INFORMATION GUIDE

The 5 PRINCIPLES OF THE GST

Date: 13 November 2015

Have you ever really thought about the goods and services tax and wondered how it really
works?
We all seem to have a feeling like we understand it but, as soon as things become a bit
complicated (GST-free, input taxed, private sales of goods) you may start to feel a little
unsure.
This Guide is designed to describe some of the “main principles” which can keep in mind
whenever thinking about the GST and how it may apply to your life or business.

The 5 Principles of the GST

 The GST is technically paid by suppliers but it is actually funded by consumers.
 The GST is funded by private consumers and not business consumers.
 The GST is a tax on the value added to a product at every point in the supply chain.
 The GST is a tax on the consumption of products from business sources, and not
on personal or hobby activities.
 GST is paid on all taxable supplies unless they are “GST-free” or “input taxed”.

What is the GST?

1. The GST is a “broad based consumption tax” which taxes “private final consumption
expenditure”.
2. The A New Tax System (Goods and Services Tax) Act 1999 (Cth) (the GST Act) was
passed on 28 June 1999. The GST commenced in Australia from 1 July 2000.
3. In general, we all know that the GST is a 10% tax which consumers pay on the goods
and services they purchase. But this conception of the GST is deceptively simple.
There is a bit more to it than that.
4. Let us meet the hat – which will serve as our example for much of this memo.

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5. A hat that cost $100 before the GST is now $110 because there is a 10% GST on the
price of the hat. In buying the hat you have now “paid” $10 of GST. This is simple
enough to understand right? Not quite.
6. The GST is actually a tax on supplies.
7. Section 9-40 of the GST Act states as follows:
(a) “You must pay the GST payable on any taxable supply that you make.”
8. In other words, it is a tax that a seller must pay for the supplies that he makes to his
customers. The seller (i.e. the supplier) is the one liable to pay the GST.
9. So how does this make sense? Isn’t the GST supposed to be a “consumption tax”?
How can it be a consumption tax and a tax on suppliers?
10. We know that when buying the hat you are the one paying $10 extra - not the
shopkeeper.
11. This is where the way the GST Act is framed differs from the real world result.
12. On paper the GST Act makes the sellers / suppliers liable to pay the GST. However,
in practice, the consumer funds this GST liability by spending 10% extra on the
product he buys.
13. In other words, the way the GST Act frames the situation is as follows:
(a) The shopkeeper sells a $100 hat;
(b) Because he is making a supply, the shopkeeper is liable to pay the
Commonwealth 10% (or $10) of the value of the product he is supplying;
(c) To cover this liability the shopkeeper then factors this extra $10 into the value
of the hat and puts it on the shelf for $110;1
(d) You then purchase the hat for the $110 and go home to enjoy contemporary
leisure activities;
(e) The shopkeeper puts the $110 into his cash register and cackles at the thought
of you wearing the hat in public;
(f) At the end of his GST period, the shopkeeper must hand over an extra $10 to
the Commonwealth in payment of the GST liability that the shopkeeper has
incurred in his supply of the hat.
14. As you can see from the above, although the supplier is technically liable to pay the
GST on his supplies, it is the consumer that funds this liability.
15. The intentional upshot of drafting the legislation this way is that it turns the suppliers
into tax collectors on behalf of the Commonwealth Government. 2 This is meant to
simplify the administration of the GST system for consumers – with businesses left to
properly account for their collections in each GST return.

1
It would not be technically correct to say that the shopkeeper has “increased” his price by 10%, because the
extra amount applicable to the GST is kept separate and isolated.
2
There was a case early on in the GST system, Halliday & Ors v The Commonwealth & Ors, which
challenged the GST on the basis (among others things) that the GST was unconstitutional because it imposed
“civil conscription” by forcing every person within the system to become a tax collector for the government in
breach of section 51xxiiiA of the Australian Constitution (which forbids civil conscription). This lost.

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16. As we will discuss later, this also assists in deciding which transactions to which GST
will apply by linking things to the status of the suppliers (e.g. generally whether they
are a business3 or a private individual).
17. This brings us to our FIRST PRINCIPLE of GST:
The GST is technically paid by suppliers but it is actually funded by consumers.

