04 February 2005
The honeymoon is over. GST & long-term non-reviewable contracts.
Supplies made under certain long-term contracts signed before the introduction of the GST with no price review opportunity are currently GST-free pursuant to A New Tax System (Goods and Services Tax Transition) Act 1999.
The transitional relief was implemented to ensure that suppliers with no opportunity to recover the GST cost from their recipient customers under long term contracts were not disadvantaged. Typically these are long term leases but other kinds of long term supply contracts are also affected. Transitional relief comes to an end on 30 June 2005. This date has always loomed as a problem for suppliers who have no right to recover GST under their contracts.
Shortly after the GST was introduced the Government promised to address this. Parliament has now passed the Tax Laws Amendment (Long-term Non-reviewable Contracts) Bill 2004. The new law is currently awaiting Royal Assent.
Policy underlying the changes
Many suppliers would prefer the Government simply to extend the transitional relief from 1 July 2005. However the Government has decided on an approach to "normalise" long term contracts by bringing them into the GST system in one way or another. The resulting scheme is designed to afford an equitable outcome to suppliers and recipients but it is complex and businesses will incur significant compliance costs.
Overview of new measures
The new legislation introduces an opportunity for suppliers to negotiate an increase in the price with their recipient customers in order effectively to "pass on" the GST imposed from 1 July 2005 to the customers, but also taking into account the GST and accompanying tax reforms. If a supplier cannot reach an agreement with a recipient through voluntary negotiation, the supplier must comply with a prescribed arbitrated offer procedure.
If the recipient rejects the arbitrated offer then the recipient becomes liable to pay the GST to the ATO instead of the supplier. The new legislation introduces a "reverse charge" mechanism, which effectively shifts the GST burden to the recipient. This can even apply to a recipient who ordinarily would not be required to report for GST. The GST liability can also shift to the recipient voluntarily where the recipient elects to pay the GST. Whether the recipient gets an input credit for this "recipient GST" is determined according to the usual criteria.
The arbitration process
Where the parties cannot agree on a price adjustment to take account of GST and related tax changes, the supplier must follow the prescribed timeframe and procedures in order either to increase the price, or shift the liability for GST to the recipient.
The supplier is required to make an initial offer to the recipient to increase the contract price. This initial offer must remain open for at least 28 days before the supplier is entitled to begin the arbitration process. The supplier can then apply for an arbitrator to appoint an assessor who determines an "appropriate price change".
In determining the "appropriate price change" the assessor must consider the impact of the New Tax System changes (as defined in the Trade Practices Act) on the supplier's costs and expenses. The Government expects that the price change will leave the same net dollar margin to the supplier.
The assessor must make a determination of an appropriate price within 28 days from the end of the initial offer period. The supplier makes a final arbitrated offer using the assessor's determination of an appropriate price change. The final offer must remain open for at least 21 days.
Many details of the arbitration process are still unclear. It is uncertain who will be required to bear costs in relation to the arbitration process. It is also not clear whether either party will have any rights to appeal the assessor's determination.
The new law will not apply where the contract contains express provisions disallowing any price increase for GST.
What action should be taken
Suppliers must first ascertain whether they are party to contracts that currently take advantage of transitional relief. Suppliers need to be aware that transitional relief ceases on 30 June 2005.
Suppliers will need to conclude negotiations with recipients or conclude the arbitrated offer process by then or be out of pocket (for unrecoupable GST) from 1 July, 2005. There may well be practical difficulties in concluding the offer and arbitration process in time for this deadline.
The negotiation process will require a commercial evaluation of the contract and the commercial and GST impacts for both the supplier and recipient. This will be a case by case analysis.
The impact of State taxes may also be relevant. For example, a change to price may attract higher State duties, but if the recipient elects to pay GST without changing price, that may be avoided.
Author: Oliver Shtein