invoice. The landowner responded by suing for the full tax-inclusive amount even though, as it had indicated, it had no intention of remitting any GST to the ATO ...
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Involuntary and Statutory Supplies – The Australian GST Base Narrows Richard Krever1 1. AN ILLUSTRATION OF THE ISSUE The recent New South Wales Supreme Court decision in Hornsby Shire Council2 illustrates well the fallout hitting taxpayers and revenue collectors as a result of the decision by the Australian Taxation Office (ATO) to exclude “passive” supplies from GST (goods and services tax, the Australian term for VAT). The taxpayer in the Hornsby Shire Council case was a local city council which had expropriated immovable property for civic purposes. In Australia, supplies of immovable property are taxable supplies, subject to exceptions for some farmland, residential premises after the first sale and immovable property sold as part of a going concern, which is treated as GST-free (zero rated). To refund input tax to local government bodies, the Australian GST Act allows these entities to register for GST purposes and file ordinary GST returns. As the input tax will always exceed the output tax for local governments (local governments may provide some taxable supplies but the bulk of their services are not subject to GST), their excess input tax will be refunded through the ordinary GST rules. Under the relevant expropriation law, the Council was required to compensate a person whose land is expropriated by paying an amount equal to the fair value of the land. This was interpreted by an independent valuer as the GST-inclusive price of the land and the Council indicated it would pay this figure. The amount being paid was for what was presumed to be a GST-inclusive supply (given its GST-inclusive valuation) and the supplier was registered for GST. Accordingly, before making payment, the Council sought an assurance from the landowner that it would issue a tax invoice. The Council needed the invoice to claim input tax. However, the landowner declined to provide a tax invoice, citing a private ruling from the ATO, that stated there was no taxable supply when a registered business received compensation for expropriated property. The Council paid the landowner a net-of-GST value and withheld the remainder pending presentation of a tax invoice. The landowner responded by suing for the full tax-inclusive amount even though, as it had indicated, it had no intention of remitting any GST to the ATO in respect of the payment. The state court in which the landowner sued held in favour of the landowner, directing the Council to pay the tax-inclusive value while upholding
the landowner’s right to refuse to issue a tax invoice. The ATO was not party to the proceedings. The landowner’s position and the private ruling on which it relied derived from the ATO’s somewhat narrow interpretation of the concept of “taxable supply” in the Australian GST Act.3 Under the GST legislation, GST is payable on a taxable supply, which is defined in terms of four elements. Each of these elements is separately defined. They are joined together in a definition of a taxable supply that utilizes the new Australian “personal touch” tax law drafting technique of speaking to the taxpayer by using the second person in all operative sections: Sec. 9-5: You make a taxable supply if: (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 Australia; and (d) you are registered, or required to be registered.
Constructing the provision using the second person “you” required the drafter to find a joining word to show that a taxable supply required all four elements set out in the section. The drafter settled on the word “make” – “you make a taxable supply if you make the supply for consideration, ...”. The intention of the drafter to convey a comprehensive meaning to the term “taxable supply” is illustrated by the definition of “supply”: “a supply is any form of supply whatsoever”4. However, at an early stage of consideration of the new Act, the ATO interpreted the opening words of Sec. 9-5 as imposing a fifth condition on a taxable supply – a person had to actively make the supply, meaning there had to be some action on the part of the person who gave up rights or property and as a consequence received some compensation. The ATO has explained the logic behind its position in this way: By use of the word “make” in the phrase “you make the supply” in Para. 9-5(a) of the GST Act, there is a requirement for a supplier to take some action to cause a supply to be made.5
1. Monash University, Melbourne. 2. CSR Ltd v. Hornsby Shire Council, [2004] NSWSC 946, available at www.austlii.edu.au. 3. The Law is available at www.ato.gov.au. 4. Sec. 9-15 GST Act. 5. ATO interpretative decision (ID) 2003/1182.
