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Issue Number: 15/2009

In this issue:

  • Radical GST changes ahead
    • Domestic reverse charge
    • Input tax deductions and change-in-use adjustments
    • Sales in satisfaction of debt
    • Accommodation
    • Other proposed changes
    • PwC assistance
  • PwC’s Indirect Tax News
  • Progress of July 2009 tax bill
  • Relocation expenditure

Radical GST changes ahead

The Government is proposing sweeping GST changes that will affect many businesses. The key proposals are the introduction of a domestic reverse charge ( DRC ) on certain transactions and reforms to the rules governing input tax deductions and change-in-use adjustments.

New Zealand 's GST system is considered a benchmark globally because it is pure and simple. The proposed new rules will test this reputation.

The proposed changes are designed to address some current GST business neutrality issues. The Government has taken on board many of the submissions made in 2008 in response to its earlier proposals and has tempered the scope of the suggested amendments.

In a welcome development, the Government will not proceed with plans to impose caveats on land to protect Inland Revenue's interests, widen Inland Revenue's set-off powers and extend the associated persons rules to restrict second-hand goods deductions.

Businesses should consider the potential impact of the changes carefully and determine whether the reforms will give rise to commercial, systems and pricing issues.

The discussion document "GST: Accounting for land and other high-value assets" includes draft legislation for many of the proposals.

The deadline for submissions is 18 December 2009 . The Government is likely to introduce the proposals in a Bill in mid-2010. The changes could apply from early 2011.


Domestic reverse charge

The DRC proposals are intended to reduce revenue risk to the Government, remove GST cash flow disadvantages for businesses and prevent unexpected GST liabilities from arising. The proposed DRC model is unique as no other country currently has a DRC model of the magnitude proposed.

Overview

The proposed DRC represents a fundamental change to how GST ordinarily works as it shifts the obligation to account for GST from the supplier to the recipient.

Under the DRC , the recipient steps into the shoes of the supplier and accounts for the output tax on the transaction. The recipient then recovers the GST on the transaction in accordance with their normal GST recovery entitlement.

The DRC would apply to all transactions between GST-registered businesses involving:

  • land;
  • going concerns; and
  • supplies of goods and services with a GST-exclusive value of $50 million or more.

The DRC would not apply to sales in satisfaction of a debt (mortgagee sales) and progressive supplies.

The advantage of the DRC for businesses entering into high-value transactions is that it would eliminate any potential GST cashflow cost and remove the potential uncertainty associated with zero-rated going concern sales. It would protect Inland Revenue against a distressed vendor being unable to account for the GST. It would also deal with situations in which the purchaser has received the GST refund but the vendor has not accounted for GST.

Businesses will need to take care in drafting agreements to ensure that the parties' respective GST positions are protected.

Given that a DRC model of this magnitude is untested, the main issues will relate to:

  • pricing - the DRC rules anticipate a GST-exclusive price but market forces may resist this; and
  • systems – adapting GST accounting systems to deal with both DRC transactions and non- DRC transactions.

Other issues

  • There is the potential for two different sets of GST rules to apply for the same class of transaction – e.g. the DRC would apply to land supplied to a GST-registered business but not to land supplied to private individuals.
  • The time of supply under the DRC is the date on which payment is made to the supplier (intended to be the time payment is received in full).
  • It is unclear whether the DRC could require an unregistered recipient to register for GST.
  • As it is intended for the vendor to receive the price exclusive of GST, secured lenders to the vendor will have a lesser interest in the sale proceeds.
  • There will be transitional issues for transactions entered into before the start of the new rules.

Land transactions

Difficulties could arise where land is supplied with other goods and services under the same agreement and the business is not being sold as a going concern. The discussion document suggests that the DRC would also apply to the other goods and services supplied under the agreement if the land and buildings are the “predominant feature of the supply”.

The fact that two sets of GST rules could apply to the same transaction will add complexity to many transactions and could create pricing and invoicing difficulties.

