Private ruling: GST and cost of supply methodology
Date of advice: 20 December 2018
Published: April 2019

Ruling: Q1: Is the first methodology you proposed (methodology 1) to determine the cost of the supply of items which you refer to as ‘prepared items’ made to your employees acceptable to the Commissioner for the purpose of subparagraph 38-250(2)(b)(ii) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)? | A1: No, on the facts provided methodology 1 you proposed is not acceptable to the Commissioner because the methodology is not fair or reasonable for the reasons set out in the reasons for decision. | Q2: Is the second methodology you proposed (methodology 2) to determine the cost of the supply of prepared items made to your employees and contractors acceptable to the Commissioner for the purpose of subparagraph 38-250(2)(b)(ii) of the GST Act? | A2: No, on the facts provided methodology 2 you proposed is not acceptable to the Commissioner because the methodology is not fair or reasonable for the reasons set out in the reasons for decision. | Q3: Is the supply of prepared items made by you at two of your sites GST-free under subparagraph 38-250(2)(b)(ii) of the GST Act where the costing methodologies specified in question 1 and question 2 is applied? | A3: As the methodologies specified in questions 1 and 2 applied by you are not acceptable we are unable to determine whether the supply of each prepared item sold by you is GST-free or not. The supply of the prepared items are GST-free if each supply of a prepared item is for consideration that is less than 75% of the consideration the supplier provided or was liable to provide for acquiring the thing supplied. Alternatively your supply of a prepared item is GST-free if each supply is less than 50% of the GST inclusive market value of the supply (sub paragraph 38-250(1)(b)(ii) of the GST Act). | Q4: Will the Commissioner confirm that in your specific circumstances, you have not passed on any ‘excess GST’ to recipients for your supply of prepared items for the purpose of Division 142 of the GST Act, and therefore section 142-10 does not apply to restrict a refund of the excess goods and services tax (GST) to you in respect of supplies made on and after 31 May 2014? | A4: The Commissioner is unable at this time to confirm that in your specific circumstances, you have not passed on any ‘excess GST’ to recipients for your supply of prepared items for the purpose of Division 142 of the GST Act as it has not been established whether there was any excess GST.

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. You are registered as a charity (Public Benevolent Institution) with the Australian Charities and Not-for-profits Commission (ACNC) and are endorsed to access GST concessions. You propose the following two methods (Methodology 1 and Methodology 2) for determining the cost of prepared items for the purposes of applying subparagraph 38-250(2)(b)(ii) of the GST Act to prepared items.

Relevant legislative provisions: A New Tax System (Goods and Services Tax) Act 1999 Subsection 38-250(2) | A New Tax System (Goods and Services Tax) Act 1999 Section 142

Reasons for decision: Summary: Subparagraph 38-250(2)(b)(ii) of the GST Act provides that a supply by an endorsed charity, a gift deductible entity or a government school is GST-free where the supply is not a supply of accommodation and the supply is for consideration that is less than 75% of the consideration the supplier provided or was liable to provide for acquiring the thing supplied. Section 195-1 of the GST Act defines ‘consideration’ for a supply as meaning any consideration, within the meaning given by section 9-15 of the GST Act, in connection with the supply. Consideration within the meaning of section 9-15 of the GST Act includes any payment, or any act or forbearance, in connection with a supply of anything and any payment, or any act or forbearance, in response to or for the inducement of a supply of anything. The Goods and Services Tax Industry Charities Consultative Committee Resolved Issues Document (CCC document), sets out in section A of issue 1 of part 3 of the CCC document the cost of supply guidelines to assist charities to work out the cost of providing something for the purposes of applying subsection 38-250(2) of the GST Act. The general position in working out the cost of providing something is that the cost should include: ● all direct costs incurred – for example, materials and direct labour, and ● a reasonable apportionment of indirect costs incurred – for example, marketing, administration, office expenses, electricity, telephone and insurance. The cost of supply guidelines explain that for supplies that are not accommodation, charities should only include amount paid or payable by them in the calculation. This is because subparagraph 38-250(2)(b)(ii) of the GST Act provides that it is the ‘consideration the supplier provided or was liable to provide for acquiring the thing supplied’. You have not included depreciation costs relating to the cafeteria premises in your calculation of costs notwithstanding that Goods and Services Determination 2013/4 indicates that the consideration the supplier provides for acquiring assets that diminish in value over time can be taken into account in determining whether a supply in a period is GST-free under subparagraph 38-250(2)(b)(ii) of the GST Act. | Detailed Reasoning - Question 1 Methodology 1: Methodology 1 you proposed to determine the cost of prepared items is not acceptable to the Commissioner for the purposes of applying subparagraph 38-250(20(b)(ii) of the GST Act. This is because the allocation formulas do not provide a reasonable reflection of the costs of prepared cafeteria items and are therefore not fair and reasonable for the reasons set out below: | Detailed Reasoning - % margin: With regard to your method of allocating the cost of materials between prepared cafeteria items and pre-made cafeteria items that allocation involves a margin of % applied to pre-made items which is determined as an average of each of the different margins you apply to each of the separately listed pre-made items. That average margin of % would be correct if only one of each pre-made item listed was supplied and is not representative where, as is the case here, there is a variance between the number of pre-made food items sold. It follows that the % margin you adopted is not acceptable. | Detailed Reasoning - Till sample: The proportion of