Edited version of your written advice

Authorisation Number: 1012865671647

Date of advice: 22 September 2015

Ruling

Subject: GST and security for certain costs or expenses

Question 1

Is the Department (you) making a taxable supply when you require Entity A to give an amount of security to you, being a financial institution's undertaking in the form of an unconditional, irrevocable and on demand guarantee?

Answer

No, you are making an input taxed financial supply to the financial institution giving the undertaking and no GST is payable on the supply.

All legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) unless otherwise stated.

Under section 7-1 GST is payable on taxable supplies. However, under section 9-5 a supply is not a taxable supply to the extent that it is input taxed. If a supply is input taxed, no GST is payable on the supply.

Under section 40-5 financial supplies are input taxed. The term 'financial supplies' is defined in the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) under Subdivision 40-A. The table in sub-regulation 40-5.09(3) lists the interests which can be financial supplies when they are provided, acquired, or disposed of. Item 7 of the table specifies a guarantee. Item 7A specifies an indemnity that holds a person harmless from any loss as a result of a transaction the person enters with a third party. Parts 5 and 5A of Schedule 7 to the GST Regulations provide the following examples of guarantees covered by item 7 and indemnities covered by item 7A:

• a surety bond that is a guarantee (item 7);

• a performance bond (item 7); and

• an indemnity that is not a contract of insurance (item 7A)

In your case, you require Entity A to give an amount of security to you, being a financial institution's undertaking in the form of an unconditional, irrevocable and on demand guarantee.

Relevant guidance on the GST treatment of guarantees and indemnities is provided in Goods and Services Tax Ruling GSTR 2006/1 - Goods and services tax: guarantees and indemnities (GSTR 2006/1). Paragraphs 51 and 52 explain that common characteristics of guarantees and indemnities, in the context of items 7 and 7A of the table in subregulation 40-5.09(3) of the GST Regulations, are that the arrangements involve three parties, and in each arrangement there is an underlying indemnity which flows from the relationships between the parties. Because of the existence of this underlying indemnity, the nature of the risk undertaken by the surety in these arrangements is the risk that the principal will be unable to reimburse the surety if it is required to make a payment. This risk is a form of credit risk.

In GSTR 2006/1, the three parties involved in guarantees and indemnities covered by items 7 or 7A are referred to as:

• the 'principal' - the party who wishes, for example, to borrow money, receive services on credit, or enter into some other arrangement under which there is some form of credit risk

• the 'creditor' - the party who has the risk, and who requires the guarantee or indemnity

• the 'surety' - the party who guarantees or indemnifies the creditor against loss.

Under your arrangement you are the creditor, Entity A is the principal and the financial institution is the surety.

Supply of an interest in a guarantee

Paragraph 61 of GSTR 2006/1 explains that, whether or not the principal pays a fee to the surety, the principal has no rights under the guarantee and does not acquire an interest in a guarantee for the purposes of item 7. That is, the surety does not make a supply of an interest in a guarantee to the principal. It does, however, make a supply of such an interest to the creditor.

The financial institution, as the surety in creating the interest in the guarantee, makes a supply to you as the creditor and is therefore the financial supply provider of the interest. If the other conditions of subregulation 40-5.09(1) of the GST regulations are met, the financial institution makes a financial supply.

As you are the creditor in the arrangement, in acquiring the interest you may also make a financial supply provided the other conditions of subregulation 40-5.09(1) of the GST Regulations are met. Given that under subregulation 40-5.06(2) of the GST regulations, the acquirer of a financial interest is also the financial supply provider of the interest, it is usual for the acquirer of an interest under subregulation 40-5.09(1) to also be making a financial supply. This is known as an 'acquisition-supply'.

