Edited version of your written advice

Authorisation Number: 1012858377421

Date of advice: 12 August 2015

Ruling

Subject: GST and input tax credits

Question 1

Is the entity entitled to full input tax credits for its acquisitions of legal services under section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999?

Answer

No, the entity is not entitled to any input tax credits for its acquisitions of legal services.

Relevant facts and circumstances

The relevant facts include all documents and materials provided in the private ruling application.

The entity is a company.

The entity buys and sells shares in companies and units in trusts in addition to making and receiving loans.

The entity commenced legal proceedings seeking damages from a company.

The entity engaged a legal firm to provide legal services in relation to the dispute. The supply of the services was a taxable supply by the legal firm and the entity paid for those services.

The entity is registered for GST and does not make any taxable or GST-free supplies. The entity makes only input taxed supplies.

Relevant legislative provisions

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

A New Tax System (Goods and Services Tax) Act 1999 section 11-15

A New Tax System (Goods and Services Tax) Act 1999 section 11-20

Reasons for decision

Section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you are entitled to the input tax credit for any creditable acquisition, as defined by section 11-5 of the GST Act, that you make:

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.

The supply of legal services was a taxable supply to the entity for which the entity provided consideration. As the entity is registered for GST, the acquisition of legal services will be a creditable acquisition if it is made solely or partly for a creditable purpose, as defined by section 11-15 of the GST Act.

11-15 Meaning of creditable purpose

(1) You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise.

(2) 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.

The dispute between the entity and a third party arose as a consequence of the correct interpretation of the agreement for the entity to sell shares. The entity acquired legal services directly in relation to this dispute. Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements explains that a payment made as a consequence of a court order may be consideration for an earlier, current or discontinuance supply. GSTR 2001/4 also recognises that payment may not be for a supply at all:

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

73. The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act.

Although the dispute arose as a consequence of an agreement to sell shares, the entity's claim was a claim for damages and the third party was ordered to pay an amount in damages. The payment is not consideration for a supply made by the entity and it follows that the acquisition of legal services does not directly relate to the shares.

Goods and Services Tax Ruling GSTR 2008/1 Goods and services tax: when do you acquire anything or import goods solely or partly for a creditable purpose? provides guidance in determining whether an acquisition or importation is for a creditable purpose. It addresses both whether an acquisition is made in carrying on an enterprise and whether the acquisition relates to making supplies that would be input taxed. Paragraph 70 of GSTR 2008/1 explains some of the factors which be useful to determine whether an acquisition is made in carrying on an enterprise for the purposes of subsection 11-15(1) of the GST Act:

70. Whether an acquisition is acquired in carrying on an enterprise is a question of fact and degree, making it impractical to provide an exhaustive list of all the factors that may be relevant to determining whether an acquisition is made in carrying on an enterprise. However, some factors that would suggest that an acquisition is made in carrying on an enterprise include that:

• the acquisition is incidental or relevant to the commencement, continuance or termination of the enterprise;

• the thing acquired is used by the enterprise in making supplies;

• the acquisition secures a real benefit or advantage for the commencement, continuance or termination of the enterprise;

• the acquisition is one which an ordinary business person in the position of the recipient would be likely to make for the enterprise;

• the acquisition does not meet the personal needs of individuals such as partners or directors;

• the acquisition helps to protect or preserve the enterprise entity, structure or organisation; and

• the acquisition is made by the entity in accordance with, or to satisfy, a statutory requirement imposed on the enterprise.

In reference to the deductibility for income tax purposes of legal costs incurred in defending criminal charges laid against directors of a company in Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation (1980) [1980] FCA 150, paragraph 94 of GSTR 2008/1 confirms that the acquisitions of the legal services would have, for GST purposes, been made 'in carrying on the enterprise' as they had a 'sufficient connection to the commercial activities of the enterprise'.

The entity's predominant operations involve undertaking investment activities including investing, by way of share ownership. The acquisition of the legal services was incurred in the normal course of operating the business of the entity in defending its rights under a contract. That is, the services are considered to be necessary in furthering the entity's enterprise. Therefore, the acquisition has satisfied subsection 11-15(1) of the GST Act. However, subsection 11-15(2) of the GST Act provides that the acquisition will not be for a creditable purpose if it relates to making supplies that would be input taxed.

