Edited version of your written advice

Authorisation Number: 1013114306954

Date of advice: 2 December 2016

Ruling

Subject: GST and apportionment of input tax credits

Question

The entity use the proposed apportionment methodology to determine the extent of creditable purpose for the purposes of subsection 11-30(3) of the A New Tax System (Goods and Services Tax) Act 1999?

Answer

No, the proposed apportionment methodology is not a fair and reasonable method to determine the extent of creditable purpose.

Relevant facts and circumstances

The entity is an Australian authorised deposit taking Institution which provides a range of financial products.

The entity is registered for GST and makes supplies that are taxable, input taxed and, to some extent, GST-free. The entity exceeds the financial acquisitions threshold. In the course of its business, the entity makes acquisitions that are taxable supplies (ie the acquisition is a GST-bearing cost to the entity).

The entity proposes to use a methodology applied to all of its GST-bearing acquisitions to calculate its entitlement to input tax credits.

The entity's entitlement to reduced input tax credits are not affected by this apportionment methodology.

The scheme includes the information provided in the various correspondence provided by the entity including the profit and loss statement previously completed and the staff surveys.

The proposed apportionment methodology involves a number of separate procedural steps with a final extent of creditable purpose (ECP) rate being determined and then applied to all GST-bearing expenses acquired by the entity.

Step 1

The first step involves selected 'senior branch staff' (team leaders and branch supervisors) providing an estimate of time spent on eight specified activities. The surveys are to be completed on the basis that the response 'reflects the time of [the] team / branch as a whole'. The staff surveys will be undertaken at least annually. The coversheet to the survey states:

… We are looking for this to be as precise and accurate as possible and based on the time spent by you and your team on specific activities, including preparing for activities … As we don't keep formal timesheets, we are after a log by recollection of the time spent on each of the activities listed

The activities performed by branch staff are determined by the entity to be either fully creditable, fully input taxed or apportionable as follows:

● Deposit Accounts input taxed

● Credit Cards apportionable

● Merchant Acquiring (EFTPOS / BPay) apportionable

● Loans input taxed

● Insurance fully creditable

● International Matters fully creditable

● Membership apportionable

● Administration and Other Matters apportionable

An ECP rate is determined for each selected staff member by dividing the percentage of time allocated to creditable activities over the percentage of time allocated to creditable plus input taxed activities. However, only surveys where the staff member has allocated a majority of time to activities involving fully creditable and fully non-creditable will be used.

The average of these ECP rates is then used as the ECP rate for all branch staff.

Step 2

For management purposes, all staff are assigned to categories on a 'full-time equivalent' (FTE) basis, according to the type of work they undertake. For the purpose of this apportionment methodology, these categories have been condensed to Branches, General Support Services and Credit / Lending.

Step 3

An 'Activity Expense Rate' is determined for each category based on the respective FTE ratio.

Step 4

An 'Area ECP' is then calculated for each category. The Area ECP for General Support Services and Credit / Lending is determined by multiplying the Activity Expense Rate determined at Step 3 above by the Revenue Based ECP which is calculated as follows:

The Area ECP for Branches is determined at Step 1 above.

Step 5

An 'Area ECP Weighted Contribution' is calculated for each category by multiplying the Area ECP calculated in Step 4 above by the Activity Expense Rate calculated in Step 3 above.

Step 6

The Area ECP Weighted Contributions are added together to determine an overall ECP rate.

Relevant legislative provisions

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

A New Tax System (Goods and Services Tax) Act 1999 section 11-30

Reasons for decision

Generally, an entity is entitled to an input tax credit on any creditable acquisition that it makes. However, the amount of the input tax credit is reduced if the acquisition is only partly creditable. Paragraph 11-30(1)(a) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) explains that an acquisition is partly creditable if it is made only partly for a creditable purpose, as defined by section 11-15 of the GST Act. Relevantly, paragraph 11-15(2)(a) of the GST Act provides that an acquisition is not made for a creditable purpose to the extent that it relates to making supplies that would be input taxed.

Subsection 11-30(3) of the GST Act specifies that the amount of input tax credit on an acquisition that is partly creditable is determined as:

The Goods and Services Tax Ruling, Goods and services tax: determining the extent of creditable purpose for providers of financial supplies (GSTR 2006/3) outlines a number of methods of apportionment that may be used for the purposes determining the extent of creditable purpose. GSTR 2006/3 states:

26. … The fundamental requirement is that whatever method you adopt to calculate your input tax credits must be fair and reasonable, and appropriately reflect the intended use of your acquisitions (or in the case of an adjustment, the actual use) in calculating the net amount.

27. To calculate the amount of your input tax credits, you will need to make a fair and reasonable estimate of the extent of creditable purpose for your acquisitions and importations. The requirement that your estimation is fair and reasonable is a prerequisite for any decision you make.