Guidance in relation to the ascertaining the consideration for an acquisition-supply is provided at paragraph 35 of Goods and Services Tax Ruling GSTR 2002/2 - Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions which states:

Consideration for a financial interest is something given for the provision, acquisition or disposal of the financial interest. Part of what is given as consideration may include promises made, or rights granted, under a contract. In the context of financial supplies, the payment received is consideration for the provision or disposal of the financial interest and the payment made is consideration for the acquisition of the financial interest. Where consideration is given for the 'first' supply, there is no need to identify consideration specific to the acquisition-supply (the 'second' supply), as the acquisition will have been made for consideration. Where the financial supply has been made 'for consideration', the acquisition-supply will also be 'for consideration'.

The consideration provided by you as creditor is your entry into the arrangement with the financial institution.

Conclusion

Therefore, in your circumstances, you are making an input taxed financial supply to the financial institution giving the undertaking. No GST is payable on the financial supply you make.

Question 2

Is an amount of security that you claim or realise under a financial institution's undertaking in the form of an unconditional, irrevocable and on demand guarantee, consideration for a taxable supply that you make?

Answer

No.

Paragraph 74 of GSTR 2006/1 explains that if the surety is called upon to make a payment to the creditor under a guarantee or indemnity, the payment is made as a result of the exercise of the creditor's rights under the guarantee or indemnity.

Where the surety pays money, this is not consideration for the release of the surety from an obligation under paragraph 9-10(2)(g), nor is it consideration for the surrender of the creditor's rights under paragraph 9-10(2)(e). Rather, the payment discharges (or partly discharges) the surety's obligations under the contract. Accordingly, there is no supply to the surety by the creditor in consideration of the payment by the surety.

The payment of money on the exercise of a right is also not a supply by the surety because of subsection 9-10(4).

Although the payment made by the surety is not a supply and is not consideration for a financial supply of the release of obligations under the guarantee, it may be consideration for a supply made by the creditor to the principal. However, to make a supply an entity must do something. Given the security is statutorily imposed, the supply being made by you to Entity A occurs without any action by you for which the payment could be consideration.

Therefore, an amount of security that you claim or realise under a financial institution's undertaking in the form of an unconditional, irrevocable and on demand guarantee, is not consideration for a taxable supply that you make and is not subject to GST.

Question 3

Are you making a taxable supply when Entity A gives an amount of security to you in cash?

Answer

No.

Under section 9-5 one of the requirements for making a taxable supply is that you make a supply for consideration.

Under section 9-10 a 'supply' means any form of supply whatsoever and includes:

• a supply of goods or services;

• a provision of advice or information;

• a creation, grant, transfer, assignment or surrender of any right; or

• an entry into, or release from, an obligation to: do anything, refrain from an act, or tolerate an act or situation.

In your case, you can require an amount of security for certain costs or expenses. As in the Answer to Question 2, the security is statutorily imposed, the supply being made by you to Entity A occurs without any action by you for which the payment could be consideration.

Therefore, as you are not making a taxable supply when Entity A gives an amount of security to you in cash, the payment is not subject to GST.

Question 4

When you make a claim on an amount of security that was provided in cash, is it consideration for a taxable supply that you make?

Answer

No.

As discussed above in the Answers to Questions 2 & 3, under section 9-5 one of the requirements for making a taxable supply is that you make a supply for consideration.

In your case, as the security is statutorily imposed, the supply being made by you to Entity A occurs without any action by you for which the payment could be consideration.

Therefore, when you make a claim on an amount of security that was provided in cash, it is not consideration for a taxable supply that you make and is not subject to GST.

Relevant facts and circumstances

You are a State government Department.

You are registered for GST.

Under a State Act you require an entity (Entity A) to provide security for certain costs or expenses.

Under the Act, in certain circumstances, you can claim the security.

The security is given to you in the form of a bank guarantee or cash.

Relevant legislative provisions

References to the GST Act:

• section 7-1

• section 9-5

• section 9-10

• paragraph 9-10(2)(e)

• paragraph 9-10(2)(g)

• subsection 9-10(4).

References to the GST Regulations:

• Subdivision 40-A

• subregulation 40-5.06(2)

• subregulation 40-5.09(1)

• sub-regulation 40-5.09(3)

• sub-regulation 40-5.09(3) Item 7

• sub-regulation 40-5.09(3) Item 7A.