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Ruling

Subject: GST and financial supplies

Question

Will the supply by Entity A of a loan under the Loan Agreement with a customer, which incorporates a repayment mechanism for the final instalment, constitute solely a financial supply in accordance with section 40-5 of the A New Tax System (Goods and Service Tax) Act 1999 (GST Act)?

Answer

Yes, the supply by Entity A of a loan under the Loan Agreement with a customer which incorporates a repayment mechanism for the final instalment will constitute solely a financial supply in accordance with section 40-5 of the GST Act.

Relevant facts and circumstances

Entity A is registered for goods and services tax (GST) and conducts a business of lending money to qualifying customers to enable the customers to purchase assets.

The process by which a customer obtains finance from Entity A is initiated by a transaction between the customer and a retailer.

Entity A does not operationally control any retailers, however Entity A appoints retailers to originate finance on its behalf.

Entity A provides the finance (loan) to customers under a Loan Agreement.

A customer is the legal owner of the asset and at the commencement of the loan and grants a mortgage (chattel mortgage) over the asset to Entity A to secure the amounts payable under the Loan Agreement.

Under the terms of the Loan Agreement, interest is charged and in certain circumstances other fees and charges may be levied by Entity A.

The Loan Agreement currently provides the customer with two choices at the end of the term of the loan. They can either:

(i) make the last repayment and keep the asset they have purchased, or

(ii) sell or trade in the asset and make the last repayment.

Under either of the current two choices, the customer is required to pay the last loan repayment to Entity A in cash.

Entity A wishes to offer its customers under Loan Agreements a third option, which includes a repayment mechanism for the final loan instalment.

The repayment mechanism will allow a customer to sell the asset to a Purchaser (Entity A or an entity that Entity A nominates), at a predetermined price subject to certain conditions being met. The sale proceeds are then applied in satisfaction of the final loan instalment due under the Loan Agreement. In essence, the repayment mechanism is simply an alternative means of paying (in whole or in part) the final instalment of the loan.

The repayment mechanism will only be offered to customers intending to purchase certain assets. In offering the repayment mechanism to customers, Entity A aims to generate:

· increased sales of certain assets; and

· increased levels of these assets being financed by Entity A.

Entity A will set the predetermined price at the commencement of the Loan Agreement.

Under the Loan Agreement neither the standard terms and conditions, nor the accompanying schedule for the loan identifies any additional charge or increased interest rate payable by the customer on account of the customer's decision to enter into a loan with the repayment mechanism. The interest payable under the Loan Agreement is identified in the schedule as an indivisible sum.

The retailers of the asset negotiate the actual interest rate with each particular customer and are remunerated by Entity A for their services according to various methodologies agreed between the retailers and Entity A.

The repayment mechanism will be achieved by including a clause in the standard terms and conditions of the Loan Agreement. The clause will only apply if the customer has opted to proceed with a loan that includes the repayment mechanism.

The repayment mechanism is only available:

· in respect of a sale at the end of the term of the loan (ie, not an early repayment);

· if the customer has notified Entity A in writing of its decision to sell the asset at the predetermined price;

· if the customer has complied with all of the obligations under the Loan Agreement (except for the obligation to pay the final loan payment); and

· an appraisal has been carried out on the asset.

The appraisal is carried out by an authorised entity nominated by Entity A. If the appraised asset does not meet a certain standard, the predetermined price will be reduced to an adjusted price.

Where the adjusted price does not satisfy the entirety of the final loan repayment because it has been adjusted, the customer is required to pay the balance to Entity A. Further, if the customer has a balance remaining on the loan because of arrears or other fees or charges, the customer will need to settle this balance in cash with Entity A.

Relevant legislative provisions

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

A New Tax System (Goods and Service Tax) Act 1999 section 40-5

A New Tax System (Goods and Services Tax) Regulations 1999 regulation 40-5.08

A New Tax System (Goods and Services Tax) Regulations 1999 regulation 40-5.09

A New Tax System (Goods and Services Tax) Regulations 1999 regulation 40-5.10

Reasons for decision

Under section 9-5 of the GST Act, you make a taxable supply if:

(a) you make the supply for consideration

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

(c) the supply is connected with Australia, 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.

