Chapter 8 - Change-in-Use Adjustments
8.1 GST-registered persons may claim an input tax deduction for GST paid on goods and services acquired for the principal purpose of making taxable supplies.
8.2 In some cases, goods and services acquired for the principal purpose of making taxable supplies may be used partly or entirely for another purpose, such as for private and exempt purposes (non-taxable purposes).
8.3 The GST Act treats the non-taxable use of goods and services as a taxable supply by the registered person, and output tax is charged accordingly. In this way, goods and services that are “self-supplied” are treated in the same manner as other supplies.
8.4 Conversely, goods and services acquired principally for a non-taxable purpose (for which the GST-registered person is not entitled to an input tax deduction) may be partly or entirely used to make taxable supplies. In these circumstances, the GST Act allows a deduction to reflect that taxable use.
8.5 New Zealand’s approach to change-in-use adjustments is based on the principle that GST needs to reflect the consumption of goods or services in a given period. The change-in-use rules therefore apply to those that make a mixture of taxable and exempt supplies – such as financial service providers and some property developers. The change-in-use rules also ensure that private use is taxed. For example, a luxury yacht used in a chartering business but also used privately is subject to the GST change-in-use rules to ensure that the parity of treatment exists with a similar yacht purchased and used exclusively for private purposes.
8.6 New Zealand’s adjustment approach is unique among countries with GST or VAT systems. Other countries adopt an apportionment approach to mixed use. The apportionment approach is not aimed at taxing consumption, but simply seeks to apportion the initial input tax deductions received by GST-registered persons for goods and services according to their actual use. Depending on how the adjustment or apportionment process is undertaken, the result of the two approaches is usually similar. However, there are some specific differences.
8.7 In this chapter we review the treatment of changes-in-use in New Zealand, comparing New Zealand’s rules with Australia’s, and suggest some changes to improve and clarify our rules. We also compare the change-in-use adjustment rules with the second-hand goods input tax deduction and suggest some changes in this area.
8.8 New Zealand’s change-in-use adjustment rules are summarised in Table 3.
|Test||Input tax that can be claimed||Adjustment required?||Timing of any adjustment|
|The goods and services are acquired for the principal purpose of making taxable supplies.||100% of the GST paid may be deducted.||Yes, if the goods and services are applied for a purpose of making supplies of non-taxable goods and services.||At any one of the following times:
|The goods and services are not acquired for the principal purpose of making taxable supplies.||No deduction is available.||Yes, if the goods and services are applied for a purpose of making taxable supplies of goods and services.||At any one of the following times:
Timing of change-in-use adjustments
Changes from taxable to non-taxable use
8.9 The GST Act allows three timeframes for returning output tax when goods and services acquired principally for making taxable supplies are used for non-taxable purposes:
- Periodic adjustments – output tax is imposed in every taxable period in which the goods and services are used in making non-taxable supplies.
- Annual adjustments – output tax is imposed in every 12-month period in which goods and services are used in making non-taxable supplies.
- A one-off adjustment – output tax is imposed once on the non-taxable use of the goods and services.
Example: Adjustment frequency
A motor vehicle purchased for the principal purpose of making taxable supplies is subsequently used (49 percent of the time) for private purposes. The cost of the vehicle was $20,000 and the depreciation rate is 21 percent. The adjustments required for the deemed supplies under each of the above methods are:
(1) One-off adjustment:
$20,000 x 49% = $9,800;
$9,800 / 9 = $1,088 one-off GST payment.
(2) Periodic – for example, each two-monthly taxable period:
($20,000 x 21%) / 6 = $700 – depreciation value each taxable period;
$700 x 49% = $343 – non-taxable portion of depreciation;
$343 / 9 = $38.1 – two-monthly GST payment.
($20,000 x 21% x 49%) / 9 = $229 annual GST payment.
Changes from non-taxable to taxable use
8.10 In common with changes from taxable to non-taxable use, adjustments for changes from non-taxable to taxable use may be made on a period-by-period, annual or one-off basis. The one-off basis is, however, available only for goods and services that cost up to $18,000, or above that amount with Inland Revenue’s agreement.
Calculating the value of the asset to be adjusted
8.11 Adjustments are calculated by treating goods or services as having been supplied to the extent that they are not used for taxable purposes (output tax adjustments) or are used for taxable purposes (input tax adjustments). Therefore, the value of the goods or services has to be determined. The GST Act stipulates that the value may be calculated on the basis of the cost or the market value of the goods or services – whichever value is lower.
