Edited version of your written advice

Authorisation Number: 1013037561515

Date of advice: 30 June 2016

Ruling

Subject: GST and Nominal consideration

Question 1

Is the methodology used for determining the cost of supply of Cafeteria Sales, made by Entity A, through its in-house Cafeteria to its employees and contractors during the Ruling Period, acceptable to the Commissioner for the purpose of subparagraph 38-250(2)(b)(ii) of the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act)?

Answer 1

No.

Question 2

By applying the costing methodology specified in Question 1, is the supply of each Cafeteria Sales item, made by Entity A's in-house Cafeteria, GST-free under subparagraph 38-250(2)(b)(ii) of the GST Act?

Answer 2

No.

Relevant facts and circumstances

• Entity A is registered as a charity on the Australian Charities and Not-for-profits Commission (ACNC) register.

• Entity A is an endorsed charity for goods and services tax (GST) purposes in accordance with Division 176 of the GST Act.

• Entity A is registered for GST and accounts for GST monthly on a non-cash basis.

• The Cafeteria is an in-house cafeteria with different categories of products/items available for sale based on specific price ranges (collectively referred to as 'Cafeteria Sales').

• No separate records are kept of the cost of supply for each of the categories of Cafeteria Sales. Cost of supply records are only kept for the Cafeteria Sales as a whole.

n In addition to Cafeteria Sales, the Cafeteria also makes other types of sales and generates other types of income.

n The Cafeteria also provides internal catering for which there is no charge, but Entity A recognises and records internal catering as 'internal sales' to reflect an allocation of 'notional' revenue attributable to the Cafeteria.

• In determining the total cost of supply of Cafeteria Sales made by the in-house Cafeteria, Entity A has adopted a methodology whereby the cost of producing the internal sales has not been completely excluded from the total cost of supply of the Cafeteria Sales.

• When determining the cost of supply of each Cafeteria Sales item, Entity A has allocated the total cost of supply of the Cafeteria Sales against the categories of Cafeteria Sales on the basis of the estimated amount of time and labour that goes into preparing the categories of items for sale.

• Entity A has kept records to enable it to broadly estimate the number of items sold each day for each of the categories of Cafeteria Sales, and has extrapolated this data to determine the number of items sold each year for each of the categories of Cafeteria Sales.

• To calculate the cost of supply for each item sold within each of the categories of Cafeteria Sales, Entity A has divided the total cost of supply that it calculated for that particular category for the year, by the total estimated number of items sold in that particular category for the year.

• Using the above methodology, Entity A has calculated that the highest sale price of items in each of the categories of Cafeteria Sales was less than 75% of the 'per item' cost of supply within each of the categories.

Relevant legislative provisions

All references below are to the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act):

Subsection 38-250(2)

Reasons for decision

Question 1 - costing methodology used by Entity A

Summary

The methodology Entity A has used in determining the cost of supply of Cafeteria Sales, for the purpose of subparagraph 38-250(2)(b)(ii) of the GST Act, does not produce a fair and reasonable outcome and as a result is not acceptable.

Detailed reasoning

Subsection 38-250(2) of the GST Act states as follows:

A supply is GST-free if:

(a) the supplier is an *endorsed charity, a *gift-deductible entity or a *government school; and

(b) the supply is for *consideration that :

…

(ii) if the supply is not a supply of accommodation - is less than 75% of the

consideration the supplier provided, or was liable to provide, for acquiring the thing supplied.

(*an asterisk denotes a term defined in section 195-1 of the GST Act)

The ATO view on the methodology to determine the cost of making a supply (cost of supply) for subparagraph 38-250(2)(b)(ii) purposes is contained in GST Industry Issues Charities Consultative Committee Non-commercial activities of charities, cost of supply and market value tests (CCC).

The CCC provides as follows:

When working out the cost of providing something, a charity should include:

• all direct costs incurred - for example, materials and direct labour, and

• a reasonable apportionment of indirect costs incurred - for example, marketing, administration, office expenses, electricity, telephone and insurance.

For supplies that are not accommodation, charities should only include amounts paid or payable by them in the calculation.

This is because subparagraph 38-250(2)(b)(ii) states that it is the 'consideration the supplier provided or was liable to provide for acquiring the thing supplied'.

The consideration the supplier provided or was liable to provide is GST-inclusive.

Charities cannot include the following things in the calculation as they do not involve an actual outlay by the charity:

• depreciation of assets, and

• imputed costs for things like volunteer labour, donations, and free rent where the charity has not actually provided any consideration or incurred any real costs.

However, Goods and Services Tax Determination 2013/4 (GSTD 2013/4), which issued since, provides that the consideration the supplier provided for acquiring those assets that diminish in value over time can be taken into account in determining whether a supply in that period is GST-free under subparagraph 38-250(2)(b)(ii) of the GST Act, to the extent the consideration provided reasonably relates to that supply.