18. Now let us explore further backwards through the supply chain.
19. When our shopkeeper purchased the hat from the wholesaler he handed over $88 for
it. This was made up of the $80 price + GST.
20. Same as before, the wholesaler – in her supply of the hat for $80 – now must pay the
Commonwealth 10% (or $8) as her GST liability. This $8 GST liability has been
funded by our shopkeeper.
21. So at the end of this transaction doesn’t this mean that the shopkeeper has ended up
shouldering $8 of the GST burden? Not quite.
22. Because the GST is (at least in practice) a tax on private consumption, it is not to be
funded by businesses like our shopkeeper. The GST system gives the shopkeeper an
“out” through its use of input tax credits.
23. An input tax credit is effectively a recognition by the Commonwealth of how much
GST that a business has already funded.4
24. Input tax credits are then used by the business to deduct the amount of GST that the
business has funded from the GST that it must pay.
25. In other words, a business’ GST liability is reduced by the amount of the GST that the
business has funded. (Again we emphasise the effectively artificial – but technically
meaningful – distinction between having to pay the GST and having funded it).
26. A business’ input tax credits are equal to the amount of GST that it has already
funded.
27. In our example, we may see the application of the input tax credits to the shopkeeper:

3
For simplicity sake much of this paper will refer to ‘businesses’ – by which we more technically mean
entities under the GST Act which are registered or required to be registered for GST as per sections 23-5 and
23-10 of the GST Act.
4
Sections 11-20 and 11-25 of the GST Act. Input tax credits will only apply to purchases made to carry on
an enterprise.

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28. As we can see, the shopkeeper is able to offset the $8 of GST he has already funded
from the $10 of GST that he must pay to the Commonwealth to give him a Net GST
liability of $2.
29. This is the calculation that every business does when they lodge their GST return
with the government, which they usually do on a quarterly basis along with their
Business Activity Statement (BAS).5
30. When the shopkeeper lodges his BAS for the quarter, he will also have to pay the
Commonwealth the $2 Net GST liability.
31. So doesn’t this seem like the shopkeeper is still paying $2 from his own pocket?
32. No – because the $2 that the shopkeeper is paying the Commonwealth is actually
funded by you when you purchased the hat. It is you (the consumer) who ends up
paying it.
33. To illustrate the position of businesses in the middle of the supply chain we will look
at things from the perspective of the wholesaler in ‘slow motion’.

34. The wholesaler in the above scenario is paying $40 + GST to purchase the hat from
the manufacturer.
35. The wholesaler then sells the hat for $80 + GST to the retailer. The wholesaler has
now funded $4 in GST (in its purchase of the hat from the manufacturer) making her
$4 out-of-pocket.
36. The wholesaler has then made a supply of the hat for $80 (excl. GST), and so must
pay the Commonwealth $8 in GST liability. The wholesaler’s position at this point
can be summarised as follows:
(a) $4 out-of-pocket for GST funded; and
(b) $8 GST liability that the wholesaler must pay to the Commonwealth.
37. However, because the wholesaler has funded $4 of GST, she is entitled to an input tax
credit in the sum of $4. This input tax credit of $4 is then used to offset the
wholesaler’s GST liability of $8 so that the wholesaler’s Net GST liability is only $4.
The wholesaler’s position at this point can now be summarised as follows:
(a) $4 out-of-pocket for GST funded; and
(b) $4 Net GST liability that the wholesaler must pay to the Commonwealth.
38. The wholesaler, as part of its sale of the hat for $80 (excl. GST) then receives $8 from
the retailer in payment of the ‘GST component’ of the hat’s price. In other words, in
the course of the sale the wholesaler receives an extra $8.

5
Technically the GST is only one aspect on which businesses report in their BAS. Other tax liabilities that
businesses must account to the Tax Office on a (usually) quarterly basis can be included in the BAS – such as
Pay-As-You-Go Withholding and Fringe Benefits Tax.

