Edited version of private advice

Authorisation Number: 1051699779619

Date of advice: 26 June 2020

Ruling

Subject: The doctrine of set off and GST liability

Question

Will the fact that the sum of $x for interest owed to the purchaser was set-off against the purchase price of real property, reduce the GST liability accordingly?

Answer

No, the amount of $x set-off against the liability for the purchase of the property does not reduce the GST liability as a set-off only operates to reduce commercial liabilities but does not change the mutual liabilities of the parties for their respective supplies.

This ruling applies for the following periods:

From 1 April 20XX onwards

Relevant facts and circumstances

The Company (or you) was established as a special purpose vehicle for the purpose of managing the day to day operations involved with the construction and sale of property development site.

The Company purchased the land and subsequently cleared and built an apartment complex comprising XX individual residential lots. The development was completed with the strata plan registered a few years later.

The company got into financial difficulty Administrators were appointed.

Sometime later, settlement occurred for the sale of Lot ZZ to Person X.

The background in respect to Person X's purchase is summarized as follows:

1.            Some years before, Person X advanced to the Company an amount of money pursuant to a 'First Loan Deed' accruing interest at QQ% per annum.

2.            The loan under the 'First Loan Deed' was discharged and replaced with an arrangement designed to protect Person X's investment and help the Company complete the development.

3.            Later, the Company and Person X entered the operative transactional documents which are the basis for the sale of the property. These were:

·                     a new Loan Deed between the company, Person X and the Company's Director Person Y (as guarantor) dated AA/BB/CC ('the Loan Deed'), and

·                     a standard land contract for the sale of the property by the Company to X for a price of $EE ('the Sale Contract').

4.            The Sale Contract was also entered at the same time.

5.            The Sale Contract recorded a deposit of $HH as having been paid, with a balance remaining to be paid of $II.

6.            The Loan Deed contains recitals and terms including as follows:

·                     Recital a) states:

At the request of the borrower the lender has assisted the borrower with funds to help the borrower with a development project ('the development').

·                     Recital b) states:

The parties agree that the balance outstanding as at EE/FF/GG is $II 'the principal sum'

·                     Recital c) states:

This agreement discharges any previous loan agreement or mortgage between the parties.

·                     Clause 4 states:

The principal sum shall be payable by the borrower to the lender on or before BB/CC/DD (hereinafter referred to as 'the repayment date') and shall bear interest on the amount outstanding at the rate of QQ%... per annum from CC/DD/EE until the date of payment in full.

·                     Clause 6 states:

At the same time as entering into this loan agreement, the parties will enter into a contract for sale with the borrower as vendor and the lender as purchaser of proposed Lot in the said development and the parties specifically note that the said contract will provide that the purchase price will be $TT (inclusive of GST), the principal sum shall be the deposit...

·                     Clause 7 provides that there is no obligation on either the borrower or the lender to proceed with the sale if the principal sum and interest is repaid by the repayment date.

·                     Consistent with clause 7 above, clause 8 states:

If the borrower does not pay the principal and interest owing to the lender on or before the repayment date then the parties acknowledge that the sale of proposed Lot to the lender by the borrower shall proceed and the lender as purchaser under the contract will be allowed to offset against any balance of purchase moneys owing on settlement of the said purchase the interest owing herein by the borrower.

7.            The Sale Contract had a number of key terms, a GST clause indicating GST applies to the sale, other clauses reflecting the Loan Contract allowing interest to be offset against the price.

8.            The Company did not make any payments to Person X after they entered into the Loan Deed or Sale Contract.

9.            Attached as Annexure C of the ruling application is a copy of the settlement statement in respect of the settlement for 6 April 2018, which records the following:

·                     Purchase price $TT

·                     Less Deposit $HH

·                     Balance $II

·                     Taking into account adjustments, the balance payable on settlement was $II+

·                     A set-off was allowed in Person X's favour (the set-off amount) of $x. Under payees on the statement it states:

Person X [NO CHEQUE REQUIRED - OFF-SET AGAINST PURCHASE PRICE] $x

Assumptions

The supply of the Lot is made in the course or furtherance of an enterprise that you carry on.

