Chapter 3 - Problems When Neutrality is not Achieved
3.1 The credit-invoice method of collecting GST, while generally effective in achieving the objective of business neutrality, can present risks for both businesses and the government. For businesses, the risk is that if the GST consequences of a transaction are not properly taken into account, that could give rise to penalties or even produce a non-deductible GST liability. For the government, the risk is the possibility that Inland Revenue will refund an input tax deduction that may not be offset by an expected corresponding payment of GST.
3.2 This chapter describes these problems in more detail.
Risks to businesses
3.3 Transactions that are not neutral to businesses can result in GST becoming a fixed burden on production. This can affect business margins, distort business decisions and alter perceptions about voluntary compliance. Non-neutral business-to-business transactions can also have wider economic implications if the tax has the potential to cascade.
The “carrying” cost of GST
3.4 GST-registered businesses can face a cashflow cost if they are unable to immediately recognise input tax deductions when GST is paid on purchases. This cost is particularly relevant for exporters because zero-rated exports do not produce the usual offsetting cashflow benefits that arise by holding GST charged on supplies to customers until payment to Inland Revenue is required.
3.5 Another cashflow cost facing businesses that use the invoice or hybrid accounting bases arises if GST has to be returned to Inland Revenue in connection with supplies made over the taxable period in question, but payment has not yet been received from customers.
3.6 These costs are sometimes referred to as the “carrying” cost of GST. The GST Act attempts to deal with this cost by permitting a variety of accounting bases and filing frequencies. Other rules, for example, those applicable to the supply of “going concerns”, further help to mitigate the carrying cost of GST.
3.7 When these legislative solutions do not provide the required degree of relief, administrative solutions can provide assistance. For example, exporters, who make predominantly zero-rated supplies do not receive the benefit of holding GST charged on their supplies of goods and services. To deal with the carrying cost of GST on their purchases, Inland Revenue has a practice of ensuring that excess input tax deductions are promptly refunded to exporters on the receipt of a valid GST return. Exporter GST returns are therefore processed well within the 15-working day requirement.[18]
3.8 In other instances, Inland Revenue may permit the GST liability incurred by a GST-registered supplier on a transaction to be set off against the input tax deduction that would otherwise be available to the GST-registered recipient.[19]
3.9 The New Zealand Customs Service may provide administrative relief to importers by allowing the payment of GST on imported goods to be deferred for up to seven weeks.[20] The deferral allows qualifying importers to claim input tax deductions for GST levied under section 12 before the GST payment needs to be made to Customs.
Potential for over-taxation
3.10 Subject to a GST-registered person holding a valid tax invoice, a deduction of input tax is allowed when GST has been invoiced or paid or, in the case of imported goods, levied. It is important that these deductions are dealt with promptly, particularly when they give rise to a refund, so that GST does not become a cost of production rather than a tax on consumption, as intended.
3.11 If the input tax deduction arises by some other means – for example, from the purchase of second-hand goods or from adjustments for changes in use – Inland Revenue may need to give the deduction closer scrutiny. This is because these deductions do not arise from the payment of GST to another GST-registered person or to the New Zealand Customs Service and therefore do not immediately give rise to offsetting output tax.
3.12 Case law on the deduction of input tax by GST-registered persons has generally emphasised that legal ownership of the goods and services purchased is a prerequisite to deduction.[21] Businesses may therefore face problems when the legal entitlement to input tax cannot be established but the cost of the purchase has been incurred. For example, when a nominee provides consideration for a supply of goods and services to the vendor, but the contract treats the named purchaser – rather than the nominee – as the recipient, uncertainty can arise about the entitlement to deduct input tax and this can possibly even result in over-taxation.
3.13 Another area of uncertainty exists when a nominee provides the consideration for the supply of a “going concern”, but is not the identified recipient on the agreement for sale and purchase. This can affect whether the going concern is zero-rated or subject to GST under the usual rules.
3.14 These uncertainties add to compliance costs as well as affecting businesses’ ability to receive full input tax deductions. The risks of this uncertainty are exacerbated by the potential for short-fall penalties or use-of-money interest charges to apply if, for example, a decision to claim an input tax deduction or to zero-rate a supply ultimately proves incorrect.
