GST and contingent debt

Is an entity making a supply of an interest in a debt under sub-regulation 40-5.09(3) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) when it enters into an agreement to repay an amount to a contributor under certain circumstances?

Yes, the entity makes a supply of an interest in a debt under sub-regulation 40-5.09(3) of the GST Regulations when it enters into an agreement to repay an amount to a contributor under the circumstances given in the facts.

The entity makes an agreement with another entity (the contributor). The agreement provides: • for the contributor to advance a sum of money upfront, to be used by the entity for a specific project in the carrying on of the entity's enterprise • that the project will be accounted for separately • if the project is sufficiently profitable, the amount contributed (or a reduced amount) will be repaid to the contributor by the entity-depending upon the level of funds available, and • that the level of funds available will be determined after a financial audit of the project has been completed at a specified time.

Under subsection 40-5(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), a financial supply is input taxed. Subsection 40-5(2) of the GST Act provides that a financial supply has the meaning given in the GST Regulations.

Sub-regulation 40-5.09(1) of the GST Regulations provides that the provision, acquisition, or disposal of an interest mentioned under sub-regulation 40-5.09(3) or 40-5.09(4) of the GST Regulations is a financial supply if: (a) the provision, acquisition or disposal of that interest is: • for consideration, and • in the course or furtherance of an enterprise, and • connected with Australia, and (b) the supplier is: • registered or required to be registered for GST, and • a financial supply provider in relation to the supply of the interest.

Item 2 in the table in sub-regulation 40-5.09(3) of the GST Regulations (Item 2) lists an interest in or under a debt.

Under the agreement the entity enters into an obligation to repay the money advanced, provided the project is sufficiently profitable, and the profitability has been confirmed by an audit to be completed within a specified timeframe.

The entity has a contingent liability when it enters into the agreement. The liability to repay the contribution, or a portion of it, is contingent upon a financial audit finding available funds. On the happening of that event, the contingent liability matures into a debt due and payable. A debt, based on an existing obligation, that will or might arise at a future time or if a future event occurs, has been defined as a 'contingent debt' by Butterworths Australian Legal Dictionary , 1997, Sydney.

It follows that an amount that may become payable by the entity under the agreement is a contingent debt at the time of entering into the agreement.

The contributor's interest in or under the contingent debt arising out of the agreement will be an interest in or under a debt for Item 2 if a contingent debt is recognised as a debt for the purposes of the GST Regulations.

The GST Regulations do not define the term 'debt', however the Courts have held that contingent debts may be debts for the purposes of other legislation.

In Hawkins & Ors v. Bank of China (1992) 26 NSWLR 562, the New South Wales Court of Appeal considered whether the contingent liability undertaken by a guarantor, when entering into a guarantee, is a debt at the time of entering into the guarantee. The question arose in the context of section 556 of the Companies (New South Wales) Code (Companies Code). Per Gleeson CJ (at 572): '"Debt" is capable of including a contingent liability.... Dictionaries define "debt" as a liability or obligation to pay or render something. Such a liability may be conditional as well as present and absolute...'

Hawkins & Ors v. Bank of China was applied in Commissioner of State Taxation (WA) v. Pollock 93 ATC 5220; (1993) 27 ATR 108 where the issue before the court was whether the Commissioner of State Taxation could bring a claim against a director for unpaid payroll tax due from the company of which Pollock was a director. The court concluded that the balance of authority was to the effect that a contingent debt is capable of being a debt for the purposes of section 556 of the Companies Code.

A conclusion that an interest in a debt includes an interest in a contingent debt for the purposes of item 2 is consistent with the above decisions.

This conclusion is also consistent with the views of the Tax Office stated in Goods and Services Tax Ruling GSTR 2004/4 Goods and Services Tax: assignment of payment streams including under a securitisation arrangement.

Paragraphs 81 to 82 of GSTR 2004/4 state: A hire purchase agreement gives rise to a presently existing right to receive regular payments from the debtor. In some circumstances receipt of the final payment may be contingent on the option to purchase the goods being exercised . Even though the payment may be subject to a contingency, the right to the payment stream, under an existing hire purchase agreement, is a presently existing right that is property and an interest for the purposes of regulation 40-5.02. Assignment of this property is the disposal of an interest in a debt for GST purposes ..' (emphasis added)

Similarly, paragraphs 83 to 84 of GSTR 2004/4 state: The supply that is the subject of a royalty agreement or licence is a taxable supply where the requirements of section 9-5 are satisfied. The agreement or licence may provide for payment of royalties that is subject to contingences such as certain production levels being reached or commodity prices achieving certain levels . Even though payments may be subject to contingencies, the right to the payment stream, under an existing agreement or licence, is a presently existing right that is property and an interest for the purposes of regulation 40-5.02. Assignment of this property is the disposal of an interest in a debt for GST purposes ... (emphasis added)

That is, the right to receive these contingent payments is an interest in a debt for the purposes of Item 2. The hire purchase agreement, royalty agreement and license referred to above are agreements under which there is a presently existing obligation to make a payment in the future subject to a contingency.

The same may be said of the agreement between the entity and the contributor. In the agreement there is a presently existing obligation to make a payment in the future subject to a contingency. Therefore, consistent with the Tax Office view that the right to receive the contingent payments under the hire purchase agreement, royalty agreement or license is an interest in a debt, the right to receive the contingent payment under the agreement is also an interest in a debt for the purposes of Item 2.

As the interest in the debt was created by the entity in making the supply, the entity is a financial supply provider under sub-regulation 40-5.06(1) of the GST Regulations. Provided the other requirements of sub-regulation 40-5.09(1) of the GST Regulations are met, the supply of the interest in the debt will be a financial supply. Note - Section 556 of the Companies Code was replaced by section 592 of the Corporations Law, which was subsequently replaced by section 592 of the Corporations Act 2001 .