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GST: zero-rating of land

SECTION 11(1)(mb) – REQUIREMENTS FOR ZERO-RATING LAND TRANSACTIONS

Clause 10


Issue: Transitional provision for zero-rating rules


Submission
(Russell McVeagh)

A transaction may be documented before the legislation is enacted, with a time of supply after 1 April 2011. In these circumstances, there will be contractual uncertainty as to the transaction document, given that the zero-rating rules will likely to be in “draft” form at the time of the contract. Since it will not be a straightforward matter to vary contracts already entered into, there should be an ability to preserve existing GST treatment at the parties’ option, or upon application by the parties to the Commissioner.

Comment

We consider that a transitional provision is needed for transactions to which the zero-rating rules would apply that are entered into before 1 April 2011. The supplier would have the option of either using the new rules or applying the legislation in existence before 1 April 2011 even if the time of supply is triggered after 1 April 2011.

Recommendation

That the submission be accepted.

 

Issue: Application of zero-rating to components other than land


Submissions
(KPMG, Ernst & Young)

The legislation should be clarified as to whether the requirement to zero-rate a supply in section 11(1)(mb) of the Goods and Services Tax Act 1985 (“the GST Act”) applies to all goods and services supplied with land or just land and buildings (except if the building is a residential building which is excluded from the application of the zero-rating rules by section 5(15)). (KPMG)

The submitter seeks clarification as to which goods supplied as part of a supply involving land must be intended to be used for making taxable supplies. (Ernst & Young)


Comment

By referring to a supply that “wholly or partly consists of land”, section 11(1)(mb) intends that a supply should be zero-rated in full if any part of that supply consists of land (unless it is a principal place of residence of the recipient of the supply). For example, in the sale of a farming business, any livestock sold as part of the supply will also be zero-rated under the section, even if the transaction is not a supply of a going concern.

The goods and services supplied under a transaction may be in part for making taxable supplies and in part not – in that case zero-rating would still apply. However, if the supply includes portions that are used for non-taxable purposes, an apportionment of the non-taxable and taxable components will be required. Thus the purchaser will be required to pay GST on any non-taxable portion under proposed section 20(3I). Moreover, section 5(15) of the GST Act already requires a private residence as part of wider supply to be treated as a separate supply.

Recommendation

That the submissions be declined.

 

Issue: The required extent of taxable supplies


Submission
(Ernst & Young)

Clarification is needed about the extent of taxable supplies for which recipients must intend using the land and other components of the transaction, as distinct from other types of supply.

Comment

The requirement in section 11(1)(mb)(i) that a recipient must intend to use the land and other components of the supply for making taxable supplies will be satisfied unless the recipient intends the use to be wholly for exempt and/or private purposes.

Section 11(1)(mb)(i) seems to be sufficiently clear in this regard.

Recommendation

That the submission be declined.

 

Issue: The timing of the registration status of the recipient


Submissions
(PricewaterhouseCoopers, Ernst & Young)

Clarification is required as to when the parties’ registration status and the recipient’s intentions in respect of land are to be measured for the purposes of new section 11(1)(mb). The current wording is unclear on whether the recipient’s intention is required to be tested immediately or in the future (depending on what the ultimate intention is).

Comment

Officials agree with the submission. It is recommended that a purchaser be required to make representations regarding their registration status or that of the ultimate recipient, and their intentions in relation to land as they are expected to be at the time of settlement. By being able to make representations on a prospective basis, the purchaser will be required to provide information that they predict will be correct at the time of settlement. The purchaser will be responsible for any tax unpaid as a result of the representation not being correct.

Recommendation

That the submissions be accepted.

