Edited version of private ruling

Authorisation Number: 1011813009383

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Ruling

Subject: GST & a Tax Law Partnership

Questions

1. Is the supply of the indemnity by Entity A to Entity B an input taxed financial 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 A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) and therefore, not subject to GST; or

2. Alternatively, if the supply of the indemnity is not an input taxed financial supply but is a taxable supply and therefore, subject to GST that the Joint Venture (JV) is entitled to claim input tax credits for the acquisition of the indemnity from Entity A.

Answers

1. No, the supply of the indemnity by Entity A to Entity B is not an input taxed financial supply pursuant to section 40-5 of the GST Act and subregulation 40-5.09(3) of the GST Regulations. It is a taxable supply and is subject to GST.

2. Yes, we confirm that the JV is entitled to claim input tax credits for the acquisition of the indemnity from Entity A.

Relevant facts

The JV

As part of the Project, Entity C has engaged the JV as sub-contractor to design and construct the Facilities under a contract.

Entity A and Entity B has an interest in the JV.

GST Registration

Entity A is registered for GST purposes.

Entity B is registered for GST purposes.

The JV is registered for GST purposes as a tax law partnership with the entity name 'Entity A & Entity B', the trading name 'Entity A Entity B Joint Venture'.

Entity A, Entity B and the JV are not members of the same GST group.

The Indemnity Fee

Under the JV Agreement, Entity A is to supply the Process Design to the JV. Entity A is highly specialised in this technology which is fundamental to the ultimate success of the Project. Put simply, if Entity A is not able to successfully apply its expertise to come up with a working design, the Project will fail.

Therefore, given there are no guarantees that the Project will be successful and that success primarily hinges upon Entity A's role in the JV, Entity A has agreed to provide an indemnify to Entity B for certain losses.

It was confirmed that the reason for the indemnity was in effect to protect the tax law partnership. Accordingly, the indemnity fee was paid by the tax law partnership account. The indemnity could not be provided to the tax law partnership because legally it was not an entity. Therefore, the indemnity was provided to Entity B as representative of the tax law partnership. Entity B was eager to make sure that it had an express and undeniable right to unilaterally act on behalf of the JV to enforce the indemnity against Entity A. Without this added layer of legal protection Entity B would have to rely on the cooperation of Entity A to enforce the indemnity (which it would be doing effectively against itself) in the event of a dispute between the JV participants. This is alleviated by Entity B being specified as the beneficiary of the indemnity under the JV agreement.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999:

Section 7-1;

Section 9-5;

Section 9-10;

Section 40-5.

A New Tax System (Goods and Services Tax) Regulations 1999:

Regulation 40-5.09(1).

Regulation 40-5.09 (3)

Reasons for decision

1. Is the supply of the indemnity by Entity A to Entity B an input taxed financial 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 A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) and therefore not subject to GST;

Section 7-1 of the GST Act provides that GST is payable on a taxable supply. Under section 9-5 of the GST Act, an entity makes a taxable supply if:

(a) it makes the supply for consideration

(b) it makes the supply in the course or furtherance of an enterprise that it carries on

(c) the supply is connected with Australia, and

(d) it is registered, or required to be registered for GST.

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

The supply of the indemnity by Entity A will satisfy the definition of a supply in section 9-10 of the GST Act. This supply is for consideration namely, the indemnity fee that is paid by the JV and made in the course or furtherance of Entity A's registered enterprise in Australia. Therefore, the positive limbs of section 9-5 of the GST Act are met and the supply of the indemnity is prima facie a taxable supply to the extent that it is not GST-free or input taxed.

There are no GST-free issues in the present case and accordingly, the pertinent issue is if the supply of the indemnity by Entity A is an input taxed financial supply consisting of a supply of an interest in or under an indemnity.

Section 40-5 of the GST Act states that a financial supply is input taxed and that the term has the meaning given by the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations).

Relevantly, the GST Regulations provide that the provision, acquisition or disposal of an interest mentioned in the table in subregulation 40-5.09(3) of the GST Regulations is a financial supply if the provision, acquisition or disposal is for consideration, in the course or furtherance of an enterprise, connected with Australia and the supplier is registered or required to be registered for GST and a financial supply provider in relation to the supply of the interest.

Indemnities are mentioned in item 7 in the table in subregulation 40-5.09(3) (item 7) and it states:

7 'a guarantee, including an indemnity (except for goods or a contract of insurance or reinsurance) is a financial supply'.

The Commissioner's view on what constitutes a guarantee including an indemnity that falls within item 7 is set out in Goods and Services Tax Ruling GSTR 2006/1: Goods and services tax: guarantees and indemnities (GSTR 2006/1).

Paragraph 7 of GSTR 2006 states that, the guarantee and indemnity arrangements covered by item 7 have certain characteristics in common. Namely, that they all involve three parties, and underlying indemnities flow from the relationships between the parties.

