Journal of Australian Taxation
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THE GRAPES OF WRATH:
GST AND FOOD
By Paul Kenny[*]
This article examines the recent decision by the Commissioner of Taxation to exempt grapes used for the manufacture of wine from the Goods and Services Tax. This article builds on an earlier article[1] published by the author in this journal that examined the policy rationale for exempting basic food and the design features of the food exemption.
The issue of taxing wine grapes provoked a strong reaction from the wine industry and resulted in the Australian Taxation Office ("ATO") recent press release that announced that wine grapes were considered to be Goods and Services Tax ("GST") free. Further, the ATO advised that there will be no change to the treatment of wine grapes without full and further consultation with industry, stating:
The issue of the application of GST law to the "boundary" areas of GST-free or taxable food products is a subject of ongoing consultation by the Tax Office with the food industry.
The food industry consultation process with the Tax Office is chaired by the Australian Food and Grocery Council. The Tax Office also consults with a wide range of other industry bodies on food classifications. This ensures the Tax Office's administration of the law is based on a good understanding of industry processes and views.
This process often involves circulation draft views among participants on a confidential basis.[2]
This press release provides two interesting and related issues. Firstly, is there any policy rationale for treating wine grapes as GST free given that they are used to produce a taxable good that is a non-basic food? Secondly, under A New Tax System (Goods and Services Tax) Act 1999 (Cth) ("Act"), are wine grapes in fact GST free? This article finds no convincing policy reason for exempting grapes used for the production of wine and no basis in law for the exemption of wine grapes.
Having regard to the three taxation policy criteria, equity, economic efficiency and simplicity there does not appear to be a case for exempting wine grapes. The taxation policy principle of horizontal equity is a core principle of social justice that demands people in similar circumstances be treated (ie taxed) in a similar way.[3] In an earlier article the author found that the equity problem of taxing basic food at a flat rate occurs because of the greater proportional cost of food to income for low-income earners as opposed to high-income earners. In particular such a tax will harshly impact on low-income households, especially older people and welfare recipients. Those who live in rural and remote areas and Aboriginals already pay substantially higher prices for food, accordingly they will suffer the most. Clearly a GST on basic food could not be justified on equity grounds.
There, however, exists no compelling rationale in equity for exempting non-basic foods or luxury foods from GST. Accordingly, there is no reason to be concerned about imposing GST on alcohol and wine from a community equity perspective. It follows that all components of wine, including grapes, should be subject to GST. Further, treating grapes as exempt creates inequities between different industries that use land that raises a GST liability. This offers a benefit for grape growers since they are refunded all input tax credits for their costs yet do not have to charge GST.
It may be argued that exempting all grapes simplifies GST since growers do not have to separately account for taxable and exempt sales. The New Zealand experience, though, shows that business with GST exemptions have compliance costs which are 5% higher than business with fully taxable goods and services.[4] Pope[5] and Walpole,[6] leading Australian academics on compliance costs, have asserted that from a simplicity point of view food should be subjected to the GST. Also, Cnossen takes the view that "a zero rate substantially increases the administration and compliance costs of the GST".[7]
However, a United Kingdom report on compliance costs of their value added tax (which exempts food) found that the total compliance costs for business is only around 4.3% of revenue.[8] Given that the compliance costs for the Australian Wholesale Sales Tax is about 4.7% of revenue in 1994-95[9] and that businesses will
have cash flow and managerial benefits from a GST, then these costs do not appear to be unduly high. Whilst exempting wine grapes is manageable in terms of compliance costs it certainly will add to complexity. Indeed the impact of these additional compliance costs may be quite severe for small business.[10]
From a GST perspective, economists seek a neutral tax, one that imposes a single rate of tax that applies to all goods and services with no exemptions. Under a GST that exempts grapes, businesses may prefer to produce grapes rather than other taxable activities. Arguably demand and market prices will be unjustifiably distorted resulting in a loss of economic efficiency. Despite these inefficiencies the results of economic modelling provided to the Senate Committee inquiries into the GST and a New Tax System[11] suggests that the impact on economic growth is somewhat minute.
