Edited version of your written advice

Authorisation Number: 1051466642010

Date of advice: 14 December 2018

Ruling

Subject: GST and entitlement to an input tax credit

Question

1. Are you entitled to an input tax credit (ITC) when the cash deposit (converted from a bank guarantee) was applied to the termination fee under the deed?

Answer

1. Yes, you are entitled to an ITC when the cash deposit was applied to the termination fee under the deed as all of the requirements of a creditable acquisition under section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) are satisfied.

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.

You and the entity entered into the Project Deed (the Deed). The Deed provided for the entity to deliver something for you. The Deed also provided that a particular agreement would be entered into when particular segments of the supply became available.

Under the Deed, you were required to pay certain fees. You were registered for goods and services tax (GST) at the time of the transaction

Administrators were appointed to you.

You claim that ultimately the payment held was applied to the Termination Fee owed by you to the entity.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Division 99

A New Tax System (Goods and Services Tax) Act 1999 Section 11-20

A New Tax System (Goods and Services Tax) Act 1999 Section 11-5

Reasons for decision

Are you entitled to an ITC in relation to the payment?

To answer in the affirmative, you must have made a creditable acquisition. In this case the particular elements of focus under section 11-5 of the GST Act are whether the payment is consideration for a supply and if so, whether you provided or were liable to provide the consideration for the supply.

Termination fees – consideration for the earlier or intended supply

A number of Rulings deal with the issue of whether a payment is in connection with a supply when the agreement between the parties does not proceed as intended. The question is whether there is a supply and whether there is a sufficient connection or relationship between a supply and the consideration.

Relevantly, Goods and Services Tax Ruling GSTR 2001/4 recognises that a payment under an out-of-court settlement may be in connection with an earlier supply made under an arrangement between the parties. Goods and Services Tax Ruling GSTR 2009/3 explains that a supplier may make the intended supply even though a customer fails to take advantage of that supply. It goes on to state that a cancellation fee is consideration for the intended supply if it represents payment for work done by a supplier in making the intended supply.

Under the Deed, the supplier must do particular things for you. The fees are consideration for the provision of the infrastructure.

As the Project was completed the entity has fulfilled its obligation under the Deed or made the intended supply/earlier supply prior to the termination of the Deed. The Termination Fee is directly linked to this intended/earlier supply.

The payment is not in the nature of damages or compensation for loss

In some cases a payment in the nature of damages or compensation may not be consideration for a supply.

GSTR 2003/11 Goods and services tax: payment on early termination of a lease provides an analogous example where a lessor exercises its right to terminate a lease agreement for goods when the lessee shows an intention to repudiate the agreement. Where this occurs, the damages payable by the lessee may be calculated by reference to the residual value of the goods and the future rental (commonly adjusted to present values) less any net sale proceeds from sale of the goods by the lessor.

The ruling explains that characterisation of different components of a payment will depend on the agreement, how the agreement is implemented by the parties and other relevant surrounding circumstances. If a component of the payment is paid in connection with an earlier or current supply, GST is payable and an entitlement to ITCs arise.

In the present case, the payment can be linked to a supply. As stated above, there was a supply in relation to the completion of the relevant segments. The payment, which takes account of the cost of the project, allows recoupment of the costs of the project over a specified term. The termination of the Deed allows for the payment to be brought forward representing the present value of the amounts otherwise payable under the Deed if there had been no early termination. If the payment of the Termination Fee was for the “loss of opportunity” or “loss of bargain” to provide particular rights, it would be akin to damages as they are compensatory in nature and there is no connection to any supply made. However, the Deed makes it clear that the payments are not for the particular rights and are payable whether or not an agreement has been entered into. It is therefore consideration for the supply of the thing supplied and not compensation for any “loss of bargain” to supply the proposed particular rights as a result of early termination.

Did you provide the consideration or was it liable to provide the consideration?

When the administrators of you advised that they were not intending to replace the expiring bank guarantee, the entity drew down the bank guarantee as per the conditions of the Deed to hold it as a ‘Cash Deposit’ under the Deed. Originally, a bank guarantee was provided by financier on the behest of you as the ‘Initial Security’. It is clear that the action on the part of the entity was not recourse on the Initial Security but merely changing the form of the security from a bank guarantee to cash. But the legal form involved a payment by the bank under its contract with the entity, not a payment by you.

Despite initial confusion about what the payment was ultimately applied to, according to the private ruling application, the parties now agree that the payment was applied to the liability that arose when the entity terminated the Deed in acceptance of the repudiation of the contract by the administrators under the Deed.

GSTR 2006/1 Goods and services tax: guarantees and indemnities provide that where a supplier makes a supply to a recipient, for which the payment is guaranteed, the payment by a surety is third party consideration. Consistent with this, the payment by the bank is a third party payment. Springsure did not provide the consideration. The terms of the Deed that provide that you and the entity will treat any payment under the bank guarantee as “delivered by or on behalf of” you does not change this legal reality. The liability by the financier to make payment under the bank guarantee is based on a demand by the entity, the beneficiary, and not subject to any consent or agreement on the part of you. There is, however, a connection between the payment by the financier and the earlier supplies made by the entity when the amount paid was applied to the Termination Fee, as discussed above.

The Deed provides that you “must” pay the Termination Fee to the entity upon termination of the Deed. You are thus liable to pay the Termination Fee and therefore are entitled to claim the ITC relating to the payment notwithstanding the consideration is from a third party. The other requirements of a creditable acquisition are satisfied.

The quantum of the ITCs is one eleventh of the entire amount of the Termination Fee subject to an increasing adjustment under Division 21 of the GST Act (about adjustments for bad debts) if the remainder of the Termination Fee remains unpaid. As the ITC has yet to be attributed by you due to the lack of a tax invoice and more than 12 months has passed since the due date of the Termination Fee, the ITC and increasing adjustment can be attributed in the same BAS but must be accounted for separately under the Business Activity Statement as per Goods and Services Tax Act GSTR 2000/2 Goods and Services Tax: adjustments for bad debts. You need to hold a valid tax invoice in order to be able to claim the input tax credits.

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