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39. This $8 received by the wholesaler can then be divvied up as follows:
(a) $4 to reimburse the wholesaler for the $4 out-of-pocket GST funded; and
(b) $4 to allow the wholesaler to pay the $4 Net GST liability that she owes to the
Commonwealth.
40. As you can see, despite the wholesaler funding one amount of GST (in her purchase
from the manufacturer) and collecting another amount of GST (in the course of
supplying the hat to the retailer), the wholesaler ends up in the same net position.
41. Though technically she has paid tax, she has made no net loss (or gain) in doing so.
42. All that has happened is that the GST has passed through and now moved on further
down the supply chain:
(a) The Net GST liability that must be paid by the manufacturer is funded by the
wholesaler;
(b) The Net GST liability that must be paid by the wholesaler is funded by the
retailer; and finally
(c) The Net GST liability that must be paid by the retailer is funded by the
consumer.

43. In our example you may notice that the total of the Net GST liabilities of all the
businesses in the supply chain is $10. This is exactly the amount that the final
consumer pays to purchase the hat at the end of the supply chain.
44. The Net GST liabilities effectively cascade down the supply chain.
45. It is like a game of pass-the-parcel where only the person who ends up with the
product at the end of the supply chain – the consumer – ends up paying anything.
46. Although businesses temporarily fund some of the GST liability, through the ability
of business to claim input tax credits ensures they pay nothing in the end.
47. The consumer – who is not able to claim any input tax credits – is funding the full
$10 Net GST liability that has been accumulated along the entire supply chain.
48. This brings us to our SECOND PRINCIPLE of GST:
The GST is funded by private consumers and not business consumers.

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A Brief Interlude about Input Tax Credits
49. You can only claim input tax credits on inputs which are creditable acquisitions.
50. A creditable acquisition is an acquisition for consideration by a registered entity of
goods or services which are a taxable supply wholly or partly for a creditable
purpose.
51. An entity is said to be making an acquisition for a creditable purpose to the extent
that it makes it in carrying on its enterprise.
52. In other words, a business can only claim input tax credits on inputs that it acquires as
part of its business activities. Just because you have a business this does not mean
you can claim input tax credits on private or domestic items.6
53. It is possible to have acquisitions which only have a partial creditable purpose, at
which point an apportionment is required:
John is a lawyer and has office premises for his law practice. However he has
a special room in his office where he keeps his collectable coins – which is
something he does for a hobby. For GST purposes, John’s law practice is an
enterprise, but his use of the separate office for the coins is outside of that
enterprise. This means that John’s expenses for maintaining the office are
spent partly for the enterprise and partly for his hobby – which means that any
input tax credits that apply to these expenses need to be apportioned and
reduced by the part attributable to the hobby.7
54. Similarly, if an acquisition was originally for a creditable purpose, but later becomes
used for private purposes, an adjustment must be made to that entity’s GST return
effectively wiping out the benefit of any input tax credit.8
55. Generally speaking, input tax credits can only be claimed on a supply when the
claimant holds a valid tax invoice at the time of lodging their BAS.9
56. Input tax credits do not need to be claimed in the same reporting period that the
relevant GST was funded. You can choose to claim them in a later BAS period but
you have to use them within 4 years or they expire.10
57. If your input tax credits exceed your GST liability you can actually claim a refund
from the Commonwealth and get money back.

6
For example, a businessman who usually can claim input tax credits for business purchases, cannot claim
any credits for a computer he buys for his personal use.
7
The real fun starts when we have to start talking about the appropriate method to determine the
apportionment of any expense between its business use and its private/domestic use. See GST Ruling 2006/4.
8
This would be called an “increasing adjustment”. A “decreasing adjustment” would occur when you paid
too much GST due to a subsequent change in circumstances such as the amount of the consideration or the
status of a supply as a taxable supply.
9
Section 29-10(3) of the GST Act. However, a valid invoice is not needed if the supply is less than $75 or if
the Commissioner uses his special powers to waive the requirement - see GST Determination 2004/1. A valid
invoice is also not required for an importation (as opposed to a supply) as the import declaration is sufficient
here – see GSTR 2003/15 par. 292.
10
Division 93 of the GST Act.

