On 17 January 2012 I posted about the proposed changes to the GST regulations dealing with supplies to trusts.  Also included in those Exposure Draft regulations (link) was the final piece of the puzzle for the substantial amendments to the GST rules for hire purchase (or “CHP”) transactions, to come into force from 1 July 2012.

This proposed regulatory change is coupled with the earlier Tax Laws Amendment (2011 Measures No.9) Bill 2011 currently before Parliament (link) intended to allow cash-based taxpayers (generally those with annual turnover of less than $2 million) to claim the input tax credits upfront on hire purchase transactions (currently they can only claim input tax credits progressively with each instalment). This is achieved by a legislative change that, for hire purchase transactions only, a cash-based taxpayer is able to claim input tax credits on a non-cash (or accruals) basis. Cash-based taxpayers had tended to turn to chattel mortgages since the GST was introduced, so this cash flow change may then cause a swing back to hire purchase financing for smaller businesses.

The proposed changes to the GST regulations in the recent Exposure Draft are intended to make the separately disclosed credit component of a hire purchase transaction taxable rather than input taxed. The interest and other finance charges (eg fees, and recovery of some types of costs) will therefore become subject to GST, by being specifically excluded from being input taxed financial supplies.

The draft legislation still appears to treat the credit component as a separate supply to the sale of the asset, and an interesting issue that then arises is the GST treatment of a credit supply for a hire purchase of GST-free goods (eg medical equipment). Is the credit supply also GST-free?

The GST on the separate credit supply will be attributable upfront, so that the 10% GST on the total expected interest and other finance charges over the term will be attributable (for both the financier and customer) to the first tax period in which any invoice is issued or payment is made (whichever is earlier) for that credit supply. The GST on the supply of the asset (the principal) will also be attributed upfront. The GST on ongoing independent services, such as maintenance of the asset, will however be likely to continue to be attributed to tax periods progressively over the term.

There are clearly cash flow and quoting implications for the financier. Typically financiers already include the GST component of the principal in the amount financed, and they may in future also finance the GST component of the credit charges. This then gives rise to GST on interest, then interest on GST, then GST on interest… and so on. It is expected that the GST calculation on these iterations will be allowed to be rounded in some way. Alternatively, instead of funding the GST, the financier could require payment by the customer of the full GST amount on the credit component upfront.

A further effect of the amendments will be on GST adjustments arising for both the financier and the customer on termination of a hire purchase agreement. Where GST is accounted for upfront and a hire purchase agreement is terminated, Division 19 GST adjustments will arise where the consideration for the upfront supplies has changed, along with Division 21 bad debt adjustments for instalments in arrears written off or overdue for 12 months. Currently these GST adjustments only apply to the principal component, but in future they will also apply to the taxable credit component.

In addition to a termination, any variation or refinancing which has the effect of changing the interest or fees to be received by the financier will also give rise to a GST adjustment on that credit supply for both the financier and the customer, eg where the term is extended or the contract is paid out early.

Financiers will need to develop methods to calculate and process these GST adjustments which they can claim from the ATO, and issue adjustment notes to their customers where required.  The customers may then be required to repay to the ATO a portion of the input tax credits previously claimed.

As with any tax law change the transitional rules will also be important. It would obviously be unreasonable for the law changes to apply to agreements already in existence. The proposed amendments will not apply to an agreement entered into before 1 July 2012 unless there is some variation or amendment that results in a new agreement. Financiers will have to look closely at whether particular types of variations or amendments do in fact result in a new agreement. When an agreement was actually entered into will also need to be considered carefully in respect of transactions close to 1 July 2012 and in respect of conditional contracts. The previous experience of dealing with the transitional rules for pre 1 July 2000 agreements may be of relevance.

There are clearly also input tax credit recovery implications for financiers on overhead costs due to the finance charges becoming taxable (and therefore creditable). Interesting issues may arise for post 1 July 2012 apportionment methods while pre 1 July 2012 hire purchase agreements are still in existence. What (if any) ongoing acquisitions will continue to relate to making input taxed financial supplies?

Where the asset financed is a luxury car, the Explanatory Memorandum to the Exposure Draft regulations confirms that in determining whether the Luxury Car Tax (LCT) threshold is exceeded you only look at the GST-inclusive price of the car, and not to the credit charges, recognising that the credit is a separate supply. The input tax credit recovery restriction for a luxury car will also only apply to the principal component.

Cash-based customers will in particular welcome the new rules. The change to making the credit supply taxable was supposed to simplify the GST treatment of hire purchase transactions, but at least in the transitioning to the new rules there will be considerable extra work for financiers to do to have systems and processes in place to correctly account for GST and process adjustments, and to prepare quotes and documentation to their customers. While it may be a few months until the Act is actually passed and the regulations made, with less than 5 months until the proposed changes come into force financiers need to be considering the implications now.