In the absence of clarifying amendments to the GST legislation there are three possible GST treatments of hire purchase agreements.
Businesses wishing to buy a motor vehicle by finance will usually either lease the asset or purchase it via hire purchase. The GST treatment of leases has been discussed in previous issues of GST Today. Here we discuss the possible GST treatment of hire purchase agreements. Unfortunately, the application of GST to hire purchase agreements is not a simple matter. The very nature of hire purchase agreements makes that so. Moreover, the GST legislation is largely silent on how hire purchase agreements are to be treated for GST purposes. And where it does comment on hire purchase agreements the legislation sends conflicting messages.
The ATO attempts to overcome this uncertainty by positing in draft GSTR 1999/D7 a deemed approach to the GST treatment of hire purchase agreements. Unfortunately this deemed approach has no basis in legislation. Moreover, the arguments given in support of it are unconvincing and lacking in intellectual rigour. It is therefore unlikely to be correct. In the absence of amendments to the GST legislation clarifying the treatment of hire purchase agreements there are three possible GST treatments of hire purchase agreements. In this article we explain the circumstances in which each of these treatments may be applied.
What are hire purchase agreements? From a consumer's perspective hire purchase agreements can be seen as just another form of finance or instalment purchase contract. Like instalment payment contracts, such as lay-by sales, they involve the purchase of goods via the payment of instalments with legal title being retained by the vendor until receipt of the final instalment. However, hire purchase agreements are different from lay-by sales in two critical respects:
- Possession of the goods is not retained by the vendor until the hire purchase agreement is concluded. Instead, the purchaser has the right to use the goods throughout the period of the hire purchase contract. In this respect hire purchase agreements are more like leases than lay-by sales.
- They involve a financier. The financier purchases the goods from the original vendor immediately prior to, or at, the outset of the hire purchase contract. The purchaser then purchases the goods by paying instalments to the financier rather than the original vendor.
These differences mean that payments made under a hire purchase agreement can be conceptually analysed in three different ways. First, the payments could be regarded as simple instalment purchase payments. These will comprise a capital component or a capital and interest component. The capital component relates to the purchase of the goods. Where it includes an interest component this is intended to compensate the vendor for selling the goods via hire purchase rather than a simple sale. This analysis emphasises the similarities between lay-by and hire purchase sales.
Second, the payments could be regarded as comprising a capital and hire component. The capital component is that part of the payment that relates to the instalment purchase of the asset. The hire component relates to the use of the asset during the hire purchase agreement. This approach emphasises the hire or lease like nature of hire purchase sales.
Third, the hire purchase arrangement could be regarded as an in-substance sale and loan arrangement. This approach emphasises the involvement of the financier. Financiers always require a return on their investment via the payment of interest and/or other charges. This view therefore posits that there is no economic difference between the financier purchasing the goods and:
- the consumer then purchasing the goods in instalments which presumably would include an interest element; or
- immediately selling them to the purchaser, the goods being purchased via a notional debt which is then repaid in instalments. Again the instalments will include a capital, or in this case debt, repayment and interest element.
As there is no economic difference between the two, this view considers that hire purchase agreements should be analysed according to their economic substance in preference to their legal form. Before leaving this issue it should be noted that hire purchase agreements can be structured so that at the conclusion of the agreement the asset is transferred to the purchaser either:
- automatically upon receipt of the last payment; or
- upon the exercise of an option by the purchaser after or at the same time as making the last payment.
This difference in structure is recognised in the proposed definition of hire purchase agreements to be inserted in the income tax legislation. The former structure is associated, in the words of that definition, with the "purchase of goods by instalments" and the latter with the "hire of goods". The ATO uses this definition for its discussion of hire purchase agreements in draft GSTR 1999/D7.
What is the GST conceptual analysis of hire purchase agreements?
A GST analysis of a transaction always commences by identifying the supply or supplies being made and by whom. The GST consequences of a transaction will then generally fall out of this identification. For example, if it is a taxable supply then there will be a GST liability on the supply and that liability will be accounted for according to the attribution rules used by the supplier. Alternatively, if it is an input taxed supply then there will be no GST liability, but the supplier will have to take account of this supply when determining its ability to claim input tax credits on its expenses. The correct identification of the supply or supplies being made is therefore critical. In the case of hire purchase agreements this task is complicated by:
- the hire purchase agreement's multi-faceted character; and
- a tendency to analyse hire purchase agreements from the perspective of "the payment" rather than "the supply" or supplies being made. This tendency is evident in draft GSTR 1999/D7, where the ATO refers to the treatment of "a separate credit charge" rather than the provision of credit the charges for which are separately identified.
As noted, a hire purchase agreement can be analysed in at least three ways. Depending upon the analysis used, different supplies will be identified. It is therefore important to examine the GST legislation, assisted by the accompanying explanatory memoranda, to ascertain which approach the legislation uses.
