Goods and services tax: do the acquisitions of the services provided under the arrangement described in Taxpayer Alert TA 2010/1 form part of a reduced credit acquisition made by the financial supply provider under item 9 of the table in subregulation 70-5.02(2) of the A New Tax System (Goods and Services Tax) Regulations 1999?

The acquisition of the investment banking services referred to in the arrangement described in Taxpayer Alert TA 2010/1 that the financial supply facilitator (FSF) [1] acquires and then supplies to the financial supply provider (FSP) [2] is a reduced credit acquisition made by the FSP under item 9 of the table in subregulation 70-5.02(2) of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations). [3]

The tax, legal and public relations advisory services referred to in the arrangement and other services that are acquired by the FSF from service providers and merely passed on to the FSP do not form part of a reduced credit acquisition by the FSP under item 9 of the table in subregulation 70-5.02(2).

Bengal Manufacturing Ltd (Bengal) carries on a manufacturing enterprise. It identifies Siam Electronics Ltd (Siam) as a potential takeover target. Bengal establishes a subsidiary company Sumatran Pty Ltd (Sumatran) to purchase Siam shares. Sumatran is not a member of Bengal's GST group. Bengal engages an investment bank to prepare for and plan the takeover, value the target company, develop an appropriate strategy, and negotiate and arrange aspects of the transaction. Bengal engages a legal firm to provide advice on regulatory matters, to conduct legal due diligence, and to draft relevant legal documents. Bengal engages accountants to supply financial due diligence services that are required to complete the takeover .

Concurrently, Bengal and Sumatran enter into an agreement whereby Bengal undertakes to supply all the investment banking, legal, and accounting services that it acquires (and pays for) from the third party providers and which are necessary to carry out Sumatran's takeover of Siam. The fee agreed between the parties is cost recovery for the third party services plus a mark-up for Bengal organising the third party expertise that is required. Bengal subsequently issues a tax invoice to Sumatran in which it describes its services as 'Arranging Services' and charges the relevant fee in accordance with the agreement. While Bengal contracts directly with the third parties, it merely passes the services it acquires on to Sumatran .

Bengal is a financial supply facilitator as set out under regulation 40-5.07 as the services it supplies to Sumatran help take forward the acquisition of the shares in Siam by Sumatran . [4]

Regard must be had to the nature of the services that Bengal supplies under the agreement to determine whether Sumatran acquires 'arranging' services from Bengal for the purposes of item 9 of the table in subregulation 70-5.02(2). The investment banking services obtained by Bengal involve the preparation and planning for Sumatran to acquire the shares in Siam. These services are 'arranging' services for the purposes of item 9(e) and item 9(f); this component of the supply made to Sumatran involves the arrangement of Sumatran acquiring the shares in Siam .

Bengal does not integrate the legal and accounting services into the preparation and planning for Sumatran to acquire the shares in Siam. Rather, these services are merely passed on to Sumatran. Accordingly, the legal and accounting service components of the supply Bengal makes to Sumatran are not 'arranging' services under item 9. Sumatran may require these services in the preparation and planning of the transaction. However, the services are not accurately described as arranging services. The legal and accounting service components are not, in the circumstances described in this example, 'integral, ancillary or incidental' [5] to an arranging service. Each of the legal and accounting services components are significant components of the supply Bengal makes to Sumatran which need to be considered by themselves .

The acquisition by Sumatran is a mixed acquisition. The investment banking service component of the acquisition is a reduced credit acquisition of 'arrangement services' under item 9 of the table in subregulation 70-5.02(2) for which Sumatran is entitled to a reduced input tax credit (RITC). The legal and accounting components do not form part of a reduced credit acquisition under item 9 .

The description 'Arranging Services' on the tax invoice issued by Bengal to Sumatran, while taken into account in the assessment of the character of the acquisitions, is not conclusive. The characterisation depends on the true nature of the services .

When the final Determination is issued, it is proposed to apply both before and after its date of issue. However, the Determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination (see paragraphs 75 to 77 of Taxation Ruling TR 2006/10 ).

This draft Determination applies to the arrangement described in Taxpayer Alert TA 2010/1 (TA 2010/1). That Alert describes an arrangement whereby an associate of a Financial Supply Provider [6] (FSP) (that is not a member of the same GST group) acquires from third parties all of the services necessary for the FSP to complete a company takeover. The associate then purports to make a single 'bundled' supply of 'arranging services' to the FSP for a fee calculated by reference to the costs incurred by the associate in paying the third party providers. The FSP then claims an RITC on this acquisition on the basis that it is acquiring a bundled 'arranging service' within the meaning of item 9 in the table in subregulation 70-5.02(2).

