Alternative methods to calculate Goods and Services Tax input tax recovery

There has been discussion about providing alternatives options to the current FITR regime in Singapore. The FITR, which has been in place since the introduction of the GST, allows licensed GST registered banks to claim GST input tax based on a prescribed fixed rate that varies according to the specific category of banking license that is held.

The rates are currently in a range between 72%—94%.

We understand that a public consultation has commenced with responses being sought from the Singapore licensed banks in relation to providing an option for banks to elect on using an alternate method to calculate the input tax recovery rate for GST paid on expenses and acquisitions.

In this article we explore how such an option could operate under the current Law in Singapore including where appropriate citing suitable references and practices from outside of Singapore, where the Law and concepts are similar.

We note that there is only one possibility with what is outlined below, based on our review and interpretation of the relevant Law. It is certainly possible that over the course of the public consultation that alternative approaches and models are presented.

What does the Law require?

The Legislation must always be the starting point, and in our case, this would be the Goods and Services Tax Act 1993 (SGSTA) and the Goods and Services Tax (General) Regulations (SGSTR). Section 19 of the SGSTA sets the principle that a GST registered business is entitled to credit input tax (i.e., GST paid on purchases) against output tax (i.e., GST collected on supplies). Section 20 of the SGSTA goes on further to state the conditions underpinning the crediting of input tax as outlined in the SGSTR.

In the context of banks, the critical provisions are Regulation 29 (attribution of input tax to taxable supplies) and Regulation 30 (use of other methods)¹. Regulation 29 outlines the steps that a bank would need to follow in determining its input tax claim. We have summarised the steps as follows:

1. Identify the input tax that are used or to be used exclusively in making of taxable supplies (standard and zero-rated supplies) (Regulation 29[2][b]).
2. Identify the input tax that are used or would be used exclusively in making of exempt supplies (Regulation 29[2][c]);
3. The input tax identified under step 1 would be claimable in full whilst the input tax identified in step 2 would not be claimable at all;
4. The remaining input tax (residual input tax) represents purchases that are used for both taxable and exempt purposes and would need to be apportioned based on the formula provided in regulation 29(2)(d)(i). The formula applies a revenue or outputs based method which apportions based on the proportion of the taxable supplies made over the value of the total supplies.
   

¹ Regulation 33, which relates to incidental financial supplies and Regulation 35, which contains a De Minimis rule, would have no relevance to a bank. The application of regulation 33 is not applicable to banks by virtue of regulation 34 which specifically excludes such entities from the scope. Regulation 35 would not have relevance to a bank due to the volumne and size of the exempt activity undertaken.

We note the above steps are consistent with the published views of the Inland Revenue Authority of Singapore (IRAS) on the application of Regulation 29, and we refer to the e-tax guide “GST: Partial Exemption and Input Tax Recovery”² and the e-tax guide “GST Guide on Attribution of Input Tax”³ which outlines that a process of direct attribution is then followed by the apportionment of residual input tax.

² Refer to section 7 (Input Tax Apportionment) pages 6-7 and flowhcart in Appendix 1 page 17
³ Refer to section 5 (What is Directly Attributable) and section 6 (Residual Input Tax) pages 6-8

The approach and method specified under Regulation 29 is the only method that is prescribed as standard under the Law (i.e., an outputs-based method is the standard method for apportioning input tax).

Regulation 30, however, allows for the Comptroller to “approve or direct the use” of an alternative method other than what is under Regulation 29. At present there is no guidance publicly available on the process or scenarios under which the Comptroller reviews and/or approves alternative methods under Regulation 30.

Why is an alternative or special method required for a bank?

The central issue is the application of the standard outputs-based method in regulation 29(2)(d)(i) to apportioning residual input tax for a bank which may have multiple products and business lines that often operates with some level of independence and autonomy. An adoption of an entity-wide revenue-based formula would be distortive and not truly reflective of how the various inputs within a bank have been used.

This principle has been generally accepted in other developed GST/Value-Added Tax (VAT) jurisdictions. For example, the Australian Taxation Office (ATO) in its GST Ruling, “GSTR 2006/03: Goods and services tax: determining the extent of creditable purpose for providers of financial supplies” suggests that entity-wide revenue formulas are more suitable for smaller financial institutions with limited classes of supplies.⁴ GSTR 2006/3 goes on to highlight a bank with multiple classes of supplies or businesses would not get an accurate reflection of the use of its inputs through the use of an entity-wide formula as there may be “wide revenue fluctuations between classes of supplies or business areas within the [entity].⁵”

⁴ GSTR 2006/3, paragraph 107
⁵ GSTR 2006/3, paragraph 110

To manage the differences between the different classes of products and businesses within a bank, alternative methods to apportion residual input tax for a bank tend to adopt a ‘sectorised approach’. A ‘sectorised approach’ is a multi-step process where the residual input tax is first allocated or apportioned across the various product lines and business units using an appropriate cost driver or proxy. Once this is done, at a business unit/product line level, further levels of calculations are done using suitable proxies to arrive at a recovery rate percentage for that unit/product line. The amalgamation and application on each of these calculations and formulas will determine the amount of total input tax the bank can recover. The complexity of the methodology is linked to the complexity of the operations of a particular bank and the robustness of systems and processes that deal with the allocation of costs.

Should the special method be applied across all input tax or only residual input tax?

