The current formula has the effect of diluting the value of supplies made to other financial services providers and correspondingly reduces the amount that should otherwise be deductible. This outcome is inconsistent with the policy intent.
The change applies from 1 January 2005, the date that section 20C first had effect.
Section 20C is being changed by defining element “c” of the formula so that it refers to exempt supplies of financial services, rather than to total supplies, made by the supplier.
In 2005, changes were made to the GST Act which zero-rated certain business-to-business supplies of financial services by introducing new sections 11A(1)(q) and (r). The changes allowed suppliers of financial services to claim input tax deductions when previously such supplies were treated as exempt from GST (and no input tax deductions were allowed). The 2005 changes were designed to remove economic distortions such as “tax cascades”, a phenomenon that occurs when irrecoverable GST connected with making exempt supplies is passed on by a supplier to another GST-registered person who makes taxable supplies and so on.
Financial services supplied between financial services providers (such as banks) cannot generally be zero-rated because most recipient financial services providers (“the direct supplier” in section 20C) will not satisfy the requirements under sections 11A(1)(q) and (r). Financial services providers are therefore unable to deduct input tax in connection with these transactions because they are exempt from GST.
The deduction calculated by the formula in section 20C replaces the denied input tax deduction, to the extent that the direct supplier makes supplies to taxable businesses. It therefore reduces the possibility of tax cascades arising if the financial services are on-supplied by the direct supplier to taxable businesses.
The amount deductible is the product of the formula:
The formula is based on two fractions which measure the mix of taxable and exempt supplies made by the supplier and the direct supplier in a taxable period. The product of the two fractions is applied to the amount of input tax that is unclaimed by the supplier for the taxable period.
The proposed amendment to the formula ensures that it produces a result that is consistent with the original policy intent. The amendment changes the denominator in the first fraction (element “c”) so that it is defined by reference to the amount of total exempt supplies of financial services made by the supplier rather than its current reference to total supplies, which has the effect of reducing the amount that should otherwise be deducted.
a is the total amount in respect of the taxable period that the registered person–
(a) would not be able to deduct under section 20(3); and
(b) would be able to deduct under section 20(3),other than under section 20(3)(h), if all supplies of financial services by the financial services provider were taxable supplies:
b is the total value of exempt supplies of financial services made to the direct supplier in respect of the taxable period:
c is the total value of supplies made in respect of the taxable period:
d is the total value of taxable supplies made by the direct supplier in respect of the taxable period as determined under section 20D:
e is the total value of supplies made by the direct supplier in respect of the taxable period as determined under section 20D