Edited version of private advice

Authorisation Number: 1051738828164

Date of advice: 31 August 2020

Ruling

Subject: GST and supplies

Question

Did the entity make a creditable acquisition under section 11-5 of the A New Tax System (Goods and Services Tax) Act 1999 when the customer cancelled the entity's engagement under the contracts?

Answer

No, as the customer did not make a taxable supply, the entity did not make a creditable acquisition.

Relevant facts and circumstances

The entity is registered for GST.

The entity entered into a contract with the customer for construction works.

The contracts required the entity to provide a security to the customer in the form of unconditional undertakings to pay on demand, provided by an approved financial institution.

The customer invoked a clause in the contract to terminate the entity's engagement under the contract.

The contract provides that the customer could get others to complete the construction works\ in which case the entity was required to do a range of things including leaving the construction site and removing materials. In addition, the entity was required to assign or novate to the customer its rights and benefits in all its contracts and subcontracts regarding the construction.

The contract provides that any additional cost incurred by the customer in completing the construction works becomes a debt due by the entity.

The customer incurred further amounts to complete the construction and made a call on the Undertakings in relation to this debt.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

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

Reasons for decision

The entity will have made a creditable acquisition if it satisfies the requirements of section 11-5 of the GST Act, which states:

11-5 What is a creditable acquisition?

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.

For the entity to have made a creditable acquisition when the customer terminated the entity's engagement, the customer must have made a taxable supply to the entity as defined by section 9-5 of the GST Act:

9-5 Taxable supplies

You make a taxable supply if:

(a) you make the supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with the indirect tax zone; and

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

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

As the customer is registered for GST; any supplies that it makes are done in the course or furtherance of its enterprise and any supplies made in relation to its contracts with the entity would be connected with the indirect tax zone (being done in Australia), the customer will have made a taxable supply if:

·         the customer made a supply to the entity when it terminated the contracts; and

·         any supply made by the customer to the entity was for consideration.

A 'supply' is defined by section 9-10 of the GST Act as 'any form of supply whatsoever' and paragraph 9-10(2)(g) specifically includes:

(g) an entry into, or release from, an obligation:

(i) to do anything; or

(ii) to refrain from an act; or

(iii) to tolerate an act or situation

The Goods and Services Tax Ruling, Goods and services tax: supplies (GSTR 2006/9) identifies a number of propositions that assist the analysis of a transaction to identify any supplies made. Proposition 5 states that 'an entity will make a supply if it provides something to another entity' and is discussed from paragraph 71:

71. An entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient). This is consistent with the ordinary meaning of 'supply', being to furnish or provide.

72. The High Court said in Commissioner of Taxation v. MBI Properties Pty Ltd [2014] HCA 49 (MBI Properties) that it is not necessary that the making of a supply must always involve the taking of some action on the part of the supplier. In this regard, the reasoning adopted in some earlier court and tribunal decisions that considered when an entity makes a supply needs to be qualified to reflect this observation. The High Court recognised that an entity can provide something, and therefore make a supply, by means of refraining from acting or by means of tolerating some act or situation, just as it can by means of doing some act.

...

75. In light of the High Court's comments, read in the context of the case, we consider that an entity may be said to be making a supply by refraining from doing something or tolerating some act or situation if the entity was subject to an obligation to do so and then performed accordingly. While the circumstances in MBI Properties involved the performance of an obligation originally sourced in contract, and 'assumed by operation of law', we do not see any reason why performance of an obligation sourced otherwise could not also involve a supply by an entity in circumstances where the performance of that obligation involves no more than refraining from doing something or tolerating some act or situation.

The contract entered into by the entity and the customer provide that a range of goods, services, rights and obligations are passed between the parties. The terms of the contract permits the customer to terminate the entity's engagement under the contract and require the entity to assign or novate to the customer its rights and benefits in all its contracts and subcontracts regarding the agreement. However, the contract does not specifically provide for a release to be provided to the entity upon termination of its engagement under the contract. Nor is there any other agreement which releases the entity from the contract. Although the entity has been stopped from continuing to perform its obligations under the contract, paragraph 71 of GSTR 2006/9 states that something of value must be provided by the supplier for there to be a supply. It is not clear that, when the customer exercised its rights that it has provided anything of economic value to the entity.

The Goods and Services Tax Ruling, Goods and services tax: cancellation fees (GSTR 2009/3) discusses arrangements that are cancelled by a recipient (or intended recipient) and specifically states that, although a supplier may also cancel an arrangement, a cancellation fee is usually not charged and the ruling 'does not deal with cancellations made by a supplier except in relation to a ticketed arrangement for the supply of performances, events or similar arrangements'. Nevertheless, paragraph 55 of GSTR 2009/3 provides an explanation of when the Commissioner considers a fee or payment may be consideration for a 'release supply':

55. Without limiting subsection 9-10(1), a supply includes the supply of services, the creation or surrender of any right and the release from an obligation under paragraphs 9-10(2)(b), 9-10(2)(e) and 9-10(2)(g) respectively. In the context of the broad definition of supply, and having regard to the things included as supplies as set out in subsection 9-10(2), the Commissioner's view is that, if it is not consideration for any other supply, a cancellation fee may be consideration for the creation or surrender of rights and/or a release supply that occurs when an arrangement is cancelled, and/or a combination of these supplies under paragraph 9-10(2)(h).

