

· It is also contended that Entity H to have the necessary recourse to secure its entitlement to either 10% of the shares on IPO or an equivalent value if it surrendered its rights to those shares, it was necessary for Entity H to contract with the Vendor shareholder.

· The Vendor shareholder collectively owned over 95% of the issued shares in Entity B.

· Entity B decided to pursue a dual trade sale and IPO process.

· The Vendor shareholder sold their shares in Entity B to enable the IPO to occur.

· The Vendor received cash and shares another entity (Entity C) as part of the IPO process.

· The Vendor paid Entity H and amount which was labelled "Final Commission Payment". This amount is contended to be essentially equal to the value of shares that Entity H would have received had the equity provisions in both the Operating Agreement and Restated Agreement not been altered.

· The Vendor shareholder is registered for GST.

Note: For convenience we have referred to the payment that Entity H received from the Vendor shareholder as a commission payment. The reference to commission payment should not be taken that the payment is a commission for the purposes of item 27 in subregulation 70-5.02(2) of the GST Regulations (item 27). We will separately address whether the payment falls within item 27 in addressing the first question.

Detailed reasoning

Question 1

Section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you are entitled to an input tax credit for any creditable acquisition that you make. For an acquisition to qualify as a creditable acquisition it must, amongst other things, be acquired 'solely or partly for a creditable purpose' as per section 11-5 of the GST Act.

Under subsection 11-15(1) of the GST Act, a thing is acquired for a creditable purpose to the extent that you acquire it in carrying on your enterprise. Under paragraph 11-15(2)(a) of the GST Act, a thing acquired in carrying on an enterprise is not acquired for a creditable purpose to the extent that the acquisition relates to making supplies that would be input taxed.

Section 40-5 of the GST Act provides that a financial supply, as defined in the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations), is input taxed.

The provision, acquisition or disposal of an interest in or under a matter mentioned in items listed in the table in subregulation 40-5.09(3), or an interest mentioned in subregulation 40-5.09(4) of the GST Regulations is a financial supply provided:

· the conditions in subregulation 40-5.09(1) of the GST Regulations are all satisfied, and

· the interest is not excluded from being a financial supply because it is mentioned in regulation 40-5.12 of the GST Regulations.

In this case, the acquisition and disposal of shares by the Vendor as part of the IPO process falls within item 10 (securities) of the table in subregulation 40-5.09(3) of the GST Regulations. Provided the requirements in subregulation 40-5.09(1) are met, the provision of the interest in or under the share acquisition and disposal is a financial supply.

The Vendor has supplied their shares in Entity B and also been issued (i.e. received) shares in Entity C as part the IPO that occurred. As such the Vendor would have made acquisitions related to the financial supply of the interest in the shares which falls within the definition of securities. These acquisitions are not for a creditable purpose under section 11-15 of the GST Act as they relate to making a supply that is input taxed. Therefore, the acquisitions, to that extent, do not ordinarily give rise to an input tax credit under Division 11 of the GST Act.

However, subsection 70-5(1) of the GST Act states that the GST Regulations may provide that acquisitions of a specified kind that relate to making financial supplies can give rise to an entitlement to a reduced input tax credit. Subregulation 70-5.02(1) of the GST Regulations provides that an acquisition mentioned in subregulation 70-5.02(2) that relates to making financial supplies gives rise to this entitlement.

The expression 'an acquisition…that relates to making financial supplies' used in subregulation 70-5.02(1) identifies a class of acquisitions that are denied input tax credits because of the operation of paragraph 11-15(2)(a) and subsection 40-5(1) of the GST Act. Such acquisitions are referred to as reduced credit acquisitions.

Division 70 of the GST Regulations provides an exhaustive list of items which have the status of reduced credit acquisitions. Under item 27 of the table in subregulation 70-5.02(2) of the GST Regulations, supplies for which financial supply facilitators are paid commission by financial supply providers are reduced credit acquisitions.

Therefore, for item 27 to be met, there must be:

· a financial supply provider;

· a financial supply facilitator; and

· commission.

Financial supply provider

Subregulation 40-5.06(1) of the GST Regulations provides that an entity, in relation to the supply of an interest that was immediately before the supply, the property of the entity or created by the entity in making the supply, is the financial supply provider of the interest.

In this case we accept that the Vendor is a financial supply provider as they are selling their shares in Entity B. In addition as part of the IPO process the Vendor is also issued shares in Entity C.

Financial supply facilitator

A financial supply facilitator is defined in regulation 40-5.07 of the GST Regulations as an entity facilitating the supply of an interest for a financial supply provider.