Going concerns and high value transactions

Sales of businesses that are either going concerns or valued at more than $50 million would also be subject to the DRC . The Government would repeal the zero-rating rules for transfers of going concerns.

Parties to a sale would still need to determine whether a sale is of a going concern to determine whether the DRC rules apply. If the sale does not amount to a going concern and the value is less than $50 million, the general GST rules would apply.

Mistaken application of the DRC

If a supply is mistakenly treated as subject to the DRC (e.g. where a transaction has been incorrectly treated as the sale of a going concern), Inland Revenue will have recourse against the supplier only if:

  • the recipient has not accounted for the GST payable; and
  • the supplier has failed to keep adequate records in relation to the transaction.

Alternatives to the DRC

Inland Revenue is concerned about potential GST leakage from transactions where the recipient makes deductions and the supplier fails to account for the GST. The discussion document notes that the DRC will remove GST cashflow concerns for parties to high value transactions, but arguably these issues are already managed adequately by the existing zero-rating rules for going concerns, the use of GST offsets and forward planning around payments timing.

The DRC is a pragmatic solution to these problems from the Government's perspective. However, it will introduce an additional level of complexity for businesses and deviate from New Zealand 's existing world class GST system that is predicated on simplicity.

As the advantages of the compulsory DRC could be outweighed by the disadvantages, we consider that the alternatives should be canvassed more thoroughly. These alternatives could include expansion of the existing zero-rating provisions, an ability to “opt in” to the DRC rule, or a special declaration procedure for certain business transfers that some other countries adopt. The last approach would leave the other GST obligations constant but would involve an internal GST offset within Inland Revenue's system for specified transactions.


Input tax deductions and change-in-use adjustments

The discussion document proposes significant changes to the rules for determining input tax deductions and change-in-use adjustments. The changes are intended to address the uncertainty and complexity inherent in the current rules and to align the New Zealand approach more closely with the Australian approach.

The proposals are a step in the right direction and will provide greater certainty about entitlement to GST deductions. However, the new rules will result in additional compliance obligations. Businesses will need to adapt their GST systems to monitor the use of assets over a number of years. Some may face negative GST consequences compared to the position under the current rules when assets are sold or used concurrently for mixed taxable and exempt purposes.

Existing rules

Currently businesses can deduct GST on costs in full if the goods and services were acquired for the principal purpose of making taxable supplies. They must make adjustments for GST on any non-taxable use of the goods and services.

Conversely, businesses cannot claim GST deductions for goods and services not acquired for the principal purpose of making taxable supplies. They can make input tax adjustments subsequently to the extent that the goods or services are used for a taxable purpose.

Proposed changes

Businesses would take a GST deduction upfront when they first acquire the goods or services. The deduction would be based on the intended taxable use of the goods and services. Businesses would need to estimate the intended taxable use on a fair and reasonable basis using available records, previous experience with similar assets and business plans.

Annual adjustments to the upfront deduction would be made if the initial intended taxable use changed by more than 5%. If the actual taxable use is less than the intended taxable use additional GST would be payable and vice versa.

Entitlement to a partial deduction in the first instance would provide some businesses with a positive timing advantage compared to the current position whereby no initial deduction is allowed.

If the proposed changes are implemented, the current “principal purpose” test for determining entitlements to input tax deductions will be repealed. Deduction entitlements would be based instead on a “use” test that may change the scope of GST recoveries in practice.

Practical effect

To illustrate the potential impact of the changes:

Say a GST-registered business acquires goods that will be used 70% for taxable purposes and 30% for exempt purposes. Under the existing rules, if the goods were acquired for the principal purpose of making taxable supplies, a full input tax deduction is taken upfront. The business would then make an output tax adjustment to reflect the 30% exempt use. Under the proposed new rules, the business would be able to claim only a 70% GST deduction upfront (and adjustments would be made going forward where usage of the acquisition changes by 5% or more).

