Chapter 6 - Accounting for GST and Timing Mismatches
6.1 Chapter 2 broadly described the range of accounting bases that are available to GST-registered persons. These bases determine when registered persons are required to account for output tax and when they are entitled to deduct input tax. This chapter considers the effect of those choices and the opportunities they present in creating what we refer to as “timing mismatches” between GST-registered persons.
6.2 It also considers two options that would reduce these timing mismatches:
- limiting the choice of accounting bases; and
- strengthening the application of existing anti-avoidance measures.
6.3 The consequences to the revenue base of providing a choice of accounting bases and, to a lesser degree, taxable periods has been well documented by the New Zealand courts, tax practitioners and the government. What we refer to as “timing mismatches” involves a GST-registered person who accounts for GST using the payments basis making a supply to a GST-registered person who accounts for GST using the invoice basis. The payment basis supplier provides the invoice basis purchaser with a tax invoice. The purchaser claims an input tax deduction following receipt of the tax invoice, but payment of GST is deferred. In some cases, payment may be deliberately deferred for a significant period of time or even indefinitely.
6.4 In cases when the timing difference created by the arrangement is clearly inconsistent with the policy intent of the GST Act, the general anti-avoidance provision has been successfully applied. Questions remain, however, about the long-term desirability of using the general anti-avoidance provision for this purpose and whether policy changes that would have more certain application are required. Several tax commentators have noted that the outcomes created by general anti-avoidance provisions have the potential to create uncertainty. Uncertainty is unhelpful in promoting voluntary compliance.
6.5 A more fundamental approach to business neutrality may therefore be required, with solutions not necessarily limited to transactions involving the supply of specific goods and services such as “going concerns”, extremely high value transactions and land, as discussed in Chapter 4.
6.6 One possible response to the problems presented by deliberate timing mismatches would be to move to a single compulsory basis of accounting for GST, coupled with a single taxable period. However, this could give rise to significant revenue losses for the government as well as increased compliance costs for taxpayers. It is possible that a combination of proposals in this paper will strike an adequate balance between tax base risks, revenue costs and compliance costs. Accordingly, the potential single accounting basis, single taxable period approach is not being explored further at this time. Submissions are, however, welcome on the issue.
6.7 Assuming the current position is retained whereby businesses are free to make their own decisions about the accounting bases and taxable periods that best suit them (within the confines of the GST Act), we have suggested other measures that could minimise the revenue risks connected with timing mismatches.
6.8 The relative advantages and disadvantages of the accounting bases permitted under the GST Act are discussed next.
6.9 Day-to-day accounting for GST depends on the size of the GST-registered person and whether it is a retailer, a service provider, manufacturer, distributor, importer or exporter. Accounting practices may also vary depending on whether the GST-registered person is a non-profit body, a public sector organisation or a private enterprise.
6.10 The GST Act currently caters for these differences by allowing for a variety of accounting bases and filing frequencies, including a grace period before payment is required.
The invoice basis
6.11 Of the three accounting bases allowed by the GST Act, the invoice basis is most closely aligned with the principle that GST should apply, and a deduction correspondingly be allowed, when the economic benefits of the goods and services have been transferred from the supplier to the recipient. The invoice basis reflects not only a GST-registered person’s present GST obligations and entitlements but also future GST commitments and benefits.
6.12 The basis is consistent with the rules that apply to businesses for the purposes of complying with income tax and with any external financial reporting requirements and assumptions. This means large businesses do not need to maintain dual accounting systems – one for GST and one for general accounting purpose.
6.13 The benefits of the invoice basis are also apparent for businesses that rely on the prompt recognition of input tax deductions, such as importers, who may be permitted by the New Zealand Customs Service to defer the payment of GST levied on imported goods, and exporters.
The payments basis
6.14 Although the invoice basis recognises the economic consequences of transactions, for some businesses it can increase the carrying cost of GST, particularly when GST liabilities have to be recognised well in advance of the related payment being received. This earlier obligation to account for GST can present a problem if the regular terms of trade provide for a period of credit that is longer than the GST payment date.
6.15 This concern was recognised in 1986 by the Advisory Panel on Goods and Services Tax, which noted that dairy farmers, builders and non-profit bodies would be at a financial disadvantage if the obligation to pay GST to Inland Revenue was triggered by an invoice when payment from the customer was not immediately forthcoming. The solution to this problem was the payments accounting basis, which allows GST-registered persons to account for GST on the basis of cash receipts and cash payments.
6.16 Apart from addressing the potential cashflow effects, the payments basis dispenses with the need to maintain debtors’ or creditors’ ledgers to complete the calculation of “tax payable” at the end of each taxable period.
6.17 Aligned to this, the payments basis is also the simplest basis for determining the time of supply for certain transactions such as agreements to hire and supplies that provide for periodic payment. The benefits offered by the payments basis in reducing the carrying cost of GST would be enhanced if the time of supply rules were replaced by using payment as a means of determining when supplies should be recognised in a taxable period. Special rules would in that case need to be retained for associated persons and other special transactions, such as gaming and gambling.
6.18 The main criticism of the payments basis is that it is less accurate than accrual accounting in measuring the majority of transactions that come within the GST Act. This concern is, in part, overcome by the GST Act requiring GST-registered persons to file more frequently than they do for income tax.
The hybrid basis
6.19 In 1991, a further accounting basis was added to the GST Act, giving GST-registered persons the option of not maintaining a creditors’ ledger to complete their GST return.
6.20 The advantage of the hybrid basis is that it can approximate the accounting practice of some businesses whereby income is recognised at the time a transaction occurs and expenses are recorded when they are paid. The basis does, however, have the potential to increase the carrying cost of GST as it defers the recognition of input tax deductions until payment is made but brings output tax into account at the earlier time at which an invoice is issued or payment is received.