The Commissioner, in 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) and Goods and Services Tax Ruling GSTR 2004/1 Goods and services tax: reduced credit acquisitions (GSTR 2004/1) has set out principles for determining whether an entity is a 'financial supply facilitator' for the purposes of subregulation 70-5.02(2) of the GST Regulations. They are as follows:

· being a financial supply facilitator describes the role that the entity plays in a particular transaction and is not characteristic inherent of the entity itself;

· an entity can be a financial supply facilitator in relation to some transactions but not in relation to others;

· the particular supply may be an actual supply or it may be a supply that the entity intends to make; and

· the activities of the entity must have an identifiable association with the supply that goes beyond a mere general association for the entity to be a financial supply facilitator. An identifiable association requires there to be a substantial connection so as to exclude activities that are generally related.

Substantial connection with the sale/acquisition of shares as part of the IPO

Under the terms of the Operating Agreement Entity H was entitled to 10% of the equity in Entity A when it was sold by way of trade sale or IPO. The Restated Agreement amended the Operating Agreement by introducing further entities. However, Entity H's equity entitlement remained unchanged. At this time the Vendor was majority shareholder in Entity Bs, the parent entity of Entity A.

The Restated Agreement was modified by the Amending Deed. The Amending Deed introduced the Vendor shareholder to the Restated Agreement with Entity H, where Entity H was to receive a commission payment in lieu of the 10% shares.

It has been submitted that Entity H was facilitating the sale of shares in Entity B by agreeing to accept the commission payment in lieu of their previous right to 10% of the shares on IPO. That is, the commission payment was made to discharge the obligation to supply the 10% equity in Entity A. It is then submitted that but for Entity H making the supply it did, in respect of which it was paid the commission payment, the Vendor would not have dealt with their shares in the way that they did. This, it is contended, is a facilitation of the sale/acquisition of shares by the vendor shareholder.

In the Operating Agreement and the Restated Agreement, it is Entity A rather than the Shareholder who are required to provide the 10% equity to Entity H. The purpose of providing the 10% equity in the Operating Agreement and Restated Agreement would also need to be taken into account. Doing so, it is our view that the 10% equity is consideration for Entity H promoting and providing Entity A's facilities in its retail outlets as described in the Operating Agreement and Restated Agreement.

The later amendments and to the Agreement resulted in a change to the consideration, that is, instead of receiving consideration of 10% equity, Entity H would receive the 'commission payment'. Therefore, it is our view that the 'commission payment' was made not to enable Entity H to facilitate the sale of the shares. Rather it was made as consideration for Entity H promoting and providing Entity A's facilities.

It is also our view there is a lack of substantial connection between the activities Entity H have undertaken and the sale/acquisition of shares by the Vendor. In the foremost, the IPO process in which the Vendor has to sell/acquire shares only occurs when a liquidity event happened. A liquidity event is defined in the Participation Deed (the Deed) as a sale of shares or an IPO. This Deed provides for payment of a final commission to Entity H upon a liquidity event (either under an IPO or sale of shares). The Deed also provides that as a default for the payment of this final commission, Entity H may demand that the Vendor transfer the shares to them in lieu of the unpaid commission payment. In other words, the contractual arrangement of having either a commission payment or a share transfer under the Deed is merely a mechanism in providing a degree of flexibility in discharging the obligations to Entity H in consideration for Entity H's commitments to promote Entity A.

From this perspective, Entity H in accepting the commission payment in lieu of the shares entitlement cannot be construed as having a 'substantial connection' with the Vendor's sale/acquisition of shares in the IPO process. Entity H's relinquishment of the shares in return for the commission payment did not impact on the Vendor's sale/acquisition of shares in the course of an IPO process. Further, Entity H did not perform any activities/services in facilitating the actual sale/acquisition of shares during the IPO on the part of the Vendor.

Commission

In view of our conclusion that Entity H did not facilitate the supply or acquisition supply of shares during the IPO, it is not necessary for us to address the contention advanced that the payment made by the Vendor was a 'commission payment' that falls within item 27 in subregulation 70-5.02(2) of the GST Regulations. However, for completeness, we will address the contention.

The term 'commission' is not defined in the GST Regulations for the purposes of item 27 in subregulation 70-5.02(2) of the GST Regulations (item 27). The Commissioner considers that the term 'commission' for these purposes means: Payment to an agent or similar entity, or to an employee for particular services rendered. The payment may be made on a fixed sum or fixed percentage basis, or on a sliding scale based on the value of the transaction.

It is contended that the payment made by the Vendor is in fact a commission as the later Agreements were entered into to revise the nature of the entitlement of Entity H. Further, reference is made to a separate but related private ruling in which we have accepted the payment constitutes a commission.

Firstly, we need to emphasise that the word 'commission' for the purposes of item 27 has the meaning which we have set out above. We do not consider Entity H is a financial supply facilitator for which they are paid a commission by the Vendor as the financial supply provider in respect of any acquisitions made by the Vendor that relate to the particular transaction, that is, the sale/acquisitions of shares in the IPO process.