If the respective taxable and exempt usage percentages are reversed i.e. the business intends to apply only 30% of the goods for a taxable purpose, under the current rules the business would not be entitled to a GST deduction on acquisition (and could only make periodic input tax adjustments over time). Conversely, under the proposed new rules, the business would be entitled to a 30% GST deduction upfront (which would then be adjusted as necessary).

Calculating change-in-use adjustments

Adjustments are made annually in the first taxable period corresponding to a taxpayer's balance date that is at least 12 months after the date the goods and services were acquired. Where businesses acquire goods and services shortly after balance date, it may take close to two years for the first adjustment entitlement to arise. This does not compare favourably with the flexibility of the current adjustment rules that allow adjustments in each return period (or annually).

No adjustments are required where either the goods and services have a value of $1,000 or less, the business only makes minor exempt supplies or the change in taxable use is 5% or less.

The number of annual adjustments required will be determined by either the value of the acquisition (2, 5 or 10 periods) or its estimated useful life. Taxpayers will be able to choose to use either the “value” or “depreciation” based intervals.

There is no limit on the number of annual adjustments required in relation to land regardless of its value.

Disposal of assets

New rules are also proposed for the sale or disposal of assets that have been subject to change of use adjustments.

Concurrent usage of assets

The Government will introduce specific apportionment rules to cover assets used concurrently for taxable and non-taxable purposes (e.g. a residential property leased and advertised for sale at the same time). The effect of the proposals is to require the vendor to pay additional output tax from the sale proceeds to reflect the temporary exempt use of the asset.

Transitional issues

The new rules would apply to assets acquired after the date of enactment. It is unclear how the existing change-in-use rules will interact with the new rules in relation to assets for which adjustments are required both before and after the date of enactment. It is unclear whether the existing principal purpose test and change-in-use provisions will continue to apply to assets acquired before the date of enactment.


Sales in satisfaction of debt

The Government proposes to extend the existing rules for sales in satisfaction of a debt (mortgagee sales) to capture “in substance” mortgagee sales. The proposed widening of the rules may result in lenders incurring unexpected GST payment obligations.

The introduction of specific measures (rather than reliance on the general anti-avoidance rule) is a positive development as there is currently uncertainty and contentious issues in relation to GST priorities.

Background

If a mortgagor defaults on a loan, the mortgagee may exercise its power of sale to recover its debt. The mortgagee must account for the GST.

The Government is concerned that it is losing GST revenue because of a growing number of “de facto mortgagee sales”. Such sales arise where the mortgagee assists with the sale of a property but does not take possession of the property. These sales fall outside the ambit of the current GST rules and the mortgagor is required to account for GST on the sale. However, the mortgagor is often insolvent and unable to fund the payment of the GST.

Indicators of mortgagee sales

Under the proposals, a sale will be treated as a mortgagee sale if one or more of the following occurs:

  • a mortgagee takes control of, or induces the sale of, the property by exercising a power under a contract with a mortgagor;
  • a mortgagee signs the sale and purchase agreement, or requests the mortgagor to sign the sale and purchase agreement already negotiated by the mortgagee;
  • a mortgagee organises services such as conveyancing, auctioning or advertising;
  • a mortgagee pays directly for the services related to the sale of the property;
  • the mortgagor's solicitor is also the mortgagee's solicitor;
  • a purchaser is associated with the mortgagee.

Effect of proposed changes

The proposals are potentially far reaching and could bring a number of ordinary sales into the mortgagee sale rules. As currently drafted, there is a risk that ordinary sales by vendors could fall within the mortgagee sales regime. Lenders pursuing a commercial solution could find themselves with a GST liability they did not anticipate.


Accommodation

The Government will amend the GST Act to clarify the definitions of "dwelling" (GST-exempt) and "commercial dwelling" (subject to GST). This is a positive development as the boundary between the two has been uncertain.