The arrangement has the following features: (a) A special purpose vehicle entity (the FSP) is established for the purpose of acquiring shares in a company as part of a takeover. (b) An associate of the FSP (but not a member of the same GST group), enters into an Arranging Services Agreement (ASA) with the FSP to supply the FSP with a bundle of services which is described as 'arranging services'. These services are performed exclusively for the purposes of the FSP's takeover and include, amongst other things: (i) tax, legal and public relations advisory services in relation to the proposed transaction; and (ii) investment banking services involving activities to prepare for and plan the takeover, value the target company, develop an appropriate strategy, and negotiate and arrange aspects of the transaction. (c) The associate acquires the relevant tax, legal, public relations and investment banking services from third parties and claims input tax credits on these acquisitions. (d) The associate passes on these services to the FSP calculating its fee by reference to the costs it incurred in paying the third party service providers in accordance with the ASA. The associate describes its supply to the FSP as a single supply of 'arranging services'. (e) The associate is a financial supply facilitator (FSF) as set out in regulation 40-5.07 as it helps take forward the securities transaction through the services it supplies to the FSP. [7] (f) The FSP claims an RITC for its entire acquisition of the purported 'arranging services' that it has acquired from its associate. The FSP would not have been entitled to an RITC on some of the acquisitions, such as tax, legal and public relations services, had it acquired those services directly from the service providers. (g) The FSP acquires the shares from the shareholders of the target company. (h) The basic features of this arrangement can be summarised diagrammatically as follows:

An acquisition of an interest in a security, including an interest in a share, is an input taxed financial supply under subsection 40-5(1) of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), by reference to subregulation 40-5.09(1) and item 10 of the table in subregulation 40-5.09(3). Acquisitions that relate to making input taxed supplies are not made for a creditable purpose under paragraph 11-15(2)(a) of the GST Act. Accordingly, in the arrangement described in paragraph 12 of this draft determination, the FSP is not entitled to input tax credits for the acquisition it makes from the FSF under Division 11 of the GST Act. [8]

However, subsection 70-5(1) of the GST Act states that the GST Regulations may provide that acquisitions of a specified kind that relate to making financial supplies can give rise to an entitlement to an RITC. Subregulation 70-5.02(1) of the GST Regulations provides that an acquisition mentioned in subregulation 70-5.02(2) 'that relates to making financial supplies' gives rise to this entitlement. Such acquisitions are referred to as reduced credit acquisitions. [9]

Division 70 of the GST Regulations contains an exhaustive list of reduced credit acquisitions. Item 9 of the table in subregulation 70-5.02(2) of the GST Regulations provides for an RITC for an acquisition of the 'Arrangement, by a financial supply facilitator, of the provision, acquisition or disposal of an interest in a security...', including item 9(e) in relation to 'arranging mergers and acquisitions' and item 9(f) in relation to 'arranging takeover bids'. Acquiring the shares in the target company is a merger and acquisition activity for the purposes of item 9(e) and may follow a takeover bid for the purposes of item 9(f).

For an acquisition to fall within item 9 of the table in subregulation 70-5.02(2), it must be the acquisition of an arranging service. Paragraphs 284 to 303 of Goods and Services Tax Ruling GSTR 2004/1 Goods and services tax: reduced credit acquisitions provide guidance in relation to the scope of item 9, and in particular the meaning of the term arrangement. In particular, paragraph 287 of GSTR 2004/1 states: 287. The term arrangement is not defined in the GST Act or regulations, nor does it have a specific industry meaning. Its ordinary meaning is a 'preparatory measure, previous plan, preparation or a final settlement, adjustment by agreement'. Arrangement under this item includes activities relating to the preparation for the transaction, the planning of the transaction and the settlement of the details of the transaction . [emphasis added]

For a supply to be the arrangement of the provision, acquisition or disposal of a security the supply must have a sufficient connection to the arrangement of the proposed transaction to be properly described as itself constituting the 'arranging' of the transaction. A remote connection would not suffice.

Paragraph 289 of GSTR 2004/1 provides guidance in respect to determining whether a specific supply has a relevant connection with the preparation, planning or settlement of a transaction: 289. Although many activities may be undertaken as part of the preparations for, for example, the public float of a company, not all of these are the arrangement of the provision of an interest in securities. Planning by the financial supply facilitator may require that a company group restructures. However, it is the acquisition of the planning which is the arrangement service, not the activities involved in the restructure that is the reduced credit acquisition. Equally, due diligence activities, though part of the preparation for the float, are not arranging for the purposes of item 9(d). This is because due diligence by itself, does not have sufficient connection to the 'arrangement' of preparing or planning a float. However, where an entity provides due diligence activities, as part of its services in planning or preparing a float, then it may come within item 9(d).

This paragraph clarifies that not all of the things that may be acquired to undertake a securities transaction (whether that transaction ultimately proceeds or not) fall within item 9 of the table in subregulation 70-5.02(2). Due diligence activities fall within item 9 if they form part of the planning or preparing a float and are therefore properly described as part of the 'arranging' of the float. However, specialist advisory services [10] do not qualify as a supply of 'arranging services' merely because they are supplied in conjunction with a supply that does qualify as 'arranging'.