The supply of the Lot is connected with the indirect tax zone.

You are registered or required to be registered.

Relevant legislative provisions

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

A New Tax System (Goods and Services Tax) Act 1999 Section 9-10

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

A New Tax System (Goods and Services Tax) Act 1999 Section 9-17

A New Tax System (Goods and Services Tax) Act 1999 Section 9-75

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

Reasons for decision

You have asked us to focus on the question whether setting off the amount of $x for interest owed to Person X, reduces the GST liability in making supply of the Lot.

Under section 9-5 of the GST Act, you make a taxable supply if all the relevant criteria are met:

(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 the indirect tax zone, and

(d)          you are registered or required to be registered.

However, the supply of the Lot is not a taxable supply to the extent that it is GST-free or input taxed.

The sale is not input taxed or GST free for any reason.

On the assumption that paragraphs 9-5 (b) to (d) are met we need to consider whether there is a supply for consideration.

'Supply' is widely defined in section 9-10 of the GST Act:

9-10 Meaning of supply

(1)          A supply is any form of supply whatsoever.

(2)          Without limiting subsection (1), supply includes any of these:

(a)          a supply of goods

(b)          a supply of services

(c)          a provision of advice or information

(d)          a grant, assignment or surrender of * real property

(e)          a creation, grant, transfer, assignment or surrender of any right

(f)           a * financial supply

(g)          an entry into, or release from, an obligation

(i)            to do anything, or

(ii)           to refrain from an act, or

(iii)         to tolerate an act or situation.

(h)          any combination of any 2 or more of the matters referred to in paragraphs (a) to (g).

The arrangement the Company entered with Person X involves multiple identifiable obligations, but the main supplies are as follows:

·                     Person X provided access to a loan for which he will receive the principal sum with interest. This meets the definition of a supply and it is a financial supply per subparagraph 9-10(2)(f) of the GST Act.

·                     The Company effected a property settlement. This is a supply of real property to Person X by the Company. This is an assignment of real property and a supply per subparagraph 9-10(2)(d) of the GST Act.

Each supply, if for consideration, has a corresponding liability which creates mutual liabilities.

Testing consideration for the supply

Section 195-1 of the GST Act defines 'consideration':

'consideration' for a supply or acquisition, means any consideration, within the meaning given by sections 9-15 and 9-17, in connection with the supply or acquisition.

Section 9-17 of the GST Act effectively excludes things as consideration but in this case none of these exclusions apply.

Section 9-15 of the GST Act sets out the definition of consideration. Subsection 9-15(1) relevantly provides:

(1)          Consideration includes:

(a)          any payment, or any act or forbearance, in connection with a supply of anything, and

(b)          any payment, or any act or forbearance, in response to or for the inducement of a supply of anything.

(2)          It does not matter whether the payment, act or forbearance was voluntary, or whether it was by the recipient of the supply.

The definition of consideration provides that the form of the consideration can be monetary or non- monetary such as doing an act or not doing an act (forbearance). Therefore, to assess whether consideration for the two main supplies set out above was provided, it is necessary to analyse the financial supply and the supply of the real property under the two agreements in a two-step process:

(1)          identify any relevant any payment, or any act or forbearance for each supply

(2)          consider whether any payment, act or forbearance was 'in connection with' or for the inducement' of the two main supplies. That is, consider whether there is a sufficient nexus between the payment, act or forbearance and the abovementioned supplies.

Is the consideration for each supply monetary or non-monetary?

Section 9-75 sets out amongst other things that a primary step is to assess if the consideration is expressed in money per paragraph 9-75(1)(a) and or non-monetary consideration expressed as a GST inclusive market value of that supply per paragraph 9-75(1)(b). This is echoed in paragraph 10 of Goods and Services Tax Ruling GSTR 2001/6 Non-monetary consideration.

Paragraphs 31 to 46 of GSTR 2001/6 set out what amounts to consideration expressed as monetary consideration.