8.12 For period-by-period adjustments, depreciation is generally used to approximate the value (based on the lower value of cost or market) of the change in use of the goods and services over the adjustment period.
Allocation between taxable and non-taxable supplies
8.13 The GST Act provides for three methods of allocating input tax deductions between taxable and non-taxable supplies:
- actual use;
- turnover method; and
- an alternative (or special) method.
8.14 In each case, the method of allocation used must result in a fair and reasonable allocation of input tax between taxable and other supplies.
8.15 In certain circumstances, goods and services may be simultaneously used for taxable and non-taxable purposes. In Lundy Family Trust, for example, the buildings and the land were simultaneously rented out (an exempt purpose) and available for sale (a taxable purpose). Therefore, the Court of Appeal considered that the properties were used 100 percent for taxable purposes and 100 percent for non-taxable purposes. The Court directed that a 50/50 apportionment of the depreciation on the building was appropriate.
8.16 The apportionment approach used in other countries requires any non-taxable use to be reflected in the apportionment of the initial input tax deduction when the goods or services are acquired. Subsequent adjustments are made, as necessary, to reflect the actual use of the goods and services.
8.17 The apportionment approach looks backward and attempts to put GST-registered persons in the position where they would have been had they correctly predicted the extent to which they would use the goods and services for taxable and non-taxable purposes at the time they acquired them. Different countries adopt different variations of the apportionment approach. Apportionment rules were considered by the government in 1999 but were thought to have certain disadvantages, including:
- the difficulty for GST-registered persons in predicting future use;
- the complex treatment of apportioned goods and services on disposal; and
- the fact that the apportionment approach did not adhere to the GST principle that GST should be a tax on consumption.
8.18 At that time it was agreed that there should be a further review of the change-in-use rules, and this is outlined in this chapter.
8.19 In July 2000, Australia introduced a GST tax system that includes a set of comprehensive rules using the apportionment approach. In Australia, the amount of the input tax deduction that a GST-registered person receives depends on the extent to which the acquisition or importation is for a taxable purpose. Following the initial apportionment of input tax, the person may need to make subsequent input tax adjustments when there is a difference between the actual use and the planned use of the goods and services for a taxable purpose.
8.20 It might appear that the apportionment approach is conceptually simpler than the adjustment approach because it is based on the initial input tax deduction and cost of the goods and services that are being adjusted. This approach has its advantages, including being able to use a single valuation measure when making any adjustment.
8.21 However, making input tax adjustments under the apportionment method may not be as simple in practice. In Australia, in order to accurately calculate an entitlement to deduct input tax, a taxpayer must ascertain the extent to which the asset has been applied for a taxable purpose, from the time of acquisition until the end of the relevant adjustment period. These calculations may become progressively complicated with every subsequent adjustment for a particular asset and any ultimate sale or disposition of the assets. This complication, and the fact that GST-registered persons have to keep continuous records of the use of their assets from the date of acquisition (which is also a requirement under the New Zealand approach), may make adjustments under the apportionment approach compliance intensive.
8.22 For these reasons, we do not consider that the benefits of the apportionment approach outweigh the disadvantages. We do consider, however, that some of the elements of the apportionment approach can be used to improve the New Zealand approach.
8.23 We have identified a number of concerns with New Zealand’s change-in-use adjustment rules. Some of these arise from the legislation itself. Additional concerns were highlighted in the decision of the Court of Appeal in Lundy Family Trust, and it is useful to review whether aspects of that decision achieve the desired policy outcome. With this in mind, some potential problem areas are discussed below.
The maximum amount of adjustments
8.24 Since adjustments may be made on the period-by-period or annual basis for an indefinite period, it is possible that the value of adjustments could accumulate to more than the original GST paid on the purchase of the property.
8.25 The Court of Appeal in Lundy Family Trust has effectively rejected this possibility and suggested capping the maximum amount of the adjustments to the original amount of GST paid. Greater certainty is needed to deal with possible ambiguities in the legislation in this area.
Adjustments do not necessarily refer to the initial input tax deduction
8.26 As with the previous issue, the change-in-use adjustment approach may ignore the original input tax deduction claimed by the GST-registered person. Change-in-use adjustments may not relate to the amount of the initial input tax deduction, as the purchase of goods and services and their use for a non-principal purpose are treated as, in effect, separate supplies. Accordingly, the rules are intended to measure the current consumption of the goods and services.
