Private ruling: GST and capital funding agreements
Date of advice: 9 February 2018
Published: June 2018

Ruling: Q1: Does the provision of the Promissory Note, by the outgoing service provider to the entity, constitute consideration for any taxable supply made by the entity under section 9-5 of the GST Act? | A1: No, the provision of the Promissory Note by the outgoing service provider to the entity is not consideration for any taxable supply made by the entity. | Q2: Is the entity’s acquisition from the new service provider, of the entry into obligations under the funding agreement, a creditable acquisition under section 11-5 of the GST Act, where the entity provides consideration in the form of a Promissory Note, and the new service provider acquires the property from the outgoing service provider? | A2: Yes, the entity’s acquisition of the entry into obligations from the new service provider is a creditable acquisition under section 11-5 of the GST Act.

Relevant facts and circumstances: The entity is registered for goods and services tax (GST). The entity administers a number of programs under legislation. The entity enters into funding agreements with service providers to provide funding under the terms and conditions of that agreement. Entry into the funding agreement by a service provider is a taxable supply (entry into obligations) by the service provider, consideration for which is the entity’s grant of funding to the service provider. The funding provided by the entity under a funding agreement can be either a transfer of properties (residential premises or vacant land) or monetary funding. The entity either: a) buys or owns property, the title to which is granted to the service provider and the service provider then provides services to eligible recipients b) provides monetary funding to the service provider and the service provider uses it to construct a building on land already owned or land to be purchased by the service provider. The service provider then provides services to eligible recipients, or c) provides funding to enable the service provider to purchase established premises which the service provider uses to provide services to eligible recipients. In all scenarios the entity takes security over the property by way of a mortgage. Under the funding agreement, a ‘Contingent Liability’ is payable by the service provider to the entity if the following circumstances occur: ● the service provider wishes to sell the property ● the service provider wishes for the funding agreement to come to an end, or ● the service provider breaches the funding agreement and the entity demands payment of the Contingent Liability. The Contingent Liability is calculated using a formula prescribed in the funding agreement. After payment of the Contingent Liability the entity must release the security. The funding agreement terminates when the service provider no longer owns the property or the property is released from the security. Outgoing service provider replaced by new service provider When the service provider chooses to no longer provide services, the following can occur: ● A different service provider (the new service provider) will agree to enter into a funding agreement with the entity and, as per that agreement, will allow the entity to take security (by way of mortgage) over the property proposed to be used to provide the services (the Property). ● In return for the new service provider’s entry into the funding agreement, the entity will provide monetary consideration, in the form of a Promissory Note and cash. The face value of the Promissory Note will equal the contingent liability that the new service provider has agreed to pay to the entity at the time of entry into the funding agreement, which at that time will equal the contingent liability of the outgoing service provider. The cash will be equal to the amount of GST payable by the new service provider on entering into the funding agreement (i.e. the GST gross-up amount). ● The outgoing service provider will enter into an agreement to transfer title in the Property to the new service provider for consideration. ● In return for the outgoing service provider’s supply, the new service provider will provide consideration in the form of the Promissory Note. ● The outgoing service provider will satisfy the conditions of its funding agreement with the entity by paying out its contingent liability by providing the entity with the Promissory Note. The face value of the Promissory Note will be equal to the contingent liability amount as calculated under the outgoing service provider’s original funding agreement.

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 section 9-5 | section 9-10 | section 9-15 | section 11-5 | section 11-15

Reasons for decision: Summary: No, the provision of the Promissory Note by the outgoing service provider to the entity is not consideration for any taxable supply made by the entity. This is because the Contingent Liability is not paid in connection with, in response to, or for the inducement of a supply of anything by the entity. | Detailed Reasoning - Detailed reasoning: An entity makes a taxable supply if the requirements of section 9-5 are met. One of those requirements is that the supply is made for consideration. Under subsection 9-10(1) a supply is ’any form of supply whatsoever’. Under subsections 9-15(1) and (2) consideration includes ‘any payment, or any act or forbearance, in connection with, in response to or for the inducement of a supply of anything’. For a supply to be made for consideration there must be a sufficient nexus or connection between that supply and the consideration received. In the scenario in question, the outgoing service provider terminates the funding agreement but retains the Property and transfers it to the new service provider. This triggers the requirement for the outgoing service provider to pay to the entity the Contingent Liability as per the funding agreement. The outgoing service provider gives the Promissory Note to the entity in satisfaction of the Contingent Liability. A promissory note falls within the definition of ‘money’ for the purposes of the GST Act, and therefore is capable of constituting a payment as per the definition of consideration in section 9-15. Under the GST law, for such a payment to be consideration it needs to be in connection with, in response to or for the inducement of a supply of anything. Where the outgoing service provider makes a payment of the Contingent Liability to the entity, either in cash or with a Promissory Note, we do not consider that the service provider makes a payment in connection with, in response to, or for the inducement of a supply of anything by the entity. The service provider is merely fulfilling its obligations under the funding agreement. Once the payment of a Contingent Liability is made the funding agreement comes to an end. The entity does not make any taxable supplies in return for that payment. | Detailed Reasoning - Question 2: Is the entity’s acquisition from the new service provider, of the entry into obligations under the funding agreement, a creditable acquisition under section 11-5, where the entity provides consideration in the form of a Promissory Note, and the new service provider acquires the property from the outgoing service provider? | Summary: Yes, the entity’s acquisition of the entry into obligations from the new service provider is a creditable acquisition under section 11-5. | Detailed Reasoning - Detailed reasoning: Under the GST law, you make a creditable acquisition if: (a) you acquire anything solely or partly for a creditable purpose (b) the supply of the thing to you is a taxable supply (c) you provide, or are liable to provide, consideration for the supply, and (d) you are registered, or required to be registered . In this case, the entity is registered for GST. Under the terms of the funding agreement, the new service provider makes a taxable supply to the entity of the entry into a binding obligation to use the funding from the entity (either cash or property) to provide housing in accordance with the terms of the funding agreement. The entity provides monetary consideration for that taxable supply in the form of the Promissory Note, whose face value equates to the Contingent Liability payable by the new service provider at the time of entry into the funding agreement; plus cash equal to the amount of GST payable by the new service provider on entering the funding agreement (i.e. the GST gross-up amount). Therefore the entity’s entitlement to an input tax credit relies on its acquisition from the new service provider being solely or partly for a creditable purpose. Section 11-15 discusses the meaning of ‘creditable purpose’. It states that you acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise. However, you do not acquire the thing for a creditable purpose to the extent that: (a) the acquisition relates to making supplies that would be input taxed; or (b) the acquisition is of a private or domestic nature. In this situation, the entity acquires a taxable supply from the new service provider of the entry into the obligation to provide housing in accordance with the terms of the funding agreement. The entity makes this acquisition in the course of its enterprise (for GST purposes ‘enterprise’ includes activities done by the Commonwealth, State or Territory – see paragraph 9-20(1)(g)). This acquisition does not relate to the making of any supplies by the entity that would be input taxed nor is the acquisition of a private or domestic nature. Accordingly, the entity is making a wholly creditable acquisition under section 11-5.

Reasons for Decision: These reasons for decision accompany the Notice of private ruling for the entity. | While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. | (All references are to the GST Act unless otherwise specified).