This is because in the context of the contractual arrangements entered between the Vendor and Entity H, the term 'commission payment' has been used in relation to the remuneration payable to Entity H in respect of their services rendered in connection with the promotion and provision of Entity A's facilities in certain retail stores. This is evident from the Restated Agreement and the subsequent Amending Deed and Participation Deed. The evidence does not disclose that Entity H has provided any services as an agent or similar capacity to facilitate the Vendors sale/acquisition of shares in the IPO process upon which Entity H was remunerated a commission payment for the purposes of item 27.

Question 2

Section 9-5 of the GST Act provides that you make a taxable supply if:

· you make the supply for consideration;

· the supply is made in the course or furtherance of an enterprise that you carry on;

· the supply is connected with Australia; and

· you are registered or required to be registered.

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

It is submitted by way of analysis that Entity H have entered into an obligation to promote Entity A's facilities. These activities constitute a supply under subsection 9-10(2) of the GST Act. In accordance with the requirements of section 9-5 of the GST Act, this supply will be taxable where it is made for consideration. Consideration is defined in section 195-1 to mean "any consideration within the meaning given by section 9-15, in connection with the supply". The meaning given to consideration in subsection 9-15(1) extends beyond monetary payments to include such things as acts and forbearances.

Entity A provided Entity H with an entitlement to the grant of ordinary shares when Entity A or its business is sold (i.e. the equity) under the Operating Agreement. Entity H's equity entitlements were set out in the Operating Agreement which was replicated in the Restated Agreement.

It is then argued that the grant and the release of the right should be characterised in a similar manner. Because the right that Entity H received was a financial supply consisting of a right to receive shares, the release of this right by Entity H should be treated in accordance with the nature of that right. Hence, so it was contended, the release supply should be a financial supply.

By way of developing the contention, it is submitted that the substance of the later Agreements was that the consideration was relabelled as a final commission and the supply to which the final commission relates was Entity H surrendering its right to be issued with shares. Thus, the submission was that the Agreements resulted in Entity H effectively releasing/surrendering its right to receive ordinary shares. The release/surrender was effected when the liquidity event occurred, on the sale of shares by the vendor shareholders as part of the IPO process. Consequently, it is submitted that pursuant to paragraph 9-10(2)(e) of the GST Act and subregulation 40-5.09(1) of the GST Regulations, the act of Entity H releasing Entity A from their rights to shares is an input taxed financial supply.

Our view is that in order to determine whether a payment is consideration under subsection 9-15(1), the test is whether there is a sufficient nexus between the supply and the payment made.

In determining whether a sufficient nexus exists between supply and consideration, regard needs to be had to the true character of the transaction. An arrangement between parties will be characterised not merely by the description that parties give to the arrangement, but by looking at all of the transactions entered into and the circumstances in which the transactions are made.

The test as to whether there is a sufficient nexus is an objective test. The motive of the supplier and the recipient also may be relevant in determining whether the supply was made for consideration, if a reasonable assessment of the evidence supports that motive.

It is our view that there is a direct nexus between the grant of ordinary shares to Entity H which is part of the consideration for the supply of services by Entity H as disclosed by the various contracts discussed above. The subsequent change to the commission payment in lieu of the grant of shares merely represents a change in the form of consideration. The subsequent change does not detract from the original intentions that the commission payment still constitutes part consideration for the supply of taxable services by Entity H to promote and provide Entity A's facilities as provided under the various contracts.

In this regard, we do not accept the contention that the commission payment paid by the Vendors is consideration for Entity H to surrender its right to a supply of ordinary shares which in itself is a form of supply to the Vendors under paragraph 9-10(2)(e) of the GST Act. In order for this 'surrender of a right' to be a separate supply, it must have economic value and an independent identity that is separate from the underlying transaction.

The true nature of the transaction will characterise whether the provision/surrender of some rights are conditions of the contract or supplies within the meaning prescribed in section 9-10 of the GST Act. We are of the view the underlying transaction is essentially the supply of taxable services by Entity H to Entity A in return for consideration consisting of, among other things, the grant of shares to Entity H.

The change in consideration from the grant of shares to the commission payment is contended to result in Entity H surrendering its right to be issued with shares.

It is our view that the characterisation of there being a surrender of a right arising from a change in the form of consideration from being one of 'in-kind' to one of 'monetary' does not give adequate expression to the factual context in which the commission payment was made. We consider that the change in consideration from one of a right to shares to one of commission payment does not result in there being a surrender of a right that is regarded as a separate supply for the purposes of section 9-10 of the GST Act.

Accordingly, we consider that Entity H's agreement to accept a commission payment does not amount to it surrendering its right to be issued with shares. In our view it merely represents Entity H accepting a different form of consideration for its supply of services in promoting and providing Entity A's facilities in its retail outlets.

Consequently, the commission payment made to Entity H is considered to be consideration for its taxable supply of services (in promoting and providing the facilities in Entity H retail outlets) provided all the requirements of section 9-5 of the GST Act are satisfied.

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