prepared to pre-made cafeteria food items applied to the costs is based on a ratio derived from a sample of sales of prepared and pre-made food items made in one five day period referred to as the ‘till sample’. The ‘till sample’ indicates that total sales of pre-made and prepared items sold in the sample week. The till sample week records sales made by cafeterias and that the number and type of food items sold is representative of the type and number of food items sold for the entire financial year in which the sampling was carried out. When the total cafeteria sales for the sample week of is multiplied by the 48 weeks in the financial year the result of pre-made and prepared cafeteria items sold in that financial yea. The P&L Report shows that the total sales of pre-made and prepared items sold in each of the cafeterias. The total cafeteria sales of prepared and pre-made items shown in the P&L Report and those extrapolated from the ‘till sample’ data indicate a degree of statistically significant variation such that it casts doubt over the accuracy of the ‘till sample’ data or the Report data. From the calculation it is clear that the till sample which forms an integral part of your methodology did not produce an acceptably accurate result and hence is neither fair nor reasonable. The Commissioner suggests that a minimum sample period of two weeks twice a year is required to obtain a more representative sample subject to any changes that may require further sampling. This means the result from applying the method of allocating the cost of materials between prepared and pre-made cafeteria items is not fair and reasonable and therefore unacceptable. With regards to where you seek to allocate a proportion of the indirect costs (overheads) using a revenue formula where you have divided the total of revenue generated from the entire division in a financial year shown in the P&L Report by the total amount of revenue generated from sales of prepared items in a financial year amount. As above those results calculated are unreliable and when they are used in the revenue formula will lead to those results also being unacceptable. The till sample also indicates that errors in the data recorded such that the variation between the price of a particular item raises further concerns about the reliability and accuracy of the data collected in the ‘till sample’. Applying that data to the calculations carries the error through in step 2, 3 and 4 and 5 and would lead to those results being neither fair or reasonable and therefore unacceptable. | Detailed Reasoning - Indirect cost allocation of labour: The general position set out in the CCC document indicates that when working out the cost of providing something you need to include all direct costs incurred – for example materials and direct labour and a reasonable apportionment of indirect costs incurred such as electricity, etc. The reasonable apportionment relates to indirect costs incurred not to direct costs. Paragraph 98 of Goods and Services Tax Ruling GSTR 2006/4 explains that the High Court in Ronpnbon Tin NL v FC of T (1989) 78 CLR 47 considered both the distinct expenditure to specific activities and also apportionment and said: ‘… there are at least two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or service. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors’ fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or rateable division because it is common to both.’ You have included labour costs as part of indirect costs because you do not have the data to be able to determine your direct labour costs in supplying each of the prepared items. However it is possible and practical for you to factually dissect these direct labour cost amounts even though you have not done so. The basis of apportionment or allocation needs to make sense in the context of an enterprise and should not produce significant distortions. If different types of indirect costs are being allocated, it may be appropriate to use different allocation criteria. Were a direct method is available on which to base an allocation the Commissioner is of the view that this will most accurately reflect the use of the acquisition. In choosing a method to measure an application of an acquisition the matters that can be considered include: ● the nature of the acquisition and the ways of directly measuring its use and ● the value of the acquisition and the cost of directly measuring its use. The method you propose of allocating indirect costs based (for labour and other indirect costs identified) on a revenue formula is not reasonable with respect to variable labour costs or some of the other indirect costs because there is little correlation between revenue derived from the sale of prepared cafeteria food and the labour or other indirect costs such as cleaning required to prepare the cafeteria item. Direct methods seek to identify a direct measure of the use of an acquisition. Measures based on factors directly connected with the acquisition usually give a fair reflection of the use of the thing in this case labour and some of the other indirect costs. It follows that having taken into consideration the nature of labour and the ways of directly measuring its use and the value of labour and the cost of measuring its use as well as the variation of the use of labour in each of the supplies of prepared and pre-made cafeteria food, the method of allocation of labour costs using a revenue based indirect method is not fair and reasonable. An acceptable direct method may be a detailed time study that accurately reflects the direct labour costs associated with the making and selling each of the prepared cafeteria food items. An acceptable direct method in relation to the allocation of direct materials costs may involve an assessment of the material involved in preparing each prepared food item. A sample for a longer period may be more representative of the actual number and type of items sold. | Detailed Reasoning - Determining direct materials: With regard to your method of allocating the cost of materials to prepared cafeteria items is arbitrary and not reflective of the actual materials used in the preparation of each item supplied. A direct method involving identifying each prepared food item, the materials used to prepare that item and the cost of those materials based on purchase orders is more accurate and reliable than an indirect method based on estimates of the percentage of the selling price