Indirect tax sharing agreements

Articles Written by Andy Milidoni (Partner), Raymond Yu

Introduction

On 28 June 2010 Tax Laws Amendment (2010 GST Administration Measures No. 2) Act 2010 (Cth) (the Act) was given Royal Assent.1 The Act establishes the legislative framework for entities which are members of a GST group or GST joint venture to enter into an indirect tax sharing agreement (ITSA).

Broadly speaking, an ITSA serves a similar purpose to a tax sharing agreement (TSA) in the income tax consolidated group context (the consolidation provisions).2

Since the introduction of GST on 1 July 2000 members of a GST group or a GST joint venture have been, and continue to be, jointly and severally liable for indirect tax liabilities of the group or the joint venture.3 However, prior to the Act, there was no mechanism available to limit or otherwise remove joint and several liability of each member over the GST group's or GST joint venture's indirect tax liability.

The proposal to implement an ITSA in the GST context emanates from the Board of Taxation's report entitled Review of Legal Framework for the Administration of the Goods and Services Tax (December 2008) (the Report). In the Report, the Board of Taxation recommended, among other things, that members of a GST group or GST joint venture be able to enter into an indirect tax sharing agreement.4 In Media Release No 42 of 12 May 20095, the Government accepted this recommendation.

Accordingly, the Act will ensure that indirect tax liabilities of GST groups and GST joint ventures are treated consistently with tax related liabilities of income tax consolidated groups.

The ITSA provisions of the Act will apply from 1 July 2010.

This article will examine:

  • The provision which imposes joint and several liability;
  • the proposed changes and more specifically the main functions of an ITSA and how the new clear exit rules will apply to members of a GST group leaving the group; and
  • some issues in the mergers and acquisitions context.

References in this article made to legislative provisions relate to GST groups. ITSAs for GST joint ventures are contained in section 444-80 of Schedule 1 of the Taxation Administration Act 1953 (TAA) and is drafted in the same way. Accordingly, only section 444-90 of Schedule 1 of the TAA, which relates to GST groups, will be examined in this article.

While the article does not cover specific funding arrangements to be put in place, it is considered that:

  • such arrangements will be similar to funding arrangements in place for consolidated groups; and
  • the accounting treatment will be similar for the funding of indirect tax liabilities as is the case for income tax liabilities.6

What will ITSAs cover?

As members of a GST group and a GST joint venture are jointly and severally liable for the group's or joint venture's indirect tax liability (that is, amounts payable under an indirect tax law), ITSAs will cover GST, wine tax, luxury car tax and fuel tax credits. In addition, General Interest Charge (GIC) and administrative penalties are also covered because they are amounts payable under an indirect tax law.7

Taxes other than GST are covered because the legislation which charges luxury car tax and wine tax and enables credits to be claimed in the case of fuel tax, there are provisions which make the representative members of a GST group or GST joint venture liable for these taxes or able to claim the fuel tax credits on behalf of the members of a GST group or GST joint venturer.8

The Current Position

Subsection 444-90(1) of Schedule 1 of the TAA provides:

The members of a GST group are jointly and severally liable to pay any amount that is payable under an indirect tax law by the representative member of the group.

From this, there are carve-outs for certain taxpayers who are prohibited by law from entering into arrangements under which the taxpayer becomes subject to such liability such as certain financial institutions.9 Subsection 444-90(4) of Schedule 1 of the TAA provides that offences against an indirect tax law committed by the representative member of a GST group are taken to be committed by each member of the GST group. Subsection 444-90(5) of Schedule 1 of the TAA provides for certain defences.

The Act does not amend subsections 444-90(4) and (5) and these provisions will apply in the same way after 1 July 2010.

What does an ITSA do?

An ITSA, like a TSA, will serve 2 purposes:

  • joint and several liability will not apply to members of a GST group or in respect of the indirect tax liabilities of the group for the tax periods covered by an ITSA; and
  • members of the GST group will be able to leave the group clear of certain indirect tax liabilities arising for the tax period in which the member leaves the group. These rules replicate the clear exit rules in the consolidation provisions.

Removal of Joint and Several Liability of Group Members

As set out above, members of a GST group will be jointly and severally liable for the indirect tax liabilities of its representative member. However, for GST returns (or Business Activity Statements) due for tax periods commencing after 1 July 2010, joint and several liability will not apply if an ITSA is entered into before the due date of the GST return. Under an ITSA, the group's total indirect tax liabilities will be allocated amongst members of the GST group. Provided that the allocation amongst members is reasonable and the other requirements of the ITSA are met, the member's liability will be limited to the allocation amount (or contribution amount) so determined.

