Private ruling: GST and the supply of loans
Date of advice: 27 August 2018
Published: October 2018

Ruling: Q1: Is the supply of loans by you, in the circumstances set out in this private ruling, GST-free under section 38-190 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)? All further legislative references are to the GST Act unless specified otherwise. | A1: No, a supply of a standard or investment loan by you is not GST-free if the loan is used to purchase real property situated in the indirect tax zone, and that real property is to be used to make supplies of residential rent (subdivision 40-B) or the sale of residential premises (subdivision 40-C), as s.38-190(2A) applies. Therefore, a standard loan is GST-free if the loan is not used to purchase real property that is to be used to make supplies of residential rent or the supply of a sale of residential premises. A standard or investment loan is not directly connected with real property and the exclusion in item 2(a) of s.38-190(1) doesn’t apply.

Relevant facts and circumstances: You are an Australian private company that is registered for GST. You hold an Australian Credit License and are in the business of providing interest bearing loans to resident and non-resident individuals. This private ruling concerns the loans provided by you to non-resident individuals (Borrowers). The term ‘non-resident’ is used in this submission to mean a person who is not a resident of Australia for the purpose of the Income Tax Assessment Act 1936 (ITAA 1936). You provide the following types of loans (collectively ‘the Loans’) to Borrowers: ● investment loans, being a loan that is provided to Borrowers for the purpose of acquiring new residential premises which the Borrowers will lease to third parties (Investment Loan); and ● standard loans, being a loan that is provided to Borrowers for the purpose of acquiring new residential premises which Borrowers will use for private or domestic purposes (Standard Loan). The terms and conditions of the agreement between you and Borrowers provide that if Borrowers change the use of the property that is secured by the mortgage (for example, from owner-occupier to residential investment and vice-versa) at any point in time during the loan term, they are obligated to notify you (in writing) of this. Borrowers are physically located overseas at all times throughout the application, approval and issuing process. Other information ● The relevant requirements of a financial supply under regulation 40-5.09 of the GST Regulations are satisfied such that Loans made by you are input taxed financial supplies for GST purposes. ● Specific terms and conditions in the agreement between you and Borrowers are not reproduced here. ● For the purpose of this private ruling all real property is taken to be located in Australia (the indirect tax zone).

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 section 38-190 | A New Tax System (Goods and Services Tax) Act 1999 subsection 38-190(1) | A New Tax System (Goods and Services Tax) Act 1999 subsection 38-190(2)

Reasons for decision: Summary: For the purposes of these reasons ‘loan purpose property’ refers to the named real property specified in the loan application as the purpose of the loan. That is, how the loan funds are to be used. ‘Mortgaged property’ refers to the secured property specified in the mortgage used as security for the loan. It is recognised that in many cases these are the same property, but this distinction is relevant to applying section 38-190. The loans supplied by you are a financial supply of an interest in a credit arrangement. This supply will be input taxed unless it is GST-free. The issue is therefore whether the supply of a loan is GST-free under subsection 38-190(1). The relevant provisions are: ● item 2 in the table to subsection 38-190(1), in particular the exclusion in item 2(a); and ● subsection 38-190(2A) which overrides items 2 to 4 in certain circumstances. The table to subsection 38-190(1) sets out supplies that are GST-free (except to the extent that they are supplies of goods or real property). Item 2 in that table states: a supply that is made to a *non-resident who is not in the indirect tax zone when the thing supplied is done, and: (a) the supply is neither a supply of work physically performed on goods situated in the indirect tax zone when the work is done nor a supply directly connected with *real property situated in the indirect tax zone; or (b) the *non-resident acquires the thing in *carrying on the non-resident's *enterprise, but is not *registered or *required to be registered. In relation to your loans the borrowers are non-residents and they are situated outside of Australia at the time that the loan is applied for and executed. In relation to a loan it is considered that the thing is done at the time the loan is entered into and at this point in time the borrower is located outside of Australia. The first requirement in item 2 is met in this case. The borrower is not in Australia at the time that the loan is supplied, but paragraph (a) provides that item 2 will not apply, and the loan will not be GST-free, if the loan is a ‘supply directly connected with real property situated’ in Australia. | Detailed Reasoning - Meaning of ‘directly connected with real property’: The addition of the adverb “directly” to the phrase “in connection with” qualifies and narrows the scope of the expression “connected with”. It implies a more emphatic connection. Goods and Services Tax Ruling GSTR 2003/7 Goods and Services Tax: what do the expressions 'directly connected with goods or real property' and 'a supply of work