As stated in paragraph 26 of GSTR 2006/3, an apportionment method must 'appropriately reflect the intended use' of acquisitions. Paragraph 33 of GSTR 2006/3 provides a succinct set of principles for choosing an apportionment method:

33. Following the principles set out by the High Court, the method you choose to allocate or apportion acquisitions between creditable and non-creditable purposes needs to:

● be fair and reasonable;

● reflect the intended use of that acquisition (or in the case of an adjustment, the actual use); and

● be appropriately documented in your individual circumstances.

The acquisitions being apportioned are all of the acquisitions made by the entity in the course of its business. In this context, the aim of an apportionment methodology is to determine the percentage that those acquisitions (as a single group) are used to made input taxed supplies and the percentage that is used to make taxable or GST- free supplies. Paragraph 75 of GSTR 2006/3 states:

75. … Any apportionment method should aim to achieve an accurate reflection of the input tax credits available for acquisitions or importations acquired in carrying on your enterprise. The criteria used in relation to any expense must therefore recognise the nature of the underlying supply to be made.

Staff Surveys

The use of the staff survey in the manner proposed is only an estimation of time rather than a measure of time. Although it is recognised that any ECP apportionment methodology is an attempt to estimate the use of acquisitions, it not likely to be appropriate to use estimations to do so. Apportionment methodologies should be based on empirical data that is used to estimate the use of acquisitions.

Whilst the coversheet to the surveys requests staff to be as precise and accurate as possible, the survey is a recollection of the time spent on each of the activities. When discussing direct estimation methods from paragraph 92 of GSTR 2006/3, it does so on the basis that the method is actually measured, not estimated. Furthermore, the use of any 'direct estimation' method is only fair and reasonable where there is a direct link between the acquisition and its application. Paragraphs 95 and 96 of GSTR 2006/3 provide further explanation:

95. … [a] direct estimation method … seeks via an automated procedure to identify the costs incurred in achieving a particular income flow. For instance, the costs incurred by a bank in establishing and maintaining a home loan portfolio would be capable of identification and attribution to the supply of home loans.

96. The direct estimation method matches specific costs with specific outputs and also allocates mixed purpose costs to specific outputs in accordance with an internal cost allocation system. For example, the system you use may allocate costs to a specific:

● transaction;

● product line;

● function or activity;

● cost or profit centre; or

● business division.

These are referred to, for simplicity, as business units and products - generally the lowest functional area into which an entity is organised

The GST apportionment guide for financial supply providers (Guide) published on the ATO website (www.ato.gov.au) provides some common methods which may be appropriate to use and explains that a method based on time spent (such as staff time or computer processing time) may be appropriate when:

… [a]cquisitions related to the relevant supplies are used in proportion to staff time or computer time and where the time spent provides a reasonable measure of business activities.

Staff time may be a fair and reasonable proxy for determining the ECP of some acquisitions where the acquisition has a direct link to the activities undertaken by staff. For example, there is likely to be a direct connection between the acquisition of branch premises (ie rent) and the activities undertaken by staff using those premises. However, where the acquisition does not relate to the activities of the staff in branches, then staff time (even if it is measured) is not an appropriate proxy to determine ECP. For example, the acquisition of ATM running costs directly relates to supplies of bank accounts but has no relationship to the activities of staff.

Although the Guide provides an example for 'identifying an apportionment method for branches and lending business units', the provided background is considerably different to that of the entity. The example in the Guide states

A financial supply provider offers the following services to its customers: loans, everyday accounts, credit cards and insurance. The costs of operating the business are sometimes clustered into categories of staff, data processing, property, lending, marketing and general administration.

The business activities often operate through business units of branches, lending, contact centre, cards and administration.

In addition to each business unit bearing its own direct costs, the entity utilises an internal management costing system that reallocates the costs of administration to the other business units, based upon the ratio of the number of staff that are employed in each business unit. This means, for example, that overall administration costs are allocated to branches, lending, contact centre and cards and each of these business units has its own management accounts including all expenses related to that business unit.

As the entity manages its business, and in particular, its acquisitions in a significantly different way, this example does not provide a meaningful comparison with the apportionment method proposed by the entity. Specifically in relation to the branch costs, the Guide states that staff time would most likely represent a fair and reasonable apportionment of overall costs only where 'staff time is measured to a degree which enables an analysis of effort between the various supplies that are made' in the context of the example. As mentioned above, there is no measurement of staff time in the proposed apportionment methodology.

The Guide explains, in the context of the lending business unit of the example entity, that:

… it is likely that some loan costs, such as document costs and ongoing systems costs are not reflected in the time spent by staff and accordingly the time spent may not be reflective of all acquisition usage.

Distortion may arise if the time spent by staff is not reflective of the usage of other resources. For example it is unlikely that staff time will reflect the ongoing maintenance of the loan through systems that manage payments, interest charges, issue of statements etc.

It is likely the method will not be fair and reasonable as the use of staff time across the term and activity of a loan is not consistent and hence not entirely representative of the use of acquisitions.

This explanation of why staff time is not fair and reasonable in the example applies equally to the entity in both the Branches and Lending / Credit categories. That is, there are a large and significant range of acquisitions that are made by the entity that relate to the ongoing supply of loans and accounts that have no direct link with staff time. Furthermore, the opposite is also true, that most (or all) acquisitions made by the entity that relate to the supply of services provided to third parties for which the entity earns commissions are directly linked to the staff. This results in a distortion that is biased towards the supplies made which have direct staff involvement.

