The Government recently passed the Taxation (GST & Remedial Matters) Act which received the royal assent on 20 December 2010.
The Act contains important changes to three areas of the Goods and Services Tax Act as well as changes to the Loss Attributing Qualifying Company rules which we will cover in a separate newsletter.
The three key changes are:
- Introduction of zero-rating on land sales.
- Changes to input tax change of use rules.
- Changes to transactions involving nominations (see our November Newsletter).
1. Zero-Rating on Land Sales
The Government has been looking at ways to combat phoenix schemes for some time as they resulted in large losses of GST revenue to the IRD through the vendor being unable to pay the GST on land sales and the purchaser being entitled to GST inputs on the transaction.
The IRD looked at various methods to prevent this and, based on feedback from taxpayers, New Zealand Institute of Chartered Accountants and the industry, the zero-rating mechanism was extended to capture land sales.
From 1 April 2011, GST registered vendors will be required to charge GST at the rate of 0% on any supply to another registered person which involves land, if the purchaser intends to use the land for making taxable supplies and the land is not intended to be used as the principal place of residence of the recipient (or a relative of the recipient).
This applies to supplies where land is wholly or partly supplied. This means, for example that the sale of a business which includes the sale of land would be fully zero-rated under the new provisions. Additionally, where land is supplied as part of a service, that service is treated as a supply of goods and zero-rated.
A new definition of land is being inserted into Section 2(1). Land is defined as including:
- an estate or interest in land:
- a right that gives rise to an interest in land:
- an option to acquire land or an estate or interest in land:
- a share in the share capital of a flat-owning or office-owning company, as defined in
Section 121A of the Land Transfer Act 1952:
But does not include—
- a mortgage:
- a lease of a dwelling:
- “an interest in land in circumstances where the supply is made periodically and 25% or less of the total consideration specified in the agreement, in addition to any regular payments, is paid or payable under the agreement in advance of or contemporaneously with the supply being made.”
We note that “an estate or interest” in land could have a broad interpretation. An interest in land includes both legal and equitable interests. One example of a legal interest in land is a “profit a pendre” that is the right to enter onto another person’s land and take profit from the soil, for example cutting rights for timber or the right to mine for minerals.
Finally, a new Section 78F is added which deals with the requirement of the purchaser to provide a written statement to the vendor. That Section states that at or before settlement of the transaction, the recipient is required to provide a statement in writing to the supplier as to whether, at the date of settlement,—
(a) they are, or expect to be, a registered person; and
(b) they are acquiring the goods with the intention of using them for making taxable supplies; and
(c) they do not intend to use the land as a principal place of residence for them or a person associated with them under Section 2A(1)(c).
We expect that these requirements will be incorporated in the standard Agreement for Sale and Purchase of Real Estate in due course. You should ensure this written statement is present, especially if you are acting on behalf of the vendor, and ensure the price is “plus GST if any”.
If the purchaser does not provide such a statement then the whole transaction must be charged with GST at the standard rate.
If the purchaser is a registered person the vendor must also obtain the purchaser’s:
- name and address;
- GST registration number;
- a description of the land;
- the consideration for the supply.
These provisions apply to supplies made on or after 1 April 2011, however, if an agreement was entered into before 1 April 2011 with time of supply on or after 1 April 2011, a supplier can choose to zero-rate the transaction.
- Input Tax Change of Use Rules
Previously an input credit was only available if an asset was acquired for the principal purpose of making taxable supplies. This was one of the cornerstones of our GST legislation for the last
25 years. However, the principal purpose test became troublesome to apply where an asset was acquired 100% for a taxable activity but also applied for a non-taxable activity. One example of this is a property developer who has completed developing a property, but is unable to sell it for the desired asking price and rents the property out. This was the exact situation in the Lundy case which led to an arbitrary decision where the Courts said that the property was being used 75% for taxable purposes and 25% for a non-taxable purpose.
In our view, the changes to the principal purpose test have their origins in the Lundy case.
Inputs on Acquisition
On and after 1 April 2011, a purchaser will be able to deduct input tax on acquisition of goods or services to the extent to which the goods or services are intended to be used by the person in making taxable supplies. Section 20(3G) reads:
In determining the extent to which goods or services are used for making taxable supplies, a person must estimate at the time of acquisition how they intend to use the goods or services, choosing a determination method that provides a fair and reasonable result. The determination is expressed as a percentage of the total use.