The GST legislation therefore does not give any universal rule as to precisely what supplies are made under hire purchase agreements. Rather this would seem to depend upon the structure of a particular hire purchase agreement.
Unfortunately, this does not provide much help. Moreover, the indications are confusing. The only reference to hire purchase in the GST Act, albeit via the regulations, is to hire purchase agreements which involve the provision of "credit" and disclose it as a separate charge. This could imply that the GST Act does not adopt the second approach. Item 8 of regulation 40-13(2) refers to the provision of credit and not to the hire of the goods. But, on the other hand item 8 only refers to hire purchase agreements where the provision of credit is separately identified and disclosed. The language used is very clear and specific. It does not deal with other types of hire purchase agreements, such as where a credit charge is not separately identified or where it is structured as a hire and option agreement (per the ATO definition). Section 11 of the GST Transition Act also refers to hire purchase agreements. Section 11 serves to deem rights, such as options, which are exercised after 30 June 2000 to be supplies made after 30 June (and hence potentially subject to GST) where this was reasonably expected. However, section 11 is specifically stated as not applying to "an option to purchase, under a hire purchase agreement, goods hired under that agreement". Section 11 of the GST Transition Act therefore clearly implies that the second approach (or "hire plus option" per the ATO definition) is to be used where hire purchase agreements are structured in that manner. However, section 11 would equally not apply where the hire purchase agreement was structured as an instalment purchase agreement (per the ATO definition).
The GST legislation therefore does not give any universal rule as to precisely what supplies are made under hire purchase agreements. Rather, this would seem to depend upon the structure of a particular hire purchase agreement. This in turn will depend upon which of hire purchase's many facets the agreement emphasises, whether it be hire or instalment purchase. The net result is that different hire purchase agreements will involve different supplies and, accordingly, different GST consequences will attach to different hire purchase agreements. The ATO, however, takes a contrary view.
What is the ATO's GST treatment of hire purchase agreements?
The ATO considers that all hire purchase agreements are "to be regarded as a sale of goods". The ATO believes that this is the only supply made under a hire purchase agreement, subject to the existence of any separate credit charge.
The ATO not only considers hire purchase agreements to be nothing more than sales of goods, but it also presumes that those sales will always be taxable supplies. However, that will not always be the case. Under the legislation where the supply of the sale of goods is made for:
- in the course or furtherance of an enterprise;
- by a supplier who is registered or required to be registered; and
- is connected with Australia it will be a taxable supply and the supplier will have a GST liability on the "sale".
But if the subject matter or other attribute of the sale makes it a GST-free or an input taxed supply then it will not be a taxable supply. A good example is the sale of a motor car. Usually the sale of a car will be a taxable supply. But, if the car is sold to a disabled Vietnam veteran or certain other disabled persons it will not be a taxable supply. In that case it will be a GST-free supply by virtue of Subdivision 38-P of the GST Act. This analysis will hold true regardless of whether that sale is an actual sale or a hire purchase agreement which the ATO regards as a sale.
Input taxed supply
The ATO states that where there is a separate credit charge then that credit charge may be input taxed. Correctly speaking, where there is a provision of credit under a hire purchase agreement under item 8 of regulation 40-13(2) that supply will be a financial supply. Financial supplies are input taxed supplies. GSTR 1999/D7 presumes that only the separately identified credit charge component of a hire purchase payment is input taxed and not the entire payment. This is because it treats the remainder of the payment as relating to a taxable supply. If this is correct then two practical implications follow:
- Financiers will be encouraged to provide credit to customers wishing to acquire assets via hire purchase agreements rather than personal loans or other forms of credit. This is because, under the ATO view, they will only have to use the amount of "the credit charge" when determining the value of their input taxed supplies (as an initial step when calculating their input tax credit entitlement). However, if a personal loan were instead extended then the financier would have to use the total amount of "the loan" when determining the value of their input taxed supplies. Therefore, by lending via hire purchase, financiers will be able to lower the amount of their input taxed supplies and thereby claim more input tax credits on their expenses.
- Businesses purchasing assets will not be able to claim input tax credits on that part of hire purchase payments that relate to this separately identified credit charge.