GSTR 2009/3 explains that a cancellation fee paid by an intended recipient may be consideration for a 'release supply' made by the intended supplier as that supplier has an enforceable right to provide the intended supply. The cancellation fee is consideration paid in order for the supplier to release the recipient from the contracted obligations and not pursue its rights under the agreement. This can be contrasted with the contract between the entity and the customer as the entity, the supplier, was required to make a payment (via the Undertaking being called upon) upon termination of the entity's engagement. However, the payment must have a connection with a supply (or intended supply). Because there is a payment, it doesn't automatically mean that there is a supply connected to that payment. GSTR 2009/3 further discusses the relationship between payments and supplies:

58. If the termination payment or cancellation fee has a sufficient nexus with an earlier supply, the fee may change the consideration for the earlier supply but is not consideration for a release supply. The change in consideration gives rise to an adjustment event in relation to the earlier supply. For example, this may occur where an agreement for progressive and periodic supplies has been terminated because the making of the supply has already commenced or the supply has been made. This is different from the scenarios addressed in this Ruling where the intended supply has not been made at the time of release.

...

65. Regardless of whether an amount paid or payable is damages as properly understood (whether it is paid or payable under a liquidated or agreed damages clause or otherwise), the fundamental question to be answered in an Australian GST context is whether the amount is consideration for a supply. The classification of an amount as consideration for a supply or as damages is to be made in accordance with Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements.

66. GSTR 2001/4 sets out the Commissioner's views on when damages are, and are not, consideration for a supply. The Commissioner takes the view that payments that are called 'damages' resulting from court orders and out-of-court settlements need to be examined to establish whether the payment relates to a supply.

...

96. For paragraph 9-5(a) to be satisfied, it is necessary that the entity makes 'the supply for consideration'. Goods and Services Tax Ruling GSTR 2001/6, which is about non-monetary consideration, explains what consideration is. Paragraphs 49 to 72 of GSTR 2001/6 explain that a payment, act or forbearance is consideration for a supply if there is a sufficient nexus between the payment, act or forbearance and the supply.

97. In Reliance Carpet the High Court noted that, under section 9-15, consideration includes, among other things, any payment 'in connection with' a supply of anything. The High Court in analysing the decision of the European Court of Justice in Société thermale d'Eugénie-les-Bains v. Ministére de l'Économie, des Finances et de l'Industrie (Société thermale), gave some indication that the connection between consideration and a supply need not be direct, though it did not expand on what the extent of the connection needs to be.

97A. Further, in Qantas, the High Court found that the word 'for' in the phrase 'the supply for consideration':

[...] is not used to adopt contractual principles. Rather, it requires a connection or relationship between the supply and the consideration.

Although it is obvious that the termination of the entity's engagement under the contract has released the entity from a wide range of obligations that it had to perform under that contract, the entity was not released from the contract unconditionally. That is, the entity continued to be bound by the contract and continued to have obligations such as ensuring that relevant contracts and subcontracts were novated or assigned to the customer. Although it is arguable that the customer made a supply as defined by paragraph 9-10(2)(g) of the GST Act, no evidence to support the suggestion that the 'release', as provided by the termination of the entity's engagement has an identifiable value that has passed from the customer to the entity as is discussed at paragraph 71 of GSTR 2006/9.

Even if the customer did make a supply to the entity when it terminated the entity's engagement under the contract, the supply will only be a taxable supply if the supply is made 'for consideration'. Consideration is defined by section 9-15 of the GST Act to include:

(a) any payment, or any act or forbearance, in connection with a supply of anything; and

(b) any payment, or any act or forbearance, in response to or for the inducement of a supply of anything.

It is not sufficient that there be a supply and a payment, the payment must be 'for' the supply. That is, there must be a relevant connection between the two. The Goods and Services Tax Ruling, Goods and services tax: non-monetary consideration (GSTR 2001/6) discusses the meaning of consideration and states:

50. Section 9-15 further provides that a payment will be consideration for a supply if the payment is 'in connection with', 'in response to' or 'for the inducement' of a supply. Thus, there must be a sufficient nexus between a particular payment and a particular supply for the payment to be consideration for that supply.

51. It follows that there are two elements to the definition of consideration. The first is the payment by one entity to another. The second element is the nexus that must be established between the payment and a supply

In discussing the nexus test in Australia, GSTR 2001/6 states:

71. 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.

72. 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.

