Private ruling: GST and the supply of derivatives
Published: September 2013

Ruling: Q1: Does the entity make: (a) input taxed supplies of derivatives under section 40-5 of the A New Tax System (Goods and Services Tax) Act 1999 ; or (b) taxable supplies of brokerage services under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 ? | A1: The entity provides derivatives which are input taxed supplies under section 40-5 of the A New Tax System (Goods and Services Tax) Act 1999 . | Q2: How should the entity determine its input tax credit entitlement under subsection 11-30(3) of the A New Tax System (Goods and Services Tax) Act 1999 for acquisitions which relate to both input taxed and GST-free supplies? | A2: The entity must determine its entitlement to input tax credits for acquisitions that relate to both input taxed and GST-free supplies using a method that is fair and reasonable.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The entity is an Australian company which is wholly owned by a overseas company. The entity is registered for GST. The entity will provide several financial products for consideration to its customers including: · foreign exchange margin trading (FX Margin); · contracts for difference (CFD); and · binary options. The entity will provide these products by giving customers access to a computerised trading platform which allows the customer to 'open a contract'. That is, the platform is the means by which the entity enters into contracts with its customers. The customers may be located within Australia or outside of Australia. As advised, supplies made by the entity to customers located outside of Australia are GST-free under Division 38 of the A New Tax System (Goods and Services Tax) Act 1999 . The entity has an agreement with its overseas parent which results in all trading profit (or loss) being transferred to the parent. In turn, the entity is paid a rebate by its parent, which is based on transaction volume. The entity has prepared two draft product disclosure statements (PDSs). One relates to foreign currency transactions and the other relates to contracts for difference (referred to in the PDS as 'index contracts' and 'commodity contracts'). The PDSs explain that the contracts entered into by the entity and its customers are 'over-the-counter' derivatives issued by the entity. The PDSs also state that the entity acts as principal to all client trades. Money deposited by customers is paid into a trust account maintained by the entity. The entity is entitled to retain any interest earned on the money held in the trust account. The PDSs explain the main risks involved in entering into a contract with the entity and explain that the entity may hedge any position. The PDSs identify a third party as the entity's hedge counterparty. The PDSs also explain that all dealings with the entity are governed by the laws of the state government. Assumptions It is assumed that supplies by the entity to customers which are not located in Australia are GST-free under item 3 of the table in subsection 38-190(1) of the GST Act.

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 section 9-5 | A New Tax System (Goods and Services Tax) Act 1999 section 40-5 | A New Tax System (Goods and Services Tax) Act 1999 section 11-15 | A New Tax System (Goods and Services Tax) Act 1999 subsection 11-30(3) | A New Tax System (Goods and Services Tax) Regulations 1999 regulation 40-5.09 | A New Tax System (Goods and Services Tax) Regulations 1999 regulation 40-5.12

