28 JUNE 2016
MANAGING GST ON ACQUISITIONS - "CASH FLOW ACCELERATORS" AND OTHER NEW OPPORTUNITIES
Cash is king. Get every drop of cash you can get and hold onto it. That is number one. - Jack Welch
This update was initially published as an article in Thomson Reuters Weekly Tax Bulletin, Issue 25, 10 June 2016.
CASH IS CRITICAL TO THE SUCCESS OF ANY BUSINESS. SO IT IS UNDERSTANDABLE THAT SOPHISTICATED TAXPAYERS WILL EXPLORE ALL AVENUES TO BEST MANAGE GST-RELATED CASH FLOWS. IN THIS REGARD, ACQUISITIONS MUST BE A KEY FOCUS AREA.
Broadly, GST-related cash flows for acquisitions can be improved in the following ways:
Bring forward input tax credit (GST credit) claims for acquisitions of taxable supplies to the earliest time available at law.
Where commercially possible, negotiate deferred GST payments with suppliers.
Appropriately structure transactions so that the "thing" acquired is a GST-free or input taxed supply (and not subject to GST).
In very limited circumstances, involving material one-off transactions, the ATO may agree to apply the input tax credit entitlement of the recipient towards the GST liability of the supplier (as part of a negotiated set-off arrangement).
Generally, only the first of these options is wholly within a taxpayer's control. The other options listed above will often (but not always) require the agreement of the supplier.
The main practical difficulty for taxpayers who want to bring forward input credit claims is the limitations of their finance systems. This has led to the development of commercial solutions known as "cash flow accelerators" or "ITC estimators" (input tax credit estimators). As discussed further below, such products can deliver a material one-off cash flow benefit. However, these products are not free from risk and the ATO has significant concerns about how they are applied in practice. Further, the products also involve on-going maintenance costs.
The best way to reduce GST-related cash flow costs is to eliminate such costs entirely. Acquiring things which are GST-free or input taxed obviates the need to pay any amount on account of GST to the supplier, meaning there is no need to wait to receive the benefit of an input tax credit. Unlike cash flow accelerators / ITC estimators, the risk of acquiring things on a GST-free or input taxed basis will generally rest with the supplier and not the recipient (subject to any contractual indemnity for interest and penalties the recipient may agree with the supplier). Further, there are no on-going maintenance costs.
Of course, not all acquisitions will involve things that are GST-free or input taxed. However, as discussed further below, recent GST reforms for exported intangible supplies (which apply from 1 October 2016) may create increased opportunities for Australian based businesses with overseas procurement hubs to acquire GST-free supplies.
BRINGING FORWARD INPUT TAX CREDIT CLAIMS
NOTE: The commentary below relates to taxpayers who are GST registered and who account for GST on an accruals basis (and not a cash basis).
Under s 29-10(1) of the GST Act, and subject to holding a "tax invoice", taxpayers that account for GST on an accruals basis may claim a full input tax credit for a wholly creditable acquisition in the first tax period in which either:
any part of the consideration is provided for the acquisition; or
the supplier issues an invoice.
For the purposes of s 29-10(1), the invoice issued by the supplier does not need to be in the form of a tax invoice. However, given the recipient cannot claim an input tax credit for an acquisition until it holds a tax invoice (regardless of when any earlier consideration was paid or invoice issued), the issuance of a tax invoice will generally be the trigger for the recipient's input tax credit entitlement.
SYSTEMS LIMITATIONS RESULT IN DELAYED CLAIMS
As noted above, the main practical issue for most taxpayers is whether their finance system can accurately capture and record when a tax invoice was received by the taxpayer and the date on which it was issued by the supplier. Such a system would allow input tax credits to be claimed in the earliest GST return possible. In some instances, this could mean that the benefit of the credit is received before the supplier has been paid.
However, rather than claiming a credit in the tax period in which the tax invoice is issued, many accruals taxpayers will instead only claim a credit once the tax invoice is paid.
Assume that OzCo has made a taxable supply of services to Office Ltd for $1,100 (including GST of $100). OzCo issued a tax invoice on 29 January 2016 (last business day in January) in respect of the services. The tax invoice is received by Office Ltd in during the first week of February.
Office Ltd's internal policy is to only pay invoices 30 days after receipt, meaning payment is not made until early March. Office Ltd has monthly tax periods and is entitled to a full input tax credit for the $100 of GST.
In this scenario, Office Ltd would be entitled to the $100 input tax credit in the GST return for the January tax period, which would be due on Monday, 23 February.
Note that if Office Ltd did receive the benefit of the input tax credit on 23 February, that would precede its payment of the tax invoice in early March.