In Commissioner of Taxation v. Qantas Airways Ltd [2012] HCA 41 the Court notes, at [14], that the 'word "for" is not used to adopt contractual principles. Rather, it requires a connection or relationship between the supply and the consideration'. The Goods and Services Tax Ruling, Goods and services tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) comments on the nexus test and states:

90. The Commissioner considers that, in the context of the GST Act, the expression 'you make the supply for consideration' in paragraph 9-5(a) means the same as 'there is consideration for the supply that you make'.

91. The references in the GST Act to 'supply for consideration' and more commonly to 'consideration for a supply' underscore the close coupling between the supply and the consideration that is necessary before a payment will be consideration for a supply that will make the supply subject to GST.

92. In a similar fashion to the GST legislation in New Zealand, the nature of the nexus required between supply and consideration is specified in the definition of consideration. A payment will be consideration for a supply if the payment is 'in connection with', 'in response to' or 'for the inducement' of a supply.

GSTR 2001/4 also discusses the High Court decision in Berry v. FC of T (1953) 89 CLR 653 where Kitto J considered the meaning of consideration 'for or in connection with' in the context of former section 84 of the Income Tax Assessment Act 1936, a provision which included consideration for or in connection with goodwill in a lease premium. Kitto J held that 'in connection with' was a broader test than 'for'.

95. The meaning given to the term 'in connection with' in Berry's Case is similar to that which was described by the Court of Appeal in New Zealand Refining [(1997) 18 NZTC 13187, at 13193-13194 per Blanchard J.], but needs to be applied with regard to the structure of the definition of supply in the GST Act. In Berry's Case, Kitto J held that 'in connection with' was a broader test than 'for'. At page 659 he commented that consideration will be in connection with property where:

'the receipt of the payment has a substantial relation, in a practical business sense, to that property'.

Specific to GST, the Full Federal Court in AP Group Limited v. Federal Commissioner of Taxation [2013] FCAFC 105) (AP Group) noted, at [33] that, in identifying the character of the connection, the word 'for' ensures that not every connection between supply and consideration meets the requirements for a taxable supply. That is, merely having any form of connection of any character between a supply and payment of consideration is insufficient to constitute a taxable supply:

33. Sections 9-15 and 9-17 identify circumstances which are included within the meaning of consideration including, relevantly in s 9-15(1)(a), " any payment, or any act or forbearance, in connection with a supply of anything ". Even if these words are substituted for " consideration " the result is simply repetition of the " in connection with " element of the statutory condition, not omission of the word " for ". The consideration must be " in connection with " the supply but the supply must also be " for " the consideration. " For ", in this context, means " in order to obtain " (Macquarie Dictionary Online, item 3, Oxford Dictionary Online item 9(a)). The word " for " thus functions in the statutory description to identify the character of the connection which is required. It ensures that not every connection between the giving of consideration and the provision satisfy the first condition of making a taxable supply. If it were otherwise, any form of connection of any character between the making of a supply and the payment of consideration would suffice. The decisions on which the Commissioner relied to support this proposition, on analysis, do not do so.

The contract provides that, upon termination of the entity's engagement, any additional cost that the customer has incurred in completing the project becomes a debt due by the entity to the customer and the customer can make a demand under the Undertakings for that debt. The customer determined that it incurred further amounts and made a call on the Undertakings in relation to this debt. That is, the debt outstanding was reduced by the amount of the Undertaking recovered by the customer. Had the Undertaking been a higher amount, then the customer would have been entitled to call on that higher amount - up to total extra costs incurred by the customer. This demonstrates that the Undertaking is not consideration for a supply of a release from the entity's obligations under the contract but is part payment of the debt that is owed to the customer for the additional costs incurred by the customer in having the construction completed.

Neither the contact, nor any other documents refer to a 'release supply' being made by the customer upon termination of the entity's engagement and nor is there any documented agreement between the two parties that the payment of the Undertaking is in connection with the customer releasing the entity from its obligations under the contract.

As discussed in GSTR 2001/6, an objective assessment of the true character of the transaction must be made to determine whether a payment is consideration for a supply for the purposes of section 9-5 of the GST Act. As noted above in AP Group, in the context of section 9-5 of the GST Act, the supply must be 'for consideration'. That is, the supply must be made in order to obtain consideration.

In this case, the Undertaking was part payment of the total debt owing to the customer by the entity for the extra costs incurred by the customer in having others complete the construction works for which the entity was contractually engaged to perform. The debt owed by the entity and the part payment of that debt in the form of the Undertaking was compensation for the extra costs incurred by the customer. While the debt has a connection to the overall arrangement, this is insufficient to be consideration for a supply. It is not a payment made for the customer to release the entity from its obligations under the contract.

The entity did not make a creditable acquisition when the customer terminated the entity's engagement under the contract because the entity did not provide any consideration for any supply that may have been made by the customer in relation to the termination of the entity's engagement under the contract. The Undertaking is not consideration for any supply made by the customer to the entity, it is part payment of a debt owed by the entity to the customer for additional costs incurred by the customer when having the constructions works completed.

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