In characterising the things supplied and acquired under the arrangement described in TA 2010/1, the logical starting point is the ASA. [11] Under that agreement, the associate purports to make a single bundled supply of 'arranging services'. However, the characterisation of the supply/acquisition depends on the nature of the services supplied, not the name applied to them. [12]

Under the arrangement to which this draft Determination applies, the FSP acquired from the FSF investment banking services which involve the preparation, planning and settlement of the details of the transaction. This is so notwithstanding that the FSF has subcontracted these services from an investment banking services provider and passed those services onto the FSP. In preparing and planning the transaction through the investment banking services supplied to the FSP, the FSF has supplied the 'arranging services' for the FSP to acquire the shares in the target company. Accordingly, the FSP has made a reduced credit acquisition under item 9 of the table in subregulation 70-5.02(2) in respect of the investment banking services and is entitled to an RITC for that component of the acquisition.

The FSP also acquired from the FSF separate advice on the proposed transaction, being the tax, legal and public relations advisory services. Under the arrangement the FSF does not integrate the advisory services into the activities of preparing and planning the transaction. The FSF passes these advisory services onto the FSP. The advisory services are not 'integral, ancillary or incidental' [13] to an arranging service that comes within item 9; each of the advisory services is a significant component of the supply. Therefore, each of these services needs to be considered by itself.

The tax, legal and public relations advisory services by themselves do not have a sufficient connection to the 'arrangement' by the FSF of preparing or planning the merger and acquisition to be properly described as arranging.

This view is consistent with the mixed acquisition analysis referred to at paragraphs 223 to 256 of Goods and Services Tax Ruling GSTR 2002/2 Goods and services tax: GST treatment of financial supplies and related supplies and acquisitions . To work out whether there is a mixed acquisition, the Ruling states that the characterisation of the thing acquired must be viewed from the perspective of the acquirer and the key question is what 'in substance and reality' is acquired for the consideration paid. In this case, notwithstanding the description of all the things supplied under the ASA as arranging, the lack of integration by the FSF of the tax, legal and public relations services into the preparation, planning and settlement services indicates that the FSP has made a mixed acquisition of services from the associate.

Therefore, the tax, legal and public relations services components of the acquisition made by the FSP do not comprise a reduced credit acquisition within item 9 of the table in subregulation 70-5.02(2). The FSP is not entitled to an RITC for these components of the acquisition.

This outcome reflects the mere passing on, by the associate, of the acquisitions from third party service providers. The position may be different if, on an analysis of the ASA in its context, the true position is that the FSF is engaged to, and does, provide a service of arranging a share acquisition or disposal that incorporates the tax, legal, and public relations components into the preparation, planning and settlement of the details of the transaction. In those circumstances, the acquisitions from third parties may be acquired and consumed by the FSF such that they are integrated into an arranging service. Whether this is so will depend upon close analysis of the terms of the agreement and the way in which it is carried out.

The Commissioner considers that the correct application of the substantive provisions of the GST Act to the arrangement described in paragraph 12 of this draft Determination results in the FSP being entitled to an RITC for only that part of its acquisition that would be a reduced credit acquisition of an arrangement service had it been acquired by the FSP directly from the relevant service provider/s.

On that basis, it is unlikely that the Commissioner would need to consider the application of the anti-avoidance provisions in Division 165 of the GST Act in the circumstances described in this draft Determination. However, the application of Division 165 is sensitive to the particular facts and circumstances of a case; variations upon the particular arrangement described in this draft Determination may warrant consideration of Division 165 of the GST Act or the common law concept of sham depending upon the particular circumstances.

Under Division 165 of the GST Act, the Commissioner may issue a declaration to negate an entity's GST benefit if the following elements are satisfied: one or more of the steps in the arrangement is a 'scheme' as defined in subsection 165-10(2); an entity gets a GST benefit from the scheme; and it is reasonable to conclude, taking account of the matters in section 165-15, that the dominant purpose or principal effect of entering into or carrying out the scheme was to obtain a GST benefit. For further guidance on the operation of Division 165 see PS LA 2005/24 Application of General Anti-Avoidance Rules.

Alternatively, if the Commissioner considers part of an arrangement to be a sham, he may disregard the sham transaction in determining the GST consequences of the arrangement. Kirby J provided the following guidance on sham in Raftland Pty Ltd as Trustee of the Raftland Trust v. Commissioner of Taxation (2008) 246 ALR 406 at 442: The key to a finding of sham is the demonstration, by evidence or available inference, of a disparity between the transaction evidenced in the documentation (and related conduct of the parties) and the reality disclosed elsewhere in the evidence. Where, for example, the evidence shows a discordance between the parties' legal rights or obligations as described in the documents and the actual intentions which those parties are shown to have had as to their legal rights and obligations, a conclusion of sham will be warranted.

You are invited to comment on this draft Determination. Please forward your comments to the contact officer by the due date.

A compendium of comments is also prepared for the consideration of the relevant Rulings Panel or relevant tax officers. An edited version (names and identifying information removed) of the compendium of comments will also be prepared to: • provide responses to persons providing comments; and • publish on the Australian Taxation Office website at www.ato.gov.au Please advise if you do not want your comments included in the edited version of the compendium. Due date: 7 October 2011 Contact officer details have been removed following publication of the final determination.