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58. If we look at our scenario of the supply chain we may also notice another pattern.

59. We have now pointed out the increases in value that have occurred across each supply
in the supply chain. You will notice that the Net GST that the manufacturer, the
wholesaler and the retailer are all liable to pass on to the Commonwealth correlate to
the amount of value added since the last transaction in the supply chain.
60. In fact, the Net GST equals 10% of the value added at each step.
61. This is no accident – it is a unique characteristic of the GST that it is imposed on the
added value at each supply in the supply chain.
62. The value that is added does not have to be limited to one specific product along a
single supply chain – like our example with the hat being passed down the line.
63. The GST can apply more generally to tax the increases in value between the inputs
and the outputs of a business.
64. The diagram below clarifies this point a bit further.

65. Here you can see that $300,000 of inputs have gone into a factory and $700,000 of
output have gone out of the factory.
66. This represents a value added (through the processes of the factory) of $400,000. The
Net GST that must be paid by the factory is 10% of the added value or $40,000.
67. The GST’s nature of taxing increases in value at each supply along the supply chain is
precisely what makes it an improvement over the Wholesale Sales Tax (which we
will touch on shortly).

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68. As the GST is a tax on the value added to products through the supply chain it is also
called a Value-Added Tax or VAT.11
69. The GST is called VAT in most other jurisdictions, particularly those to introduce it
earlier like the United Kingdom and the rest of Europe.
70. Australia is one of the few who call it the GST - the others being New Zealand and
Canada.12
71. This brings us to our THIRD PRINCIPLE of the GST:
The GST is a tax on the value added to a product at every point in the supply chain.

72. As we have seen, the GST is not funded by businesses (though technically it is paid
by businesses). This is because the effect of the GST is that it is a tax on
consumption by consumers, and not a tax on businesses.
73. However, more specifically, the GST is a tax on the consumption of goods and
services purchased from business sources.
74. The GST Act limits the tax to these business sources through its definition of taxable
supplies.
75. As we have seen, section 9-40 states that “you must pay the GST payable on any
taxable supply that you make.”
76. Section 9-5 states that something is taxable supply if:
(a) you make the supply for consideration;
(b) the supply is made in the course or furtherance of an enterprise that you carry
on;
(c) the supply is connected with the indirect tax zone (i.e. Australia); and
(d) you are registered, or required to be registered.
However, the supply is not a taxable supply to the extent that it is GST-free or input
taxed.

What is a taxable supply?

77. The above definitions are extensively defined in the GST Act. We will briefly gloss
over these to provide some context.
78. A supply is broadly defined to include (among other things) a supply of goods; a
supply of services; a provision of advice or information; a grant, assignment or
surrender of real property; a creation, grant, transfer, assignment or surrender of any
right; and a financial supply.13 In other words, pretty much everything is a supply.
79. Consideration is broadly defined as including any payment, or any act or
forbearance, in connection with a supply of anything or in response to or for the

11
Do not say “VAT tax” – see also ATM machine.
12
The VAT was initially dreamed up by Dr Wilhelm von Siemens in 1918. France was the first nation to
introduce in 1954. The Nordic countries (Denmark and Norway etc.) introduced VAT in the 1960’s, and the
United Kingdom in 1973. Even China had introduced a form of VAT by 1984.
13
Section 9-10 of the GST Act.

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 inducement of a supply of anything.14 In other words, there will be consideration
when pretty much anything is handed over or done for the supply.
80. An enterprise is broadly defined as an activity or series of activities including in the
form of:
(a) A business;
(b) An adventure or concern in the nature of trade;
(c) A lease, licence or other grant of an interest in property on a regular or
continuous basis;
(d) The trustee of a fund that is a deductible gift recipient;
(e) A trustee of a complying superannuation fund;
(f) A charity; or
(g) The Commonwealth, a State or a Territory, or by a corporation established for a
public purpose under the law.15
81. The phrase in the course or furtherance on an enterprise is not defined in the GST
Act but has been defined in case law as being wide enough to cover even anything
done in the course of the commencement or termination of the enterprise.16
82. Connected with the indirect tax zone effectively includes bringing goods or services
into Australia, taking them out of Australia or supplying them within Australia.17
83. You are required to be registered for GST if the following applies:18
(a) you are carrying on an enterprise; and
(b) your GST turnover meets the registration turnover threshold, currently being
an annual turnover of $75,000 for businesses and $150,000 for non-profit
bodies.19
84. The annual turnover is determined at any time during the year with reference to your
turnover from the previous 12 months and to the expected turnover in the next 12
months. If either of these exceeds the threshold then you need to register for GST.