Whilst it is accepted that the acquisition of legal services does not directly relate to the sale of shares, the acquisition may, nonetheless, indirectly relate to making input taxed supplies. In HP Mercantile Pty Ltd v Commissioner of Taxation [2005] FCAFC 126, Hill J said (at 35):

"It was common ground that the words 'relates to' are wide words signifying some connection between two subject matters. The connection or association signified by the words may be direct or indirect, substantial or real. It must be relevant and usually a remote connection would not suffice. The sufficiency of the connection or association will be a matter for judgment which will depend, among other things, upon the subject matter of the enquiry, the legislative history, and the facts of the case. Put simply, the degree of relationship implied by the necessity to find a relationship will depend upon the context in which the words are found.

The acquisition of the legal services was not directly related to any one (or one type of) supply but is nevertheless, an acquisition made in the course or furtherance of the entity's enterprise. GSTR 2008/1 explains that acquisitions that relate to the general operation of the enterprise may indirectly relate to making input taxed supplies:

138. Other acquisitions do not directly relate to any specific type of supplies. Instead, they have an indirect relationship to all the supplies that the entity makes in carrying on its enterprise. If an entity makes both taxable and input taxed supplies, paragraph 11-15(2)(a) precludes these types of acquisitions from being for a creditable purpose to the extent that they relate to making supplies that would be input taxed.

Goods and Services Tax Ruling GSTR 2006/3 Goods and services tax: determining the extent of creditable purpose for providers of financial supplies further explains that acquisitions which are made in the course or furtherance of an enterprise but don't specifically relate to a particular supply are not made for a fully creditable purpose:

53. Carrying on an enterprise includes those activities that you undertake in actually managing or conducting that enterprise. Certain acquisitions or importations relate to the carrying on of the enterprise as a whole and are not directly linked to the making of supplies but nonetheless they relate indirectly to all activities of the enterprise. These may be referred to as enterprise costs and may include costs such as compliance costs for meeting Australian Securities and Investments Commission (ASIC), GST or income tax obligations, directors' fees or maintaining a register of shareholders. These may still be creditable acquisitions provided you made them in carrying on your enterprise. However, if you make input taxed supplies as well as taxable supplies or GST-free supplies, you will still need to establish the extent of creditable purpose relating to these acquisitions and importations.

54. An alternative view has been raised that this approach to enterprise costs is not consistent with the provisions of section 11-15. The alternative view requires that the words in subsection 11-15(2), '…to the extent that … the acquisition relates to making supplies that would be input taxed', are to be interpreted as requiring some direct connection between the acquisition and the supply. It follows from this view that if the acquisitions cannot be directly linked to making supplies or carrying out other activities (including input taxed supplies) the extent of creditable purpose is 100%.

55. One possible consequence of the alternative view is that all indirect and overhead costs of an enterprise that makes only input taxed supplies would arguably be creditable acquisitions. This is clearly not the intention of the legislation. In the context of section 11-15 the Commissioner's view is that if acquisitions are made in carrying on an enterprise that involves making input taxed supplies, even if those acquisitions are not directly related to making particular supplies they are still indirectly related to making all supplies. For the purpose of section 11-15, acquisitions can relate indirectly to making input taxed supplies, and the extent of creditable purpose will need to be established accordingly.

In accepting that an acquisition is made in the course of carrying on a business, it is reasonable to conclude that the acquisition must also relate, indirectly at least, to the supplies made through that business. The acquisition of legal services was made in the course or furtherance of the investment enterprise carried on by the entity. That is, there was a benefit to the business in acquiring the legal services. Although the services did not directly relate to a specific supply made by the entity, like an overhead expense, the services generally and indirectly relate to the operation of the enterprise including the supplies made through that enterprise.

The entity only makes input taxed supplies in carrying on its enterprise. As the acquisition of the legal services indirectly relates to making only input taxed supplies and does not relate to any other supplies, the acquisition has not been made for a creditable purpose under section 11-15 of the GST Act.

Consequently, the acquisition of legal services is not a creditable acquisition under section 11-5 of the GST Act and there is no entitlement to an input tax credit under section 11-20 of the GST Act.