 


DEFINITION OF “LAND” FOR THE PURPOSES OF SECTION 11(1)(MB)

Clause 4(5)


Issue: Leases and periodic payments


Submissions
(Corporate Taxpayers Group, KPMG, PricewaterhouseCoopers, New Zealand Bankers’ Association, New Zealand Institute of Chartered Accountants)

The Corporate Taxpayers Group is concerned that the definition of “land” in the bill is too wide, and may catch transactions that are not intended by officials to be zero-rated. The concern is specifically about the meaning of “interest in land”, which will form part of the definition of “land”. Under ordinary legal principles, an interest in land will include leases. The creation or transfer of a leasehold interest should be within the zero-rating provisions, given that such a transaction is effectively a quasi sale and purchase of land. However, ongoing lease payments should be carved out. In order to achieve this outcome, the submitter suggests that there should be a bright-line test applying the zero-rating provisions to the creation or transfer of a leasehold interest that meets a particular threshold. An appropriate bright-line test would be to zero-rate the creation or transfer of leasehold interests which are 20 percent or more of the total market value of the land. Ongoing rental payments under a lease arising from such a transaction should be carved out and not subject to the zero-rating provisions. (Corporate Taxpayers Group)

The definition of “land” should expressly exclude payments for the supply of a commercial dwelling that are subject to the time of supply rules in section 9(3)(a) of the GST Act (that is, periodic payments). (KPMG)

Normal commercial leasehold interests should not be captured by the zero-rating regime. Officials’ concerns in respect of leases being used for “phoenix” schemes could be addressed by zero-rating only transfers of leases and prepayments of more than 12 months on leases. (New Zealand Bankers’ Association)

The zero-rating rules should not apply to successive supplies of a commercial dwelling subject to a lease. The definition of “land” will need to be amended to exclude these transactions. (New Zealand Institute of Chartered Accountants)

Further consideration could be given to whether periodic supplies of land, such as commercial leases, should be included in the application of the new zero-rating provisions. (PricewaterhouseCoopers)


Comment

Submitters consider that periodic supplies of land, especially commercial leases, should be excluded from the definition of “land” used for the zero-rating amendments. The key issue is the compliance costs that would arise from existing commercial leases or other periodic supplies of land having to be altered to take account of the zero-rate, even though the contract is unlikely to generate a phoenix fraud risk. Most submitters do recognise, on the other hand, that for new transactions leasehold interests could relatively easily become a substitute for freehold interests and give rise to the possibility of such a risk.

Officials agree that the definition of “land” in the bill is too broad and should exclude most leases of land and other periodic supplies such as easements over land. The solution, however, must strike a balance that addresses both the compliance cost and the tax base risk concerns. The solution should also provide as much certainty as possible regarding which transactions should be zero-rated and which transactions should be standard-rated.

Officials recommend an amendment to the definition of land that uses a “bright-line” test to exclude periodic or ongoing supplies of interests in land. The test would be based on whether, after 1 April 2011, more than 25 percent of the total consideration under the agreement is provided in advance of, or contemporaneously with, the provision of the land, in addition to the regular ongoing payments under the agreement. If the 25 percent threshold is exceeded, the whole transaction (or remaining part of the transaction) would have to be zero-rated. If not, the transaction would be standard-rated.

The 25 percent figure should therefore apply to zero-rate all transactions with unusual commercial terms that could provide an incentive for phoenix fraud. We prefer basing the test on rental payments rather than the market value of the land as this should remove the compliance cost of any additional valuation.

Officials have considered whether a transitional rule is needed that would allow the provisions in the bill to not apply to periodic supply contracts that met the 25 percent test and that were entered into before 1 April 2011. Given the limited number of agreements that would fall into this category, and that the issue is one of compliance costs only, we do not think that such a provision is warranted.

Recommendation

That the submissions be accepted.

That the definition of “land” be amended to exclude interests in land that involve more than 25 percent of the total consideration under the agreement provided in advance of, or contemporaneously with, the provision of the land, in addition to the regular ongoing payments under the agreement.

