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Ruling

Subject: GST and reduced input tax credits

Question

Is the acquisition of services by you from a service provider a reduced credit acquisition (RCA) under item 5 and item 25 of subregulation 70-5.02(2) of A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations)?

Answer

Yes, the acquisition of services by you from the service provider is a RCA under item 5 and item 25 of the subregulation 70-5.02(2) of the GST Regulations.

This ruling applies for the following periods:

Not applicable

The scheme commences on:

Not applicable

Relevant facts and circumstances

· This ruling is sought jointly by you as the representative member of the GST group and by a member of the GST group.

· You provide loans secured by mortgages to third party borrowers.

· The member of the GST group is the captive lenders mortgage insurer in the GST group and the member of the GST group insures you against losses that may arise from defaults under the loans secured by mortgages known as Lenders Mortgage Insurance (LMI)

· LMI is required as part of a loan application where the borrowing is greater than X% of the underlying value of the security. LMI is only ever required in relation to mortgage loan applications and in certain situations it is a prerequisite to the provision of the loan. Accordingly, LMI is integral to the application process of new loan accounts.

· You do not charge a separate fee to the borrowers for the LMI but the LMI is part of the input taxed loan fees charged by you to the borrowers.

· You exceed the financial acquisitions threshold under Division 189 of the GST Act.

· The member of the GST group acquires "stop loss reinsurance" from offshore reinsurers and the member of the GST group is the insured under the relevant stop loss reinsurance contracts.

· The member of the GST group has entered into an agreement ("Management Agreement") with the service provider where the service provider will provide management and administration services to the member of the GST group for its operation as a lenders mortgage insurer.

· Under the service level agreements in place the service provider agrees to:

(i) manage, co-ordinate and monitor the issuing of LMI policies in accordance with the underwriting standards and delegate underwriting authority in place with the member of the GST group and reinsurance with offshore reinsurers;

(ii) manage and settle claims under any LMI policy issued by the member of the GST group;

(iii) exercise any rights of the member of the GST group under any LMI policy;

(iv) recover any monies payable under the reinsurance arrangements;

(v) support the relationship between the member of the GST group and the insurers;

(vi) perform all administrative and accounting services in relation to the operation of the member of the GST group;

(vii) prepare and provide to the member of the GST group on a monthly basis, financial, statistical and management services provided;

(viii) ensure that premiums for policies of reinsurance are paid to the relevant reinsurer;

(ix) attend to all the member of the GST group enquiries, policy variations, policy cancellations and premium refunds in relation to any LMI policy issued by the member of the GST group; and

(x) prepare, complete and respond to any directive or request of government regulations in connection with the activities of the member of the GST group.

· Your group is organised along lines of business rather than legal entity lines. Accordingly, the "residential mortgage business" will set the policy which governs whether a loan application will require LMI.

· Based on the policy, the personnel in the residential mortgage business will decide whether a loan application will require LMI. These applications would then be forwarded to the service provider for assessment on behalf of the member of the GST group. A loan application requiring LMI cannot be finalised until the decision on LMI is made.

· The service provider would have the original loan application and the supporting documents for the assessment.

· The operation of the member of the GST group was entirely outsourced and the member of the GST group only retained one dedicated member of staff who had the responsibility of establishing underwriting policy, monitoring the business relationship and monitoring the service levels provided from the service provider to the member of the GST group. Although the member of the GST group establishes the parameters under which mortgage risk could be accepted, it is the role of the service provider to undertake assessment and/or processing of the LMI as part of the loan application.

· The service provider will follow the underwriting guidelines established by the member of the GST group and will decline any loan application that falls outside of these guidelines. They will also inform you of the decision on behalf of the member of the GST group.

· The service provider's ongoing responsibilities in relation to an issued LMI would limited to some of the following administrative functions:

(i) Calculating and remitting applicable taxes and levies on the policy, such as stamp duty.

(ii) Calculating and remitting reinsurance payments pursuant to the reinsurance programme developed and implemented by the member of the GST group.