31. You need to establish whether the consideration provided for a taxable supply is monetary or non-monetary to decide whether paragraph 9-75(1)(a) or 9-75(1)(b) applies to it. Where parties are dealing at arm's length and the consideration is wholly monetary (that is, 'expressed as an amount of money'), you do not need to establish the market value of the consideration to work out the price. If the consideration is wholly (or partly) non-monetary, you need to establish the GST inclusive market value of the non-monetary portion of the consideration (and add it to the monetary amount) to work out the price of the supply.

32. For the purposes of subsection 9-75(1), we are of the view that 'consideration expressed as an amount of money' is consideration that finds expression in money. The distinction between paragraphs 9-75(1)(a) and 9-75(1)(b) is essentially between monetary consideration and what can be broadly described as 'in kind' consideration.

33. As defined in section 195-1, 'money' includes:

(a)          currency (whether of Australia or of any other country)

(b)          promissory notes and bills of exchange

(c)          any negotiable instrument used or circulated, or intended for use or circulation, as currency (whether of Australia or of any other country), and

(d)          postal notes and money orders, and

(e)          whatever is supplied as payment by way of

(i)            credit card or debit card

(ii)           crediting or debiting an account, or

(iii)         creation or transfer of a debt.

...

35. We consider that a promise to pay an amount of money is consideration expressed as an amount of money. For example, if two parties set-off (in full or in part) mutual debts that were created as a result of mutual supplies for monetary consideration, the consideration for each supply is expressed as an amount of money.

From this we can conclude that in relation to the supply of the loan, the Company's promise to pay is expressed as an amount of money of the principal sum plus interest of $x. Further the total consideration for the supply of the real property is also expressed in money in the sum of $TT Australian currency.

Is there a nexus between the supplies and the consideration?

The second stage of the analysis is to establish a nexus between the supplies and the consideration.

In determining whether there is a sufficient nexus between supply and consideration, regard needs to be had to the true character of the transactions. An arrangement between the parties will be characterised not merely by the description that parties give to the arrangement but by looking at all of the transactions entered into and the circumstances in which the transactions are made: see paragraph 71 of GSTR 2001/6.

The test as to the sufficiency of the connection is objective per paragraph 72 of GSTR 2001/6. The motive of the supplier and the recipient may also be relevant in determining whether the supply was made for consideration, if a reasonable assessment of the evidence supports that motive.

The best objective evidence is the Loan Deed and the Sale Contract. Read together they set out the motives of the parties. Person X sought to protect his previous investment by entering the two agreements. The intention of Person X was to ensure the loan plus interest was repaid. However, if that became impossible, Person X entered into the Sale Contract to ensure that an earlier amount advanced to the Company could be applied to the Sale Contract. The Company also had a motive of either repaying the loan plus interest or applying its debts to Person X against a sale. The Company's purpose is to develop and sell the property.

In our view these agreements provide a strong framework for finding that the two main supplies, the provision of the loan and the supply of the real property are separate supplies with separate consideration for those supplies.

This brings us to the final stage of analysis of the mutual debts - Mr G was owed the principal and the interest of $x and the Company was owed $TT for the sale of the property. The doctrine of set-off was applied by the parties in relation to the settlement of the real property.

The concept of a set-off is discussed at paragraph 11 in GSTD 2004/4 Goods and services tax: can consideration for a supply 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)?

10.         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.

This set-off by agreement is confirmed in the Sale Contract at clause 74.2:

...the purchaser shall be entitled to deduct form the balance due any interest accrued but not paid owing by the vendor to the purchaser under the Loan Agreement entered contemporaneously with this Contract.

It is also noteworthy that the settlement statement provided recognises that as the interest is to be off set no cheques were required at the settlement meeting.

GSTD 2004/4 makes it clear that the doctrine applies where there is no transfer of funds but can be evidenced by book entries. Very importantly, the supplies remain separate for GST purposes, only the liabilities are set-off. At paragraph 13 it says:

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 ...

Therefore, despite the fact that the interest of $x was set-off against the consideration owed on the purchase of the Lot, it does not reduce the GST liability on the sale of the Lot. That is, the consideration for the taxable supply is $TT which means the GST liability is 1/11 of that amount.