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2. THE ATO’S SHIFTING POSITIONS The ATO’s position can be traced back to a series of nontax civil law cases decided soon after the GST was introduced in mid-2000. In each of these cases, plaintiffs asked courts to include, in their judgments, an indemnity clause that would require the defendants to appropriately augment damages awards in the event the plaintiffs were required to pay GST on the proceeds. In every case, the plaintiffs were unsuccessful, as the courts concluded that no GST would be payable on the damages. The decisions suggested that a damages award would not give rise to a GST liability because the receipt was passive, as it derived from an external stimulus (a court order) rather than a direct action by the recipient.6 In a draft public ruling issued in late 2000,7 the ATO had initially stated that court judgments might give rise to taxable supplies in some cases. However, the final version of the ruling, issued in mid-20018 retreated substantially from that position. Drawing upon the reasoning in the civil law damages cases to which the ATO had not been a party, the final ruling adopted a narrower view of “supply”, which excluded most payments resulting from the termination of a legal suit. Critics of the narrower view pointed out that at the termination of a successful legal action, the plaintiff explicitly or implicitly by operation of law releases the defendant from any further liability and agrees to discontinue its claims; such actions appeared to many to constitute supplies. The ATO’s acceptance of the reasoning behind the civil law “damages” cases turned out to be the thin edge of what would prove to be a very large wedge into the GST base. Almost on the heels of the damages decisions, the ATO was faced with queries over a different type of passive supply, in the context of payments by a former employer to a new employer in respect of the new employer’s obligation to assume responsibility for various accrued leave entitlements of transferred employees. The liability arises as a result of state employment law and was thus in a sense both involuntary and passive from the recipient’s perspective. When first confronted with employment transfer cases, revenue authorities adopted the approach they had taken prior to the civil damages cases. In an “interpretative decision” (a sanitized version of a private ruling that is released on the public database) released soon after the final public ruling on civil law damages, the ATO stated that there was a taxable supply when a former employer paid an amount to a new employer in recognition of the new employer assuming the burden of the transferred employee’s accrued leave entitlements.9 The fact that the new employer assumed the liability automatically (and involuntarily) as a result of state employment law was not seen as detracting from the conclusion that there was a supply by the new employer related to the payment. However, the return by revenue authorities to a broader view of what might constitute a “supply” and a “taxable
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supply” proved to be short-lived. Over the following year, the ATO gradually retreated from its position concerning involuntary or passive supplies set out in the decision on payments for assuming liability for employees’ accrued leave entitlements.10 By late 2002, the ATO has swung to the other extreme, excluding transactions from the GST net if the taxpayer could show that there was no immediate and direct action by the recipient that precipitated payment, even if the payment could ultimately be traced to an earlier action. The new position was set out in two interpretative decisions dealing with payments made pursuant to supplementary agreements that terminated earlier commercial contracts. The ATO distinguished between termination agreements in which the beneficiary of a contract explicitly accepted the termination payment stipulated by the original (terminated) contract and termination agreements which stated that the parties were ending the contract in conformity with termination provisions in the original contract so that payment flowed solely from the termination clauses in the original contract. The former, the ATO stated, gave rise to taxable supplies and GST was payable on the consideration received.11 In the latter case, however, the ATO asserted there was no taxable supply and no GST payable.12 The absurdity of the ATO position was manifestly obvious to all external observers, as was the door it opened to simple avoidance arrangements. However, the ATO was slow to recognize the problem, and it was not until half way through the following year that it moved to withdraw its controversial interpretative decisions on contract terminations. Soon afterwards, it issued a public ruling, GSTR 2003/11, which apparently marked a dramatic retreat from the extreme and narrow view of “taxable supply” suggested by the withdrawn decisions. The new ruling stated that a contract termination payment would be treated as consideration for a taxable supply (or give rise to an adjustment event) whether it flowed from a separate agreement upon termination, or from terms of the original agreement. The rule went further and stated that there would be a taxable supply or adjustment event even if the termination resulted from the application of state consumer credit legislation, so the person making the payment was doing something as a result of the application of a law. However, Ruling 2003/11 was subject to a potentially enormous proviso. It stated that there would not be a taxable supply if the payment was characterized as damages, 6. See, for example, Shaw v. Director of Housing and State of Tasmania (No. 2) (2001) 46 ATR 242; Walter Construction Group Ltd v. Walker Corporation LT & Ors (2001) 47 ATR 48; and Interchase Corporation Limited v. ACN 010 087 573 P/L & Ors (2000) 45 ATR 445). All cases are available at www.austlii.edu.au. 7. Draft GSTR 2000/D23. 8. GSTR 2001/4. 9. See ATO ID 2001/360. 10. As set out in ATO ID 2001/360. 11. ATO ID 2002/1079. 12. ATO ID 2002/1078.
© 2005 IBFD
Electronic copy available at: http://ssrn.com/abstract=1663632
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including liquidated damages, as provided in an agreement to compensate a party for “genuine damage or loss” arising from early termination. As it is in the parties’ power to characterize payments, the ruling was seen by many as tantamount to an invitation to draft agreements that avoid GST.
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ing with transferred leave entitlements. The new decisions18 withdrew entirely from the position in the mid2003 decision that there had been a supply by the new employer, but not a taxable supply, by asserting there was not any supply in the first place if the transfer arose as a result of state employment legislation and the new employer has not entered into any contract with the former employer.
