ATO ID 2004/360: GST and cancellation fees for deliverable commodity forward contracts
Date of decision: 14 August 2002
Business line: Indirect Tax

Issue
Is the entity, a commodity trader, making a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), when it receives a cancellation fee in relation to a deliverable commodity forward contract?

Decision
Yes, the entity is making a taxable supply under section 9-5 of the GST Act when it receives a cancellation fee in relation to a deliverable commodity forward contract.

Facts
The entity is a commodity trader. The entity enters into forward contracts to buy and sell a taxable commodity with another entity. The physical delivery of the commodity would be a taxable supply under section 9-5 of the GST Act. The relevant contracts conform to an industry association's trade rules. The entity and the other entity verbally agree to terminate the forward contracts and agree on a cancellation fee. This process is an alternative to the formal default process under the industry association's trade rules. The entity has agreed to accept a cancellation fee for agreeing to allow the other party to default on its obligations in relation to delivery of the commodity. The entity is registered for goods and services tax (GST). The transaction is made in the course of an enterprise carried on by the entity and is connected with Australia.

Reasons for decision
Summary: Under section 9-5 of the GST Act, an entity makes a taxable supply if: However, a supply is not a taxable supply to the extent that it is GST-free or input taxed. A transaction is only a taxable supply under section 9-5 of the GST Act, if it also comes within the meaning of the word 'supply' as discussed in section 9-10 of the GST Act. Subsection 9-10(2) of the GST Act provides a non-exhaustive list of things that are a 'supply' for GST purposes. Subparagraph 9-10(2)(g)(i) of the GST Act provides that an entry into, or release from, an obligation to do anything is a supply under the GST Act. The agreed termination of the forward contracts, without physical delivery occurring, results in the entity releasing the other entity from its obligations in relation to delivery of the commodity. As such, the entity is making a supply under subparagraph 9-10(2)(g)(i) of the GST Act. The cancellation fee is consideration for the supply of that release. The entity is registered for GST, the transaction is in the course or furtherance of the entity's enterprise and the supply is connected with Australia. The entity's supply meets the positive requirements of section 9-5 of the GST Act. However, it needs to be determined whether the entity is making an input taxed supply. Financial supplies are input taxed under section 40-5(1) of the GST Act. An interest in or under a derivative that is cash settled, will be a financial supply if the all the requirements in subregulation 40-5.09(1) of the A New Tax System (Goods and Services Tax) Regulations 1999 are satisfied. The payment (cancellation fee) that occurs when both parties agree to terminate the contract is not the cash settlement of a derivative. This is because when the two parties verbally agree to pay a cancellation fee this is a new agreement, outside the terms of the original contract. Therefore, when a cancellation fee is paid, the transaction that occurs does not result in either party making a financial supply that is input taxed. Accordingly, the entity is making a taxable supply under section 9-5 of the GST Act when it receives a cancellation fee in relation to a deliverable commodity forward contract.

Legislative references: A New Tax System (Goods and Services Tax) Act 1999 section 9-5 section 9-10 subsection 9-10(2) subparagraph 9-10(2)(g)(i) section 40-5(1)
Related ATO interpretative decisions: ATO ID 2004/358 | ATO ID 2004/359
Subject references: Goods and services tax GST supplies & acquisitions GST supply Taxable supply Input taxed supplies GST financial supplies GST derivatives