GSTD 2013/4 also provides that in working out the amount of the consideration that can be taken into account a supplier should apply any reasonable methodology that reflects the proportion of the consideration that relates to each supply made. Consideration for acquisitions cannot be double counted in determining whether subparagraph 38-250(2)(b)(ii) of the GST Act applies to the various supplies made by the entity.

How this applies to Entity A

In this case, Entity A has excluded 'internal sales' from the denominator of its formula when calculating the amount of Cafeteria revenue that represents just the Cafeteria Sales for the purposes of determining the percentage to be used for calculating the total labour costs and total overhead costs that form part of the total cost of supply for producing the Cafeteria Sales.

We do not consider what Entity A has done to be fair and reasonable. This is because what needs to be calculated for the purposes of subparagraph 38-250(2)(b)(ii) of the GST Act is the cost of producing the Cafeteria Sales.

Whilst Entity A states that it has separately accounted for the cost of ingredients that go into making internal sales, Entity A contends that it would incur the same labour and overhead costs regardless of whether or not it has any internal sales. However, we consider that there would be some labour and overhead costs associated with producing internal sales, and the fact that consideration is not provided for internal sales should not result in an increase in the cost of producing Cafeteria Sales, which would be the case if 'internal sales' were excluded from the denominator of the formula used by Entity A.

We also question whether there may be more direct methods to allocate some of the labour and overhead costs against the Cafeteria Sales (for example, with labour costs, the amount of time spent on generating the different revenue streams).

Regarding the apportionment of executive salaries, our concerns are twofold. Firstly, there is no account in the Cafeteria profit & loss management accounting report relating to executive salaries & wages (that is, for the portion Entity A contends relates to generating Cafeteria Sales) like there are for all other costs. Secondly, the portion of executive salaries & wages that Entity A has determined to relate to generating Cafeteria Sales appears excessive, considering that executive staff would generally not be involved in the day to day running of the Cafeteria.

Entity A has stated that it is a large organisation with multiple sites and multiple divisions/business units.

We consider that under these circumstances it is likely executive staff would need to devote their time to managing all of the different sites and different divisions/units.

We therefore question how the percentages of executive staff salaries & wages that Entity A has estimated as being applicable to generating Cafeteria Sales could be considered to be fair and reasonable.

We also note that the Cafeteria has been up and running for a number of years now and is not, for example, in a 'set-up' phase. Therefore it is questionable whether executive staff would actually need to devote as much time as Entity A has estimated towards the day to day running of the Cafeteria in order to produce the Cafeteria Sales.

It is acknowledged that some part of executive salaries & wages may be applicable, but the amount and basis of calculation/allocation needs to be fair and reasonable.

We also have concerns regarding the apportionment of some of Entity A's other costs.

Entity A contends that that GSTR 2006/4 states at paragraphs 45 and 108 to 110 that the Commissioner considers that it is generally acceptable to estimate the use of acquisitions based on management accounting records, which usually give a fair and reasonable use of the thing. Entity A also makes reference to example 9 in GSTR 2006/3 to support its contentions.

Paragraph 45 of GSTR 2006/4 actually discusses apportionment in the context of estimating planned use of an acquisition based on records kept for some other purpose (such as management accounting records), and paragraphs 108 to 110 of GSTR 2006/4 discuss direct methods of apportionment which would usually give a fair reflection of the use of the thing.

However, the underlying requirement provided in GSTR 2006/4 (see in particular paragraph 3) is that the basis of apportionment chosen must be fair and reasonable in the circumstances of the taxpayer's enterprise. GSTR 2006/4 and example 9 in GSTR 2006/3 both also include comments to the effect that the basis of apportionment should reflect the use of a thing.

Whilst we acknowledge Entity A's contention that the Cafeteria profit & loss management accounting reports have been prepared on the same basis now for a number of years and therefore Entity A should be able to rely on the apportionment methodology adopted when compiling those reports, without knowing the details of the actual basis of apportionment for each of the abovementioned costs, we have been unable to confirm whether the method(s) of apportionment used in preparing the management reports are fair and reasonable.

For the above reasons, we do not consider Entity A's methodology for determining the cost of supply of Cafeteria Sales is acceptable for the purposes of subparagraph 38-250(2)(b)(ii) of the GST Act.

Question 2 - whether the Cafeteria Sales are GST-free

Summary

We determined that Entity A's costing methodology, as detailed in Question 1, is not acceptable. Entity A also failed to isolate its costs when calculating the cost of supply for each Cafeteria Sales item. As such, Entity A has not established that any of its Cafeteria Sales are GST-free under subparagraph 38-250(2)(b)(ii) of the GST Act.

Detailed reasoning

Section E of the CCC provides the approved methodology for applying the cost of supply test for organisations in the cultural and performing arts sector making supplies of tickets to concerts and performances. It explains that an endorsed charitable institution or a deductible gift recipient making different types or classes of supplies can choose one of two options to use in determining the cost of making a supply.

