Edited version of your private ruling

Authorisation Number: 1012438048467

Ruling

Subject: Attribution of GST

Question

Can the Commissioner confirm that under the agreement between Entity A and Entity B (Subcontract Agreement) the:

(a) Advance Payment received by Entity A from Entity B is treated as a loan and not consideration for any taxable supply of Services, and

(b) consideration for the taxable supply of Services received by Entity A from Entity B is attributed to the tax period in which the relevant milestones are met and Entity A issues the tax invoice?

Answer

The Commissioner confirms that under the Subcontract Agreement the:

(a) Advance Payment received by Entity A from Entity B is treated as a loan and not consideration for any taxable supply of Services, and

(b) consideration for the taxable supply of Services received by Entity A from Entity B is attributed to the tax period being the earlier of:

· the tax period in which Entity A receives consideration (the Milestone Payment) for each progressive component of the Service or

· if the tax invoice is issued before Entity A receives consideration, the tax period in which the tax invoice is issued.

Relevant facts and circumstances

Entity A entered into a Subcontract Agreement with Entity B. A copy of the Subcontract Agreement has been provided as part of this ruling request.

Under the Subcontract Agreement the 'Subcontractor' (Entity A) is required to perform the works (Works) for the Contractor (Entity B).

The scope of the work to be undertaken in Australia includes all work required for the provision of project management, engineering, procurement, construction, commissioning, assistance to start-up and confirmation of performance tests for the building of specific assets.

Under the Subcontract Agreement, the specific works Entity A will supply to Entity B consists of the following services (the Services):

· Engineering;

· Procurements;

· Installation; and

· Supervision.

The supply of the Services by Entity A to Entity B will be a taxable supply for the purposes of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

The Services supplied by Entity A will be a progressive supply under Division 156 of the GST Act.

Under the Subcontract Agreement, Entity B agrees to provide consideration (the Subcontract Price) for the supply by Entity A. The Subcontract Agreement sets out the relevant rates, sums and prices in 'Exhibit B'.

For the purpose of commencing the Works and in accordance with the Subcontract Agreement Entity B agrees to make a payment (Advance Payment) to Entity A.

Under the Subcontract Agreement Entity B agrees to pay the Advance Payment to Entity A by way of an interest-free loan.

The Advance Payment must be repaid by Subcontractor in accordance with the schedule set out in Exhibit B.

Entity A issues tax invoices in relation to the Services provided to Entity B. These invoices represent flat monthly rates, monthly progress payments and payment milestones. A sample copy of a tax invoice that is issued by Entity A has been provided as part of this ruling request.

The sample tax invoice issued by Entity A shows that Entity B is required to pay an amount equal to the 'Milestone Payment'. The Milestone Payment is then reduced by an amount equal to the 'Interest Free Loan Repayment'.

Entity A reports on a non-cash method of accounting.

Entity B is entitled to recover the goods and services tax (GST) incurred on the Services provided by Entity A in full.

Entity A and Entity B are both registered for GST.

Relevant legislative provisions

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999

Section 9-15 of the A New Tax System (Goods and Services Tax) Act 1999

Section 29-5 of the A New Tax System (Goods and Services Tax) Act 1999

Section 29-39 of the A New Tax System (Goods and Services Tax) Act 1999

Section 40-5 of the A New Tax System (Goods and Services Tax) Act 1999

Section 156-5 of the A New Tax System (Goods and Services Tax) Act 1999

Reasons for decision

Section 9-5 of the A New Tax System (Goods and services Tax) Act states that:

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 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.

 (*denotes a defined term under section 195-1 of the GST Act)

It is not in contention that the supply of Services by Entity A to Entity B satisfies the requirements of paragraphs 9-5(b), (c) and (d) of the GST Act. It is also not in dispute that the Services provided by Entity A will be made for consideration (being the Subcontract Price). Further, the Services by Entity A are not of a kind that is GST-free or input taxed. However the issue in this case is whether the Advance Payment received by Entity A is treated as consideration for the supply of Services.

The term 'consideration' is defined in section 9-15 of the GST Act to include any payment, act or forbearance, in connection with, in response to or for the inducement of a supply of anything.

It is submitted by Entity A that the Advance Payment is a loan received by Entity A from Entity B, which is separate to the supply of the Services by Entity A to Entity B. On this basis, Entity A submits that the receipt of the up-front loan (i.e. Advance Payment) is not consideration for the taxable supply of Services provided by Entity A. Therefore it does not represent money paid in advance for the provision of the Services by Entity A.

Treatment of Advance Payment received by Entity A

In this case, what needs to be determined is whether the Advance Payment received by Entity A represents a financial supply which is separately identifiable from the supply of Services by Entity A to Entity B.