8.27 Determining an open market value for every adjustment period could be quite compliance-intensive. For this reason, the GST Act allows GST-registered persons to use either the cost or market value of the goods or services, whichever is lower.
8.28 If it is accepted that the adjustment should make reference to the original deduction claimed, as occurs in the apportionment approach, the question of whether there should be a choice of valuation methods should be reviewed.
Treatment of adjustments on return to the original taxable purpose
8.29 The Court of Appeal in Lundy Family Trust held that when a GST-registered person who has been making output tax adjustments to reflect non-taxable use changes the use of the asset back to making taxable supplies, the GST-registered person may claim back any output tax adjustments that they paid.
8.30 The outcome of this decision is that the benefit that the registered person has received from the consumption of the goods or services for non-taxable purposes is ultimately disregarded. This outcome is generally inconsistent with the adjustment framework, which is based on taxing any non-taxable use of the goods and services in question at any point in time.
One-off output tax adjustments
8.31 The GST Act requires a GST-registered person to base the timing of output tax adjustments on a period-by-period, annual or one-off basis.
8.32 Although a registered person may currently choose which of the three bases for adjustment to use, there may be circumstances when only the one-off adjustments basis may be suitable, such as when there is total change of use of the goods or services.
8.33 Currently, one-off output tax adjustments can be valued on the basis of the lower of cost or market value and are not limited to total changes in use. This may provide opportunities to reduce the amount of the adjustment. Since the adjustment effectively reflects that the asset is leaving the GST base (just as it would if the asset was sold), the choice of valuation method available to GST-registered persons should be reviewed.
8.34 The options below, which share some of the advantages of the apportionment approach, may deal with some of the uncertainty when using the change-in-use adjustment rules. We favour retaining the change-in-use adjustments approach, with some modifications to provide a closer link between the adjustments, initial input tax deductions and the cost of goods to the taxpayer.
Recognising earlier output tax adjustments for appreciating goods and services
8.35 When GST was introduced the intention was that a GST-registered person’s output tax adjustments would be made for as long as the goods or services remain a part of its business activity, to reflect the consumption that occurs in each period. This principle was not accepted by the Court of Appeal in the Lundy Family Trust decision.
8.36 We agree with the outcome determined by the Court of Appeal because of the cashflow disadvantage that arises if market value is taxed before disposition to a third party. However, we are concerned that the legislation could be interpreted in a number of ways. Therefore, it is suggested that the legislation be modified in line with the Lundy Family Trust decision by capping the output tax adjustments to the amount of the original input tax deduction received by the registered person.
8.37 The cap would apply on the realisation of the asset only. That would ensure that the goal of taxing consumption is achieved for as long as a person keeps a business asset in the tax base and uses it for non-taxable purposes. If the asset is realised and taken out of the GST base the GST-registered person will be able to use any adjustments paid in excess of the cap as a deduction in the calculation of “tax payable”.
8.38 Allowing registered persons to cap their output tax adjustments should provide them with certainty on their final liability for adjustments (if they choose to realise the asset).
8.39 Our suggestion to cap periodic output tax adjustments would not change the obligation to pay output tax on disposal of the asset.
Valuation of supplies
8.40 In the case of goods and services that are consumed over a number of taxable periods or years, output tax adjustments are frequently made on the cost basis, by using depreciation as a measure of the use of those goods and services over the relevant period. While depreciation may not be a precise estimation of the actual consumption of an asset, it is a verifiable and reliable method to approximate the value of a consumed asset. In that regard, using the cost basis for valuing assets subject to periodic adjustments is less compliance-intensive than using the market value basis, under which the taxpayer must find the market price of the asset at the time of the adjustment.
8.41 Therefore it is suggested that all valuations for the purposes of periodic output tax adjustments should be made using the cost basis. Requiring businesses to value goods and services on the cost basis should remove any uncertainty for them over what valuation method to use, and links the valuation method for change-in-use adjustments with the initial input tax received.
Refunding output tax adjustments on return to the taxable purpose
8.42 In the Lundy Family Trust decision, the Court of Appeal held that when a GST-registered person who has been making output tax adjustments changes the use of the asset back to the taxable purpose, the registered person may claim back any output tax adjustments that it paid.
8.43 This outcome seems inconsistent with the objective of taxing consumption, as it appears to treat the exempt or non-taxable supplies as having no value for GST purposes. We suggest that output tax adjustments paid in earlier taxable periods be treated as not refundable and that, if submissions consider it necessary, a clarifying legislative amendment be made.
