Publications
FYI
Tax Update
24 Sep 2010
Benefits in Proposed GST Changes
Proposed GST changes will be beneficial for many businesses. The proposals, in a Bill currently at the Select Committee stage, aim to tidy up a number of areas that have created compliance issues for taxpayers as well as revenue risk for Inland Revenue.
Zero-rating of Business-to-Business Transactions involving Land
Possibly the most significant proposal is that virtually all transactions between two GST registered persons that have a land component will be zero-rated from 1 April next year.
Frauds Targeted
From the Government's perspective, the zero-rating proposal is aimed at wiping out so-called "phoenix company" fraud schemes that have arisen in a land sale context. In a phoenix fraud, IRD refunds GST "input tax" to the purchaser, but the vendor company is wound-up (and its directors often disappear) without GST "output tax" being paid on the sale. IRD is left out of pocket and with limited scope for recovery.
Zero-rating means that the GST cash component of the purchase price is removed. The vendor does not have an output tax liability, but the purchaser cannot claim any input tax. The position is GST neutral, as it would be under current rules if the purchaser's input tax claim was matched by vendor output tax.
But Far Wider Implications
However the implications of zero-rating are much wider. As noted, the rule will apply to essentially all business-to-business transactions that have a land component. This means, for example:
- A commercial lease will be zero-rated, saving the tenant the cashflow expense of paying and then claiming back GST.
- Sales of most businesses and parts of businesses will be zero-rated. As long as the assets sold include a land component, however small, the entire transaction will be zero-rated.
How will Zero-rating Assist with Compliance?
Zero-rating of any asset sale with a land component will remove a significant compliance headache that arises for many taxpayers under current rules.
At present, a business sold as a "going concern" can be zero-rated, but there is often uncertainty whether the facts permit zero-rating. Vendors, who have the immediate exposure to IRD if a transaction is incorrectly zero-rated, tend to adopt a conservative position. If there is any uncertainty about "going concern" status, they will insist the transaction not be zero-rated, requiring the purchaser to pay GST on top of the purchase price. The purchaser then either has to fund the additional GST component until it gets an input tax refund from IRD, or if possible (and usually at the cost of engaging advisers) arrange an IRD approved offset of its input tax against the purchaser's output tax.
Automatic zero-rating of any transaction with land content will remove these costs and complexities.
For example, suppose Tree Co Ltd owns several forestry blocks. Each block is managed by a small management team from a central office. Pruning and other maintenance is carried out by contractors. Tree Co Ltd signs an agreement with Forest Co Ltd to sell one of the blocks for $1m "plus GST (if any)". Both parties are GST registered.
Under current law, even though the sale of part of a going concern which is capable of separate operation can be zero-rated, it is unlikely that the sale of one land block with standing timber, but without ongoing management arrangements, personnel and other related assets, is a going concern. Therefore Tree Co Ltd decides that the sale will not be zero-rated, so at settlement Forest Co Ltd has to pay $1m plus $125,000 in GST (or $150,000 from 1 October). Although Forest Co Ltd can claim the GST back from IRD as input tax, until the refund is received, it incurs an interest cost on the additional amount borrowed to pay the GST at settlement.
Under the new land zero-rating rule, the transaction would be zero-rated, irrespective of whether the assets sold amounted to a going concern. Forest Co Ltd would only be required to pay $1m at settlement and would make no input tax claim.
What Limitations will Apply?
Zero-rating will only apply where the purchaser is acquiring the land, at least in part, for the purpose of making its own GST taxable supplies (ie for its taxable activity). It will not apply where a GST registered person, such as a property developer, sells a home or other land to an unregistered individual. Zero-rating will also not apply where the purchaser is a registered person but is purchasing the property as a private home (even, it seems, if it will also be used for making GST taxable supplies).
In order to zero-rate, the supplier will need the purchaser to confirm that the purchaser is GST registered and intends to use the land for making taxable supplies. Formal legal warranties will be needed in most cases. If the supplier is unable to obtain these details from the purchaser, the supplier must make its own inquiries to satisfy itself that the sale can be zero-rated, at the risk of being liable to account for GST otherwise. In cases of mistake or misrepresentation by the purchaser, the purchaser will be liable if the transaction is incorrectly zero-rated.
What about Mortgagee Sales?
The new zero-rating rule will apply to mortgagee sales of land or land with other assets. In circumstances where a mortgagee sale is deemed to be a taxable supply by the debtor, the new rule will zero rate the sale provided the purchaser is GST registered and the other requirements discussed above are satisfied.
