GST and mergers and acquisitions: the Australian Taxation Office takes aim

Key point: The Australian Taxation Office will be scrutinising arrangements used to increase the recovery of GST incurred in mergers and acquisitions.

The Australian Taxation Office (ATO) has announced that it intends to target arrangements used to increase the recovery of GST incurred in M&A transactions. It has indicated that will consider challenging these arrangements under the anti-avoidance provisions, and is also considering actions against entities that have promoted these arrangements under the new promoter penalty regime.

The ATO's announcement was set out in a Taxpayer Alert (TA 2010/1). This specifically addresses arrangements involving the interposition of associate entities to "create or enhance" entitlements to reduced input tax credits (RITCs) for an entities making "financial supplies" as part of a "company takeover" (a float, merger or acquisition).

It appears that the ATO's focus will be on whether there is substance to the arrangements and whether or not there is a legitimate commercial rationale for the arrangements. The absence of commercial purpose may be one of the factors that the ATO utilises in seeking to apply the general anti-avoidance provisions.

Broadly, the arrangements addressed by TA 2010/1 have the following (or substantially similar) features:

• An special purpose vehicle (Bid Co) is established for the purposes of acquiring shares in a company (a transaction that would be a financial supply and input taxed. This means that Bid Co, would ordinarily be restricted in its ability to claim input tax credits for transaction costs associated with the transaction).
• A related company (often newly formed), Facilitation Co, enters into an agreement, commonly known as a "facilitation agreement", pursuant to which Facilitation Co agrees to provide services to "arrange" the SPV's acquisition of shares.
• Under the facilitation agreement, Facilitation Co undertakes to acquire various services (eg. tax, legal and investment banking services, etc.) from third party service providers. Facilitation Co claims full input tax credits for the GST charged by the third party service providers.
• Facilitation Co charges BidCo a fee plus GST for its services under the facilitation agreement. The fee charged is calculated by reference to the costs incurred by Facilitation Co in engaging the third party service providers.
• BidCo claims an RITC equal to 75 percent of the GST charged by Facilitation Co on the basis that the services provided by the associate qualify as a "reduced credit acquisition" under the GST Regulations.

Had BidCo acquired services directly from the third party service providers, it generally would only have been entitled to claim a lesser amount of RITCs for the GST charged, and in some cases would not have been able to claim any input tax credits at all.

Taxpayers who have entered into such arrangements should carefully examine their circumstances. Any companies considering using these arrangements in the future should approach these arrangements with caution. The ATO is increasing its audit activities in this area and will look to impose significant penalties if the ATO is able to successfully change the arrangements.