One-off output tax adjustments in relation to low-value mixed use assets
8.44 The purpose of the threshold is to remove the need to make compliance costly periodic adjustments when tax arising from adjustments would be relatively small. A threshold of $20,000 is suggested, to remove most consumable assets such as computers, office equipment and low-value cars from the need for regular adjustment.
8.45 The calculations required by the change-in-use rules impose compliance costs for, at times, very low amounts of revenue. For this reason, we suggest retaining the option of allowing registered persons to make one-off adjustments for low-value assets.
One-off output tax adjustments in relation to total change-in-use
8.46 If a GST-registered person partly uses an asset that was acquired for a taxable purpose for a non-taxable purpose, the asset still forms part of the business activity of the registered person, and it is appropriate that periodic adjustments are made (either in each taxable period or annually). The situation is different when an asset acquired for a taxable purpose is used exclusively for a non-taxable purpose. In the latter situation, the asset stops being used in the registered person’s taxable activity and is, in effect, removed from the tax base.
8.47 To reflect this, GST-registered persons should be required to make one-off output tax adjustments when there is a total change-in-use of the goods or services.
Valuation basis for one-off output tax adjustments
8.48 When a business deregisters, its assets are valued at market value. This treatment ensures that the output tax liability reflects the value that has been added by the registered person. It also ensures that supplies made by GST-registered persons to themselves are treated in an equivalent way to those made to another person.
8.49 In contrast, taxpayers may choose to value one-off output tax adjustments at the lesser of the cost of the goods or services or the open market value of the supply. In the case of a total change-in-use, however, the asset is removed from the tax base and an equivalence in treatment with a sale of the asset or business deregistration is warranted.
8.50 We therefore suggest that GST-registered persons should be required to value the goods and services entirely applied for non-taxable purposes at their market value. As we have noted, goods and services with a value of less than $20,000 could still be valued at the lower of cost or market value.
One-off output tax adjustments and adjustment capping
8.51 We consider that if an asset that is subject to a one-off output tax adjustment for a total change-in-use is treated similarly to an asset that is realised in some other way, any previous periodic output tax adjustments in relation to that asset should be subject to the input tax deduction cap. This means that if a registered person has made periodic output tax adjustments in excess of the initial input tax deduction, the excess would be a deduction in the calculation of “tax payable”. The amount of the output tax received from the one-off adjustment on the total change-in-use of the asset, on the other hand, should be treated in the same manner as output tax received from the sale of the asset. Therefore this amount should not count for the purpose of calculating whether output tax adjustments exceeded the initial input tax deduction.
Example: Making one-off output tax adjustments
Alison purchased a building for use in her business and received an input tax deduction of $60,000. In subsequent years, she converted a part of the building to residential dwellings and rented them out. During that period, she made output tax adjustments on the exempt use of the building on a period-by-period basis, totalling $70,000. At the end of that period, she decides to use the asset 100 percent of the time for the purpose of providing residential accommodation. She makes a one-off output tax adjustment of $80,000, calculated on the basis of the market value of the asset.
Since her periodic adjustments ($70,000) exceed the initial input tax credit ($60,000), Alison may use the excess amount ($10,000) as a deduction in the calculation of “tax payable”. Her final GST liability on the total change-in-use is therefore $70,000.
Under the suggested rules, the same result would be achieved if, instead of a 100 percent change-in-use, Alison either sold the asset or deregistered her business.
Period-by-period and annual deduction (input tax) adjustments
8.52 For input tax deduction purposes, GST-registered persons will still be able to base their adjustments on the lower of the cost or market value. This divergence from the suggested valuation of periodic output tax adjustments (that is, the cost basis only) is necessary for practical reasons – registered persons may not have retained records of the original price of assets that were acquired for non-taxable purposes, and may not recall details of their acquisitions by the time the need for input tax adjustments arises. If the original price of an asset is not known, GST-registered persons will be able to calculate adjustments by reference to their market value.
8.53 On the other hand, consistent with the suggested change to the output tax adjustment rules, however, input tax adjustments should also be capped. It is suggested that the amount of the cap should depend on the valuation method adopted by the GST-registered person so that:
- if the registered person chooses the cost method of valuing an asset, the input tax adjustments should be capped at an amount equal to the input tax deduction that the person would have been eligible for if it had acquired the asset for the principal purpose of making taxable supplies; and
- if the registered person decides to value the asset on a market value basis, the cap would be equal to the amount of the input tax deduction that the person would have received if it acquired the asset at market value at the time the first deduction by way of change-in-use adjustment is made.