Reasons for decision: Summary: Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) sets out when a supply is a taxable supply: 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. However, the supply is not a taxable supply to the extent that it is GST-free or input taxed. Section 40-5 of the GST Act states that financial supplies are input taxed. A financial supply is defined in regulation 40-5.09 of 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 in subregulation 40-5.09(3) or 40-5.09(4) of the GST Regulations is a financial supply if: (a) the provision, acquisition or disposal of that interest is: (i) for consideration (ii) in the course or furtherance of an enterprise, and (iii) connected with Australia, and (b) the supplier is: (i) registered or required to be registered for GST, and (ii) is a financial supply provider in relation to supply of the interest. Item 11 of the table in subregulation 40-5.09(3) of the GST Regulations refers to an interest in a derivative. The supply of broking services is specifically excluded from being a financial supply by item 11 in the table in regulation 40-5.12 of the GST Regulations. Therefore, if the entity provides broking services, its supplies will be taxable supplies. Alternately, if the entity provides derivatives, its supplies will be input taxed. Generally, a broking service involves an entity acting at the request of the customer to acquire (or sell) an item. That is, the broker is an intermediary between buyers and sellers. In the context of financial services, a broker ordinarily acts as agent for the customer to buy or sell an interest in the financial product. The information provided in the draft PDSs suggests that the entity provides the contracts as principal rather than as broker (or agent) of the customers. This is supported by the PDSs which state that the entity acts as principal 'to all client trades'. Further support is found in the PDSs where the entity explains that it may hedge positions using a third party (it is assumed that this entity is the overseas parent of the entity or an entity related to the parent entity). Finally, the PDSs clearly state that there is no legal relationship between the customer and the third party and that any dealings with the entity are governed by the laws of state government in Australia. A derivative is defined in the dictionary of the GST Regulations: derivative means an agreement or instrument the value of which depends on, or is derived from, the value of assets or liabilities, an index or a rate. The entity's supplies of financial products (FX Margins, CFDs and binary options) to customers are supplies of derivatives for the purposes of the GST Regulations as the value of the contracts depend on, and are derived from the movement of the value, or price of assets, an index or rate. The entity supplies interests in derivatives as principal to the customers. For this reason the entity is a financial supply provider in relation to such supplies. The entity is registered for GST, the supplies of the interests will be made for consideration in the course of the entity's enterprise; and will be connected with Australia. Therefore, the entity's supplies will be input taxed under section 40-5 of the GST Act. However, it is noted that derivatives made by the entity to entities which are outside of Australia are GST-free rather than input taxed. Determining which supplies are input taxed and which are GST-free is a question of fact. The supply of a derivative by the entity is GST-free if it is made to a recipient who is not in Australia at the time of the supply and the effective use or enjoyment of the supply takes place outside of Australia or the recipient is a non-resident. The entity will need to determine the location of the customers in order to satisfy itself that the supplies are GST-free. Presumably, the entity will gather some information about its customers when an account is created and this may form part of that initial contact with the customer. An acquisition which relates to making input taxed supplies is not made for a creditable purpose under section 11-15 of the GST Act and therefore, does not give rise to an entitlement to an input tax credit. Acquisitions made by the entity which relate to making input taxed supplies, such as its supplies of derivative contracts, will not be made for a creditable purpose and the entity will not be entitled to an input tax credit for those acquisitions. Acquisitions which relate to both input taxed and GST-free supplies will be made partly for a creditable purpose and the entity will need to apportion the acquisitions as directed by subsection 11-30(3) of the GST Act which states: The amount of the input tax credit on an acquisition that you make that is partly creditable is as follows: Full input tax credit X Extent of creditable purpose X Extent of consideration where: extent of consideration is the extent to which you provide, or are liable to provide, the consideration for the acquisition, expressed as a percentage of the total consideration for the acquisition. extent of creditable purpose is the extent to which the creditable acquisition is for a creditable purpose, expressed as a percentage of the total purpose of the acquisition. full input tax credit is what would have been the amount of the input tax credit for the acquisition if it had been made solely for a creditable purpose and you had provided, or had been liable to provide, all of the consideration for the acquisition. Goods and Services Tax Ruling GSTR 2006/3 Goods and services tax: determining the extent of creditable purpose for providers of financial supplies (GSTR 2006/3) provides guidance on methods that can be used for calculating input tax credits by providers of financial supplies. Paragraph 33 of GSTR 2006/3 states: 33. Following the principles set out by the High Court, the method you choose to allocate or apportion acquisitions between creditable and non-creditable purposes needs to: · be fair and reasonable; · reflect the intended use of that acquisition (or in the case of an adjustment, the actual use); and · be appropriately documented in your individual circumstances. The choice of apportionment method must be done so on a fair and reasonable basis, as explained in GSTR 2006/3: 75. The extent of your planned use of an acquisition for a creditable purpose must be established on a fair and reasonable basis having regard to the nature of the acquisition and the circumstances of your enterprise. Any apportionment method should aim to achieve an accurate reflection of the input tax credits available for acquisitions or importations acquired in carrying on your enterprise. The criteria used in relation to any expense must therefore recognise the nature of the underlying supply to be made. … 93. Direct estimation methods are preferable to indirect estimation methods (see paragraphs 102 to 130 of this Ruling), particularly if the direct estimation method used involves a detailed measure of the intended (or actual) use of the acquisition or importation. Measures based on inherent characteristics of, or factors directly connected with, the acquisition usually give a fair reflection of the use of the thing. These factors are sometimes referred to in management accounting and costing systems as 'drivers'. 94. The use of such characteristics or factors provides an estimation of a direct link between the acquisition or importation and its (or its intended) application. Some examples of these factors and characteristics are: · distance (for example, for fuel acquired for use partly in connection with bank branches, the kilometres travelled by a motor vehicle as evidenced by a logbook); · time (for example, computer processing time spent on various input taxed and other activities, as evidenced by a time sheet); · volume (for example, numbers of financial transactions of particular types); · space (for example, floor area if the space is used for different activities); and · staff numbers (for example, measuring the actual use of acquisitions by identified staff). The method chosen as fair and reasonable would express the relevant use of the acquisition or importation as a percentage of total application (or intended application). An apportionment methodology which is based on the number of contracts entered into which are GST-free may be a fair and reasonable basis for apportioning between input taxed supplies and GST-free supplies.