However, if Office Ltd's systems only allow credits to be claimed once an invoice is paid, Office Ltd may not claim the credit until the March tax period, for which the GST return is due on 21 April. If so, Office Ltd would have forgone the cash flow benefit of receiving the $100 credit two months earlier in February (and prior to the payment of the invoice in early March).
If Office Ltd did claim the $100 credit in its January GST return, it would need to have systems in place to make subsequent increasing GST adjustments if the invoice is ultimately not paid or is only part paid (for example, as a result of a discount or dispute).
CASH FLOW ACCELERATORS / ITC ESTIMATORS
To address any systems limitations, software products have been developed that instead allow input tax credit entitlements to be estimated. The estimations are based on information that is typically obtained using software based data analytics. Such information may include details around the average length of time between when an entity first receives a tax invoice and when credits are typically claimed. It may also include analysis around the average level of input tax credits the taxpayer has previously claimed in earlier tax periods, having regard to any seasonal trends or other patterns in the taxpayer's acquisitions.
If a taxpayer brings forward credit claims based on an estimation, it will provide a one-off cash flow benefit in the first tax period in which an estimation is used. In subsequent tax periods, the taxpayer will need to continue to estimating its input tax credit entitlements so that the cash flow benefit is maintained.
Prior to 1 January 2016, OzCo only claimed input tax credits for its acquisitions once an invoice had been paid.
During January 2016, OzCo engaged an advisory firm to conduct analysis of its input tax credit claims. Based on the advice received, OzCo estimates that it is entitled to an additional $1.2 million of input tax credits in the January tax period (for tax invoices that would otherwise likely be processed in February and March tax periods).
To be conservative, OzCo only included an additional $1 million credit claim in its GST return for January, which it lodged on 23 February 2016.
To preserve this initial benefit, OzCo needs to also estimate and bring forward its input tax credit claims for February and subsequent tax periods. Otherwise OzCo would have lower claims in February and March (as a result of credit claims being brought forward to January).
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RISKS USING ESTIMATOR
There are risks associated with using cash flow accelerators / ITC estimators, including the following:
the taxpayer may not hold tax invoices that support the level of credits claimed (notwithstanding historical data analysis indicates the taxpayer will likely hold sufficient tax invoices)
the initial data analysis / estimation process may have been undertaken using a flawed methodology (or, alternatively, an appropriate methodology may have been applied incorrectly)
the taxpayer's business may have changed significantly subsequent to the analysis being first undertaken, resulting in a lower level of acquisitions (for example, as a result of a sale of a part of a business or an unexpected down turn in business)
the estimation methodology may not be reviewed periodically to ensure that it continues to be appropriate (ie it may have been applied on a "set and forget" basis).
THE ATO POSITION ON CASH FLOW ACCELERATORS / ITC ESTIMATORS
The author made enquiries to Ms Deborah Jenkins (Assistant Commissioner, Technical Leadership & Advice - Indirect Tax) and Mr Steve Howlin (Assistance Commissioner, International, Digital and Financial Services - Indirect Tax) as to the ATO's current position on the use of estimators for the purposes of this article. The response to those enquiries is set out below.
"In relation to the current use of ITC estimators, we note:
Businesses can use estimators, subject to the comments outlined in the attached document
The ATO has significant concerns about how they are practically applied, in terms of:
Overgenerous methods of calculating the estimate,
Overly long periods between reviews and revised estimations,
Failure to revise estimates when major changes or events impact the business, such as downturns in an industry, loss of a key client etc
The ATO has seen numerous examples of the above issues and, in some cases, this has been brought to our attention through voluntary disclosures
Based on those examples, the ATO is reviewing a number of taxpayer's methods and estimates.
We are considering whether it may be appropriate to issue further guidance following our review."
In the first dot point above, the comments make reference to a guidance document which the ATO had previously issued in respect of ITC estimators in 2014. The author was not able to readily locate a copy of that
document on the ATO's website. However, the key points from that document have been extracted below.
Where you make an estimate of the GST credit it is preferable that you notify us before lodgment that labels G10, G11 and 1B include estimates of the purchases and GST credits.
We expect that you will review the GST claims and estimates of GST credits in each BAS to verify these are sustainable in light of the purchases and GST credits recorded in your accounts.
This verification process must occur on a regular basis (at least semi-annually).
Where, following verification, you discover that there has been an overstatement of GST credits in a BAS covered by the review period (including but not limited to the absence of a tax invoice), you must request an amendment of the net amount to ensure that the correct amount of tax payable is properly assessed.
However, you can include the correction in a subsequent BAS where it is within the "limits" set out in GSTE 2013/1 Goods and Services Tax: Correcting GST Errors Determination 2013.