The definition of “dwelling” will focus on the use of the accommodation rather than the “bricks and mortar”. “Dwelling” will be defined as premises that a person occupies as their principal place of residence and to which the person has an exclusive right of possession.

The definition of "commercial dwelling" will be changed to include homestays, farmstays, bed and breakfast establishments and all other premises other than “dwellings”. “Serviced apartment” will also be included in the definition of “commercial dwelling”.

Practical issues

Under the proposed changes, the supply of holiday homes and similar supplies (e.g. renting out a second home) will become subject to GST.

The addition of serviced apartments to the definition of “commercial dwelling” will require a number of suppliers of accommodation (e.g. retirement village operators and suppliers of student accommodation) to reconsider the GST treatment of their supplies.

The proposed changes to the definitions of "dwelling" and "commercial dwelling" run counter to some of the guidelines provided by Inland Revenue in its recent draft statement: IS3571 “Retirement Villages - GST Treatment”.

Significantly, the proposals include a catch-all provision, “all premises other than a dwelling”, within the definition of “commercial dwelling”. Practically this means that there will be a presumption that a supply of accommodation is subject to GST. The taxpayer will bear the onus of demonstrating that the accommodation is used as a dwelling and therefore GST-exempt.

Once the changes are implemented taxpayers may be required to change the GST treatment of accommodation from GST-exempt to subject to GST or vice-versa. This raises practical issues including:

  • GST recovery for both the past and the future;
  • pricing of the accommodation; and
  • transitional issues.

Other proposed changes

Transactions involving nominations

New rules are proposed to clarify the GST treatment of nominee transactions where the DRC does not apply (e.g. where a party is not GST-registered).

The GST treatment of nominee transactions is often uncertain and inconsistent. Legislative clarification is a positive development. The proposed legislative changes will cover most but not all nomination scenarios.

Underlying the proposed rules is a presumption that the GST treatment of transactions involving nominations should be based on the economic substance of the transaction. When there is a single transfer of title, the Government believes there must be a single supply for GST purposes.

However, the proposed rules represent a departure from a fundamental GST principle - GST is a transaction based tax. In nomination scenarios there may be several distinct transactions and consequently several different supplies for GST purposes. So any proposal for legislative change should address this.

The Government has not published draft legislation yet.

Invoice-basis accounting for certain transactions

Currently GST-registered persons using the payments basis of accounting must use the invoice basis to account for GST for supplies over $225,000 where settlement is deferred for over a year. This rule is intended to mitigate unintended or orchestrated timing mismatches on transactions where the parties use different GST accounting bases.

Under the proposed changes, the focus will be on the recipient of the supply rather than the supplier. The recipient will be entitled to a GST deduction only when payment is made.

The use of specific measures rather than reliance on the general anti-avoidance rule is a positive step. However, the proposed rules will limit the GST deductions that would otherwise be available.

Businesses using the invoice accounting basis will be required to identify any deferred settlement arrangements to which they are a party. They will need to put in place controls to prevent GST deductions being taken earlier than is allowable.

GST refunds – timing rules

Inland Revenue must pay a GST refund within 15 working days of receipt of the relevant GST return. If Inland Revenue is proposing to investigate the GST refund and withhold payment, a taxpayer must receive notification within 15 working days.

The Government is proposing to amend the legislation so that the 15 working-day rule refers to the issue of the notice by Inland Revenue rather than its receipt by the taxpayer. This will extend the period available to Inland Revenue for investigating GST refunds.

The proposed changes are preferable to the 20 working day period proposed in the 2008 GST issues paper. However, the ability to claim deductions efficiently is fundamental to the operation of GST. Given the current economic climate, it is disappointing that the Government is proposing measures to delay the processing of GST refunds further.


PwC assistance

If you would like to discuss or submit on the proposals, please contact your normal PwC adviser or a member of our GST team.