For an indirect tax liability which is GST (as opposed to other indirect taxes), the contribution amount will be in respect of each amount of GST payable for each of the group's tax periods. If the group has credits (for example, input tax credits and fuel tax credits) in a tax period and they exceed GST payable, the contribution amount will be nil.

The introduction of an ITSA does not alter the representative member being the entity primarily responsible to report and pay the indirect tax liabilities to the Commissioner of Taxation (the Commissioner).

Clear Exit Rules

Currently, members leaving a GST group continue to be jointly and severally liable for the indirect tax liabilities of the GST group that are attributable to each tax period in which they were a member of the GST group. With a valid ITSA in place, a member can leave the GST group clear of indirect tax liabilities raised under a GST return that are yet to be due for that tax period in which the member leaves (the Due Time) provided that the contribution amount or a reasonable estimate of the contribution amount is paid before the Due Time.

Like TSAs and the clear exit rules under the consolidation provisions, the clear exit will not apply to indirect tax liabilities which have fallen due prior to the member's leaving date. Unless these indirect tax liabilities are covered by an ITSA, leaving members will continue to be jointly and severally liable for those liabilities even after they have left. This will be the case for all indirect tax liabilities that:

  • arise in tax periods commencing prior to 1 July 2010; and
  • arise in tax periods commencing after 1 July 2010 and are not covered by an ITSA entered into on or after 1 July 2010.

What are the Specific Requirements?

ITSA

Subsection 444-90(1A) of Schedule 1 of the TAA10 sets out the requirements before joint and several liability is removed in respect of an indirect tax liability for members of a GST group. These are:

  • an agreement, this being the ITSA, has been entered into between the representative member and one or more members of the GST group (a contributing member) before the representative member of the group is required to lodge a GST return (i.e. the Business Activity Statement) for a tax period;
  • a particular amount could be determined under the ITSA for each contributing member in relation to that tax period (the contribution amount); and
  • the contribution amount for each of the contributing members under the ITSA represents a reasonable allocation of the total amount payable by the group in respect of the indirect tax.

No other requirements are specified in the Act.

Where these requirements are met, the contributing member's liability for indirect tax liabilities that fall due after the execution date of the ITSA will be covered by the ITSA. This means that a contributing member's liability to the group's indirect tax liability will be limited to its contribution amount (that is, jointly and several liabilities for the group's total liability will be removed).

Clear Exit

Where an ITSA is in place in respect of an indirect tax liability, a leaving member can obtain clear exit in respect of an indirect tax liability that has yet to fall due prior to the leaving time provided that it has paid the contribution amount so determined under the ITSA for the tax period for which the Due Time has not occurred or a reasonable estimate thereof.

Based on the Commissioner's view of the requirement to pay an amount prior to the leaving time under the consolidation provisions, it is expected that an amount will be taken to be paid for clear exit purposes if:

  • it is actually paid in cash or cash equivalent;
  • it is subject to an agreed set-off where cross-liabilities exist; or
  • payment is made by the transfer of property other than cash or cash equivalent.11

The Commissioner considers that mere book entries do not amount to payment for clear exits under the consolidation provisions12 and we would expect the same view to be taken in respect of clear exits in the indirect tax context.

Arrangements to prejudice recovery

A clear exit will not be given where a leaving member leaves the GST group as part of an arrangement to prejudice recovery by the Commissioner of an indirect tax amount.13

Likewise, an ITSA will not be valid and joint and several liability will continue to exist, where an ITSA is entered into for this purpose of prejudicing the Commissioner's recover of indirect tax amounts.14

Commissioner's Request for copy of ITSA

Under subsection 444-90(1D) of Schedule 1 of the TAA, if the representative member of the GST group does not give the Commissioner a copy of the ITSA, in the approved form, within 14 days of a notice given by the Commissioner requesting a copy of the ITSA, the members remain subject to joint and several liability over the group's liability and a clear exit on leaving will not be available.

While the approved form is not specified, it is expected that the Commissioner will take a similar approach with ITSAs as he does with TSAs. For TSAs, the Commissioner states in Chapter 35 of the ATO Receivables Policy15 (the Receivables Policy) that a TSA will be in the approved form if, among other things16:

  • it is in writing;
  • it shows the execution date;
  • it specifies the names of the head company and each contributing member;
  • it specifies the group liability covered;
  • it specifies the allocation methodology (for further detail see below);
  • it includes any deeds of assumption in relation to a particular liability for a particular period.