Dixon analysed the effects of the GST exemption on food assuming that labour accepts the tax cuts as compensation without seeking wage increases to offset inflationary effects. He found that the positive effect of the reduction in food prices would offset the negative impact of higher tax rates on increasing wage levels, finding that the exemption would result in a short-term impact of 8,000 extra jobs.[12] Murphy reviewed these results and found that the impact on GST revenue would cost $4 billion, with a small reduction in inflation and a loss in long run welfare of $9 million.[13] This mirrors the views of prominent tax economists who concluded that exempting food would only have a marginal effect on economic efficiency.[14]
Importantly only four Organisation for Economic Cooperation and Development ("OECD") countries apply the standard Value Added Tax ("VAT") rate to basic food, that is: Denmark, Japan, New Zealand and Norway.[15] Most OECD countries tax food on a concessionary basis. Austria, Belgium, Finland, France, Germany, Greece, Italy, Luxembourg, Netherlands, Spain and Sweden all apply lower than standard VAT rates to basic food.[16] Whilst, Canada, Ireland, United Kingdom and Australia all totally exempt basic food from VAT.[17]
Previously the author examined the policy rationale for exempting basic food and found overwhelming support on equity grounds. In the case of grapes used for the production of wine, though, the policy criteria appear to point in the other direction, as such, there is no case for preferential GST treatment for grape growers. Given the Government's decision to treat grapes as GST free, this article considers whether grapes are GST free under the Act.
Whilst a supply of food is GST free under s 38-2, there are two requirements for the GST free food status. Firstly, the good must constitute food.[18] Secondly, s 38-3 must not apply so as to tax the supply of food.
Section 38-4 governs the meaning of food and provides:
1) Food means any of these, or any combination of any of these:
(a) food for human consumption (whether or not requiring processing or treatment);
(b) ingredients for food for human consumption;
(c) beverages for human consumption;
(d) ingredients for beverages for human consumption;
(e) goods to be mixed with or added to food for human consumption (including condiments, spices, seasonings, sweetening agents or flavourings);
(f) fats and oils marketed for culinary purposes;
but does not include:
(a) live animals (other than crustaceans or molluscs); or
(b) unprocessed cow's milk; or
(c) any grain, cereal or sugar cane that has not been subject to any process or treatment resulting in an alteration of its form, nature or condition; or
(d) plants under cultivation that can be consumed (without being subject to further process or treatment) as food for human consumption.
It is clear that wine grapes constitute food as an ingredient for a beverage[19] for human consumption under para 38-4(1)(d) and given that the four exclusions from food in paras 38-4(1)(g)-(i) do not generally apply. An exception though would apply to edible wine grapes under cultivation since this will not constitute food per para 38-4(1)(i).
Subsection 38-3(1) provides five alternative means of taxing a supply of food:
1) A supply is not GST free under s 38-2 if it is a supply of:
(a) food for consumption on the premises from which it is supplied; or
(b) hot food for consumption away from those premises; or
(c) food of a kind specified in the third column of the table in clause 1 of Schedule 1, or food that is a combination of one or more foods at least one of which is food of such a kind; or
(d) a beverage (or an ingredient for a beverage), other than a beverage (or ingredient) of a kind specified in the third column of the table in clause 1 of Schedule 2; or
(e) food of a kind specified in regulations made for the purposes of this subsection.
Also, s 38-3(2)-(3) provides:
2) However, this section does not apply to a supply of food of a kind specified in regulations made for the purposes of this subsection.
3) The items in the table in clause 1 of Schedule 1 or 2 are to be interpreted subject to the other clauses of Schedule 1 or 2, as the case requires.
