ATO ID 2010/176: GST and termination payment relating to assignment of payment streams
Date of decision: 15 September 2010
Business line: Indirect Tax

Issue
Is Entity A providing consideration for a taxable supply made by Entity B under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), when Entity A makes a payment in the course of exercising its right to terminate an agreement relating to the assignment of payment streams relating to loans from Entity B?

Decision
Yes, Entity A is providing consideration for a taxable supply under section 9-5 of the GST Act when it makes a payment to Entity B in the course of exercising its right to terminate the agreement.

Facts
Entity B, a financier, enters into an agreement with Entity A under which Entity A is obliged to accept any sale notice offered by Entity B for loans it makes to third parties (specifically the equitable assignment of the payment streams relating to the loans). Each sale and purchase of these loans under the relevant sale notice is a separate financial supply. The agreement provides that Entity A's obligation terminates on a stipulated date (called the termination date), which may be extended at the sole discretion of Entity A. The agreement's termination clause provides that prior to each termination date Entity A at its sole discretion determines whether to extend this date. A determination by Entity A not to extend the termination date requires a formal notification, accompanied by a termination payment, to Entity B. The amount of the payment decreases with each extension of the current termination date. Entity A exercises its right under the agreement not to extend the termination date and it pays the required termination amount to Entity B. Entity A and Entity B both carry on enterprises and are both registered for GST. Their relevant dealings with each other are conducted entirely within Australia.

Reasons for decision
Summary: Section 9-5 of the GST Act provides that you make a taxable supply if: Subsection 9-10(1) of the GST Act provides that a 'supply is any form of supply whatsoever'. Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are included as supplies. The Commissioner's view on the meaning of 'supply' is set out in Goods and Services Tax Ruling GSTR 2006/9 Goods and Services Tax : Supplies (GSTR 2006/9). GSTR 2006/9, sets out a number of propositions to assist in analysing a transaction to identify supplies made in the transaction. Proposition 5 is that to 'make a supply' an entity must 'do something'. The action required by proposition 5 does not have to be the supply itself. If an entity takes some action that causes a supply to occur, that can be sufficient (paragraph 74 of GSTR 2006/9 and Hornsby Shire Council v. Commissioner of Taxation [2008] AATA 1060; 2008 ATC 10-061; 71 ATR 442). In agreeing to the termination date clause on entry into the agreement rather than each time the exercise of the Entity A's discretion fell due, Entity B has 'done something' for purposes of Proposition 5. Proposition 9 of GSTR 2006/9 is that the creation of expectations alone does not establish a supply. When the entities entered into the agreement, they were bound by its specific provision that extension of the termination date would be at the sole discretion of Entity A. This was more than simply the creation of expectations as contemplated in Proposition 9. The principles discussed in Goods and Services Tax Ruling GSTR 2009/3 Goods and services tax : cancellation fees (GSTR 2009/3) are also relevant to determining this issue. GSTR 2009/3 recognises a 'release supply' when a customer exercises their contractual right to be released from the performance of their obligations, for which they agree to pay a cancellation fee as consideration. The termination in this instance is not a breach of the contract (paragraphs 51-58 of GSTR 2009/3). Paragraph 55 of GSTR 2009/3 states: ...the Commissioner's view is that, if it is not consideration for any other supply, a cancellation fee may be consideration for the creation or surrender of rights and/or a release supply that occurs when an arrangement is cancelled, and/or a combination of these supplies under paragraph 9-10(2)(h). In the context of the overall operation of the agreement, formal notification of termination, making the appropriate payment, may be viewed as having similar characteristics to the early termination (or cancellation fee) scenarios described in GSTR 2009/3. Paragraph 18 of GSTR 2009/3 notes that a supply for which a cancellation fee may be consideration can be 'a release from an obligation to do anything, refrain from an act or tolerate an act or situation'. Entity A exercised unfettered discretion as to whether to extend the termination date or not. Entity B was a passive participant in relation to this process. Thus, in exercising its discretion not to extend and in paying the required termination amount, Entity A acquired a release from Entity B in relation to its ongoing obligations under the agreement, but did not acquire rights from Entity B (nor did Entity B surrender any rights). Paragraph 55 of GSTR 2009/3 contemplates that a 'release supply' may stand alone from a supply that is constituted by the 'creation or surrender of rights' and the release supply that occurred in this case was a release by Entity B of Entity A's relevant obligations under the agreement. This 'release supply' is made for consideration, in the course or furtherance of Entity B's enterprise, it is connected with Australia, and Entity B is registered for GST. The supply is not GST-free. Therefore it is a taxable supply except to the extent, if any, to which it is input taxed. The obligations entered into on entry into the agreement are not themselves the provision, acquisition or disposal of an interest mentioned in subregulation 40-5.09(3) or (4) of the A New Tax System (Goods and Services Tax) Regulations 1999 and as such are not input taxed financial supplies. Each specific financial supply is made under the terms set out by the relevant sale notice which specifies the price and terms under which the loans are sold. Both entities' obligations continue to exist for these loans after the termination date. The termination payment is therefore not consideration for these earlier financial supplies. It follows that this current situation is not analogous to early termination payments relating to loans, because there is not sufficient nexus between the underlying supplies that were made prior to the termination date and the termination payment. The termination payment does not change the consideration of the earlier financial supplies of the sale of loans. As the 'release supply' is not an input taxed supply, Entity A is providing consideration for a taxable supply under section 9-5 of the GST Act when it makes a payment to Entity B in the course of exercising its right to terminate the agreement.

Legislative references: A New Tax System (Goods and Services Tax) Act 1999 section 9-5 subsection 9-10(1) subsection 9-10(2) paragraph 9-10(2)(h)
Case references: Hornsby Shire Council v Commissioner of Taxation [2008] AATA 1060 2008 ATC 10-061 71 ATR 442
Related public rulings and determinations: Goods and Services Tax Ruling GSTR 2009/3 | Goods and Services Tax Ruling GSTR 2006/9
Subject references: Goods and services tax GST debt, loan and credit GST financial supplies Input taxed supplies Securitisation