physically performed on goods' mean for the purposes of subsection 38-190(1) of the A New Tax System (Goods and Services Tax) Act 1999? (GSTR 2003/7) acknowledges that for a supply to be directly connected with goods or real property there must be a close link between the supply and the goods or real property, for example, where the real property is the “direct object” of the supply. The “direct object” concept is illustrated at paragraph 134 of GSTR 2003/7 in the sense that: ● The supply changes or effects the goods or real property in a physical way; ● There is a physical interaction with the goods or real property but without changing the goods or real property; ● The supply establishes the quantity, size, other physical attributes or the value of the goods or real property; ● The supply affects (or its purpose is to affect) or protects the nature or value (including indemnity against loss) of the goods or real property; or ● The supply affects, or is proposed to affect, the ownership of the goods or real property including any interest in, or right in or over goods or real property. | Detailed Reasoning - Is the supply of a loan directly connected with real property?: To determine if the supply of a loan is directly connected to real property, the exact nature of the supply of the loan needs to be established (paragraph 29 of GSTR 2003/7). As concluded above, the supply of a loan is the provision of an interest in or under a credit arrangement or right to credit, under item 2 of the table in subregulation 40-5.09(3) of the GST Regulations. In Amex v. FC of T citing Fitz-gibbon v Inspector General in Bankruptcy (2001) 180 ALR 475 at 479 [15], ‘…[b]roadly speaking, the term ['credit'] means the provision of funds either directly to the person obtaining the credit or to a third party provider of goods and services to that person subject to the obligation of the person obtaining credit to pay at a later time’. The essential nature of a loan is that funds are provided to the borrower giving rise to a debt obligation, and the obligation to repay this debt is deferred. There are two reasons by which a loan may potentially have a connection with real property: ● the mortgage over specific real property, that is used as security for the loan. ● the use of the loan funds by the borrower. Either tracing the use of the funds, or identifying an obligation in the loan contract to use the funds to acquire real property. In determining if there is a direct connection the relevant principle in GSTR 2003/7 is that ‘The supply (of the loan) affects, or is proposed to affect, the ownership of real property including any interest in, or right in or over real property.’ For these particular loans in this case, the mortgage security supply made by the borrower to you, is directly connected with the ‘mortgaged property’ as it provides you as lender, with an interest in that property. To the extent that the supply of the loan relates to the relevant real property because of the existence of the mortgage used as security, the loan is one step removed, and there is not a direct connection. The direct object of a loan is to supply the borrower with credit and therefore allow the borrower to defer the repayment of those funds. A loan can “relate to” real property as the ‘use of the funds’ by the borrower is to purchase the real property (see discussion below concerning the application of subsection 38-190(2A)). The supply of the loan itself does not affect the ownership of the relevant real property, it is one source of funds to be used as consideration in acquiring the relevant real property and this is not sufficiently close to be a direct connection. Objectively, as it relates to the change in title of specific real property, there is no distinction between the specific sources of funds used to provide the agreed consideration, whether it is a loan, or the bank account from which to deposit is paid are all sources of funds. This is consistent with debt collection services not being directly connected, where the debt arises from the sale of real property (paragraph 44 of GSTR 2003/7). The debt would be consideration owing for sale of a specific property, but the collection of that debt is not directly connected, similarly the supply of a loan to pay the consideration for a specific property is not directly connected. | Detailed Reasoning - The combined effect of the mortgage and the purpose in the loan contract: The loan terms do require that the loan funds are used to acquire the ‘loan purpose property’. The nature of the loan agreements and mortgage documents illustrate that the mortgage security has direct connection to the ‘mortgaged property’, rather than to the ‘loan purpose property’. For example, there is no requirement to notify change of use of the loan purpose property, the requirement attaches to the use of the mortgaged property. The loan terms places specific obligations upon the borrower to pay all rates, taxes, and outgoings, take out insurance, and keep the mortgaged property in good repair, and not deal with the mortgaged property without written consent. This illustrates that whilst these loans may require that the funds are used to purchase a property, to some degree this is a function of the mortgaged property also being the loan purpose property. That is, the lender requires that the borrower be able to obtain title to the relevant property, so that the lender is able to mortgage that property as security. Over the term of the loan it is only the mortgaged property that has ongoing relevance – as the lender retains an interest in that mortgaged property and also places the