Clearly para 38-3(1)(a) does not apply since wine grapes do not constitute food for consumption on premises. Also, para 38-3(1)(b) does not apply since wine grapes do not constitute hot food for consumption away from premises. Additionally, paras 38-3(1)(e) and s 38-3(2) do not apply since wine grapes are not considered in A New Tax System (Goods and Services Tax) Regulations 1999 ("Regulations"). Relevantly, Pt 3-1 of the Regulations lists supplies
that are not taxable supplies and this only includes financial supplies[20] as input taxed supplies. Although Pt 4-2 of the Regulations provide special rules about supplies and acquisitions but these only deal with financial supplies[21] and insurance.[22]
Paragraph 38-3(1)(c) of the Act only applies to food of a kind specified in Sch 1. Since wine grapes, do not fall within the categories of prepared food, confectionery, savoury snacks, bakery products, ice cream food and biscuit goods, para 38-3(1)(c) does not apply to tax wine grapes. Given that wine grapes are fruit that can be eaten without processing, such as supplies of fresh fruit and vegetables,[23] suggests that wine grapes may be exempt under para 38-3(1)(c).
Wine grapes though clearly fall within the scope of para 38-3(1)(d) as an ingredient for a beverage, that is wine. Further, since wine falls outside Sch 2, that only exempts milk products, soy milk, rice milk, tea, coffee etc, non-alcoholic fruit and vegetable juices, beverages for infants or invalids and water,[24] wine is subject to GST. It follows then that the supply of wine grapes, an ingredient for a taxable beverage constitutes a taxable supply under para 38-3(1)(d).[25]
The possible application of both s 38-3(1)(c) and s 38-3(l)(d) raises the issue as to which is the most appropriate class of food for wine grapes. The striking similarities between the wording used in the food exemption and the Sales Tax exemptions[26] means that Sales Tax case law and ATO Rulings are highly relevant in determining a GST classification issue.
The Courts and Tribunals often applied an "essential character" test in determining classification in Sales Tax cases. In Thomson Australian Holdings Pty Ltd v FC of T,[27] Davies J described the "essential character" test as "the basic nature of the goods, from what they are, though composition, function and other factors necessarily play a part".[28] Given that wine grapes are used in the manufacture of wine, the essential character arguably as an ingredient for a beverage rather than as for consumption as a food suggests that s 38-3(1)(d) would apply in preference to s 38-3(1)(c).
Diethelm Manufacturing Pty Ltd v FC of T,[29] Hygienic Lily Ltd v DFC of T,[30] Feltex Commercial Interiors Pty Ltd v FC of T[31] and K Mart Australia Ltd v FC of T ("K Mart Australia")[32] prescribed a
test based on the genus or class of the goods, rather than opting for a test based on essential character. In K Mart Australia the Full Federal Court considered whether paintbrushes fell within the Sales Tax item that included "brooms, mops, dusters, brushes, buckets and basins". In a joint judgement the Court found:
... the collocation or context can affect the meaning of a term and give it a connotation different to that which might otherwise be attributed if the term appeared in isolation.
It is not necessary in this case to decide whether there is a specific genus of goods used for cleaning or having a common characteristic associated with the activity of cleaning.
If the word "paint brushes" were to be included as one of the meanings attributable to brushes, then it would sit uneasily with the description of the other goods specified in the paragraph. It would be inappropriate given the context to say that the word "brushes" included for example tooth brush, a nail brush, a hair brush, a clothes brush or a pastry brush. They are primarily directed to matters of personal grooming, or in the case of the pastry brush, to the activity of cooking.
A "paint" brush is not a brush used for cleaning or analogous purposes. Its use is as an implement or tool in order to apply paint to a surface.[33]
Applying this genus test to wine grapes it is evident that wine grapes would sit uneasily in the category of food in para 38-3(1)(c) since wine grapes are not used for direct human consumption. More appropriately wine grapes form part of the class of food covered by para 38-3(1)(d) as an ingredient for a beverage.
Such an approach would be consistent with the Commissioner's approach in Sales Tax Ruling SST 5, which relevantly considered the classification of goods (furniture) of a kind for Sales Tax purposes, stating:
3.9 Identifying the class of goods to which an item of furniture belongs involves determining the common characteristics that turn a collection of individual articles into a kind or class. Many articles of furniture fall into more than one class of furniture. A kitchen table, for example, could reasonably be said to fall into the classes, tables and kitchen furniture, as well as the class of kitchen tables. An armchair might belong in the classes, chairs, lounge room furniture or lounge chairs.
