GST issues registers

Financial services - questions and answers

Hire purchase arrangements and apportionment methodology

(a) added, (u) updated, (w) withdrawn

14.1. How does a financier calculate entitlement to input tax credits in relation to hire purchase contracts?

For source of ATO view, refer to paragraphs 70 to 130 of GSTR 2006/3 Goods and services tax: determining the extent of creditable purpose for providers of financial supplies.

Due to amendments made to the GST law which took effect from 1 July 2012, the supply of credit under a hire purchase agreement entered into on or after that date will be subject to GST. As such the following answer is relevant only for hire purchase agreements entered into before 1 July 2012.

In calculating input tax credits you need to estimate the extent to which your acquisitions are for a creditable purpose. To the extent the acquisitions relate to making financial supplies, you do not have a creditable purpose and input tax credits are denied unless you are entitled to reduced input tax credits.

In estimating the extent of creditable purpose you need to make a reasonable estimate of the planned use of the acquisition on a fair and reasonable basis having regard to the nature of the supply. 'The criteria used in relation to any expense must therefore recognise the nature of the underlying supply to be made.' (Paragraph 75 GSTR 2006/3).

For a hire purchase agreements entered into before 1 July 2012:

The supply of goods under a hire purchase agreement entered into before 1 July 2012 continues to be a taxable supply and the supply of a separately disclosed credit component continues to be an input taxed financial supply.

Hire purchase arrangements consist of taxable and input taxed components, but the underlying nature of a hire purchase arrangement is input taxed, namely the supply of credit. The methodology used to determine the extent of creditable purpose of an acquisition in connection to the taxable and input taxed components, must be applied in this context.

The direct attribution method gives the most accurate reflection of how an acquisition is used and where an expense can be directly allocated this should be done. A direct attribution method seeks to identify the costs incurred in achieving a particular income flow. Where, for instance, computers are used by credit officers, the acquisition of those computers should be directly attributed to the activities of those officers.

Other indirect methods may be used where a direct attribution is not possible. The most appropriate indirect methodology should reflect the planned or actual usage of the acquisitions. 'If more than one of these indirect measures is available you should select the one which most accurately reflects the relationship between the activities of your enterprise and your acquisitions or importations.' (Paragraph 119 GSTR 2006/3).

GSTR 2006/3 provides guidance on apportionment methodologies that can be used for calculating input tax credits by providers of financial supplies.

It is assumed for these examples below that you are registered for GST and you exceed the Financial Acquisitions Threshold (Div 189). Also these examples only apply to hire purchase agreements entered into before 1 July 2012.

Example 1

Question:

A financier offers hire purchase agreements, leases and chattel mortgages. The financier's acquisitions include an introductory/arrangement service for which a dealer commission is paid. Dealer commissions are paid once the customer agrees to finance the acquisition from the dealer by accepting a hire purchase arrangement.

Is the acquisition of the introductory/arrangement service made for a creditable purpose?

Answer:

In determining whether the financier has a creditable purpose for the acquisition of introductory services, paragraph 11-15(2)(a) of the GST Act provides that you do not acquire something for a creditable purpose to the extent that the acquisition relates to you making supplies that would be input taxed.

In terms of the financier's acquisition of an introductory/arrangement service, the dealer is acting in the capacity of a financial supply facilitator in relation to the supply of the financier's interest in a credit arrangement to the customer. Furthermore, as a result of the customer entering into the hire purchase arrangement the dealer has also facilitated the financier making a supply of the relevant goods to the customer under the hire purchase agreement. As such, the activities of the dealer are considered to have a direct relationship with the financier making both input taxed and taxable (or GST-free) supplies.

Therefore, the acquisition relates to both the taxable (or GST-free) activity and the input taxed activity of the entity under a disclosed hire-purchase agreement and is a partly creditable acquisition.

The apportionment methodology adopted to determine the extent of creditable purpose for this acquisition needs to be fair and reasonable. Typically the main activity and major focus of an enterprise which is engaged in providing finance under hire purchase agreements will be the provision of credit rather than the supply of the relevant goods .Consequently, the majority of expenditure would be related to the making of input taxed supplies, and the method adopted should take this into account.

To the extent that the acquisition is not for a creditable purpose under Division 11 and relates to making financial supplies, the financier may also be entitled to a reduced input tax credit if the acquisition in question is a reduced credit acquisition as outlined in subsection 70-5.02(2) of the GST Regulations. The introductory/arrangement service qualifies as a reduced credit acquisition by virtue of item 18 or 27 of subsection 70-5.02(2) of the GST Regulations.

Example 2

Question:

A financier offers hire purchase agreements, leases and chattel mortgages. The financier's overheads include utilities, office rental, stationery, telephone etc.

Based on the number of current contracts, the financier has estimated that hire purchase represents 50% of its business, chattel mortgages 20% and leasing 30%.

Revenue received from the supplies made by the financier is as follows:

The financier applies the general formula to estimate its extent of creditable purpose in respect of their overheads:

($1,4000m ÷ $1,468m) × 100% = 39.37%

Using the general formula approach, the financier estimates its extent of creditable purpose to be 95.37%. Accordingly, the financier intends to claim an input tax credit equal to 95.37% of the GST included in their overhead expenses.

Answer:

As discussed in paragraph 75 of GSTR 2006/3, when choosing your apportionment methodology, the apportionment methodology you select must:

•

be appropriate and reasonable

•

accurately reflect the planned use of that acquisition

•

be well documented and justifiable.