Using ‘taxable supply’ to limit the GST to consumption from business sources
85. The most significant parts of the above definitions are probably that an enterprise has
to be carried on and that the annual turnover threshold must be exceeded.
86. In other words, you need to be properly carrying on a business, and this business
needs to involve a substantive amount of activity before you will find that you need to
start paying GST (meaning before you must start charging GST on the stuff that you
sell).
87. As you can see, most minor business activity generally carried on by private
individuals will not fall within the definition of a taxable supply and so GST will not
apply to it.

14
Section 9-15 of the GST Act.
15
Section 9-20 of the GST Act.
16
Russell v FC of T 2011 ATC 20-240.
17
Section 9-25 of the GST Act.
18
Section 23-5 of the GST Act.
19
Section 23-15 of the GST Act.

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88. For example, if the consumer in our above example decided to sell the hat at a garage
sale to a student, this supply will not be part of carrying on an enterprise nor will the
consumer’s annual turnover exceed the threshold of $75,000.
89. As a result the supply will not be a taxable supply and GST will not apply.
90. This means that the consumer’s sale of the hat to the student effectively falls outside
of the GST system (see diagram below).

91. In this way, the application of the GST is framed with reference to whom is making
the supply. If the supplier is not effectively a business then the GST will not apply.
92. The upshot of all of this is that the GST does not apply to the consumption of goods
and services purchased from private sources.
93. To reiterate, the GST is a tax on consumption by consumers of goods and services
purchased from business sources. Personal and hobby activities are not covered by
the GST system.
94. This brings us to the FOURTH PRINCIPLE of the GST:
The GST is a tax on the consumption of products from business sources, and not
on personal or hobby activities.

95. As we have seen, section 9-5 of the GST Act sets out that something is a taxable
supply if:
(a) you make the supply for consideration;
(b) the supply is made in the course or furtherance of an enterprise that you carry
on;
(c) the supply is connected with the indirect tax zone; and
(d) you are registered, or required to be registered.
However, the supply is not a taxable supply to the extent that it is GST-free or input
taxed.
96. A supply is GST-free if:
(a) It is GST-free under Division 38 of the GST Act or under a provision of another
Act; or
(b) It is a supply of a right to receive a supply that would be GST-free under (a).20
97. A supply is input taxed if:
(a) It is input taxed under Division 40 of the GST Act or under a provision of
another Act; or

20
Section 9-30(1) of the GST Act.

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 (b) It is a supply of a right to receive a supply that would be input taxed under (a).21
98. Yes, it is just that simple.
99. It is an unfortunate part of the GST Act that it is not entirely free from the lists of
special cases suspending the normal rules of GST reality. This is partly as a result of
the political compromises that the Howard Government had to make to get the GST
legislation passed.

GST-free
100. GST-free supplies are simply those supplies on which the supplier does not have to
pay GST – meaning that GST is not charged on their supply.
101. However, despite no GST being charged, the supplier of GST-free products is still
able to claim input tax credits.
102. Division 38 of the GST Act states that the following categories of supplies are GST-
free:
(a) Food (Subdivision 38-A);22
(b) Health (Subdivision 38-B);
(c) Education (Subdivision 38-C);
(d) Childcare (Subdivision 38-D);
(e) Exports and other supplies for consumption outside Australia (Subdivision 38-
E);
(f) Religious services (Subdivision 38-F);
(g) Activities of charities (Subdivision 38-G);
(h) Water, sewerage and drainage (Subdivision 38-I);
(i) Supplies of going concerns (Subdivision 38-J);
(j) Transport and related matters (Subdivision 38-K);
(k) Precious metals (Subdivision 38-L);
(l) Supplies through inwards duty free shops (Subdivision 38-M);
(m) Grants of land by governments (Subdivision 38-N);
(n) Farm land (Subdivision 38-O);
(o) Cars for use by disabled people (Subdivision 38-P);
(p) International mail (Subdivision 38-Q);
(q) Telecommunication supplies made under arrangements for global roaming in
Australia (Subdivision 38-R); and
(r) Eligible emission units (Subdivision 38-S).
103. Can you see a pattern emerging? Sort of. These supplies are mostly the “feel-good
essentials” that the Howard Government had to carve out of the GST regime.