3.10 The class that is most important for sales tax classification is the one in which all the characteristics of the particular furniture to be classified are properly represented. As a practical approach, you should always look at the narrowest class. If the narrowest class or most precise description of the goods establishes them as being of a kind used for household purposes, then the particular piece of furniture will pass the test.[34]
Under this approach the narrowest class for wine grapes is found in para 3(1)(d), which deals with ingredients for beverages. This provides the most precise description of such a food. Alternatively, since s 38-3 provides five alternative tests for taxing a supply of food if anyone of the tests apply it would appear that the food would be subject to GST. Under this approach ingredients for wine would be subject to GST.
This is the approach taken in the Food Industry Issues Register, "Ingredients Used For Home Brewing"[35] which states:
... beverages (or ingredients for beverages) of a kind not listed in clause 1 of Schedule 2 of the GST Act will not be GST-free. Ingredients that are specifically for use in making alcoholic beverages are not listed in clause 1 of Schedule 2, so they are not GST-free.
The Issues Register further provides examples of taxable food that are supplied as ingredients for home brewing:
Kits for home-brewing, wine making etc.
Special wine and brewers' yeast.
Retail packs that are specialised for home brewing and winemaking, such as brewer's sugars etc.
If the supply of wine grapes is deemed to be GST free it is clear that related packaging of wine grapes will be GST free since s 38-6 provides:
1) A supply of the packaging in which food is supplied is GST- free if the supply of the food is GST-free.
2) However, the supply of the packaging is GST-free under this section only to the extent that the packaging:
a) is necessary for the supply of the food; and
b) is packaging of a kind in which food of that kind is normally supplied.
The intention of the food exemption as stated in the Further Supplementary Explanatory Memorandum,[36] was to "ensure that basic food for human consumption is GST free".
Granting GST free status to wine grapes goes well beyond both the intention and form of the legislation. Whilst there are sound policy reasons for exempting basic food there is no justification for extending the exemption to non-basic beverages such as wine, or to ingredients for non-basic beverages such as wine grapes. It is submitted that the Government needs to review its decision to exempt wine grapes or it will in time face further and increasing calls for exemptions from GST by other food producers in other industries. Additionally, the Government's confidential review
process and consultation with the food industry is of some concern as it may needlessly encourage the growth of such tax preferences.
[*] Lecturer of Taxation Law at Flinders University. Editor of the Australian Taxation Index internet site at www.commerce.flinders.edu.au/tax.
[1] P Kenny, "The GST Food Exemption" (2000) 3 Journal of Australian Taxation 424. This article found that:
1) there are strong equity grounds for exempting basic food, simplicity and economic efficiency considerations are not as important; and
2) the design of the food exemption legislation and associated measures means that this exemption will be sufficiently clear and workable.
[2] "No Slug on Grapes" Australian Taxation Office Media Release Nat 01/66 Tax Office (10 August 2001) www.ato.gov.au.
[3] R Krever and N Brooks, A Capital Gains Tax for New Zealand (1990) 43; and Review of Business Taxation, A Tax System Redesigned (1999) 105: "equity or fairness is a basic criterion for community acceptance of the tax system ... There is widespread support for ... horizontal equity. It is also accepted that taxation should be based on vertical equity". See also K Asprey, Taxation Review Committee – Full Report (1975) paras 3.7-3.18; and Draft White Paper, Reform of the Australian Taxation System (1985) 14.
[4] J Pope, "Food and the Compliance Costs of GST' (May 1999) 1(1) Business Council of Australia Papers 55 referring to C Sandford and J Hasseldine, The Compliance Costs of Business Taxes in New Zealand (1992) 70.
[5] Pope, above n 4, 57.
[6] M Walpole, Submission to the Senate Committee into the GST and a New Tax System (Submission No 139, March 1999), 1-2.
