Tax Update - Tax office reverses its position on GST and hire purchase agreements

The Tax Office recently issued an important Practice Statement for the hire purchase industry. PS LA 2008/1 (GA): GST and input tax credits related to making supplies under a disclosed hire-purchase arrangement, deals with the ability of financiers to claim back GST credits on their expenses where they provide disclosed hire purchase arrangements. Relevant expenses include the purchase of the goods, introduction commissions and general overheads.

Background

A disclosed hire purchase agreement is one where the credit component is separately disclosed to the recipient of the goods (these are generally consumer hire purchase arrangements).  Under such arrangements, any principal component paid by the recipient of the goods is generally treated as taxable for GST purposes.  This means it is subject to GST and the financier can claim GST credits on expenses associated with this component.  In contrast, any interest component paid by the recipient of the goods is generally treated as input taxed for GST purposes.  This means it is not subject to GST and the financier is not able to claim GST credits on expenses associated with that component.  This requires financiers to determine the appropriate apportionment of GST credits on its expenses between its taxable and input taxed supplies.

In the hire-purchase industry, taxpayers have generally used a revenue-based method to determine the proportion of GST credits to which they are entitled under hire-purchase arrangements.  Typically, the revenue from the sale of goods (i.e. the principal component) is greater than the interest revenue earned and this results in the recovery of a high proportion of GST credits (often more than 50 per cent).

What has changed?

The Tax Office's view is that this approach does not reflect the commercial substance of hire purchase as predominantly a financing arrangement.

The Practice Statement allows taxpayers to continue to use a revenue-based method up until 31 March 2008.  However, from 1 April 2008, the Commissioner will only accept an apportionment method that achieves a GST recovery rate less than or equal to 15 per cent.  If a taxpayer wishes to adopt a higher percentage, it will need to justify this position and the Tax Office recommends seeking a private ruling in these circumstances.

The GST recovery rates of many financiers with hire purchase arrangements will significantly reduce as a consequence of the Practice Statement.  In other words, the net GST cost to the financier will increase and this will put pressure on margins.

More broadly, the Commissioner has previously been reluctant to provide set rates or percentage ranges in relation to the apportionment of GST credits on expenses.  The 15 per cent rate stated in this Practice Statement represents a shift in the Tax Office's approach.  The Tax Office's decision to provide benchmarks for the financial services industry is a useful one for taxpayers.

What clients should do

Although the Practice Statement is not legally binding and will not protect taxpayers, it represents the internal policy of the Tax Office and consequently should be given serious consideration.

Any clients in the hire purchase industry should review their arrangements in the light of the Practice Statement.  Further, hire purchase arrangements give rise to complex GST issues and it would be an appropriate opportunity for financiers to review their hire purchase arrangements more generally to ensure they are treated appropriately for GST purposes.

For more information, please contact:

Jonathan Ackerman    
T +61 2 9286 8134    
jonathan.ackerman@dlaphillipsfox.com           
      
Dr. Gerry Bean, Partner
T +61 3 9274 5661
gerry.bean@dlaphillipsfox.com

Philip Byrnes, Partner
T +61 7 3246 4030
philip.byrnes@dlaphillipsfox.com