The content of the surveys and input into the proposed apportionment methodology is also not fair and reasonable. The eight activities and the determination of whether the activity is input taxed, fully creditable or apportionable is nor reasonable.

International Matters is deemed to be a fully creditable activity of a staff member. It has been asserted that this is because the activities relate to rights that are for use outside Australia which includes' 'cards and other accounts when a person is overseas'. As provided in Draft Goods and Services Tax Determination, Goods and services tax: in what circumstances is the supply of a credit card GST-free under paragraph (a) of Item 4 in subsection 38-190(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)? (GSTD 2014/D1), it is acknowledged that the supply of a credit card is GST-free to the extent that it is for use outside of Australia. However, GSTD 2014/D1 does not allow staff time to be a reasonable measure of that extent.

Although credit cards are GST-free to some minor extent, the supply of bank accounts is not and the staff survey does not differentiate between credit cards and other forms of accounts. Goods and Services Tax Ruling, Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions (GSTR 2002/2) specifically states that overseas use of accounts is still input taxed 'because [the] account is in Australia'.

It is accepted that Credit Cards is deemed to be apportionable. However, it is not reasonable to determine the extent to which the entity makes taxable supplies in relation to it issuing a credit card based on the time taken by staff in providing insurance referrals or dealing with international matters. time. The entity may make a taxable supply if the credit card holder uses that credit card with a merchant who does not bank with the entity. The supply of the interchange service performed by the entity has no direct connection with the staff activity whatsoever and is therefore, not a reasonable proxy.

Methodology

The proposed apportionment methodology is not a fair and reasonable basis for determining the extent of creditable purpose for acquisitions made by the entity for a range of reasons in addition to those raised specifically in relation to the use of staff surveys as explained above.

The proposed methodology does not appear to attempt to estimate the use of acquisitions with respect to supplies made in any way. As mentioned above, any apportionment method should aim to achieve an accurate reflection of the input tax credits available for acquisitions acquired in carrying on a business. The criteria used in relation to any expense must therefore recognise the nature of the underlying supplies to be made. Although it is acceptable to pool all acquisitions and apply a single ECP rate to those acquisitions, the calculation of that single ECP rate must seek to recognise how those acquisitions are used to make the supplies.

Apportionable activities such as Membership and Administration activities may relate to the entity making taxable and GST-free supplies to some small extent but this does not mean that it is acceptable to use branch staff time as the measure. Treating Credit Cards, Membership and Administration activities in the staff surveys as apportionable distorts the ECP calculation away from input taxed supplies. This is because each of these three activities mainly relate to input taxed supplies (of the supply of credit, bank accounts, loans, members' shares) and only relate in a very minor way to taxable or GST-free supplies (of interchange services or overseas use). Staff time spent on other activities is not a reasonable way to determine the ECP of these activities as there is no connection between them. Time spent on these activities are more likely to relate to total supplies made by the entity - not merely those which branch staff spend their time on.

The proposed apportionment methodology does not apply a consistent set of calculations to give a fair and reasonable reflection of use of acquisitions made by the entity. That is, while the total ECP rate is applied to all acquisitions made by the entity, the ECP rate is determined by using two very different methods, staff activities and general revenue, with the results simply added together. Paragraph 131 of GSTR 2006/3 states:

131. …Any method to allocate indirect costs must be consistently followed and there should not be any manipulation that produces an inappropriate loading of expenses to particular intended or actual uses...

In the context of the entity's business, there are a range of supplies made including (amongst others):

● input taxed supplies of bank accounts;

● input taxed supplies of credit cards (with recognition that some very minor portion may be GST-free);

● input taxed supplies of loans

● input taxed supplies of money transfer;

● taxable supplies of interchange services; and

● taxable supplies of services.

The vast majority of the entity's business is focussed on providing ordinary banking type products such as providing bank accounts, credit cards and loans, to its members. Some of these products may necessarily result in the entity making taxable supplies of interchange services. As discussed above, measurement of interchange services or the extent of a credit card supply that may be GST-free is not possible using staff time as a proxy.

Whilst it is recognised that the taxable supplies of services that the entity makes may be an important part of the entity's business and may become more important in the future, it is only a minor part of the business at this point in time.

Acquisitions that are likely to relate to supplies of insurance referrals include general overheads such as property costs. This is differentiated from acquisitions that relate to the supply of a bank account which is likely to include almost all types of acquisitions made by the entity.

Although it is accepted that revenue may not reflect how acquisitions are used, the proposed apportionment methodology does not attempt to link acquisitions with supplies and determine an ECP rate accordingly. Instead, the proposed methodology uses an estimate of staff time to determine one portion of the overall ECP and uses general revenue for the remainder.

Consequently, the entity cannot use the proposed apportionment methodology determine the extent of creditable purpose for the purposes of subsection 11-30(3) of the A New Tax System (Goods and Services Tax) Act 1999.