The Full Federal Court's decision in Commissioner of Taxation v Luxottica Retail Australia Pty Ltd [2011] FCAFC 20 (23 February 2011) provides greater certainty for commercial parties in structuring their arrangements and in determining the GST consequences of their transactions.
The decision confirms that the courts prefer to characterise transactions for GST purposes in accordance the terms actually agreed between commercial parties dealing at arm's length, rather than a more "substantive" approach which recharacterises that agreement.
It also gives valuable guidance on how section 9-80 of the GST Act works to determine the amount of GST payable on a supply (referred to as the "actual supply") which has both a taxable and a non-taxable component being sold for a single undivided price.
The glasses, the lenses, and the taxable and non-taxable components of a supply - what GST is payable?
Supplies with taxable and non-taxable components often arise in promotional campaigns – for example, one product (such as a taxable coffee cup) is "sold" or "given away" along with another product (such as a GST-free bottle of instant coffee).
In the Luxottica case, the Court had to deal with the common scenario of purchasing a pair of spectacles – involving the selection and purchase of some frames (a taxable supply) and the preparation and sale of prescription lenses to be inserted into those frames (a GST-free supply).
The supplier offered a range of promotions on the frames – discounting the frames by up to 50% in some cases. No discount was offered in relation to the price of the lenses. However, the discount was only available on the frames when they were purchased in conjunction with the lenses.
Both the Commissioner and the taxpayer accepted that there was one supply – a supply of the spectacles – for the one undissected price which was calculated after allowing for the relevant discount. Where the Commissioner and the taxpayer diverged was in relation to calculating the GST on the single supply.
The Commissioner required the taxpayer to apply the monetary discount against the combined supply of the lenses and the frames. By contrast, the taxpayer sought to apply the monetary discount only against the taxable supply of the frames. Naturally, the Commissioner's approach required the payment of more GST because the monetary discount was "shared" between the taxable supply of the frames and the GST-free supply of the lenses.
The approach taken by the Commissioner was logical – the discount was only available when the purchaser bought lenses as well as frames and so therefore, the discount needed to be applied to the whole supply. The discount would not have been available if the items had have been purchased separately.
The approach taken by the taxpayer was equally logical – the parties agreed that the discount was applicable to the frames only. The factual pre-condition for eligibility for the discount was the purchase of lenses, but this did not detract from the agreement between the parties that the monetary discount was a function of the price of the frames and independent of the price of the lenses.
The circularity of section 9-80
The Court spent a great deal of time considering the drafting – and even the mathematical integrity – of section 9-80 of the GST Act.
In a rather unique approach to statutory interpretation, the Court sought to "[strip] away the verbiage in the Act" and reduce section 9-80's operation to a mathematical equation – which clearly disclosed the fact that its operation required one to "solve an equation in two unknowns", which of course cannot be done. As such, the Court agreed with the initial finding of the AAT that the provision is "impenetrably circular".
Notwithstanding this circularity, the section's purpose was clear to the Court – it was there to enable the calculation of the taxable component of a supply involving taxable and non-taxable components. Both the Commissioner and the Taxpayer had a similar way of making section 9-80 work.
Really just a question of fact
In the end, the Court held that the determination of the value of anything – including a supply – will be a question of fact and not of law. However, it will be an error of law if a statutory valuation method is misapplied.
In the present case, the Tribunal had found that as a matter of fact, the "discount offered should be applied to the price of the frames rather than the lenses." Again, as a matter of fact, the Tribunal had found that "the fact that the discounted price was condition on the purchase of the lenses 'does not undermine the reasonableness of the calculation of the taxable proportion in this way'".
The taxable proportion determined by the Tribunal was applied by the Tribunal in resolving the circularity in section 9-80 in the same manner that was proposed by the Commissioner and the taxpayer. Therefore, the Court held that the Commissioner had failed to demonstrate any error of law in the approach taken by the AAT and therefore, the Commissioner's appeal to the Full Federal Court must fail.
Implications
The case is important for two reasons. First, although section 9-80 is "impenetrably circular" it can be made to work and should be made to work in order to give effect to its evident purpose.
Secondly, in making the provision work, the Court appears to have agreed with the taxpayer's submission that it is the "agreed price" for the taxable component of the supply that should form the basis of the calculation. This will allow resolution of the circularity.
However, there is perhaps a broader significance in this second point. It again demonstrates that the GST law should apply to transactions as it finds them, rather than seeking to recharacterise them in accordance with some other objective framework.
It is the true legal characterisation of the agreement reached between the parties that is the correct starting point for the application of the GST law. If the Commissioner wants to recharacterise the express terms of the agreement between the parties, he must do so in accordance with a clear statutory power. Clearly, section 9-80 is not such a provision.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.