In terms of 'overhead expenses', paragraph 103 of GSTR 2006/3 acknowledges that an indirect method of apportionment may be appropriate (as it is not cost effective to try to measure the use to which each separate overhead acquisition is put). Paragraphs 102-130 of GSTR 2006/3 provides financial supply providers with a non-exhaustive list of indirect methodologies.

Whilst the 'general formula' approach (paragraphs 105-108) is listed and discussed it will often be a less appropriate method than other indirect methods. The suitability of the general formula approach must always be assessed in light of the criteria mentioned in paragraph 75.

With regards to the use of the general formula in this example, it is clear that the result does not achieve an accurate reflection of how the overheads are likely to be applied in the operation of the financier's enterprise. This is because the general formula is influenced by the inclusion of bailment payouts and the supply of vehicles. The use of net income from financial supplies in the formula is also distortive in this instance as it understates the relative weighting of those supplies when compared to gross taxable supplies. Whilst there will be bailment related activities carried out by the financier, these activities are generally minor in comparison to those activities devoted to making input taxed supplies. As the general formula approach, in this instance, gives weighting to taxable activities which is out of proportion to the input taxed activities carried out, this methodology is not the most the appropriate basis to estimate the extent of creditable purpose in respect of the financier's overheads.

In this example, a more appropriate indirect methodology is one that takes into account the extent of the financier's input taxed activities. Whilst the Commissioner does not advocate any particular approach, in this case a methodology based on the number of current contracts (modified to reflect the extent of taxable activities associated with a hire purchase contract) may be a more appropriate basis of indirectly estimating the extent of creditable purpose with regards to the financier's usage of overheads.

Example 3

Question:

Incorporating the facts outlined in Example 2, the Financier also purchases two computers.

Computer 1 is used exclusively for monitoring the finance calculation on hire purchase contracts. Computer 2 is used to log customer (hire purchase/chattel mortgages/leasing) queries, keep track of all repayments and to generate reminder letters for all overdue amounts.

Both computers can generate reports on the central processing unit (CPU) time spent performing transactions (that is, it can separately report on the time taken to log in hire purchase, chattel mortgage or leasing queries). They also keep a record of the number of transactions performed (broken down into each financing category).

With regards to the planned usage of Computer 2, past experience demonstrates that 40% of the transactions performed are hire purchase related, 30% each relate to chattel mortgages and leasing. However, by the measure of time, 70% of the CPU time is spent on hire purchase transactions with the balance equally split between chattel mortgages and leasing.

In order to work out the financier's entitlement to input tax credits for the acquisition of the computers, the financier has elected to apply the general formula to estimate the extent of creditable purpose. Accordingly, the financier estimates that 95.37% of each computer is used for a creditable purpose.

Answer:

In respect of Computer 1, the facts establish that the computer is used exclusively for making financial transactions. Consequently, the financier has no creditable purpose in respect to this acquisition. Therefore, no apportionment exercise is required. Accordingly, you are not entitled to an input tax credit with regards to your acquisition of Computer 1.

In respect of Computer 2, paragraphs 95 and 100 of GSTR 2006/3 respectively explain that:

the Commissioner considers the direct attribution method to give the most accurate reflection of how an acquisition is used

you should use the direct attribution method to the greatest possible extent.

However, at paragraph 101, the Commissioner acknowledges that it may not be practical for organisations to directly attribute every individual cost. In the small number of cases where direct attribution is not possible, the Commissioner recognises that other apportionment methodologies may need to be used. Paragraph 75 sets out the criteria an apportionment methodology must satisfy in order to be considered as reasonable and fair.

With regards to the facts surrounding the planned use of Computer 2, it is evident that an apportionment methodology is necessary to estimate the extent of creditable purpose. In this instance, we consider that a direct attribution method would be the most appropriate basis of apportionment. An indirect method such as the general formula approach would only be appropriate where it is difficult (and not cost effective) to directly attribute and where the methodology satisfies the criteria laid out in paragraph 75 of GSTR 2006/3.

The facts outline that the financier has the choice of directly attributing on a number of transactions performed or time spent (number of CPU minutes) basis. In this regard, direct attribution on a transaction basis estimates the extent of creditable purpose to be 30% (30% of the transaction are leasing related). Whereas direct attribution on a time-spent basis estimates the extent of creditable purpose to be 15% (that is, CPU minutes devoted to leasing transactions).

Of the two measures, the more appropriate measure is the one that aims to achieve an accurate reflex of the planned use of Computer 2. The choice of a methodology should not be dictated by the method that gives the best input tax credit result as it may not necessarily be the most appropriate. In this instance, the time-spent basis of direct apportionment gives the best reflection of how Computer 2 will be used. Accordingly, in relation to the use of Computer 2, the financier has an estimated extent of creditable purpose equal to 15%.

The facts in this case demonstrate that the process of direct attribution is not a difficult or cost prohibitive one. As a consequence, the application of an indirect method of apportionment (such as the general formula approach) would not be appropriate in these circumstances.

The acquisition of a computer is not listed as a reduced credit acquisition under subsection 70-5.02(2) of the GST Regulations. Consequently, the financier is not entitled to a reduced input tax credit in relation these acquisitions.

For hire purchase agreements entered into on or after 1 July 2012:

all components of the supply made under a hire purchase agreement entered into on or after 1 July 2012 are treated as taxable supplies regardless of whether the credit component is separately disclosed. Therefore, it is no longer necessary to apportion overhead expenses related to the making of supplies under disclosed hire purchase agreements.

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