Multiple agreements

The removal of the joint and several liability, and the benefit of clear exit, will not be available if two or more ITSAs are entered into by the representative member that relate to the same tax period.17 In other words, there can only be one ITSA applicable to a particular tax period. This is a point that can very easily be overlooked particularly where the composition of the GST group changes over time and changes are made to existing ITSAs or new ITSAs are entered into. Multiple ITSAs could arise where, for example, an existing GST group acquired another GST group or where a new ITSA is entered into after another entity joins an existing GST group.

We note that unlike TSAs, where the TSA is an agreement in respect of each tax related liability, an ITSA will be an agreement in respect of each tax period in which an indirect tax liability falls due. This means that the ITSA will cover each tax period in which one or more indirect tax liabilities are charged.

Which indirect tax liabilities are covered by an ITSA?

Like a TSA, an ITSA can only operate prospectively. In particular, the default joint and several liability that a member has in respect of a particular tax period will be removed only if the ITSA has been entered into before the representative member of the GST group is required to lodge the GST return with the Commissioner. For example, assuming that a particular GST group has a quarterly tax period, members of this GST group will remain jointly and severally liable for the indirect tax liabilities for s the tax period ending 30 September 2010 if the ITSA was entered into on 1 November 2010. For the liability for the tax period ending 30 September 2010 to be covered, the ITSA needs to be entered into before 28 October 2010, this being the due date for lodgement of the BAS for that the September.

Thus, corporate groups will derive more benefit if they enter into an ITSA sooner rather than later.

Due to the prospective operation of the ITSA and as the Act will only apply to tax periods on or after 1 July 2010, existing GST group members will continue to be subject to joint and several liability for tax periods before 1 July 2010.

What is a reasonable allocation?

As noted above, for an ITSA to be valid, one of the requirements is that the contribution amount for each contributing members must represent a reasonable allocation of the total amount payable for an indirect tax liability. As is the case with TSAs, the term 'reasonable allocation' is not defined in the Act. The Explanatory Memorandum to the Tax Laws Amendment (2010 GST Administration Measures No. 2) Bill 2010 (the EM) suggests that members are not restricted to adopting a methodology which allocates liability amounts for each separate indirect tax law to each member although they may do so if they so choose, provided that the allocation of the total liability is reasonable.

The EM states that the Commissioner will provide some guidance regarding his view on reasonable allocation in respect of indirect taxes.18 Subject to the release of this guidance, we would expect that the Commissioner's position will not be dissimilar to his views on what is a 'reasonable allocation' in the context of a TSA. His views are largely set out in Chapter 35 of the Receivables Policy (which is in respect of TSAs). The salient points, if they were applied in the context of an ITSA, would be:

  • the ITSA does not need to specify a 'particular amount', but rather a contribution amount that is capable of being determined; for example, through a fixed or variable percentage of the group indirect tax liability or an amount based on a 'notional' contributions to the net indirect tax payable;
  • if the ITSA does not provide for a specified sum for each contributing member, a schedule is to be produced to the Commissioner together with the ITSA, if and when required, showing the contribution amount for each contributing member as determined by the methodology specified in the ITSA;
  • an allocation methodology that results in certain contributing members having a 'nil' contribution amount could still be reasonable if the circumstance justifies it (for example, a contributing member is dormant);
  • not every member of the GST group needs to be a party to the ITSA or a contributing member, but if the excluded member(s) were the majority contributor(s) to the taxable supplies made by the GST group, then the allocation of the group's indirect tax liabilities is likely to be considered unreasonable.

Careful thought will need to be given when drafting an ITSA. An ITSA, while similar to a TSA, will need to be drafted specifically to reflect the operation of the indirect taxes covered. Accordingly, allocation methodologies will no doubt be different to allocation methodologies applicable for income tax.

The Commissioner also sets out his views as to the effect of amended assessments on the reasonableness of contribution amounts determined under a TSA. In summary, his views on this are:

  • liabilities arising from an amended assessment will affect the reasonableness of contribution amounts if they are not given effect in an appropriate way under a TSA (for example, the Commissioner states that he would not consider it unreasonable if the increased liability arising from an amendment is allocated to entities whose allocations from the original assessment were understated)19; and
  • where a TSA does not cover an amended liability, joint and several liability will apply.20

It is expected that a similar approach will be taken for indirect tax liabilities. ITSAs will not only need to cover assessments and amended assessments, but also adjustment events (as GST returns are not assessments).