Goods and Services Tax Ruling GSTR 2006/9, Goods and services tax: supply (GSTR 2006/9) provides discussion on the concept of 'supply' and at paragraph 222 and 223 states:

222. Where the parties to a transaction have reduced their understanding of the transaction to writing, that documentation is the logical starting point in determining the supplies that have been made. An examination of any relevant documentation and the surrounding circumstances, which together form the total fact situation, is also important in determining whether the documentation captures the nature of a transaction for GST purposes.

223. Australian courts have held that an arrangement between the parties will be characterised not merely by the description the parties give to the arrangement, but by looking at the transactions entered into and the circumstances in which the transactions are made. …

Section 40-5 of the GST Act provides that a financial supply is input taxed and that a financial supply has the meaning given by the regulations.

Subregulation 40-5.09(1) of the A New Tax System (Goods and Services Tax) Regulation 1999 (GST Regulations) provides that the provision of an interest mentioned in subregulation (3) is a financial supply if the requirements in subregulation 40-5.09(1) are met. Subregulation 40-5.09(1) states:

(1) The provision, acquisition or disposal of an interest mentioned in subregulation (3) or (4) is a financial supply if:

(a)  the provision, acquisition or disposal is:

(i) for consideration; and

(ii) in the course or furtherance of an enterprise; and

(iii) connected with Australia; and

(b) the supplier is:

(i) registered or required to be registered; and

(ii) a financial supply provider in relation to supply of the interest.

Item 2 in the table in subregulation 40-5.09(3) of the GST Regulation provides that an interest includes 'an interest in or under a debt, credit arrangement or right to credit, including a letter of credit'.

Goods and Services Tax Ruling GSTR 2002/2, Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2) provides the Commissioner's view of the GST treatment of financial supplies. The 'Glossary of Terms' contained in Schedule 1 of GSTR 2002/2 relevantly defines the term 'loans' as follows:

Loans - (Including Borrowing and Lending)

A loan is a credit arrangement under which the lender provides the use of its funds on specified terms under a business contract. Loans may be made in Australian or foreign currency…

Further, paragraphs 39 to 41 of GSTR 2002/2 state:

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

40. Similarly, where an entity borrows money on terms that do not include payment of interest, the borrower creates and provides an interest in debt that is money as defined in section 195-1. The interest in debt is monetary consideration for the supply of an interest in a credit arrangement by the lender.

41. The lender provides an interest in a credit arrangement and the borrower acquires the interest in the credit arrangement provided by the lender. In acquiring the financial interest, the borrower is a financial supply provider of that interest, and the acquisition-supply is for consideration.

In this case, under the terms of the Subcontract Agreement, Entity B has agreed to provide the Advance Payment by way of an interest-free loan. This interest-free loan is required to be repaid by Entity A to Entity B in accordance with the schedule in Exhibit B of the Subcontract Agreement. That is, Entity A (as borrower) has an obligation under the Subcontract Agreement to repay the Advance Payment at a future date.

Accordingly, on the understanding that the requirements of subregulation 40-5.09(1) of the GST Regulations are satisfied, the acquisition of the interest-free loan by Entity A is a financial supply. On this basis the Commissioner agrees with the submission that the receipt of the Advance Payment by way of the interest-free loan from Entity B to Entity A is a separate supply to the supply of Services by Entity A to Entity B. As such the Advance Payment is not consideration for the supply of Services when it is received as an upfront payment by Entity A.

However, the terms of the Subcontract Agreement set out that the repayment of interest-free loan (i.e. the Advance Payment) by Entity A is made by way reducing the amount payable for the Services.

Goods and Services Tax Determination GSTD 2004/4 (GSTD 2004/4), deals with the issue of whether consideration for a supply can be provided or received without transferring money, such as where the parties only make book entries recording their agreement that the supply is paid for.

GSTD 2004/4 states that in the absence of the transfer of money (or non-monetary consideration) consideration can be provided or received by way of setting off mutual liabilities in accordance with the doctrine of set-off. In particular paragraph 11, 13 and 14 of GSTD 2004/4 state:

Set-off

11. For the doctrine of set-off to apply there have to be mutual liabilities of amounts presently payable between two parties. If the liability of the first party to the second party is greater than that of the second to the first, the excess amount may be discharged by transferring money or providing non-monetary consideration. In addition, there must be a binding agreement between the parties to use the set-off method of payment of debts. The agreement must be to discharge the liabilities and may be express or implied. The agreement is the legal basis for discharging the liabilities between the parties.