Input Tax and Mixed Use and Change in Use Rules
Under current GST rules, a registered person is generally entitled to make a full input tax claim when they acquire goods or services for the "principal purpose" of making their own GST taxable supplies to customers.
Where there is an additional purpose in acquiring the goods or services, such as making GST exempt supplies, or using the relevant asset privately, complicated output tax adjustments are required. Similar adjustments are required where there is a change from a wholly taxable use to an exempt or private use. These adjustments involve a deemed full or partial sale of the asset, triggering a tax liability that claws-back some of the input tax claimed at acquisition.
These rules probably have their greatest impact on taxpayers in the financial services sector, which make a mix of taxable and exempt supplies, and on certain taxpayers in the property sector which supply exempt residential rental accommodation but also make taxable supplies of land in certain circumstances. In addition, sole traders often use assets like cars for a mix of taxable and private purposes.
Proposals in the Bill aim to simplify the approach to mixed and changed uses. In relation to goods and services acquired from 1 April next year, the registered person will be required to make an estimate, at purchase, of the proportion of taxable vs. non-taxable or exempt use of the asset. They will be entitled to claim input tax at acquisition in proportion to the anticipated taxable use of the asset. Subsequent adjustments will then only be required to the extent actual taxable use differs from estimated taxable use.
No adjustments will be required for goods purchased for less than $5,000 (if they are to be used in the taxable activity) or where the change in use is less than 10% and would result in an adjustment of no more than $1,000. Further, for assets other than land, there will be a limited time in which subsequent adjustments are required. This will range between two and ten years depending on the value of the asset.
While this is an area that remains complex, the proposals do represent an improvement on the current approach.
A similar rule will apply where a land transaction is zero-rated (above), but the GST registered purchaser intends to use the land for non-taxable or private purposes, as well as for making GST taxable supplies. The transaction will still be zero-rated, but the purchaser will have to make an estimate of the percentage of intended use that is not for making GST taxable supplies and pay to IRD GST output tax on the purchase price to that extent.
Supplies of Accommodation
Another significant proposed change in the Bill is a widening of the GST net in relation to supplies of accommodation.
Supplies of accommodation in "dwellings" are GST exempt, whereas other supplies of accommodation, including accommodation in "commercial dwellings", are taxable.
Under current rules, "dwelling" is defined as any building used predominantly as a place of residence of any individual. A "commercial dwelling" includes hotels, motels, boardinghouses, camping grounds, short-term stay rest homes etc. and other similar establishments.
There has been significant uncertainty as to the margin between these definitions. Homestays, farmstays and serviced apartments are examples. Accommodation provided in these types of establishments has been treated inconsistently.
In a 2006 statement IRD said that these types of establishments are generally "dwellings" (rather than "commercial dwellings"), so accommodation in them should be treated as GST exempt. This might have been influenced by a concern that input tax claims were exceeding the collection of output tax in many establishments.
That 2006 statement is seen as inconsistent with the original policy intent of the GST exemption for residential accommodation. The original policy was to ensure that owner-occupiers of residential dwellings, who would generally not pay GST on the purchase, and never on their borrowing costs, were not placed in an advantageous position compared with those who rent. It was not intended to exempt accommodation in dwellings more generally. The wide interpretation given the current "dwelling" definition has frustrated that intent.
As a result, the Bill introduces a narrower definition of "dwelling". Under the proposed changes, for accommodation to be in a "dwelling", the building must be occupied by a person as their principal place of residence. In addition, the definition of "commercial dwelling" will be widened, and will specifically include (among other things) homestays, farmstays, bed and breakfast establishments and serviced apartments.
The changes make it clear that most supplies of accommodation to occupants using the premises as other than their principal home are potentially within the GST net - unless the supplier can establish that there is no continuity or regularity of supply required for a taxable activity (eg the occasional renting of the family bach). Many small scale operators that are carrying on a taxable activity may legitimately choose not to GST register if their annual turnover from the activity is below the $60,000 compulsory registration threshold. However, choosing not to register and charge occupants GST will come at the cost of not being able to recover GST on inputs.
Article written by Barney Cumberland, Senior Associate
Authors
Paul Windeatt
Senior Associate - Tax
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In This Article:
Proposed changes to GST rules promise to ease a number of compliance headaches.
Authors:
- Partners
- Barney CumberlandBarney Cumberland
- Stuart HutchinsonStuart Hutchinson
- Senior Associates
- Nick BlandNick Bland
- Paul WindeattPaul Windeatt