that reflects the cost of materials. No records or explanation of how the percentage of sale price representing materials submitted by the cafeteria managers was provided. This % is an integral part of your methodology and how it has been determined has not been appropriately documented in your individual circumstances. The method you propose to determine the cost of materials is based on an unsubstantiated estimate which does not accurately reflect the actual or intended use of the acquisition of materials in relation to each item of prepared food supplied in your cafeterias. Further some of the items sold encompass a number of food all sold for the same price. Although the sale price of each of the food items is the same, the nature of the materials used in each of these food items will vary and therefore the cost of materials attributable to each food item will also vary. Each prepared food item supplied must to be analysed separately to determine the actual materials used to prepare that item and not pooled together. Were a direct method is available on which to base an allocation the Commissioner is of the view that this will most accurately reflect the use of the acquisition of materials. It follows that having taken into consideration the nature of materials and the ways of directly measuring the use of those materials and the value of those materials and the cost of measuring its use in each of the supplies of prepared item, the method of allocation of the cost of materials using a revenue focussed indirect method is not fair and reasonable because a direct method is possible, practical and effective. | Detailed Reasoning - Determining direct labour: With regard to your method of allocating the cost of labour to prepared cafeteria food described in the table the allocation is arbitrary and not reflective of the actual labour used in the preparation of each item supplied. A direct method to determine the cost of labour involving identifying each prepared item, the labour used to prepare that item and the cost of that labour based on observation is more accurate and reliable than an indirect method based on average quantities of prepared items (where the calculation of that average is unsubstantiated) that are estimates of the time taken to prepare each item. We have concerns as to the accuracy and reasonableness in respect of the direct labour costs and quantities applied in relation to some items. This means the result from applying your proposed method of allocating the cost of labour is not fair and reasonable and therefore unacceptable. No explanation was given on how the employee hours and staff hours were determined. The Commissioner has suggested a method where you would accurately collate the time spent by each employee/staff in relation to the various prepared items to determine the direct cost of labour in relation to each prepared food item supplied. Such a direct method is practical and accurate and would need to be undertaken only once. The method you propose to determine the cost of labour is based on financial data rather than a direct analysis of the actual costs of labour used as it relates to each prepared food item. No substantiating records were provided as a basis for the data used. It follows that having taken into consideration the ways of directly measuring the use of labour, the value of that labour and the cost of measuring its use, the method you propose to allocate of the cost of labour is not fair and reasonable because it does not accurately reflect how labour resources are used and a direct method is possible and practical. | Detailed Reasoning - Allocation of indirect costs (overheads): Under the second methodology you seek to allocate a proportion of the indirect costs (overheads) using a revenue formula where you have divided the total average amount of revenue generated from sales of prepared and pre-made cafeteria items by the average revenue generated from the entire division in three financial years shown in the P&L Report. You determined a ratio % which you applied to an average of the indirect costs over the relevant three years listed in the P&L Report. You determined an average cost of indirect costs per year which you divided by 365 days to obtain daily overhead costs which you allocated 95% to prepared items. You erroneously applied the overhead costs to each item of prepared item on the basis that there was one item prepared instead of an average quantity resulting in a calculation error in the allocation of indirect costs to each prepared item listed. As previously advised the basis of apportionment or allocation needs to make sense in the context of an enterprise and should not produce significant distortions. If different types of indirect costs are being allocated, it may be appropriate to use different allocation criteria. Were a direct method is available on which to base an allocation the Commissioner is of the view that this will most accurately reflect the use of the acquisition. The method you propose of allocating indirect costs based on a revenue formula is not reasonable with respect to variable indirect costs because there is little correlation between revenue derived from the sale of prepared items and the indirect costs required to prepare the items. Direct methods seek to identify a direct measure of the use of an acquisition. Measures based on factors directly connected with the acquisition usually give a fair reflection of the use of the thing. You have pooled all indirect costs together irrespective of how those resources are used and have averaged those costs over a three year period. It is not fair or reasonable to average the indirect costs of the previous three years to allocate the costs for the current year or to pool those indirect costs together without having regard to each of the nature of the indirect cost or without allocating the costs down to a business area or activity. Resulting distortions are likely to arise when averaging and pooling of dissimilar costs are applied. It follows that having taken into consideration the nature of indirect costs and the ways of directly measuring its use and the value of labour and the cost of measuring its use as well as the variation of the use of labour in each of the supplies of prepared and pre-made cafeteria food, the method of allocation of labour costs using a revenue based indirect method is not fair and reasonable because a direct method is possible that gives an accurate.