Tax Update

18 Jul 2010

Must you charge GST at 12.5% for services you perform in September, but invoice in October? Or must you apply the new rate of 15%?

Suppose your contract provides a GST-inclusive price for goods you supply. Can you pass on the GST increase to your customer, by raising the price? Or must you absorb the rise?

Transitional issues like these will arise when the standard rate for GST increases from 12.5% to 15% from 1 October 2010.

This FYI discusses some of the transitional issues, and how they will be resolved.

When will the 15% rate apply?

Under the Goods and Services Tax Act 1985 (GST Act) as amended following the May Budget, the 15% GST rate applies to "supplies made on or after 1 October 2010".

When is a supply made?

For GST purposes, a supply is not considered to be made when the supplier performs the service or delivers the goods. Instead, the supply is generally made when the supplier:

• issues an invoice for the goods or services; or
• receives a deposit or any other payment for them,

whichever happens first.

In most cases, it is clear how this rule will apply:

• If a supplier performs and invoices a service before 1 October 2010, the current 12.5% GST rate will apply to it. The invoice is issued before 1 October 2010, so the supply is made before then.
• Equally, if a supplier receives a deposit and delivers goods before 1 October 2010, the 12.5% GST rate will apply. It does not matter if the supplier issues the invoice or receives the balance later. The supplier receives a payment before 1 October 2010, so the supply is made before then.
• However, if the supplier performs a service or sells goods before 1 October 2010, but only issues the invoice and receives payment on 1 October 2010 or later, the supplier will have to account for output GST at the new 15% GST rate. The invoice is issued and all payments are made on or after 1 October 2010, so the supply is considered to be made on or after 1 October 2010.

In some cases the time of supply is more difficult to determine. For example, contracts to buy and sell real estate can be problematic:

• The contract itself is not an "invoice". The only document in a land sale context that is an invoice is the settlement statement (which is typically issued by the seller's solicitor). If a buyer and seller sign an unconditional contract to buy and sell a vacant commercial building before 1 October 2010, but the buyer does not pay a deposit (or other part of the price) and a settlement statement is not issued until 1 October 2010 or later, the 15% GST rate will apply.
• Even if the deposit is paid to the seller (supplier), it does not amount to a "payment" for GST purposes for so long as the contract is conditional. The buyer and seller cannot "lock in" a 12.5% GST rate by having the buyer pay a deposit to the seller as stakeholder before 1 October 2010.

There are special time of supply rules for some kinds of supplies. For example, where goods, including land, are rented, or where an agreement provides for periodic payments for services, a series of successive supplies takes place when each payment becomes due or is received. To the extent that such payments become due or are received on or after 1 October 2010, the supplier (the lessor) will have to account for GST at the 15% GST rate.

May Suppliers Lock In a 12.5% GST Rate by Early Invoicing?

Some suppliers may see opportunities to reduce their output GST, by manipulating their usual invoicing arrangements, so as to bring forward the supply of some sales to before 1 October.

However, the IRD has sounded the following warning:

"Reliance on the normal time of supply rules may allow businesses to bring forward invoicing so they can take advantage of the old lower GST rate. In excessive cases the general anti-avoidance provision in the GST Act may be applicable if it is clearly evident that businesses are restructuring their business practices to bring forward a material number of transactions."

Accordingly, such manipulation should be approached cautiously.

On the other hand, in our view there should be no objection to taking advantage of an ability to pay "up-front", rather than in instalments throughout the year, in order to lock in the 12.5% GST rate.

For example, in many cases local authorities give their ratepayers the option to pay the whole year's rates early in one lump sum, or in instalments throughout the year. Under the instalment option there would be a series of successive supplies by the local authority under a special time of supply rule. Instalments on or after 1 October would attract the 15% GST rate. However an upfront payment of the entire year's rates prior to 1 October would attract GST at 12.5%.

Can Suppliers Increase Contract Prices Agreed Before
1 October 2010?

An important issue is the ability of suppliers to adjust contract prices so as to pass on the cost of the increased output GST to their customers. The particular concern relates to pre-1 October agreements where time of supply does not occur until on or after 1 October. Examples are:

• existing long-term sale contracts (such as properties bought "off the plans"), where the time of supply will not occur until the new GST rate is in force;
• existing long-term agreements for hire where payments will continue beyond September;
• existing lay-by sales, where under a special rule, time of supply does not occur until property in the goods passes to the purchaser, which could well not occur until October or later.

It is clear that if a contract provides for a price to be "plus GST", "plus GST (if any)" or "plus GST at the prevailing rate", the supplier can increase the price to recover the extra GST. For example, if the price was "$100 plus GST" and the time of supply was before 1 October 2010, the total price would be $112.50. However, if time of supply was on or after 1 October 2010, the total price would be $115.