21
Section 9-30(2) of the GST Act.
22
Types of food which are not GST-free are essentially those that are not consumed for “sustenance”
purposes – think hot takeaway food, confectionary, bakery products, soft drinks and of course alcohol.

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104. Let us look at the supply of GST-free products in another diagram.

105. As you can see, the college in the above example, through its supply of the
educational course (a GST-free product) ends up with a negative Net GST liability.
In other words, the college can claim a refund from the Commonwealth of $10 which
it spent on textbooks.
106. Of course, this does not mean that the college has made a profit from the government.
It just means that the college is reimbursed for all the GST it has funded through
purchasing inputs.

Input taxed
107. Input taxed supplies are also supplies on which the supplier does not have to pay
GST – and GST is not charged on their supply either.
108. Input taxed supplies are different from GST-free because the supplier of input taxed
supplies is not entitled to claim any input tax credits for items acquired or imported
for use in its business.
109. For example, financial supplies are input taxed, so a bank which buys computers for
use in its banking business is not able to obtain input tax credits for the GST it funds
on acquiring the computers.
110. Division 40 of the GST Act states that the following categories of supplies input
taxed:
(a) Financial supplies (Sub-division 40-A);
(b) Residential rent (Sub-division 40-B);
(c) Residential premises (Sub-division 40-C);
(d) Precious metals (again) (Sub-division 40-D);
(e) School tuckshops and canteens (Sub-division 40-E);
(f) Fund-raising events conducted by charities (Sub-division 40-F).

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111. Let us look at the application of supplies of input taxed products in the below
diagram.

112. As you can see, the vendor, in his sale of the residential property to the purchaser,
does not have a GST Liability and so does not charge GST on the sale.
113. However, he is also not able to claim input tax credits for the GST he has funded on
inputs into the property either. As a result the vendor is stuck funding $50 of GST
without any compensation.
114. This is where the term input taxed finds its meaning. It is the name given to the class
of goods and services which have their inputs taxed rather than the goods and services
being taxed themselves.
115. Effectively, the vendor has ended up in the same place as the consumer does when the
normal GST regime applies.
116. One reason for this system is to avoid having whole classes of people having to
register for GST – as people who are selling their houses would otherwise have to do
so that they could collect any GST on their house and pass it on the Government.
117. Those certain products were also chosen to be input taxed rather than GST-free
because it was probably decided that it was still appropriate that those specific
supplies should be liable to some tax treatment – and they were not quite high enough
on the “feel-good” scale to be GST-free.
118. So, finally, this brings us to our FIFTH PRINCIPLE of the GST:
GST is paid on all taxable supplies unless they are “GST-free” or “input taxed”.

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Conclusion
119. We hope that you have found this guide to be useful in thinking about the GST in
future.
120. If you are ever unsure about how the GST may apply in any given situation we
recommend that you obtain professional advice from your accountant or lawyer.
121. However, in the meantime, you may find it useful to remember the 5 principles that
we discussed in this guide:
(a) The GST is technically paid by suppliers but it is actually funded by
consumers.
(b) The GST is funded by private consumers and not business consumers.
(c) The GST is a tax on the value added to a product at every point in the supply
chain.
(d) The GST is a tax on the consumption of products from business sources,
and not on personal or hobby activities.
(e) GST is paid on all taxable supplies unless they are “GST-free” or “input
taxed”.

ANDREYEV LAWYERS

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