13. If mutual liabilities to pay for supplies are set off against each other, each of the supplies (some of which may be GST-free or input taxed) are separate supplies with separate consideration. It is the liabilities to pay for the supplies that are set off against each other; the supplies themselves are not set off. The GST Act does not allow the price for one supply to be reduced by the price of another in calculating each party's GST liability. The GST on each supply must be included in the calculation of the net amount by each supplier and each recipient may claim input tax credits for that tax to the extent allowed by the GST Act. Example 1 illustrates this principle.

14. The set-off of the liabilities, as evidenced by the relevant book entries in the entities' books of account, amounts to payment. It is the provision or receipt of consideration, for GST purposes, for each of the supplies. This is discussed further at paragraphs 17 to 24.

In this case, Entity A issues monthly tax invoices for its supply of Services. Upon issuing the tax invoice the final amount payable by Entity B is offset by Entity A's liability to repay the interest-free loan to Entity B. That is, the liability for Entity A to repay the loan is offset against the liability for payment of the Services to Entity B.

On this basis we consider that for the purpose of paragraph 9-5(a) of the GST Act, Entity A receives consideration for the supply of Services when the set off legally occurs. This is supported by the Commissioners view at paragraph 18 of GSTD 2004/4 which states:

18. In the case of a set-off, the consideration is provided or received on the date that the set-off legally occurs. If this time is known to only one of the entities, the consideration is provided and received by the other entity when it is informed of the date of the set-off, or when that information is first made available to it (for example, electronically) in accordance with a prior arrangement. In many cases, the date of the set-off would be the date on which the set-off is recorded in the books of the entities. But it is legally possible for the set-off to occur under the agreement between the parties before the parties make the relevant book entries. For example, if there is a written agreement providing for the set-off, it may determine that the set-off legally occurs immediately when both liabilities have been calculated regardless of when the parties make their book entries. Alternatively, there may be other documents or oral evidence as to when the parties agreed the set-off would occur. However, often the book entries will be the most important evidence.

Attribution of GST for supply of Services by Entity A to Entity B

Division 29 of the GST Act sets out the basic rules for the attribution of GST and input tax credits (the basic attribution rules). Subsection 29-5(1) of the GST Act provides that if an entity accounts for GST on a basis other than cash the GST payable on a taxable supply is attributable to:

(a) the tax period in which any of the consideration is received for the supply; or

(b) if, before any of the consideration is received, an invoice is issued relating to the supply - the tax period in which the invoice is issued.

However, Division 156 of the GST Act provides special attribution rules in relation to supplies and acquisitions that are made for a period or on a progressive basis and the consideration for the supply is provided progressively or periodically. In particular subsection 156-5(1) of the GST Act states:

(1) The GST payable by you on a *taxable supply that is made:

(a) for a period or on a progressive basis; and

(b) for *consideration that is to be provided on a progressive or periodic basis;

is attributable, in accordance with section 29-5, as if each progressive or periodic component of the supply were a separate supply.

Division 156 of the GST Act does not apply if you account on a cash basis.

A supply is for a period when it is made over a specified length of time or for a time with an identifiable end point; while a supply is made on a progressive basis when the contract or agreement provides for stages of the supply during the course of the supply. A supply may also be a progressive supply where goods or services are to be supplied on an ongoing basis.

Consideration is provided on a progressive basis when it is paid by instalments that reflect stages of a supply or acquisition. Consideration is provided on a periodic basis when it is made in equal or unequal instalments provided upon expiration of specified periods.

In this case, the supply of Services is made by Entity A for which they receive payment from Entity B on a progressive basis; and the payments are made on a periodic basis. Furthermore, Entity A accounts for GST on a non-cash basis. As such, Division 156 of the GST Act applies.

Goods and Services Tax Ruling GSTR 2000/35, Goods and services tax: Division 156 - supplies and acquisitions made on a progressive or periodic basis (GSTR 2000/35) provides guidance on how to attribute GST and input tax credits with respect to supplies and acquisitions made for a period or on a progressive basis. In particular paragraph 12 of GSTR 2000/35 states:

12. However, where you make a supply for a period or on a progressive basis and for consideration that is to be provided on a progressive or periodic basis, you attribute the GST payable as if each progressive or periodic component of the supply that you make were a separate supply. Subsection 156-5(1) requires you to attribute the GST payable on each notional separate supply in accordance with the basic attribution rules (subsection 29-5(1)).

Consistent with paragraph 12 of GSTR 2000/35, Entity A is required to attribute its GST liability on the supply of Services on the basis that each progressive component of the supply is a separate supply. On this basis Entity A will attribute the GST for each progressive component to the tax period in which they receive consideration (the Milestone Payment). However if the tax invoice is issued before the Milestone Payment, then GST will be attributed in the tax period in which the tax invoice is issued.

In determining when the consideration is received by Entity A (i.e. the Milestone Payment), Entity A will need to take into account the setting-off of liabilities arrangement with Entity B as discussed above.