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

Regulation 40-5.08 of the GST Regulations explains that a supply is a financial supply if the supply is mentioned as:

· a financial supply in regulation 40-5.09 of the GST Regulations; or

· an incidental financial supply in regulation 40-5.10 of the GST Regulations.

Under subregulation 40-5.09(1) of the GST Regulations, the provision, acquisition, or disposal of an interest mentioned in subregulation (3) or (4) is a financial supply if:

· the provision, acquisition or disposal is:

· for consideration;

· in the course or furtherance of an enterprise; and

· connected with Australia; and

· the supplier is registered or required to be registered; and

· a financial supply provider in relation to supply of the interest.

Relevantly, an interest in or under a debt, credit arrangement or right to credit and a charge or mortgage over real or personal property are listed under items 2 and 3, respectively, in the table in subregulation 40-5.09(3) of the GST Regulations as financial supplies.

Entity A submits that the provision of the loan under the Loan Agreement to its customers is the creation of an interest in or under a debt under item 2 of regulation 40-5.09(3) of the GST Regulations; it is made for consideration; it is made in the course of Entity A's enterprise; it is connected with Australia and Entity A is registered for GST. Hence the supply of the loan in accordance with the Loan Agreement would constitute a financial supply within the meaning of regulation 40-5.09 of the GST Regulations.

However, Entity A seeks confirmation that the inclusion of the repayment mechanism into its Loan Agreement does not give rise to a separate taxable supply by Entity A.

In support of its position, Entity A submits that the inclusion of the repayment mechanism is an integral, ancillary or incidental part of a single composite supply of which the loan of money to Entity A's customers is the dominant part. Since the dominant part of the supply is a financial supply, it follows that the supply is solely a financial supply under the GST Regulations.

In the alternative, Entity A submits that if the inclusion of the repayment mechanism was treated as a separate supply, it would be an incidental financial supply within the meaning of regulation 40-5.10 of the GST Regulations.

Paragraphs 38 and 39 of Goods and Service Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2) state:

37. When an entity borrows money from a lender on terms that include payment of interest, it creates an interest in a debt that includes the payment of interest. The lender creates and supplies an interest in a credit arrangement. Aside from the operation of subsection 9-10(4) each entity would make a supply of a financial interest (under item 2 in subregulation 40-5.09(3)) to the other, and each supply would be consideration for the other.

39. The supply of an interest in a credit arrangement is provided for (monetary) consideration (namely the debt) and is a financial supply.

The financing of an asset under a loan arrangement or chattel mortgage will generally involve the following supplies:

· the provision of finance to the borrower by the lender in the form of a loan;

· the provision of the asset by the supplier to the purchaser; and

· the provision of a mortgage by the borrower to the lender over the asset to secure the debt.

Following on from this, the financing of the assets under the Loan Agreement would constitute a financial supply as per item 2 of regulation 40-5.09(3) of the GST Regulation. The issue that remains to be determined is whether the inclusion of the repayment mechanism into the Loan Agreement will result in a second supply by Entity A.

GSTR 2002/2 differentiates between mixed and composite supplies as follows:

91. If you make a supply that contains separately identifiable taxable and non-taxable parts, it is a mixed supply. A composite supply on the other hand is essentially a supply of a single thing. If you make a supply that contains a dominant part and includes something that is integral, ancillary or incidental to that part, then the supply is composite. The word 'incidental' in this context is not to be confused with the term when used in connection with an incidental financial supply.

92. Where a supply contains a part that is a taxable supply and another part that is a financial interest, the relevant facts will determine the treatment of the supply. If it is a composite supply, there will be no need to separate the part that is a financial interest from the taxable part, as one is so integral, ancillary or incidental to the other part of the supply that it cannot be separately identified. If on the facts it is a mixed supply then you will need to separate the parts of the supply.

We agree with the submission by Entity A that the inclusion of the repayment mechanism into the Loan Agreement is an integral, ancillary or incidental part of a single composite supply of which the loan of money to Entity A's customer is the dominant part.

Consistent with paragraph 91 of GSTR 2002/2 a composite supply is essentially a supply of a single thing, in this case the provision of the loan under the Loan Agreement with the inclusion of the repayment mechanism. On this basis the supply of the loan under the Loan Agreement will be solely a financial supply.