• Despite nearly 13 years of operation of the GST regime, the ability of taxpayers involved in M&A to claim GST credits for transaction costs remains contentious.
  • Last week the press revealed the ATO’s scrutiny of an interposed ‘facilitator’ entity structure to maximise that recovery, in what the Commissioner says to be uncommercial circumstances.
  • Notwithstanding the Commissioner’s concerns, the use of a related entity to provide arranging services—which in many deals may be the natural structure—can be effective provided the arrangements have substance.


For most businesses GST is a wash for day to day to transactions. That is, they charge an additional GST amount to customers/counterparties and claim back an “input tax credit” (ITC) from the ATO for any GST amounts they pay on acquisitions.

However, that general proposition does not hold true in equity M&A transactions. Dealings in shares and units are classified as “input taxed financial supplies” for GST purposes. This means that while the disposal or acquisition of the securities does not attract GST, the GST component of related transaction costs cannot be reclaimed as an ITC in the absence of applicable GST Act concessions.

The use of a reasonably well-known structure to maximise the benefit of one such concession has been in the news in recent weeks. The ATO is said to be investigating whether an advisor has fallen foul of the tax exploitation “promoter penalty” regime in advising a client to implement that structure.

Without wishing to comment on that particular case, it is a timely reminder that the ATO can and will scrutinise the substance behind GST recovery in M&A transactions.

The GST issue

Because ITCs cannot, generally, be claimed for transaction costs relating to financial supplies, such as the acquisition of shares in a takeover situation, the GST component of transaction costs is an irrecoverable cost. However, if a particular acquisition (eg services) is contained in an exclusive list in the GST Regulations, a ‘reduced input tax credit’ (RITC) of 75% of the GST component can be recovered (although managed investment schemes and some superannuation funds can now claim a minimum 55% for all services).

The most commonly accessed RITC in M&A is for the supply of ‘arranging services’ by a ‘financial supply facilitator’.

Broadly, this RITC arises for the intermediary role often performed by an investment bank in bringing the transaction together (eg structuring, negotiation and implementation). Importantly, the RITC treatment does not extend to the role provided by other service providers such as lawyers, valuers and accountants. That distinction gives rise to the issue at hand–75% RITCs can be claimed with respect to investment bank services, but no GST can be claimed for lawyers and other service provider’s whose services are also crucial to the transaction proceeding. 

There is of course a threshold question to be answered before querying whether RITCs can be claimed. ITC denial (and hence the question of RITC availability) only arises where you conclude that there is a sufficient connection between an acquisition (eg legal services) and an intended input taxed financial supply (eg acquisition of shares in a takeover). Further, if the counterparty is not Australian, ITCs may be claimable notwithstanding that the services in question have a very close relationship to the intended share acquisition.

M&A transactions can broadly be thought of as having three phases:

  1. Preliminary – the taxpayer is simply investigating opportunities. The nature of a potential transaction has not yet been determined and a decision as to whether to proceed has not been made.
  2. Structuring – a project team has been established, due diligence etc occurs, financial planning and modeling leads to determination of preferred transaction structure(s).
  3. Implementation – the proposed transaction structure has been determined and activities are focused on implementation and completion (eg negotiation of terms, drafting of documents, further detailed due diligence etc).

The ATO accepts that in phase 1, the connection between a particular service and a potential transaction is too remote for ITC denial. While a share transaction may eventuate, it is not yet in serious contemplation – the purpose of this phase is to determine whether an opportunity realistically exists and whether it will be seriously pursued.

The matter in question for this article is what happens once you pass into phase 2 and beyond-where there is a genuine opportunity that is being seriously pursued that may lead to a share transaction eventuating. The services you acquire will then have a sufficient connection to the proposed share transaction for ITCs to be denied, but can 75% RITCs be claimed nonetheless?

The structure in issue

The essence of the “structure” in issue involves having one entity (not being the transaction entity) act as a conduit for external service providers. The transaction entity therefore makes a single acquisition of services from that interposed entity for which it can claim a 75% RITC, even though it would not be entitled to make such a claim for the component services had it acquired them directly.

In 2010 the ATO issued a “Taxpayer Alert” to warn taxpayers that it had concerns with structures of this type. However, TA 2010/1 only addressed one variant of what was, at that time, a reasonably well known structure.

In summary, the Commissioner expressed concerns where:

  1. A transaction entity (SPV) is established to acquire shares in another entity (Target).  
  2. Another associated entity (Arranger) provides "arranging services" to the SPV to facilitate its acquisition of shares in Target.
  3. While SPV and Arranger may be eligible to be members of the same GST group (eg 90% common ownership if they are companies), they are not.
  4. Rather than SPV engaging external service providers, Arranger undertakes to acquire and pay for those services (eg tax, legal, public relations and investment banking services) from third party service providers as part of its "arranging services" agreement with SPV.
  5. These services are performed exclusively for the purpose of the SPV's takeover and (crucially, and to use the Commissioner’s words) there is insufficient commercial rationale for Arranger’s involvement.
  6. Arranger claims full ITCs on the external costs, then makes a single “bundled” supply of “arranging services” to SPV. It calculates its fee by reference to the amounts paid to the external providers and charges GST to SPV.
  7. As Arranger is said to be a “facilitator” providing “arranging services”, SPV claims a 75% RITC on that single bundled supply even though it would not be entitled to claim RITCs on some of its components had it acquired them directly (eg legal services).

The ATO’s concerns and how they can be addressed

While TA 2010/1 is scant on details, the Commissioner’s concerns can largely be reduced to the commercial substance of the arrangement.

If Arranger is little more than a shelf company through which costs are funnelled, the Commissioner has serious concerns as to whether it even acquires the external services, let alone provides a separate arranging service to SPV. Issues that arise are:

  1. Services acquired by Arranger – this is a necessary precondition for Arranger providing services to SPV:
    1. Arranger should engage the service providers directly rather than simply agree to pay fees.
    2. Arranger’s staff should instruct and meet with the service providers and, as the entity engaging them, should receive those services.
    3. note that this can raise issues regarding professional duties etc on the basis that Arranger is the client of these service providers, while SPV is the ultimate beneficiary of the services.
  2. Arranger must in fact “arrange” the transaction – this raises a number of practical issues:
    1. staff are obviously necessary for Arranger to provide services. These would, preferably, be employed directly, but secondments from other entities such as the ultimate parent should be acceptable if on appropriately commercial terms;
    2. beyond merely engaging the external service providers in a contractual sense, Arranger should actively engage with them on a practical level conducting meetings,
    3. self-evidently, Arranger needs to “arrange” the transaction. Beyond merely coordinating the external service providers, that this should involve Arranger critically assessing the work performed by them and providing recommendations etc to SPV based on those services.
    4. Arranger’s engagement by SPV needs to be commercial, including a documented engagement, the fee charged reflecting Arranger’s “value add” rather than merely being a cost recovery.
  3. Anti-avoidance considerations–this is perhaps the most difficult issue to address. However, provided that the arrangements have commercial substance, we consider that this structure can meet the “purpose and effect” tests in Division 165 of the GST Act, especially where the use of separate service providers within a broader economic group is a longstanding practice.

As a matter of commercial practice, many corporate groups maintain a separate development entity whose function is to identify, analyse and co-ordinate M&A opportunities to be pursued by members of the group. Also, acquiring the inputs and the provision of such services to SPV transaction entities is the basis on which most private equity transaction occur. Subject to the practical issues identified above, we consider that such ‘natural’ arrangements would address the ‘uncommercial’ issues raised by the ATO in TA 2010/1.