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Ruling

Subject: GST and apportionment

Questions:

1. Is the proposed apportionment methodology set out below considered to be fair and reasonable for calculating the amount of input tax credits that Entity A is entitled to for its acquisitions referred to as 'Mixed Use Expenses'?

2. Is Entity A entitled to reduced input tax credits (RITCs) on the acquisition of other services which are subject to 'reverse charging'?

Advice/Answers:

1. Yes, the proposed apportionment methodology is considered to be fair and reasonable for calculating the amount of input tax credits that Entity A is entitled to for its acquisitions referred to as 'Mixed Use Expenses'.

2. Yes, Entity A is entitled to reduced input tax credits on the acquisition of other services.

Relevant facts and circumstances

The applicant for this private ruling is Entity A in its own individual capacity. Entity A is a member of a GST group.

Entity A exceeds the financial acquisitions threshold.

Entity A provides products to customers allowing them to make deposits in savings accounts (the Savings Business) and/or invest in a range of managed funds (the Managed Funds Business).

Entity A also acts as trustee for a trust which is separately registered for GST purposes.

Entity A in its own capacity supplies 'Other Services' (including administration and transaction processing services) to the trustee.

The Other Services are the only acquisitions made by the trustee in relation to the supplies made by the trustee.

No other supplies are made by Entity A in its own capacity apart from the Other Services (relating to the Managed Funds business) and financial supplies relating to the Savings Business.

Entity A has recently evaluated its apportionment methodology for claiming input tax credits on acquisitions that relate partly to taxable supplies and partly to input taxed supplies made by Entity A in its own capacity. These acquisitions are referred to as Mixed Use Expenses for the purpose of this ruling request.

The proposed apportionment methodology only applies to acquisitions made in relation to the Savings Business. It is not being applied to any acquisitions of the Managed Funds Business.

The Mixed Use Expenses are divided into two main categories of expenses for Entity A's business which are:

(a) IT-related expenses

(b) Marketing expenses.

Mixed Used Expenses are comprised of acquisitions that are not directly attributable to any supplies that Entity A makes.

The apportionment methodology for Mixed Use Expenses has been divided into two distinct periods as a result of the effect of the Global Financial Crisis (GFC). These periods are:

· Pre- GFC period, and

· Post- GFC period.

The reason for the allocation into Pre and Post GFC periods is due to the fact that the Managed Funds business was substantially impacted because of the GFC. Accordingly, a change in focus on growing savings products was implemented in response to the GFC.

The apportionment methodology for Mixed Use Expenses can be summarised into the four steps as outlined in Diagram 2:

Diagram 2: Summary of Apportionment Methodology.

Step 1

Step 2

Step 3

Step 4

The recovery rates that application of the above apportionment methodology yields for Mixed Use Expenses were provided to the ATO.

Apportionment methodology selected by Entity A (see diagram 2)

The apportionment methodology adopted by Entity A is detailed below.

The overall apportionment methodology will directly attribute acquisitions to product lines where possible. Where direct attribution is not possible, a variety of apportionment methodologies have been adopted.

Step 1) Direct attribution of expenses into the following two categories

• Managed Funds business - taxable supply (100% ITC recovery);

• Savings business - input taxed supply (0% ITC recovery, with some expenses eligible for a 75% RITC).

Direct attribution will be used to attribute Marketing expenses into the Managed Funds category or the Savings category. Accordingly, all expenses that relate to the Managed Funds business only will be entitled to recover full ITCs. However, all expenses that relate to the Savings business only will be denied recovery of ITCs.

Step 2) Pre-GFC period

The methodology then involves a calculation of a recovery rate which is then applied to the remaining unattributed Mixed Use Expenses for the pre-GFC tax period.

Step 2.1) Allocating Marketing expenses (not directly allocated)

Entity A will use a cost based activity approach in order to derive an ITC recovery rate which it will apply to the Pre-GFC Marketing expenses.

Entity A will therefore allocate expenses that relate to the Managed Funds business based on analysis of the mix of media expenditure. It is contended that this approach is fair and reasonable because the figures used represent the real cost of media placements in accordance with Entity A's Business Strategy with specific regard to the intended business effect of each element of the campaign. That is, the expenditure has been analysed to determine which product line it is related to.

Entity A has determined that if the expenses cannot be separated, then the following formula should be applied:

Managed funds portion of marketing expenditure

Total media expenditure

The abovementioned formula gives an overall recovery rate which will be applied to the mixed Pre-GFC marketing expenses. These figures are based on actual expenditure incurred.

Step 2.2) Allocating IT expenses (not directly allocated)

A methodology based on the Business Strategy has been adopted for the Pre-GFC Mixed Use IT expense category where IT expenses cannot be directly attributed. This is because the Business Strategy for Entity A outlines that a certain percentage of total projected revenues will be generated from the managed funds products, and the remaining XX% will be generated from the savings products.