Auckland

Eugen Trombitas
Partner
Ph: (09) 355 8686
Email: eugen.x.trombitas@nz.pwc.com

Gary O'Neill
Director
Ph: (09) 355 8432
Email: gary.oneill@nz.pwc.com

Jared Otto
Director
Ph: (09) 355 8073
Email: jared.a.otto@nz.pwc.com


Welllington

Gary Crawford
Partner
Ph: (04) 462 7251
Email: gary.crawford@nz.pwc.com

Emma Richards
Director
Ph: (04) 462 7162
Email: emma.h.richards@nz.pwc.com


PwC's Indirect Tax News

The October edition of InTouch* - PwC Asia Pacific VAT/GST Alert is now available.

In this edition we continue to keep you abreast of major VAT/GST developments in Asia Pacific that may affect your business.


Progress of July 2009 tax bill

The Finance and Expenditure Committee (FEC) has reported back to Parliament on the Taxation (Consequential Rate Alignment and Remedial Matters) Bill (the Bill) that was introduced in July.

The major policy item in the Bill is the alignment of the resident withholding tax ( RWT ) rates on interest with the new income tax rates of 12.5%, 21%, 33% and 38%. The Bill also:

  • introduces a new default RWT rate of 38% for those people who do not notify their bank of their correct tax rate;
  • introduces a new 30% RWT rate on interest paid to companies to align with the change in the company tax rate;
  • aligns the tax rates on portfolio investment entities (PIEs) with personal tax rates. The PIE rates will be 12.5%, 21% and 30%;
  • introduces a new 12.5% secondary tax code and a new 12.5% withholding tax rate for extra pays;
  • allows Inland Revenue to accept corrections of minor errors(involving $500 or less in tax) in subsequent returns to reduce compliance costs for taxpayers; and
  • allows tax agents more time to allocate beneficiary income.

Tax Tips 10/2009 contains further details on these and other changes proposed in the Bill.

The FEC has recommended a limited number of changes to the Bill. The main recommendations are:

  • not to increase the default RWT rate for existing bank accounts from 21% to 38% from 1 April 2011 as planned. The FEC is concerned that increasing the default rate for existing bank accounts to 38% would over-tax some taxpayers on lower marginal tax rates;
  • to allow Inland Revenue to instruct interest payers to shift individuals that it determines are on an RWT rate inconsistent with their marginal rate to the appropriate RWT rate; and
  • to allow a person who is moved to a higher RWT rate to elect another RWT rate subsequently.

Relocation expenditure

Inland Revenue has provided clarity on the types of relocation expenses paid by employers to employees that are exempt from income tax and fringe benefit tax.

Determination DET 09/04: “Eligible relocation expenses” lists the relocation expenditure that an employee may treat as exempt income for the 2002-2003 and subsequent years.

The list of eligible expenditure is comprehensive and expands the list in the draft determination issued in November 2008 to include expenditure on:

  • immigration and emigration applications;
  • cleaning and fumigating old and new residences;
  • Customs' clearance and other costs associated with complying with New Zealand Customs regulation and other regulatory requirements that arise when transferring household and person effects and “tools of trade” from the old to the new location;
  • additional costs associated with selling an existing home and acquiring a new home; and
  • hiring household and/or personal effects for the new location while awaiting the arrival of property.

The final Determination omits the costs of CV preparation for family members.

The Taxation (International Taxation, Life Insurance and Remedial Matters) Act 2009 enacted last month clarified the law to ensure that relocation payments specified in the Determination and that meet certain criteria are tax-free in employees' hands. Refer to Tax Tips 8/2009 for the additional requirements.

The Determination will be included in Inland Revenue's December Tax Information Bulletin.

 

Disclaimer: Tax Tips is intended as comment only and should not be relied upon or used as a substitute for professional advice. No liability is accepted for loss or damage incurred by persons who rely on this commentary. Professional advice should be sought in relation to any particular situation or circumstance.