Ultimately, whether there is a reasonable allocation is a matter that will be left to the courts. In McGrath & Ors as liquidator of HIH Insurance Ltd [2009] NSWSC 1244, Justice Barrett of the NSW Supreme Court considered the issue of reasonableness in the context of a tax sharing agreement. His Honour found:

… what is reasonable will no doubt be judged on a case by case basis having regard to the circumstances of the particular group and the role and activities within it of the company in question.

Issues in the Mergers & Acquisition Context

With the advent of ITSAs, acquirers of GST groups or members of GST groups will need to:

  • for the pre-1 July 2010 period or the post-1 July 2010 period where the target is a member of a GST group and an ITSA has not been entered into for any period, obtain specific tax warranties and indemnities for indirect tax liabilities as joint and several liability will apply; and
  • for the post-1 July 2010 period if the target is a member of a GST group and is a party to an ITSA:
    • obtain specific tax warranties and indemnities in respect of the target's share of indirect tax liabilities for tax periods prior to the leaving time on the basis that the vendor warrants the ITSA is valid;
    • obtain specific tax warranties and indemnities in respect of the target's potential exposure if the vendor will not warrant the validity of the ITSA and it is later found to be invalid; or
    • obtain a clear exit in respect of indirect tax liabilities in respect of the tax period(s) whereby GST returns have yet to fall due.

As is the case with consolidated groups, purchasers will be looking to reduce their exposure to group liabilities and will therefore be expecting that ITSAs will have been entered into and that these ITSAs comply with the legislative requirements to ensure their validity.

In the case of GST joint ventures, the participants in the joint venture will no doubt require an ITSA to be in place for the reason that in most joint ventures, the participants are unrelated entities and accordingly participants will want to reduce their exposure to the other participants' share of indirect tax liabilities.

Conclusion

Like with TSAs, directors of members of GST groups and joint ventures must consider their director's duties under the Corporations Act 2001 (Cth) before entering into an ITSA. They may also need to review finance and security documentation in respect of any covenants agreed to before entering into an ITSA.


1 Act No. 74 of 2010.
2 Since the commencement of the income tax consolidation regime in 2002, members of an income tax consolidated group or multi-entry consolidated (MEC) group (together, consolidated groups) can enter into a TSA, and if valid, the operation of the provisions which make each member of the group or joint venture them jointly and severally liable for the group's various income tax liabilities will not apply.
3 This is currently provided in subsection 444-90(1) of Schedule 1 of the TAA and prior to 1 July 2006 was provided for in former section 53 of the TAA.
4 Paragraph 7.1.40 of the report and Recommendation 32.
5 Issued by the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs.
6 Tax funding agreements are entered into to ensure, among other things, that corporate groups can comply with the accounting treatment of group liabilities as amongst corporate group members for the purposes of Urgent Issues Group Interpretation 1052, an interpretation of accounting standard AASB 112 (Income Taxes).
7 This will not include Shortfall Interest Charge which is only levied in respect of income tax, petroleum resource rent tax and excess contributions tax.
8 Subdivisions 16-A (for GST Groups) and 16-B (for GST Joint Ventures) of A New Tax System (Luxury Car Tax) Act 1999 and Subdivision 21-B (for GST Groups) and Subdivision 21-C (for GST Joint Ventures) of A New Tax System (Wine Equalisation Tax) Act 1999 and section 70-5 of the Fuel Tax Act 2006.
9 Subsection 444-90(2) of Schedule 1 of the TAA.
10 For GST joint ventures, the provision is subsection 444-80(1A) to (1E) of Schedule 1 of the TAA.
11 Paragraph 164 of the Receivables Policy.
12 Paragraph 188 of the Receivables Policy.
13 Subsection 444-90(1B) of Schedule 1 of the TAA.
14 Subsection 444-90(1C) of Schedule 1 of the TAA.
15 Version dated 24 July 2008.
16 Paragraph 74 of the Receivables Policy.
17 Subsection 444-90(1E) of Schedule 1 of the TAA.
18 Paragraph 1.61 of the EM.
19 Paragraph 188 of the Receivables Policy.
20 Paragraph 185 of the Receivables Policy.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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