A copy of the Business Strategy document was provided to the ATO.

Step 3) Post-GFC period

The methodology then involves calculating and applying a recovery rate for the remaining unattributed Mixed Use expenses for the Post-GFC period.

Step 3.1) Allocating Marketing expenses (not directly allocated)

As discussed above, a detailed analysis was conducted for the Pre-GFC Marketing expenses in order to determine the apportionment methodology. With the advent of the GFC, the ensuing weak performance of the global stock markets made managed funds an unattractive product. Entity A therefore shifted its focus away from the Managed Funds business to the Savings business. Post-GFC, Entity A estimates that a much higher percentage of its marketing spend and its staff time were spent on the Savings business.

Accordingly Entity A has determined that the percentage should be adjusted down from the higher Pre-GFC's figure to a more conservative figure.

Step 3.2) Allocating IT expenses (weighted average approach)

Entity A's managed funds products were substantially impacted as a result of the GFC. Accordingly, a change in marketing focus on growing the savings products was implemented during this period.

Entity A has developed a weighted average approach that adjusts the pre-GFC ITC recovery rate down to a more conservative figure.

This new weighted average approach considers the following three different criteria were relevant, but not suitable in isolation as an apportionment methodology:

• Business strategy (projected revenues and intention);
• Managed Funds marketing expenditure incurred; and
• Total number of active Managed Fund clients.

Entity A has performed various analyses in order to determine individual weightings and percentages that relates solely to the Managed Funds portion. The percentages for each of the three measures are multiplied by each other to derive individual recoverable rates. These recoverable rates are then aggregated to achieve a post-GFC ITC recovery rate.

Entity A proposes to utilise this amalgamation of different bases because it represents the different facets of the business where the appropriate weightings are also factored into the model.

Step 4 - RITCs

This step involves the GST liability of the "reverse charged" lT expenses and the entitlement to RITCs relating to these IT expenses from the international Head Office.

The international Head Office is situated outside Australia and provides IT services to Entity A in Australia. These services comprise:

· Software development;

· Infrastructure;

· Operational management (processing, backups, monitoring, releases, upgrades); and

· Support

Note that a number of functions which are information technology related are not outsourced to the international Head Office. The reason for this is that it is not possible from an ownership or risk point of view as local interaction is required. These costs are mainly staff related expenses and include:

· Security and audit;

· Business analysts;

· Project management;

· User acceptance testing; and

· Vendor management

Relevant legislative provisions

Schedule 1 to the Taxation Administration Act 1953

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

Section 9-5.

Section 9-30.

Section 11-15.

Section 11-5 .

Section 11-20.

Section 38-190.

Section 40-5

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

Sub regulation 40-5.09(1)

Item 1, 2, 3 of sub regulation 40-5.09(3)

Regulation 40-5.12.

Reasons for decision

Answer 1

Under section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), an entity is entitled to an input tax credit for any creditable acquisition that it makes.

An entity makes a creditable acquisition under section 11-5 of the GST Act when that entity:

(a) acquires anything solely or partly for a creditable purpose; and

(b) the supply of the thing to the entity is a taxable supply; and

(c) the entity provides, or is liable to provide, consideration for the supply; and

(d) the entity is registered or required to be registered.

Subsection 11-15(1) of the GST Act provides that you acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise. Under subsection 11-15(2) of the GST Act however, you do not acquire the thing for a creditable purpose to the extent that:

(a) the acquisition relates to making supplies that would be input taxed; or

(b) the acquisition is of a private or domestic nature.

Accordingly, to the extent that acquisitions made by Entity A relate to making supplies that would be input taxed, they are not acquired for a creditable purpose. Therefore, such acquisitions are not, to that extent, creditable acquisitions and Entity A is not entitled to input tax credits.

The exceptions to this general rule as provided for in section 11-15 of the GST Act are considered for the purpose of the methodology noted above. It is our understanding that Entity A has exceeded the financial acquisitions threshold provided for in subsection 11-15(4) of the GST Act. In this connection, the acquisition that relates to making financial supplies may attract a reduced input tax credit under Division 70 even though no input tax credit would arise under Division 11.

Goods and Services Tax Ruling GSTR 2006/3: Goods and Services Tax: determining the extent of creditable purpose for providers of financial supplies (GSTR 2006/3) outlines the Commissioner's views on apportionment and the methods of calculating the extent of creditable purpose of your acquisitions or importations.

Paragraph 44 states that:

44. For the purpose of claiming input tax credits, you need to estimate the extent to which the acquisition or importation is for a creditable purpose. This means that at the time of acquisition or importation, it is your planned use of the acquisition for a creditable purpose that is relevant in working out your input tax credit. You may estimate the planned use of the acquisition or importation based on:

· records you already have available from a previous period;

· records kept since you made the acquisition or importation, but before you lodge your BAS, including your actual use (full or partial) of the acquisition;

· records kept for some other purpose of the enterprise, for example income tax, management accounting, profitability analysis, intra-entity transfer charging or cost accounting;

· your previous experience concerning the usage of similar acquisitions;

· your business plan; or

· any other fair and reasonable basis.'