above obligations on the borrower in relation to the mortgaged property. The direct object of a loan is to supply the borrower with credit and therefore allow the repayment of the debt to the lender to be deferred. The subsequent use of the funds on the drawdown of the loan doesn’t impact on the essential character of the supply of the loan in providing credit to the borrower. The use of the funds in purchasing the property does not create a direct connection to that property, even if the lender requires the funds be used for that purpose. The supply of a standard or investment loan where the purpose of the loan specified in the loan contract is to acquire specific real property in Australia, is not directly connected with real property in Australia. The supply of the loans to non-residents is thus GST-free unless subsection 38-190(2A) applies. | Detailed Reasoning - Subsection 38-190(2A) - supplies that are acquisitions related to real property supplies: Even if the requirements of item 2 are met in relation to the loans they will not be GST-free if subsection 38-190(2A) applies. Subsection 38-190(2A) will apply if the acquisition of the loan by the non-resident borrower relates (directly or indirectly, or wholly or partly) to the making of a supply of real property situated in Australia that would be input taxed under Subdivision 40-B (lease, hire or licence of residential premises) or Subdivision 40-C (sale or long-term lease of residential premises) – an ‘input taxed supply of real property’. This is a different test to ‘directly connected to real property’ in item 2, the phrase is intended to have a wide meaning and this is put beyond doubt by the words 'whether directly or indirectly or wholly or partly' in subsection 38-190(2A), which amplifies its scope (paragraph 12 of Goods and Services Tax Determination GSTD 2007/3 Goods and services tax: if a non-resident entity owns residential rental premises in Australia and an Australian accountant makes a supply to that entity consisting of advice about the premises and tax return preparation services, is that supply wholly or partly GST-free if made on or after 1 April 2005? (GSTD 2007/3)). As recognised at footnote 10 and paragraph 14 of GSTD 2007/3 it is relevant to note that paragraph 11-15(2)(a) - creditable purpose and subsection 38-190(2A) use almost identical wording to determine the relationship between a particular acquisition and a related supply: ● ‘the acquisition relates to making supplies that would be input taxed’ in paragraph 11-15(2)(a)’. ● ‘acquisition of the supply...relates (whether directly or indirectly, or wholly or partly) to the making of a supply of real property…that would be, wholly or partly input taxed’ subsection 38-190(2A). Whilst the meaning of subsection 38-190(2A) starts and ends with the text of the provision, the statutory text must be considered in its context - FCT v Consolidated Media Holdings Ltd [2012] HCA 55 at [39]. In this instance and as it relates to the scope of the connection required by the term ‘relates (whether directly or indirectly, or wholly or partly) to’ there is nothing to suggest that the scope of the term in context is intended to be narrower than ’relates to’ in paragraph 11-15(2)(a). This is evidenced by the Explanatory Memorandum to the Tax Law Amendment (2004 Measures No.6) Bill 2004 at 9.3 which compares things acquired by resident landlords that would relate to input taxed supplies (where paragraph 11-15(2)(a) would apply), compared to non-resident landlords being able to acquire the same acquisitions as GST-free. The intent of the amendment was to provide parity as property owners outside of Australia received ‘more favourable treatment than entities in Australia’ - at paragraph 9.2 of the EM, and the amendment would ensure that ‘the same GST treatment will apply to supplies acquired by both non-resident and resident owners in relation to their Australian residential properties.’ - at paragraph 9.4 of the EM. As established in HP Mercantile v FC of T (2005) 143 FCR 553 at 562 ‘relates to’ in paragraph 11-15(2)(a) includes both direct and indirect connection and subsection 38-190(2A) specifies this in the provision. Paragraph 11-15(5)(b) is a similar provision which allows borrowing costs to be creditable if the ‘borrowing relates to you making supplies that are not input taxed’. Applying this provision and subsection 38-190(2A) consistently means that borrowings are related to supplies on the basis of where the funds borrowed are applied. Example 17 in Goods and Services Tax Ruling GSTR 2008/1 Goods and services tax: when do you acquire anything or import goods solely or partly for a creditable purpose? (GSTR 2008/1) is analogous, as the borrowing is used to purchase a capital asset (manufacturing equipment) that is not sold by the entity. In the example, the borrowing ‘relates to’ the entity to making taxable supplies to third parties using that asset. Taking into account the above factors the acquisition of a loan relates to input taxed supplies of real property under subsection 38-190(2A), and is not GST-free under item 2, where the loan funds are for use in acquiring real property, and that real property is for use in making input taxed supplies of real property. Where the loans supplied by you meet the above conditions they will be input taxed not GST-free financial supplies. For example an ‘investment loan’ with a stated purpose of acquiring new residential premises which the Borrowers will lease to third parties – provided the supply under the lease is a supply of residential rent, the loan will fall within subsection 38-190(2A) and will not be GST-free.