Supplies of going concerns
3.15 The circumstances in which the supply of a “going concern” may be zero-rated are defined by the GST Act. Whether or not a supply is of a going concern may, however, be uncertain. If this uncertainty is identified at the beginning, the parties may, as discussed earlier, seek a set off of the GST-registered recipient’s input tax deduction against the output tax owed by the GST-registered supplier. However, this may not always be possible.
Company grouping rules
3.16 The GST grouping rules play an important role in alleviating potential distortions between the treatment of single entities, branch structures and company group structures. The rules reduce compliance costs arising from transactions within a group by ensuring that intra-group supplies sourced completely from within a group’s resources are not subject to GST unless the assets are used for private or exempt purposes. In this way, the GST grouping rules treat the group as if it were a single economic entity.
3.17 The grouping rules are, however, elective, and it may be the case that related entities who wish to group cannot do so because they are unable to satisfy one or more of the requirements in the GST Act.
3.18 The GST Act was recently amended in line with the principle of treating groups of companies as a single economic entity to deal with situations when the transfer of assets within a group gives rise to a GST liability because the recipient member of the group is not registered for GST.[22] However, despite this amendment, GST risks may still exist for businesses in entering into group transactions.
Revenue risks for the government
3.19 GST presents an inevitable risk to the government by requiring the issue of refunds from input tax deductions that may not be offset by the payment of GST in circumstances when that would be the expected outcome. This can occur for legitimate reasons, in the case of liquidations or bad debts of the type that can be faced by any business. However, there are situations when this offset does not occur for other reasons – for example, if timing mismatches created by the choice of accounting bases and filing frequencies is exploited or if “phoenix” entities are used to create tax advantages.
3.20 The risk associated with timing mismatches was highlighted by the series of cases involving Ch’elle Properties (New Zealand) Limited v Commissioner of Inland Revenue.[23] These cases concerned an arrangement that was designed to produce a refundable input tax deduction of $9 million to the purchasing company (Ch’elle) but defer the requirement to account for GST by the 114 separate companies supplying the land in question to Ch’elle. The deliberate operation of the vendor companies so as not to require GST to be accounted for using the invoice basis on the transactions, together with the wider features of the arrangement, led the courts to the conclusion that there was tax avoidance.
3.21 In Australia, a similar arrangement was held to be avoidance under Division 165 of the A New Tax System (Goods and Services Tax) Act 1999 (the equivalent of section 76 of the New Zealand GST Act). In VCE and Commissioner of Taxation[24] the sale of property modified and leased as a medical centre by a taxpayer to a company owned by the taxpayer and his spouse was considered to be a scheme that had the sole or dominant purpose of achieving a GST benefit. The features of the arrangement involved an agreed selling price of $770,000 (including GST), although the market value was $250,000, with periodic payments scheduled for 2008, 2013 and 2018. A deposit of $550 was payable but the taxpayer retained ownership until the company made full payment in 2018. The Australian Appeals Tribunal Authority considered that the tax benefit of the scheme was a tax refund that was larger than could reasonably be expected.
3.22 These cases illustrate that Inland Revenue is able to use the relevant anti-avoidance provisions in the GST Act to deal with non-neutral transactions. This may limit the choices available to taxpayers when deliberately attempting to operate outside the business-neutral framework. However, because anti-avoidance rules may be highly fact-dependent and litigation can be both time consuming and costly, other measures are needed to protect the integrity of the GST system.
3.23 In 2007 the government allocated $14.6 million over three years to strengthen Inland Revenue’s audit of property transactions.[25] From 2000 the number of persons registered for GST grew from about 500,000 to just over 660,000 for the year ended 1 April 2008.[26] Further, in the last financial year, Inland Revenue processed in excess of 3 million GST returns. Against such volumes, the effectiveness of current audit strategies can be tested. Further legislative solutions, as presented in this paper, are therefore worth exploring.
19 GST offsets, or transfers of input tax deductions, may be made by the Commissioner under section 173M of the Tax Administration Act 1994. The facility is not available if the GST-registered recipient has outstanding returns or debt with Inland Revenue that limit the amount that can be used as an offset.
20 Customs Fact Sheet number 17, Deferred payment scheme, 17 August 2006, New Zealand Customs Service.
21 See Commissioner of Inland Revenue v Capital Enterprises Limited (2002) 20 NZTC 17,511 and Case T35 (1997) 18 NZTC 8,235.
22 See section 55(1) as amended by the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006.