Timing of GST liabilities and input tax credit entitlements
The ATO considers that the sale, which is the taxable supply under a hire purchase agreement, is made at the commencement of the hire purchase agreement. Like lay-by or other instalment purchase sales it does not consider the instalment nature of these sales to be significant. Therefore the ATO considers that the GST liability or input tax credit entitlement on a hire purchase agreement will be attributed under the general attribution rules:
- for accruals basis suppliers, to the first period in which it receives a payment or issues a tax invoice. Their GST liability arising at that time will be calculated on the total value of all the payments to be received over the term of the hire purchase agreement less any separately identified credit charge components;
- for accruals basis purchasers, to the first GST period in which it makes a payment or receives a tax invoice. Their input tax credit entitlement arising at that time will be calculated on the total value of all the payments to be made over the term of the hire purchase agreement less any separately identified credit charge components;
- for cash basis suppliers, as and when payments are received. Their total GST liability arising at that time will be calculated solely on the payments received in that GST period;
- for cash basis purchasers, as and when payments are made. Their total input tax credit entitlement arising at that time will be calculated solely on the payments made in that GST period.
Problems with the ATO approach
There are three basic problems with the ATO's approach:
- it has little, if any, foundation in the GST legislation;
- it is not supported by the reasons put forward by the ATO to justify the approach; and
- it is conceptually confused.
Lack of legislative foundation
The whole foundation of the ATO's approach is the deeming of a hire purchase agreement to be a supply by way of sale. Moreover, it deems it to be a single taxable supply, unless a part of the hire purchase payments relates to a separate credit charge. In that case a rather unusual input taxed supply is also made. However, the legislation does not at any point deem a hire purchase agreement to be a sale. GST consequences attach to actual, not deemed supplies, unless the GST legislation specifically deems a supply to have been made. An example of a deemed taxable supply contained in the legislation is the purchase of second hand goods under Division 66 of the GST Act. The most that the legislation says is that:
- where there is a provision of credit under a hire purchase agreement and a separate charge for that credit is identified then that provision will be an input taxed supply; and
- where a hire purchase agreement is a hire of goods with an option to purchase after 30 June 2000 then the exercise of that option after 30 June 2000 will not be a taxable supply.
Neither point supports or enables the ATO to deem a hire purchase contract to be a single taxable supply. Moreover, the second point directly contradicts the ATO's approach. Section 11(1A) of the GST Transition Act applies in its words to options under hire purchase agreements to purchase "goods hired under that agreement". That is, the section specifically contemplates that a hire purchase agreement involves the supply of hire of goods. Nevertheless, and in total contrast to the legislation, the ATO expressly states that hire purchase agreements should not be considered to involve the hire of goods. Its stated reason is that to do so would be "inconsistent with the policy intentions... and would produce unintended outcomes under the GST Transition Act". That GST Transition Act being the very same GST Transition Act which specifically contemplates a hire purchase agreement as involving the hire of goods. This direct contradiction strongly suggests that the ATO started with a pre-conceived approach to hire purchase agreements and then tried to fashion an interpretation of the legislation to suit that preconception. If so, then the ATO's approach is clearly wrong.
Lack of supporting reasons
The ATO puts forward three reasons to justify its approach. The first reason put forward is that it is "apparent that [it is] the policy intent". As earlier discussed in the article it is in fact not certain whether there is any clear policy intent in respect of hire purchase agreements. And to the extent that it is clear, it directly contradicts the ATO's approach. The second reason put forward is that this approach is consistent with the proposed income tax and present accounting and commercial treatments. While consistency with these treatments is desirable it does not determine the GST treatment. Furthermore, that proposed income tax treatment will only be achieved by the introduction of a complex set of deeming provisions into the income tax legislation. Precisely the type of deeming provisions which are so noticeably absent in the GST legislation. Furthermore, the stated motivation for those provisions (per their accompanying EM) is to prevent taxpayers from obtaining deductions greater than their outlay on assets acquired under hire purchase or limited recourse debt.
The ATO has not indicated that it has any anti-avoidance concerns with regards to the GST treatment of hire purchase agreements. The comparison, at least with regards to the income tax treatment, is therefore spurious and misleading. The third reason put forward is that other countries "typically account for GST or VAT on hire purchase agreements on the date of entry into the agreement". On its own this is a meaningless statement, as evidenced by the ATO having no difficulty in ignoring what other countries do when concluding how Australian businesses should account for GST or VAT on lay-by sales.
A conceptually confused approach
As mentioned earlier there are three basic ways to analyse a hire purchase agreement conceptually. Each method emphasises a different dimension of hire purchase's multi-faceted character. The first approach emphasises the instalment purchase dimension. The second emphasises its hire dimension. And the third emphasises the involvement of a financier in the transaction.
The ATO ostensibly uses the third approach, namely that hire purchase agreements are in reality nothing other than sale and loan arrangements. This is the proposed approach for income tax and as noted this is one of the ATO's justifications for using the approach for GST. Unfortunately, the ATO doesn't fully apply this approach. Rather, it takes the first step and treats a hire purchase agreement as a sale, but then effectively ignores the loan part of the analysis. By doing so, the ATO fails to identify adequately the consideration that relates to each supply. And by failing to do so it:
- reaches different conclusions to those logically implied by this economic equivalence approach; and
- creates distortions, such as the introduction of a bias towards lending to customers (who wish to buy assets) via hire purchase agreements rather than personal loans or other debt arrangements.