3. THE SLIDE TO A NARROWER BASE The withdrawal of the two interpretative decisions that appeared to allow taxpayers to avoid GST simply by providing for termination payments in a contract was thus a very limited retreat. Moreover, at the same time the ATO took the smallest step to restoring the GST base; it dramatically retreated in the case of involuntary disposals resulting from the use by government agencies of statutory powers. In two ATO interpretative decisions, which were released at the same time and dealt with compulsory acquisition of equitable interests13 and legal interests14 in land through government expropriation, the ATO adopted an analysis that was actually consistent with the withdrawn termination of contract decisions. The ATO declared in both expropriation decisions that there was no taxable supply if a registered person was paid for property taken through expropriation, because the person did not “make” the supply – the property was simply taken by the expropriating Council. It was on the basis of a similar private ruling that the taxpayer in CSR Ltd v. Hornsby Shire Council, described at the beginning of this article, refused to issue a tax invoice to the Hornsby Council.15 Not long afterwards, the ATO revisited the issue of payments to new employers in respect of their obligation to assume responsibility for leave entitlements of transferred employees. As noted earlier, the ATO’s initial position, taken in 2001, was that the payments by former employers to new employers were consideration for a taxable supply.16 Subsequent to that decision, the ATO was furiously backtracking from a comprehensive view of “supply” and “taxable supply” on other fronts (contract terminations and expropriation of land) and it finally also retreated on the employment case in 2003, withdrawing its 2001 decision in mid-2003. A replacement decision issued at that time17 conceded there had been a supply by a new employer that assumed liability for a transferred employee’s leave. However, it ruled that the supply could not be a taxable supply because the new employer has not “made” any supply of entry into the obligation, as the assumption of liability was not a purely voluntary action by the new employer. Rather, it resulted from the operation of state employment law. The limited concession to purposive interpretation of the GST Act in the 2003 decision (conceding there was a supply by the new employer, if not a taxable supply) was itself abandoned when that decision was in turn withdrawn at the end of 2003 and replaced with two new decisions deal-
4. THE CIRCLE CLOSES A few months later, the ATO confirmed it was adopting this approach consistently, through the release of a new decision dealing with a direct payment to a new employer from an old employer, in respect of leave obligations transferring with an employee,19 and through a draft public ruling which dealt with an indirect payment in the same circumstances.20 In both cases, the ATO stated, there would not be a taxable supply as a result of the payment (or reduction of purchase price in the second case) because there was no “supply” involved in the transaction. The draft public ruling was released in a final form in late 2004.21 At the same time, the ATO revisited the case of payments on the termination of a contract. It had appeared to retreat from the position originally taken in 2002 in its two decisions on termination of contracts,22 when it withdrew these decisions and issued a public ruling that apparently treated contract termination payments as consideration for taxable supplies, but offered taxpayers the option to opt out of a GST liability by labelling the payments compensation for damage or loss arising from the early termination.23 By early 2004, the circle was completed and the original position was in effect reinstated in two new interpretative decisions dealing with standard commodity forward contracts. A commodity forward contract is a form of bet between a notional supplier and a notional buyer, the parties hoping that the market price of the nominated commodity on the forward sale day will be higher or lower than the nominated price. If the nominated price is higher, the notional seller would not actually purchase produce on the open market to supply it at a loss to the notional purchaser. Rather, the contract would be closed out by the notional 13. ATO ID 2003/1172. 14. ATO ID 2003/1173. 15. Consistent with this approach, the ATO recently indicated in ATO ID 2005/6 that there was no taxable supply where a government used compulsory acquisition powers to acquire immovable property and extinguish native title rights to property. 16. ATO ID 2001/360. 17. ATO ID 2003/730. 18. ATO ID 2003/1182 and ATO ID 2003/1183. 19. ATO ID 2004/362. 20. Draft GSTR 2004/D2 (Para. 24). 21. GSTR 2004/9. 22. ATO ID 2002/1079 and ATO ID 2002/1078. 23. GSTR 2003/11.
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seller paying the difference between the contract price and the market price to the notional buyer. Following the pattern of the withdrawn interpretative decisions, the ATO distinguished between the case where the parties cancel the contracts at the notional sale date and a payment is made and the case where the parties simply make and accept the closing payment required by the contract itself. The first arrangement, the ATO stated, gives rise to a taxable supply,24 while the second, according to ATO logic, does not.25 The fact that the party receiving the payment in the second case has in fact made a supply to the other party when it entered into the initial contract, and agreed that the payment would follow termination in predetermined circumstances, was ignored by the ATO. 5. WILL THE NARROW BASE SURVIVE? The approach taken by the ATO, based on a literal application of the GST Act without apparent regard for the le-
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gislative intent, has opened many possibilities for taxpayers to restructure transactions to escape any GST liability. The generosity of the interpretation to taxpayers has caused raised eyebrows even among some tax practitioners and the concern that a shrinking GST base resulting from the ATO’s approach could eventually require the imposition of higher rates of tax.26 As the recent case of CSR Ltd v. Hornsby Shire Council illustrates, the ATO’s approach can also lead to windfalls for some taxpayers and inequitable losses to others. Australian GST taxpayers and practitioners await with interest future interpretations by the ATO and courts on the extent to which a registered person must “make” a supply before it will give rise to a taxable supply.
24. ATO ID 2004/360. 25. ATO IT 2004/359. 26. See, for example, Ken Fehily and Peter Konidaris, “Critical comment – Is the GST base shrinking?” (2003) 3 Aust. GST Journal 219.
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