Making a voluntary disclosure to correct an estimate will mean you will not be liable to any penalty on the shortfall amount. You will be liable to GIC where there is an amendment of an assessment for a previous tax period."
Given the ATO expects that the appropriateness of any estimation methodology will be reviewed and verified periodically, there are on-going costs associated with the use of estimators.
What to do if mistakes have been made using an estimator
If a taxpayer becomes aware that using an estimator has resulted in over claimed input tax credits, which are outside the self-correction limits, it would be advisable for the taxpayer to voluntarily disclose this shortfall to the ATO to avoid penalties (although GIC may apply).
The author was advised that any taxpayers with concerns can raise those with either Ms Jenkins or Mr Howlin. Alternatively, taxpayers can contact Mr Nigel Cousins whose contact details are set out below.
Telephone: (02) 9354 3696
CROSS BORDER GST REFORMS - INCREASED OPPORTUNITIES FOR GST-FREE ACQUISITIONS? Exported intangible supplies may be GST-free under the items listed in the table in s 38-190(1) of the GST Act. One of the principal exemption provisions is set out in Item 2. Under that item, supplies of things other than goods or real property will be GST-free if:
the supply is made to a non-resident; and
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the non-resident is not present in Australia in respect of the supply; and
the supply is not directly related to real property in Australia or work performed on goods in Australia; OR
if the supply is directly related to real property or work performed on goods in Australia, the nonresident is not GST registered (or required to be GST registered).
However, the GST-free exemption under Item 2 is lost if the provisions in s 38-190(3) of the GST Act apply. That section currently applies if the non-resident to whom the supply is made directs that the intangible supplies be provided to another entity which is present in Australia (such as a customer, agent or subsidiary in Australia).
Importantly, s 38-190(3) has recently been amended (with effect from 1 October 2016) so that it does not apply where the entity to which the relevant intangible supply is provided in Australia is an "Australian-based business recipient". Refer new s 38-190(3)(c)(i).
New s 9-26(2) in the GST Act, which sets out the tests for determining whether an entity is an Australian-based business recipient, is extracted below.
(2) An entity is an Australian based business recipient of a supply made to the entity if:
(a) the entity is *registered; and
(b) an *enterprise of the entity is *carried on in the indirect tax zone; and
(c) the entity's acquisition of the thing supplied is not solely of a private or domestic nature.
As a result of these amendments, from 1 October 2016, Australian based business that have an overseas procurement hub may be able to acquire more things on a GST-free basis as illustrated in the example below.
OzCo is part of a large multi-national corporate group. That group has a central procurement company in Singapore, Procure Ltd.
Procure Ltd engages a number of suppliers in Australia who provide services to OzCo in Australia. Presently, those services are taxable supplies as a result of s 38190(3). The suppliers charge GST to Procure Ltd in addition to their fees. Procure Ltd is GST registered and claims full input tax credits for that GST.
Procure Ltd charges OzCo for its procurement services. The fees that Procure Ltd charges cover the costs that it incurs. Procure Ltd's supply of the procurement services is not connected with the indirect tax zone (ie not connected with Australia) and is not subject to GST. OzCo is not required to reverse charge GST under Division 84, as it only makes taxable and GST-free supplies.
From 1 October 2016, the supplies that are made by the Australian service providers to Procure Ltd should be GST-free under Item 2 in s 38-190(1), notwithstanding those supplies may be provided to OzCo in Australia. This is illustrated diagrammatically below for services that cost $100 excluding GST.
In the above scenario, the practical outcome is that OzCo should receive the benefit of services in Australia without GST applying. This is notwithstanding that GST would be applicable if OzCo had acquired the services directly itself from the same supplier in Australia. Given that GST doesn't apply, this eliminates any GST related cash flow costs for both OzCo and Procure Ltd. Unlike estimator products, there should not be any need to continue to verify the GST treatment of acquisitions under this structure. If GST does become applicable for some reason, that would be a matter for the relevant Supplier and not OzCo or Procure Ltd. Further, there is no on-going verification cost and there is no risk of the errors that can arise with the use of estimators. For taxpayers that have an overseas procurement hub, it would be appropriate to review their current GST arrangements and to begin discussions with suppliers around whether GST will continue to apply to services supplied after 1 October 2016.
CONCLUDING REMARKS As stated at the outset, it is understandable that sophisticated taxpayers will look at any avenues to best manage their GST-related cash flows, including for acquisitions. For taxpayers that do not have systems capable of claiming input tax credits in the earliest tax period possible, the use of cash flow accelerators / ITC
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Estimators may be an appropriate solution, provided that it is routinely reviewed and the output verified. Taxpayers that have overseas procurement hubs should also investigate whether they may be able to benefit from the reforms to s 38-190(3) which will apply from 1 October 2016.
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