A deemed "sale and loan" approach implies two deemed supplies. The first deemed supply is the sale of the asset, the second is the extension of the loan to the purchaser so that it can acquire the asset. Supplies only have GST consequences where they are made for consideration. The consideration for the first deemed supply would be the debt or IOU from the purchaser. The consideration for the second supply would be the credit charges included within the hire purchase payments. Following this through, if a hire purchase agreement were to be deemed a sale and loan then:
- the hire purchase payments will comprise two components: a debt repayment component and credit charge component. Therefore the purchaser would not be able to claim input tax credits on any part of the payments. This is because it wholly relates to an input taxed supply; and
- both accruals basis and cash basis businesses will be liable to GST or entitled to claim input tax credits on the entire sale price at the outset of the hire purchase agreement. This is because the consideration given for the sale is the IOU and this is given by both accruals and cash basis purchasers at that time.
However, as discussed the application of a deemed sale and loan, either as applied by the ATO or as applied above, has no basis in the GST legislation.
Other possible GST treatments of hire purchase agreements
Given the present GST legislation, a more logical approach is to recognise that hire purchase agreements have many different facets and not to try to fit them all into one deemed straitjacket. The GST treatment of any one particular hire purchase agreement should be determined by the actual supplies made under that agreement. This would be determined by a review of the agreement.
The ATO's own definition of a hire purchase agreement recognises that these agreements can take two forms. The first is where it is a contract for hire together with some form of right, such as an option, for the hirer to acquire the goods upon completion of the contract. The second is where the agreement is an instalment purchase contract. The three possible GST treatments of hire purchase agreements are therefore where they are contracts for:
- the hire of goods with a purchase option;
- the instalment purchase of goods (without a separately identified and disclosed credit charge); and
- a financial supply.
Hire of goods with purchase option
Where a hire purchase agreement is structured as a hire agreement with an option to purchase there would be three supplies:
- the initial supply of the option;
- the hire of goods; and
- the supply of the goods upon the exercise option.
The supply of the use of the goods will be a taxable supply. However, as the use of the goods is a progressive supply, accruals basis businesses will be liable for GST or entitled to claim input tax credits on the hire effectively as the payments fall due. Whether either the initial supply of the option or the supply of the goods upon exercise of the option will have GST consequences will depend upon whether any part of the payments relate to these supplies. If they do then they will be taxable supplies and the normal attribution rules will apply. If not then these supplies will be outside the GST net and they will have no GST consequences. Allocation of the payments against the three supplies would be determined by the agreement, unless there was an anti-avoidance purpose in which case the ATO could apply the anti-avoidance rules.
Instalment purchase (without separately identified credit charge)
This would involve either one or two supplies depending upon which view of instalment purchase contracts one takes. Where the ATO view is applied the GST liability or input tax credit entitlement for accruals basis businesses will, broadly speaking, arise at the outset of the hire purchase agreement. That liability will be calculated on the sum of all the payments to be made under the agreement. A cash basis business will account for its GST liability or input tax credit entitlement, again broadly speaking, on a payment by payment basis. Where the alternative view is applied then the GST liability of input tax credit entitlement for both accruals basis or cash basis taxpayers will not arise until the conclusion of the hire purchase agreement.
Where under regulation 40-13 there is a "provision... of an interest... [in] credit under a hire purchase agreement" and the charge for that credit is separately identified and disclosed then that supply will be an input taxed supply. In this case neither party to the transaction will have a GST liability or input tax credit entitlement in respect of any of the payments. Presumably, as all of the payments under the agreement relate to either the credit charge or repayment of the credit provided, the actual supply of the goods will not be a taxable supply. This is because it will not have been made for consideration. It should be noted that this provision does not deem there to be a loan in this circumstance. All it says is that where there is a provision of credit that is separately identified and charged for under a hire purchase agreement then that provision will be a financial supply. It is therefore unclear how many hire purchase contracts would therefore be treated in this manner.
As mentioned at the outset of this article the GST treatment of hire purchase is not a simple matter. In fact, it is bedevilled by uncertainties. Those uncertainties are largely a function of the nature of hire purchase agreements and the absence in the GST legislation of a clear and consistent approach to the treatment of hire purchase agreements. In that absence the alternative methods mentioned above provide a logical approach to analyse the GST consequences of hire purchase agreements. Whilst the existence of three different approaches may not be the most desirable outcome, it is at least, unlike the ATO's approach, consistent with the present legislation.
Subsequent legislative and regulatory changes may have impacted upon the subject matter of this article. Paul Stacey BA LLB ACA Technical Editor - GSToday ATP - GST February 2000