The simplicity in the current FITR method is that a bank simply needs to apply a prescribed percentage or ratio to all its input tax to determine the recoverable amount (i.e., it need not directly allocate or attribute purchases between taxable, exempt, and residual).

Excluding direct attribution or allocation, whilst simpler, can also be distortive and lead to inequitable outcomes for either the taxpayer or the IRAS. To provide context under such approach, it is possible that a purchase that solely relates to a taxable activity would not receive full input tax recovery, whilst a purchase that solely relates to exempt activity would be eligible to partial input tax recovery. From a technical standpoint, this would be inconsistent with the general principles of the GST, one of which is that any input GST incurred for the purpose of making taxable supplies should be entitled to be credited and input GST that solely relates to exempt activity should not be entitled to any input tax recovery.

We do take note that the current FITR does produce such outcomes, but importantly the FITR represents a collective consensus that is intended to apply at an industry wide level. Due to the broad nature of its application, it needs to be simple and easy to apply to accommodate the wider range of banks, in size and business, that operate in Singapore. However, a special method is specific and unique to an individual bank and should reflect that bank’s circumstances. If a particular bank can directly allocate costs across taxable and exempt activity, this can be beneficial. It allows for the bank to ensure that costs incurred in relation to its taxable activity can be claimed in full (e.g., costs in relation to advisory, or mergers and acquisitions type activity).

From the perspective of equity, there should be consistency with other non-banking entities. The ability to directly attribute and allocate costs is enshrined in Regulation 29 and is applicable to all GST registered taxpayers. However, due to the different classes of financial supplies that a bank makes, the standard entity-wide outputs-based formula in 29(2)(d)(i) may not produce an accurate outcome. It should then follow that the special method be limited to alternatives to the standard formula in 29(2)(d)(i).

For completeness, we note that other GST/VAT jurisdictions (e.g., the United Kingdom, Australia and the United Arab Emirates) that have allowed sectorised special methods for banks, still require direct attribution and direct allocation of expenditure as a first step.

The FITR does contain an additional concession that differs from the general principles of input tax recovery. It allows for a percentage of input tax recovery for exempt supplies made by banks to GST registered customers. This concession is an application of the discretion provided to the Comptroller in Regulation 30(2) to “treat supplies made by that taxable person to another taxable person for the purpose of any business carried on by the last-mentioned taxable person as taxable supplies.” The rationale for such a concession would be to compensate for the cost of exemption as transactions between GST registered parties normally would be GST neutral and should not result in a GST cost, however, by virtue of the exemption for a significant portion of banking services, the bank is faced with an additional unrecoverable GST cost. The discretion to allow input tax recovery for exempt services made by a GST registered bank to GST registered customers would alleviate the additional burden of this exemption by ensuring the transaction is GST neutral.

Is it mandatory for a bank to apply a special method under Regulation 30?

Regulation 30(1) states “the Comptroller may approve or direct the use by the taxable person of a method.” One abstract of the phrase ‘may approve or direct the use’ defines that a taxpayer could apply to use a special method or be directed to use one by the Comptroller. If the abstract applies, given if the Comptroller directs the use of a special method, then the bank would not be able to use the outputs-based method. An alternative interpretation would be that the phrase is intended to be discretionary and subject to application. If a taxpayer requests a special method under Regulation 30(1), then the Comptroller would have the power to approve or direct the use of such a method. If no such application is made, then the taxpayer would continue to apply the method under outputs-based method.

As a comparison we note that VAT in the United Kingdom (UK), under Regulation 102(1) of the UK VAT Regulations 1995 which deals with the use of special methods, the same phrase is used. Under that regulation, the “Commissioners may approve or direct the use of a taxable person of a method other than specified…”. In applying this provision, His Majesty’s Revenue and Customs (HMRC) does allow applications for the use of special methods but would also direct taxpayers to apply for special methods if it felt that the use of the standard outputs-based method would produce an unreasonable outcome. As we have noted earlier, in Australia, the ATO has expressed the view that an outputs-based method would be distortive for a large bank and would not be appropriate. Consequently, the use of solely an outputs-based method is likely to be discouraged by the IRAS.

For completeness, in the Singapore context, the use of the standard outputs-based method in Regulation 29(2)(d)(i) by a bank is unlikely to result in the most optimal level of GST input tax recovery. The reason for this is because the outputs-based method in 29(2)(d)(i) does not benefit from the additional input tax recovery afforded to exempt supplies made between GST registered taxpayers under Regulation 30(2). An output-based method that incorporates Regulation 30(2) would not be the standard output-based method in Regulation 29(2)(d)(ii) but rather a special method under Regulation 30 as it would diverge from the standard method in Regulation 29.

Final thoughts

The discussion to provide an additional option to the existing FITR model in the form of alternative or special methods would represent a significant change to the GST framework applying to banks in Singapore, given the current model has existed since the inception of GST. Whilst the legal framework in the SGSTA allows for the implementation of alternative special methods at an individual taxpayer level, at present there is no published guidance available on the process underpinning obtaining such special methods.

The consultation and ongoing dialogue between the IRAS and the banking industry will be critical in shaping the model and framework to follow. One benefit is that special methods are not a unique or a novel concept and have been adopted across several jurisdictions, and there are guidelines and policies that could be adapted with Singapore. The learnings from elsewhere can serve as a useful starting point to what is ultimately implemented in Singapore.

For further information, please contact Senthuran Elalingam.