Where an agreement states the price as "GST inclusive" or "GST inclusive (if any)", it can be argued that the parties have agreed a fixed, once and for all, price, regardless of any subsequent increase in the rate of GST. From the buyer's point of view, the benefit of "GST inclusive" pricing is that it establishes certainty as to their contractual liability to the supplier. However, IRD has recently issued the following statement:

Some commentators have suggested that there is interpretative uncertainty over whether contract prices expressed as "inclusive of GST" can be increased by the amount of the GST rate increase. Given that many contracts will be expressed on a GST-inclusive basis, this issue should be put beyond doubt by amending the relevant section of the GST Act. The policy intent is clearly that contract prices expressed as GST inclusive should be able to be adjusted.

The "relevant section" of the GST Act is section 78(2). The post-Budget legislation amended this section by removing certain words that IRD considered gave rise to the uncertainty. In IRD's view, the amended section makes it clear that suppliers can increase a GST inclusive price in light of the rate change.

Given that clear statement of policy intent, in our view it is appropriate for suppliers with "GST inclusive" contracts to proceed on the basis that they can recover an additional amount from the buyer. (This will mainly be of significance for non-GST registered buyers who cannot recover GST input tax. Registered buyers will be largely indifferent, as their cost net of GST after recovering input tax will remain the same.)

Some suppliers who can technically rely on section 78(2) may, for commercial reasons, opt not to do so. They may prefer to "wear" the increased output GST liability. In certain circumstances, particularly where the buyer is not GST-registered, contractual arrangements could be adversely affected if the supplier asserted the technical position under section 78(2).

Also, despite section 78(2), we suggest that any sale contracts entered into with customers between now and 1 October, where time of supply may or will occur on or after 1 October, are priced on a "plus GST at the prevailing rate" basis, wherever possible. It is also best practice to give affected buyers a clear statement as to the pricing impact of the GST rate increase, whether the price is "plus GST" or "GST inclusive".

How Should Price Increases be Calculated?

Where a GST-inclusive price is to be increased due to the GST increase, the price needs to be increased by 2.22%, not 2.5%, as might be assumed. For example, if the price is stated as "$112.50 including GST" it will be increased by $2.50 to $115. $2.50 is 2.22% of the original $112.50 GST-inclusive price.

The supplier's return net of GST (after accounting for output tax) will be $100, as it would have been had the 12.5% GST rate still been in effect at the time of supply.

If, however, the supplier opted not to adjust the price and instead "wear" the increased output GST liability, its return net of GST (after accounting for output tax on $112.50 at the new 15% rate) would be reduced to $97.83. In other words, its post-GST return would reduce by 2.17%.

How Will Input GST be Affected?

A GST-registered buyer's GST input tax claim will be the same as the supplier's GST output tax liability.

As such, if the time of supply is on or after 1 October, so that the supplier must account for output tax at 15%, a GST-registered buyer will have an equivalent input tax claim.

The new "tax fraction" - ie the amount of input tax in a GST-inclusive purchase - is 15/115, or 3/23. This is the equivalent of the 1/9th "tax fraction" (ie. 12.5/112.5) at the current GST rate.

Straddle Returns

Some registered persons will have a GST taxable period that does not end on 30 September 2010, but straddles the GST rate change.

Under section 78A of the GST Act, such persons must file a return in two parts. One part must cover the period ending on 30 September 2010, and the other the period from 1 October 2010 to the true end of the taxable period.

What Transitional Rules Apply to Staged or Late Payments?

The time of supply generally determines the rate of GST at which the supplier must account for GST on the entire price, even if payment occurs in stages or the buyer is slow paying.

This will be the obvious position for GST "invoice basis" registered persons. For example:

• If an invoice basis person issues an invoice on or before 30 September 2010 that triggers the time of supply, it will have to account for output GST at 12.5% on the full invoice price in that taxable period. This will be the case even if the price is not paid until October or later.
• Likewise, if it receives a supply in the taxable period ending on 30 September 2010 it will have an input tax entitlement for that supply in that period at the 12.5% rate. Again, this will be so even if it makes no payment until October or later.

The position for GST "payments basis" registered persons is effectively the same. However, it is arrived at by a more circuitous route:

• A payments basis person only accounts for GST to the extent payment has been received in the taxable period and claims input tax to the extent payment has been made in the period.
• Under a special transitional rule in section 78B of the GST Act, a payments basis person who makes a supply on or before 30 September 2010, but who does not receive payment until 1 October 2010 or later, must account for output tax at the 15% GST rate as and when payment is received. Similarly, if it receives a supply treated as made on or before 30 September 2010, but does not pay until October or later, it may claim an input tax credit at the increased 15% GST rate as and when it makes payment.
• However, in its last GST return under the 12.5% GST rate (in the taxable period to 30 September 2010), there will be a one-off compensating adjustment. This will effectively "reverse out" the subsequent increase to output tax and input tax in respect of these transitional supplies.

Will there be Further Changes?

This FYI reflects the position under the GST Act at the time of writing.

However, the Government has established a GST Advisory Panel to consider transitional issues in relation to the GST increase. The Panel's deliberations could result in further legislative changes before 1 October. Those changes will not necessarily be taxpayer-friendly.

Submissions can be made to the Panel by interested parties here.