ATO ID 2007/15: GST and right to a share of net profit in return for a contribution of money - not a credit arrangement
Date of decision: 21 December 2006
Business line: Indirect Tax

Issue
Is an entity making an input taxed supply of an interest in a credit arrangement under subsection 40-5(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) when it contributes an amount to another entity's business in return for a right to a share of the net profit from the other entity's business?

Decision
No. The entity is not making an input taxed supply of an interest in a credit arrangement under subsection 40-5(1) of the GST Act when it contributes an amount to another entity's business in return for a right to a share of the net profit from the other entity's business.

Facts
The entity enters into an arrangement with another entity (the enterprise operator). Under the terms of the arrangement, the entity agrees to contribute an amount of money as consideration for the right to receive a share of the net revenue of the enterprise operator's business at a certain rate up to the extent of the contribution amount, and thereafter, at a lesser rate. In the event that the enterprise operator makes a loss, the entity will receive nothing. There is no separate obligation of the enterprise operator to repay any of the contribution amount to the entity. The entity is registered for goods and services tax (GST) and the arrangement entered into is connected with Australia.

Reasons for decision
Summary: Under subsection 40-5(1) of the GST Act, a financial supply is input taxed. Subsection 40-5(2) of the GST Act provides that a financial supply has the meaning given in the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations). Subregulation 40-5.09(1) of the GST Regulations provides that the provision, acquisition, or disposal of an interest mentioned under subregulation 40-5.09(3) or 40-5.09(4) of the GST Regulations is a financial supply if: Item 2 in the table in subregulation 40-5.09(3) of the GST Regulations (Item 2) lists an interest in or under a debt, credit arrangement or right to credit, including a letter of credit. Paragraphs 37 to 41, of Goods and Services Tax Ruling GSTR 2002/2 Goods and Services Tax: GST treatment of financial supplies and related supplies and acquisitions, state that a loan involves the supply of an interest in or under a credit arrangement by the lender to the borrower and the supply of an interest in or under a debt (that includes any interest payable) by the borrower to the lender. The term 'credit arrangement' is defined in the Glossary of Terms in GSTR 2002/2 as: an arrangement under which an entity lends money on terms that include deferred repayment, or under which payment of a debt owed by one entity to another is deferred or time is allowed to pay. The term 'debt' is defined in GSTR 2002/2 as: an amount due from one entity to another or a presently existing obligation to pay an ascertainable amount at a future time. For common law purposes, the essence of a loan is that it involves the obligation to repay the amount borrowed ( Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 72 FCR 300; 97 ATC 4151; (1997) 34 ATR 635) and it requires the existence of a debtor-creditor relationship. The enterprise operator has no obligation under the arrangement to repay the amount contributed, either in circumstances where its business generates a profit, or where no profit is made. Where the business does generate a profit, the share of the net profit which the entity is entitled to receive may be much greater than the amount that it originally contributes. An interest in a debt includes an interest in a contingent debt, which is a debt, based on an existing obligation, that will or might arise at a future time or if a future event occurs. However, the enterprise operator does not provide an interest in either a debt or a contingent debt to the entity. Although contingent in nature, the amount that the entity may receive under the arrangement is just an entitlement to a percentage share of the actual net revenue from the enterprise operator's business. The arrangement entered into by the entity therefore does not have the characteristics of a loan, because there is no presently existing obligation for the enterprise operator to repay the amount contributed, now or in the future, and there is no debtor-creditor relationship. For GST purposes, the arrangement does not involve either the making of a loan or the supply of an interest in a credit arrangement under item 2 by the entity to the enterprise operator. The arrangement is not an arrangement under which the entity lends money on terms that include deferred repayment, or under which payment of a debt is owed by the enterprise operator. As the requirements of subregulation 40-5.09(1) of the GST Regulations are not satisfied, the entity does not make an input taxed financial supply of an interest in a credit arrangement under subsection 40-5(1) of the GST Act.

Legislative references: A New Tax System (Goods and Services Tax) Act 1999 subsection 40-5(1) subsection 40-5(2)
Case references: Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 72 FCR 300 97 ATC 4151 (1997) 34 ATR 635
Related public rulings and determinations: Goods and Services Tax Ruling GSTR 2002/2
Related ATO interpretative decisions: ATO ID 2007/16 | ATO ID 2007/17 | ATO ID 2007/18
Subject references: Goods and services tax GST regulations GST supplies & acquisitions GST supply Input taxed supplies GST financial supplies GST debt, loan and credit