The three parties are described in GSTR 2006/1 as the 'principal' (the party that enters into an arrangement under which there is a credit risk), the 'creditor' (the party that has the risk and requires a guarantee or indemnity); and the 'surety' (the party that guarantees or indemnifies the creditor against loss). For the purposes of a guarantee that falls within item 7, the guarantee is a contractual arrangement under which the surety agrees to make good the obligation of the principal if the principal defaults. An indemnity under item 7 also involves the three parties mentioned above where the surety takes primary responsibility for an obligation arising in relation to a third party. Under both a guarantee and an indemnity, the surety has a right to be indemnified or reimbursed by the principal. This right may be contractual or arise only in equity, and is referred to in GSTR 2006/1 as the 'underlying indemnity'. If there is no such underlying indemnity arising as a natural consequence of the guarantee or indemnity arrangement, there is no item 7 supply.

In an alternative submission, you apply the principles outlined in GSTR 2006/1 to the facts of this case and acknowledge that the indemnity provided by Entity A is not one contemplated by the Commissioner. You state:

In applying the Commissioner's view and terminology to the present circumstances, the only entity that could be characterised as the 'indemnifier' is Entity A. Further, according to the Commissioner's view, the entity paying for the indemnity (i.e. the JV) should be the 'debtor' and there should be a third entity obtaining the rights under the indemnity (i.e. the 'creditor'). However, in present circumstances, it is accepted that the JV (if it is characterised as the debtor) does not have an obligation to Entity B (as the creditor). Also, Entity A as the indemnifier and also the debtor will presumably not seek redress from itself in the event of default. Rather, the Indemnity is more akin to a two party indemnity arrangement under which Entity A effectively indemnifies Entity B against loss that it may suffer as a failure of Entity A to supply the Process Design under the JV Agreement.

We agree with your reasoning and based on the Commissioner's view outlined in GSTR 2006/1 conclude that this indemnity is not an input taxed financial supply.

None of the other input taxed provisions apply in this case.

In support of your primary submission to treat the indemnity by Entity A as a financial supply you make two arguments. Broadly, these arguments are:

· That the Commissioner has narrowly construed item 7; and

· Treasury has recently identified the ambiguity and confusion that is caused by the present wording of item 7.

In relation to point 1 above, we advise that the Commissioner's reasoning is outlined in GSTR 2006/1 and we do not think it is necessary to reiterate his reasoning in this ruling.

In relation to point 2 above, we advise that none of Treasury's concerns is law at present. Accordingly, we are unable to comment on these matters.

In conclusion the indemnity supplied by Entity A is a taxable supply pursuant to section 9-5 of the GST Act.

2. Alternatively, if the supply of the indemnity is not an input taxed financial supply but is a taxable supply and therefore, subject to GST that the Joint Venture (JV) is entitled to claim input tax credits for the acquisition of the indemnity from Entity A.

Section 11-20 of the GST Act provides that the entity that makes a creditable acquisition is the one that can claim the input tax credit. A creditable acquisition is specifically defined by section 11-5 of the GST Act, which states:

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.'

(terms marked with asterisks (*) are defined in section 195-1 of the GST Act)

The issue that is relevant in this case is determining who made the creditable acquisition (that is, whether it was the JV or Entity B). Because the JV agreement states that "Entity A indemnifies Entity B…" it may seem as if though Entity B acquired the indemnity. However, on a closer analysis and subsequent to your confirmation it is evident that the reason for the indemnity was in effect to protect the tax law partnership and hence paid by the tax law partnership account. The indemnity could not be provided to the tax law partnership because at common law it was not an entity capable of contracting to acquire anything. Therefore, the indemnity had to have been made to Entity B as representative of the tax law partnership. Additionally, you confirmed that Entity B was eager to make sure that it had an express and undeniable right to unilaterally act on behalf of the JV to enforce the indemnity against Entity A. Without this added layer of legal protection Entity B would have to rely on the cooperation of Entity A to enforce the indemnity (which it would be doing effectively against itself) in the event of a dispute between the JV participants. This is alleviated by Entity B being specified as the beneficiary of the indemnity under the JV agreement. For these reasons the Commissioner is satisfied that for GST purposes Entity B acquired the indemnity on behalf of the tax law partnership. In other words, the tax law partnership (that is the JV in this case) acquired the indemnity.

We are satisfied that the rest of the requirements of section 11-5 of the GST Act are satisfied for the following reasons:

Creditable purpose

An acquisition of anything that is in connection with an enterprise is something acquired for a creditable purpose unless the acquisition is to be used to make input taxed supplies or is of a private or domestic nature (section 11-15 of the GST Act). In the present circumstances we are of the view that the indemnity does not come within any of the exclusions provided under section 11-15 of the GST Act.

Taxable supply

We have ruled that the supply of the indemnity by Entity A is a taxable supply.

Consideration

The JV is liable to pay the indemnity fee under the JV agreement.

GST registration

The JV is registered for GST

Conclusion

Because the JV satisfies the requirements of 11-5 of the GST Act, the Commissioner confirms that the JV made a creditable acquisition and therefore is entitled to claim the relevant amount of input tax credit on the indemnity fee.