(iii) Actioning claim payments on the policy.

(iv) Actioning variations and cancellation on the policy.

· The service provider is not responsible for risk decisions such as development of

reinsurance strategy. The member of the GST group is the licensed general insurance entity and the Australian Prudential Regulation Authority (APRA) does not permit these functions to be outsourced.

· The service provider also acts as an agent for the member of the GST group brokers in relation to the reinsurance with offshore reinsurers. They provide an intermediation service between the reinsurers and your GST group in relation to new and exiting LMI policies. However, the reinsurance agreement and the outsourced management agreement are separate contracts and are not necessarily co-dependant. The consideration for these two contracts is calculated separately.

· The service provider's revenue from the member of the GST group's reinsurance business has been variable over time and dependent on the service provider's participation in the member of the GST group's reinsurance programme which has changed on a frequent basis and the member of the GST group's business volumes in any given underwriting year.

· The management of the LMI business and its importance in the writing of mortgages are the responsibilities of your GST group. The processing and verification are the responsibilities of the service provider.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 subsection 11-15(2)

A New Tax System (Goods and Services Tax) Act 1999 subsection 48-45(1)

A New Tax System (Goods and Services Tax) Act 1999 subsection 48-45(2)

A New Tax System (Goods and Services Tax) Act 1999 section 48-55

A New Tax System (Goods and Services Tax) Act 1999 Division 70

A New Tax System (Goods and Services Tax) Regulations 1999 regulation 70-5.02

Reasons for decision

Subsections 48-45(1) and (2) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) relevantly state:

(1) If a member of a GST group makes a creditable acquisition or creditable importation:

(a) the representative member is entitled to the input tax credit on the acquisition; and

(b) the member making the acquisition or importation is not entitled to the input tax credit on the acquisition or importation (unless the member is the representative member)

(2) In deciding, for the purposes of subsection (1), whether an acquisition by a member of a GST group is a creditable acquisition, the acquisition is treated as being solely or partly for a creditable purpose if, and only if, it would be so treated if:

(a) the GST group were treated as a single entity; and

(b) the GST group were not treated as a number of entities corresponding to the members of the GST group.

In addition, section 48-55 of the GST Act also provides that a GST group is treated as a single entity and not as a number of entities corresponding to the members of the group when calculating entitlements to input tax credits. Therefore, pursuant to subsection 48-45(2) and section 48-55 of the GST Act, it is the connection between the thing acquired and the group's enterprise as a whole which determines whether or not an acquisition is made for a creditable purpose.

In this case, the acquisition by the member of the GST group of the services in relation to LMI from the service provider is a financial acquisition as the enterprise of the group as a whole is to use the acquisition in relation to the making of financial supplies consisting of loans secured by mortgages to third party borrowers. Consequently, by virtue of subsection 11-15(2) of the GST Act, there is no entitlement to input tax credits in respect of this acquisition.

An exception to this general rule applies under subsection 11-15(4) of the GST Act where an entity does not exceed the Financial Acquisitions Threshold (FAT). You confirmed that you have exceeded the FAT and accordingly, the FAT exception to the general rule does not apply.

However, another exception to the general rule is provided for in Division 70 of the GST Act. Division 70 of the GST Act provides that the acquisitions of a specific kind made in relation to making financial supplies can give rise to an entitlement to a reduced input tax credits (RITC). These acquisition known as reduced credit acquisition (RCA) are exhaustively listed in the table in subregulation 70-5.02(2) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations).

Regulation 70-5.03 of the GST Regulations provides that RITC entitlement is 75%.

Processing Services

Item 5 listed in the table of subregulation 70-5.02(2) (item 5) of the GST Regulations states 'processing services in relation to account applications for account providers, including providing credit reference and credit scoring assessment' as one of the reduced credit acquisitions which can give rise to a reduced input tax credit entitlement.