Option 1

Where a supplier makes different classes of supplies, in determining the cost of making a supply under subparagraph 38-250(2)(b)(ii) of the GST Act the supplier should:

• estimate the projected costs of making all supplies,

• determine the total number of supplies being made, and

• determine the cost of making a supply by dividing the projected costs of the supplies by the total number of supplies being made.

Option 2

Alternatively for each class of supplies, the supplier can also determine the cost of making a supply under subparagraph 38-250(2)(b)(ii) of the GST Act by:

• estimating the projected costs of making supplies of that class,

• determining the total number of supplies being made for that class,

• determining the cost of making a supply by dividing the projected costs of the supplies by the total number of supplies being made for that class.

However, an organisation would be required to isolate the costs for each class/category if option 2 were chosen.

Wide application of the methodology to non-accommodation supplies

The CCC provides that the methodology developed for charities operating public museums, public art galleries or public libraries is same as that for charities in the cultural and performing arts sector.

The CCC further provides that the methodology has wide application and can be used by charities making other kinds of non-accommodation supplies.

How this applies to Entity A

Entity A has used option 2 to arrive at the cost of supply of an item in each of the categories of Cafeteria Sales, rather than using option 1 to calculate the cost of supplying each Cafeteria Sales item on an overall basis.

Entity A explains that the examples in the CCC are to do with meals and not cafeteria items. Whilst that is the case, it is noted that some of the examples do have different priced meals (that is, not just single priced meals), yet the total cost of supply is still divided by the total number of meals sold (regardless of the different prices charged for different meals) where costs cannot be isolated between the different types/categories of supplies being made.

As such, it is only where the costs for the different categories of items sold can be isolated that there is an option for the total cost of supply for each category to be divided by the number of items sold for that category. Entity A has not been able to isolate the total cost of supply into the separate categories of Cafeteria Sales using any basis which would accurately reflect the cost of supply for each of the categories.

Entity A's accounting records do not currently isolate the costs for each of the separate categories of Cafeteria Sales; and for some of Entity A advises that for some of its costs this may not even be possible.

The apportionment method that Entity A has used is based on its view that a higher amount of time and labour goes into preparing hot meals.

It would be reasonable however to assume that the different types of costs making up the cost of supply (e.g. ingredients, pre-made products, drinks, labour and various overhead costs, etc.) would not be evenly represented in each of the separate categories of Cafeteria Sales. The cost of purchasing drinks, for example, would need to be isolated and allocated as a cost against the drinks category of Cafeteria Sales where it belongs, rather than being apportioned across all categories of Cafeteria Sales based on arbitrary factors that do not reflect the actual cost of purchasing the drink item for sale (such as an estimate of the time taken to prepare the drinks items for sale, which does not account at all for the cost of the product/ingredient).

While it may be fair and reasonable to split labour costs on some basis related to the amount of time employees/staff spend preparing and selling each of the different categories of Cafeteria Sales items, this could prove difficult from a practical point of view considering that Entity A has stated that each employee may undertake different tasks and may work in multiple divisions of the organisation depending on whether they have excess capacity.

Further, such a basis of splitting costs as mentioned above would not necessarily apply with, for example, the cost of ingredients/produce (cost of goods sold) or with overhead costs. With overhead costs for example, a method of apportionment that might be a fair and reasonable basis for splitting certain types of overhead costs between the separate categories of Cafeteria Sales may not necessarily be appropriate for splitting a different type of overhead cost.

The other methods that Entity A has proposed for apportioning the cost of supply between the separate categories of Cafeteria Sales also appear to be arbitrary, in that they fail to isolate costs and do not reflect the actual cost of supply for each of the categories of Cafeteria Sales.

Apportioning the total cost of supply on the basis of sales revenue or the number of items sold, for example, would not reflect the actual cost of supply for each of the categories of Cafeteria Sales, as both methods fail to isolate the costs relevant to each category.

Further, the different amounts of Cafeteria Sales revenue would not necessarily reflect the cost of supply of generating the different categories of Cafeteria Sales, as the items may, for example, have different profit margins.

Apportioning on the basis of the number of items sold would more likely reflect customers' preferences rather than the cost of supply.

It is also hard to see how evenly apportioning the cost of supply between the different Cafeteria Sales categories would bear any relationship to the actual cost of supply for each of the different categories of Cafeteria Sales.

We consider it is likely that the result for section 38-250 purposes would differ depending on whether or not the total cost of supply is split between the different categories of Cafeteria Sales, and also how it is split. It is therefore all the more important that where the total cost of supply is split between different categories of Cafeteria Sales, the costs for each category be isolated and reflect the cost of supply for that category.

We determined in Question 1 that Entity A's methodology for calculating the total cost of Cafeteria Sales was not acceptable because it did not produce a fair and reasonable outcome. In addition, we have now concluded that Entity A's basis for allocating these costs across the categories of Cafeteria Sales is not fair and reasonable.

Therefore, we do not accept that Entity A has established that any of its Cafeteria Sales are GST-free on the basis that the price charged is less than 75% of the cost of supply.