The ruling referred to the High Court judgement in Ronpibon Tin NL v. FC of T (1949) 78 CLR 47; AITR 236 and at paragraphs 73 and 74 noted the following in relation to apportionment:

73. Following the principles set out by the High Court, the method you choose to allocate or apportion acquisitions between creditable and non-creditable purposes needs to:

· be fair and reasonable;

· reflect the intended use of that acquisition (or in the case of an adjustment, the actual use), and

· be appropriately documented in your individual circumstances.

74. If you allocate or apportion acquisitions or importations using a method which meets all these principles, the Commissioner will not consider the fact that you choose the method that gives the most advantageous result to be, of itself, an arrangement to which Division 165 applies.

Methods of calculating the extent of creditable purpose are discussed in paragraphs 80 and 81 of GSTR 2006/3:

80. To calculate the amount of your input tax credits, you need to adopt a method of estimating the extent of creditable purpose of your acquisitions and importations. The requirement that your estimation is fair and reasonable in your circumstances is a prerequisite for any decision you make.

81. The Commissioner considers that the use of direct methods, including direct estimation … best accords with the basic principles explained above (see paragraph 73). If it is not possible or practicable to use a direct method, you may use some other fair and reasonable basis, including an indirect estimation method.

The ruling discusses direct estimation methods at paragraphs 93 and 94:

93. Direct estimation methods are preferable to indirect estimation methods ………… particularly if the direct estimation method used involves a detailed measure of the intended (or actual) use of the acquisition or importation. Measures based on inherent characteristics of, or factors directly connected with, the acquisition usually give a fair reflection of the use of the thing. These factors are sometimes referred to in management accounting and costing systems as 'drivers'.

94. The use of such characteristics or factors provides an estimation of a direct link between the acquisition or importation and its (or its intended) application. Some examples of these factors and characteristics are (relevantly):

· distance…

· time…

· volume…

· space…

· staff numbers (for example, measuring the actual use of acquisitions by identified staff).

Entity A may choose its own apportionment method, but the method it chooses needs to be fair and reasonable in the circumstances of the enterprise and must appropriately reflect the intended or actual use of its acquisitions or importations.

In this regard the Commissioner will accept any basis of apportionment of acquisitions which are applied indifferently to all supplies made, provided it is fair and reasonable in the given circumstances. In Entity A's circumstances, the ATO considers that on the basis of the information provided, the methodology it has submitted which incorporates direct methods and indirect methods as outlined in GSTR 2006/3, provides a fair and reasonable basis for calculating the extent of creditable purpose for acquisitions of Entity A's business under Division 11 of the GST Act.

Question 2

Is Entity A entitled to reduced input tax credits (RITCs) on the acquisition of Information Technology services from the international Head Office which are subject to 'reverse charging'?

Section 70-5 of the GST Act provides that certain acquisitions specified in the GST Regulations will give rise to an entitlement to a reduced input tax credit. These certain acquisitions are known as reduced credit acquisitions.

Regulation 70-5.02A provides that an acquisition mentioned in regulation 70-5.02B that relates to making financial supplies gives rise to an entitlement to a reduced input tax credit if:

(a) the supply or transfer that gives rise to the acquisition (the relevant supply):

(i) consists in:

(A) transfer of something to an enterprise in Australia (the receiving enterprise) from an enterprise outside Australia (the supplying enterprise); or

(B) the doing of something for the receiving enterprise by the supplying enterprise; and

(ii) is a taxable supply because of section 84-5 of the Act (including supply that is not connected to Australia because of section 84-15 of the Act); and

(b) the receiving enterprise and the supplying enterprise are closely related.

Item 15 of subregulation 70-5.02B(1) lists the "Maintenance and operation of transaction processing systems (including communications and applications systems)" as eligible for a reduced input tax credit.

You have advised us that the International Head Office provides information technology services to Entity A in Australia. These services comprise of:

· Software development;

· Infrastructure;

· Operational management (processing, backups, monitoring, releases and upgrades); and;

· Support.

You have also advised that a number of functions are not outsourced to the Service Centre. These functions are:

· Security and audit;

· Business analysts;

· Project management;

· User acceptance testing; and

· Vendor management.

You submit that you are entitled to a reduced input tax credit (RITC) in relation to the services of software development, infrastructure, operational management and support that are acquired from the international Head Office.

These tasks are provided to an enterprise located in Australia from an enterprise located outside of Australia and are a taxable supply because of Division 84.

We agree that you have an entitlement to a reduced input tax credit for these items.