[7] S Cnossen, "Global Trends and Issues in Value Added Taxation" (1998) 5 International Tax and Public Finance 399, 410.
[8] N Warren, "Food: Staple of Life or Staple of the GST?" (paper presented at ATAX, Faculty of Law, University of New South Wales; 16 December 1998) 16.
[9] ATAX research cited in Australian Taxation Office, A Report into Taxpayer Costs of Compliance (November 1997) 75.
[10] See Warren, above n 8, 24.
[11] Senate Select Committee into the GST and a New Tax System, Economic Modelling of the Tax Package (1999) 12-13 www.apg.gov.au/senate/committee. The Senate Select Committee, commissioned Peter Dixon and Chris Murphy to investigate the efficiency effects of exempting food from GST. Both Dixon and Murphy concluded that the exemption of food would have negligible long-term effect on economic performance.
[12] Ibid 11-12.
[13] Ibid.
[14] E Savage, J Quiggin, C Hamilton, J Neville and O Stanley, Tax Economists Oppose GST on Food (Media Release, 18 April 1999) www.tai.org.au.
[15] Warren, above n 8, 14.
[16] Ibid.
[17] Ibid.
[18] Section 38-4.
[19] In Bristol-Myers Co Pty Ltd v FC of T 90 ATC 4553, 4556-4557, Lockhart J stated: "a beverage is consumed either hot or cold and is normally taken to quench the person's thirst or for stimulation or as an accompaniment to solid foods either at meal times or between meals".
[20] Division 40.
[21] Division 70.
[22] Division 78.
[23] Further Supplementary Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Act 1999 (Cth), para 1.2 ("Further Supplementary Explanatory Memorandum") states: "... most supplies by a primary producer will be subject to GST. However, supplies of fresh fruit and vegetables by a primary producer will be GST free".
[24] See Kenny, above n 1, 430-432 for an analysis of the various tests applied by the Courts in determining what constitutes food of a kind. Although it is evident here that wine is classified as a taxable supply since alcoholic fruit juices are excluded from Sch 2.
[25] Indeed such an approach is supported by accompanying explanations to the Act. Further Supplementary Explanatory Memorandum, para 1.3 states the purpose of the GST food exemption as: "the amendments will ensure that basic food for human consumption is GST free. In addition, they will ensure that the current WST exemptions for food are, in general maintained". Further Supplementary Explanatory Memorandum, para 1.54 also relevantly states: "the definition of food includes beverages and ingredients for beverages [new paragraphs 38-4(1)(c) and (d)]. However, the only beverages and ingredients for beverages that will be GST free are those beverages and ingredients specifically listed in new Schedule 1B [paragraph 38-3(1)(d)]". Australian Taxation Office, Issues Register, Issue No 10, "Ingredients for Beverages", www.taxreform.gov.au/ind_partner/food/food.htm additionally states "the term `ingredients for beverages for human consumption' (paragraph 38-4(1)(d)) is not limited except in that the ingredients must be for beverages for human consumption. However, ingredients for beverages for human consumption are only GST free to the extent that the ingredients are specified in the third column of Schedule 2 in accordance with paragraph 38-3(1)(d) of the Act".
[26] Further Supplementary Explanatory Memorandum, para 1.3: "the amendments will ensure that basic food for human consumption is GST-free. In addition, they will ensure that the current WST exemptions for food are, in general, maintained".
[27] 88 ATC 4916.
[28] Ibid 4917.
[29] 93 ATC 4703.
[30] 87 ATC 4327.
[31] 90 ATC 4925.
[32] 96 ATC 4155.
[33] Ibid 4161-4162 (per Wilcox, Beazley and Tamberlin JJ).
[34] Sales Tax Ruling SST 5, para 3.10.
[35] "Ingredients Used for Home Brewing" Food Industry Issues Register, Issue No 24 www.taxreform.gov.au/ind_partner/food/food.htm.
[36] Further Supplementary Explanatory Memorandum, para 1.3.
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