The Australian Taxation Office (ATO) view on the acquisitions listed in subregulation 70-5.02 of the GST Regulations is explained in Goods and Services Tax Ruling GSTR 2004/1

Paragraph 223 of GSTR 2004/1: reduced credit acquisitions states:

223. The scope of item 5 depends on the meaning of the expressions: processing services; in relation to; account applications; account providers; credit reference assessment and credit scoring analysis.

The meaning of the expressions of processing services is explained at paragraphs 83 to 88 of the GSTR 2004/1 and specifically paragraphs 85 and 86 state:

85. The meaning of processing services is determined by reference to:

· the ordinary or general understanding of the expression; and

· the context in which it is used.

86. The word services, when interpreted in conjunction with the word processing, is more than an alternative to supply. It implies responsibility for processing functions. The fact that an entity with responsibility for the processing functions in relation to account information sub-contracts the performance of processing activities to a third party, does not alter the conclusion that an acquisition of processing services has been made from the principal entity.

Example 28 of the GSTR 2004/1 states:

227. The Dominant Bank has an agency arrangement with the Central West Rural Transaction Centre (CWRTC). Under the agency agreement, CWRTC opens savings accounts for Dominant Bank customers for which it receives a fee each time a new account is opened. CWRTC is responsible for processing the account applications (including those received electronically) which involves a series of verification and clerical steps. For this service, CWRTC receives a fee, regardless of whether the application is approved or not.

228. In acquiring this service, Dominant Bank makes a reduced credit acquisition under item 5 as it an account provider and acquires processing services that have an identifiable association with account applications.

In applying the above example to the management agreement with the service provider as per the information provided by you, your GST group as a whole, being the 'lender' which self-insures through the member of the GST group its mortgage risks by acquiring a LMI. The whole processing of LMI would be conducted by the service provider on behalf of the member of the GST group as the member of the GST group has outsourced the entire processing and management activities to the service provider.

Therefore, we consider that your circumstances fall within the scope of item 5 listed in subregulation 70-5.02(2) of the GST Regulations as the arrangements made with the service provider to manage and administer the LMI satisfy the expression of processing services. We agree that your GST group is entitled to the reduced input tax credits under item 5 listed in subregulation 70-5.02(2) of the GST Regulations for the acquisition of processing services from the service provider.

Brokerage services

Paragraph 613 of the GSTR 2004/1 explains, when an entity that makes financial supplies acquires the services of an insurance broker for general or life insurance, they may make a reduced credit acquisition under item 25 listed in the subregulation 70-5.02(2) (item 25) of the GST Regulations.

Example 73 of the GSTR 2004/1 states:

616.Twinkle-toes home loans (Twinkle-toes) acquires a fleet of vehicles for its consultants to use when visiting clients. It engages Bloodhound Insurance Brokers to advise on the best arrangements for insuring the fleet, and to find and arrange insurance for the fleet. Bloodhound charges a fee for the advice, but receives commission from an insurer, when the policy is arranged.

617. The acquisition of the general insurance brokerage service by Twinkle-toes is a reduced credit acquisition under item 25 of the subregulation 70-5.02(2) (item 25) of the GST Regulations.

Based on the information provided, the service provider provides an intermediation service between the reinsurers and your GST group in relation to new and existing LMI policies. The service provider also acts as an agent for the member of the GST group brokers in relation to the acquisition of reinsurance for LMI with offshore reinsurers.

Paragraph 615 of the GSTR 2004/1 states;

615. Brokerage services can be provided by insurance brokers engaged by the assured or insurance agents engaged by either the assured or the insurer. Brokerage is payment for activities done as an intermediary between supplier and acquirer.

We consider that along with the processing services provided by the service provider under the management agreement the service provider also acts as an agent or intermediary in relation to arranging the reinsurance on behalf of the member of the GST group. Therefore, the brokerage services acquired by you will be considered as a RCA and you will be entitled to the reduced input tax credit under item 25 listed in the subregulation 70-5.02(2) (item 25) of the GST Regulations for the acquisition of brokerage services in relation to the reinsurance.

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