(i) If land and buildings are acquired for use in a taxable activity and (say) 30% will be used for exempt residential dwelling purposes, and the sale takes place after 1 April 2011, then:
(a) The transaction from the vendor to the purchaser can be zero-rated; and
(b) The purchaser must pay 30% of 15% of the zero-rated purchase price as GST output tax to reflect the exempt dwelling use of the real estate purchased.
(ii) A sole trader purchases a motor vehicle for $34,500 including GST of $4,500. Estimates at the time of purchase are that business use will be 65%.
The GST input claim is $2,925, i.e. 65% of $4,500.
Subsequent adjustments required and de minimus test
After a registered person uses the goods or services in their business for a period of time (known as an adjustment period) they must compare their actual use with their intended use to work out the percentage difference.
An adjustment period starts on the date of acquisition and usually runs to the first balance date following acquisition.
An input or out adjustment must be made on the difference between intended and actual use. There is also a de minimus test in Section 21G(4) which prevents taxpayers making
adjustments for what are considered insignificant amounts. Section 21G(4) states:
The number of adjustment periods in which a registered person must determine whether an adjustment is required under Section 21A may, as the person chooses, be limited to—
(a) one of the following based on the value of the goods or services, excluding GST:
(i) $5,001 – $10,000 – 2 adjustment periods, being the first or second (where first falls within 12 months) balance date following acquisition and the next anniversary;
(ii) $10,001 – $500,000 – 5 adjustment periods, being the first or second balance date following acquisition and next four balance dates;
(iii) $500,001 or more – 10 adjustment periods; or
(b) the relevant adjustment periods that are equal to the number of years for the estimated useful life of the relevant asset as determined under the Tax Depreciation Rates Determinations set by the Commissioner under Section 91AAF of the Tax Administration Act 1994.
If the value of the change in use is less than $1,000 and less than a 10% adjustment then no adjustment is required, and for assets with a value of less than $5,000 (ex GST) no subsequent adjustments are required.
There is no limit to the number of adjustment periods in relation to land.
Concurrent uses of land
A new Section 21E deals with ‘concurrent uses of land’ as in the Lundy situation mentioned above. Under the new rules a formula determines a person’s taxable use as:
(consideration for taxable supply / total consideration for supply) x 100
where the consideration for taxable supply is:
– either the market value of the land or the sale price;
the total consideration for supply is:
– the consideration for taxable supply plus all rent received since the land was acquired and, if no rent has been paid, the market value of the rent that would have been paid if rented.
This puts significant compliance work on developers who have concurrent uses of land to make output adjustments when they are renting properties out. As also described above, multiple adjustments may be required.
As an example:
A developer has an unsold unit that is rented as a dwelling pending sale. The developer considers the unit has a market value of $400,000 and has rented the unit for 10 months at
$1,560 per month from 1 May to 31 March 2012. The GST input claimed on the unit’s share of the construction costs is $34,000.
Ignoring the de minimus exemption, the output tax adjustment on 31 March 2012 is $1,398.60, being:
17,160 (rent) x 34,000
If rented for a further 12 months to 31 March 2012 at the same rent pending sale, a further output tax adjustment on 31 March 2013 (assuming no change in the property’s market value) is
( 35,880 x 34,000) less $1,398.60 ( 435,880 )
Adjustment on disposal
Where a registered person has claimed a partial input tax credit, and subsequently disposes of the corresponding goods or services, an input credit is available under Section 21F for the difference between the amount claimed to date (including any subsequent adjustments) and a
100% input claim based on the original purchase price, to compensate for the fact that GST is payable in full on sale.
If the taxable activity use of an asset is 70% and no input tax has been claimed on the 30% exempt (private) use, then output tax is paid on the consideration received on sale with an input GST adjustment claim for 30% of the GST content of the asset’s sale proceeds (being the exempt use content).
Whilst this seems like a win for taxpayers in that it simplifies the process to claim a GST input credit, there is also a significant responsibility placed on taxpayers to monitor their use of the asset and make a change of use adjustment when their use of the asset changes or open themselves up for exposure to penalties if an audit occurs and no adjustments have been made to reflect a change in use.