8.54 In contrast to the suggested treatment of periodic output tax adjustments where a person would be required to make adjustments until the asset is realised, the GST-registered person making input tax adjustments would be required to stop making input tax adjustments when the cap is reached.
8.55 When a person is making input tax adjustments on a periodic basis without exceeding the cap, and subsequently is able to make a one-off adjustment in relation to a 100 percent change in use of the same asset, both the periodic adjustments and the one-off adjustment would count for the purpose of the cap.
Specific points for consultation
- Do the suggested rule changes outlined in this chapter improve the operation of the change-in-use rules?
- Do the suggested changes provide enough certainty about the consequences of a change in use?
8.56 GST-registered persons are allowed to deduct input tax in connection with the purchase of second-hand goods from unregistered persons, even though GST is not directly charged on that supply. This deduction is intended to recognise the GST paid when the unregistered supplier acquired the goods. Allowing deductions removes the potential for double taxation during the lifecycle of goods acquired by unregistered persons. Previously, one of the risks of the deduction was that it allowed some GST-registered persons (particularly in transactions involving associated persons) to claim large GST refunds in various circumstances, including for goods on which GST had not previously been paid – for example, when the goods had been acquired by the unregistered vendor before the introduction of GST.
8.57 The problem was dealt with in 2000 by limiting the input tax deduction available in relation to supplies of second-hand goods between associated parties to the lesser of:
- the GST component (if any) of the original cost of the goods to the supplier;
- one-ninth of the purchase price; or
- one-ninth of the open market value.
Disparity in treatment of associated and non-associated persons
8.58 One criticism of the current rules in relation to the input tax deduction for second-hand goods is that there is a disparity between the treatment of associated and non-associated person transactions. A GST-registered person buying second-hand goods from an associated unregistered person receives no input tax deduction if GST has not been paid on the original cost. On the other hand, a registered person buying the same second-hand goods from a non-associated unregistered person would receive an input tax deduction based on one-ninth of the amount paid to acquire the goods.
Using change-in-use adjustments to increase input tax deductions
8.59 As outlined earlier in this chapter, when goods and services are acquired by a registered person principally for a non-taxable purpose, the person is not entitled to an input tax deduction. If, however, the goods and services are later used in making taxable supplies, the GST Act allows the registered person to make input tax adjustments that would reflect that taxable use.
8.60 In contrast to the rules governing the second-hand goods deduction, which may require a taxpayer to calculate a deduction on the basis of the GST component in the original cost of the goods to the supplier, the change-in-use rules provide GST-registered persons with the option of using a cost or market valuation basis.
8.61 These inconsistencies between the input tax treatment of second-hand goods and the change-in-use adjustment rules can result in unintended tax consequences and even in some cases distort the behaviour of GST-registered persons in certain transactions.
8.62 The following changes are suggested in response to these problems:
- The rules for associated-party supplies of second-hand goods, should apply only in connection with transactions involving the purchase of land. To deal with consistency concerns in the treatment of purchases between associated and non-associated unregistered persons, we suggest that purchases of land from non-associated persons also be brought within the scope of the changes made in 2000. The reason for treating land differently from other types of goods is the relative ease with which a person can find the cost of the land to the original supplier from records and land deeds. Requiring taxpayers to find original costs for other types of goods and provide this information to the purchasers of those goods would be impractical.
- For purchases of second-hand goods from unregistered persons (associated or un-associated) that do not involve land, the deduction available would be calculated on the basis of the lesser of the tax fraction of the purchase price of the goods or their open market value.
- These changes will also be reflected in the rules that provide the deductions for changes in use. Thus, change-in-use adjustments for land would be based on the lesser of the original cost of the goods to the supplier, the tax fraction of the purchase price of the goods, or the tax fraction of the open market value of the supply of the goods.
8.63 If these suggestions were to be implemented, GST-registered persons would be treated equally whether buying second-hand goods from associated or non-associated unregistered persons. The changes would also deal with transactions involving land that make use of the change-in-use rules to obtain a more favourable tax treatment than that applicable to a deregistration or sale.
Specific points for consultation
- Do you agree that the treatment of second-hand goods acquired by associated and unassociated persons should be aligned in the manner suggested?
- What are the costs or benefits connected with suggested changes?
61 See GSTR 2006/4 Goods and services tax: determining the extent of creditable purpose for claiming input tax credits and for making adjustments for changes in extent of creditable purpose, Australian Tax Office.