6.21 Taxable periods establish the frequency with which GST-registered persons are required to file GST returns. They are based on competing objectives that seek to minimise the effect of GST on working capital and balance compliance and administration costs.
6.22 Shorter return periods help to reduce the effect that GST has on businesses – for example, the need to find cash to settle GST liabilities or, in the case of refunds, minimise the carrying cost of GST. For this reason, filing monthly GST returns is a popular option for exporters and is a requirement for businesses with annual taxable supplies of $24 million or more.
6.23 Shorter return periods, however, increase compliance and administration costs because of the requirement to complete GST returns more often. For example, requiring all GST-registered persons to file GST returns every month would increase the annual number of GST returns from three million to nearly seven million. For GST-registered persons who are involved in seasonal activities or whose pattern of invoicing is intermittent, the requirement to file monthly returns would result in the completion of a large number of unnecessary nil returns. The option to file on a six-monthly frequency therefore reduces the need for unnecessary returns.
6.24 Longer return periods affect the government’s collection of revenue and pose a greater risk that GST will not be returned. For this reason, the six-monthly basis is generally limited to businesses whose activities are small-scale and involve annual taxable supplies of $250,000 or less.
6.25 As we have noted, using the accounting base options to create deliberate timing mismatches can have a detrimental effect on the tax base. Because GST applies to the gross value of transactions, non-compliance can also have a material effect on the competitiveness and profitability of those that do comply. We now outline some further options, beyond those outlined in Chapter 4 and 5, for dealing with these concerns.
Limiting the choice of accounting bases
6.26 One option that we have considered but do not favour is to make one of the three bases of accounting compulsory for all GST-registered persons. This option has the benefit of reducing deliberate timing mismatches, but it is not obvious that any single basis would suit the majority of GST-registered persons. For example, while the payments basis is widely used, with about 79 percent of all GST-registered persons electing to use it, larger businesses, which contribute a substantial portion of GST to the revenue base, as well as exporters, are likely to have a strong preference for the invoice basis. Ultimately, the strong preferences exhibited by GST-registered persons at either end of the business spectrum suggest that such a change would not be workable.
6.27 As an alternative, access to certain accounting bases could be restricted – for example, GST-registered persons with annual taxable supplies below a specified threshold could be required to account for GST using the payments basis.
6.28 We have not in this paper suggested any particular threshold because, at this stage, we are more interested in submissions on the idea in principle rather than the precise spectrum of taxpayers to which it could apply. We recognise that under any compulsory threshold level, however, exclusions would be needed for exporters and other GST-registered persons whose input tax deductions regularly exceed output tax. Exclusions would also need to be considered to preserve the operation of the GST grouping rules. This may make the option unduly complex relative to the problem we are aiming to solve.
6.29 On the other hand, applying the payments basis to a wider range of businesses might reduce compliance costs for a number of GST-registered persons because businesses under the threshold would not have to complete accrual accounting adjustments for debtors and creditors for each taxable period.
6.30 If the change were made, affected GST-registered persons that did not wish to use the payments basis would still have the option of using the hybrid basis.
Specific points for consultation – limiting the choice of accounting bases
- If limitations were placed on who could account for GST using the invoice basis, what should those limitations look like?
- In the context of these limitations, what special rules would be required for exporters and other business for whom input tax regularly exceeds output tax?
Strengthening the application of section 19D
6.31 A further option is to maintain the current choice of accounting bases but review the application of the specific anti-avoidance provisions, section 19D. Section 19D preserves the current options for accounting but seeks to restrain taxpayer choice when the application of the GST accounting principles could give rise to base maintenance risks. Specifically, section 19D requires GST-registered persons accounting for GST using the payments basis to use hybrid accounting principles when high-value transactions are involved. These are prescribed as being when the consideration payable for a supply of goods and services is $225,000 (including GST) or more and payment by the customer is deferred under the agreement for more than one year. By being quite prescriptive, the application of the section is limited.
6.32 Possible options for improving the application of section 19D include:
- lowering the threshold when the section becomes effective – for example, from $225,000 to a lesser amount, say $90,000, and when payment is to be deferred for more than one year; or
- altering the section so that it instead affects the rules governing the recognition of input tax deductions. Under this option, input tax deductions would be limited to one-ninth of the payments made by the recipient. The section would apply to transactions that exceeded $225,000 (or $90,000) and would continue to be limited to situations when the contract deferred payment for more than one year.
6.33 An increase in the current payments basis threshold – possibly to $2 million – would accompany any change to the application of section 19D. Increasing the payments basis threshold is discussed in more detail in Chapter 7.
Specific point for consultation – strengthen the application of section 19D
If section 19D were to be changed, which option do you prefer and why?
44 See the Court of Appeal decision Shell New Zealand Holdings Co Ltd v Commissioner of Inland Revenue (1993) 13 NZTC 10,136; “Dilemmas for GST tax policy designers – land transactions” G Harley, published in GST in retrospect and prospect, 2007 pp. 232 to 233; and GST: A review, New Zealand Government March 1999, pp. 65 to 66.
46 See “Dilemmas for GST tax policy designers – land transactions”, G Harley, published in GST in retrospect and prospect, 2007, and “The role for a general anti-avoidance rule in a GST”, E Trombitas, published in GST in retrospective and prospect, 2007.
50 The government is proposing to raise this threshold from $250,000 to $500,000. See Reducing tax compliance costs for small and medium-sized enterprises, New Zealand Government, December 2007, pp. 14 and 15.