 


Issue: Clarifying whether certain supplies constitute “land”


Submission
(Ernst & Young)

Further thought is required as to how the proposed definition of “land” will impact on any supplies involving some element of land or rights which are related to land in some way, with express clarification of the statutory provisions and publications of adequate examples to ensure there is clarity and certainty for taxpayers. For example, there may be considerable uncertainty and compliance costs to taxpayers in determining whether a variety of transactions with some connection to land include the supply of “land” for the purposes of section 11(1)(mb) (for example, supplies of timber rights, telecommunication lines, building fixtures, etc).

Comment

Officials accept that further certainty is required regarding the ambit of the definition of “land” used in section 11(1)(mb) and recommend that Inland Revenue publish guidelines on the matter.

Recommendation

That the submission be accepted.

 

Issue: Flat- and office-owing companies


Submission
(Matter raised by officials)

Officials recommend that shares in “flat-owning companies” or “office-owning companies” should be included within the proposed definition of “land”.

Comment

The GST Act specifically excludes shares in “flat-owning companies” or “office-owning companies” (as defined in the Land Transfer Act) from the GST definition of “financial services”. This exclusion was introduced to prevent taxpayers from incorporating such companies, acquiring land and then transferring shares in the company (without having to charge GST), rather than transferring the underlying asset (which would have attracted GST).

However, this presents an issue in relation to the proposed rules, which seek to zero-rate all interests in land. If the shares in these companies are not “land” and are not “financial services”, a supply of the shares will attract the standard rate of GST. There is therefore a risk that these shares could be transferred between registered persons in a “phoenix” transaction.

Officials recommend including shares in flat-owning or office-owning companies within the proposed definition of “land” to clarify that the transfer of these shares should be zero-rated. Officials consider this is consistent with the policy intent of the changes and may prevent the zero-rating rules being circumvented by the imposition of company structures in certain cases.

Recommendation

That the submission be accepted.

 

VENDOR’S INFORMATION-GATHERING OBLIGATIONS UNDER SECTION 78F

Clause 20


Issue: Limiting information to registration status


Submission
(KPMG)

The vendor’s obligation should be limited to obtaining the purchaser’s registration details. If a supply is zero-rated and the purchaser does not acquire the land with the sole intention of using it for making taxable supplies, the new change-in-use provisions would require the purchaser to account for the non-taxable use of the land. Therefore, the requirement to confirm the intentions of the purchaser in relation to the land imposes additional compliance costs on the vendor with no additional tax revenue to the Government.

Comment

If the purchaser does not intend to use the goods or services for making taxable supplies and the relevant information is provided to the vendor, it is preferable, and more in keeping with the scheme of the GST Act, that the correct standard-rated treatment of the transaction applies from the outset.

Furthermore, the recommended changes to section 78F will simply require a vendor to obtain a written representation, rather than confirmation from the purchaser regarding the purchaser’s intentions in respect of the land. Officials consider that this obligation on the vendor will not greatly increase their compliance costs.

Recommendation

That the submission be declined.

 

Issue: Reducing the vendor’s obligations


Submissions
(Corporate Taxpayers Group, Deloitte, KPMG, New Zealand Bankers’ Association, Russell McVeagh, Ernst & Young)

The legislation as currently drafted does not provide sufficient commercial certainty as to the GST treatment applying at the time of a transaction. The proposed obligation on supplies in section 78F may be onerous, particularly the obligation to confirm the intentions of the purchaser. The submitters recommend:

  • removing the requirement on the vendor to confirm the relevant details, and allow the vendor to rely on the written representation of the purchaser.
  • replacing the reference to the purchaser’s “registration details” with the purchaser’s “registration status”.
  • removing or clarifying subsections (3) and (5) (relating to misrepresentations by either party) from the bill.

Comment

Officials agree that draft section 78F has a range of issues that need to be resolved. This is best achieved by reconsidering the section as a whole and what it is intended to achieve.

It is important to recognise that there are in essence only two problematic situations that can practically arise under the zero-rating provisions – the supply being zero-rated when it should have been standard-rated, and the supply being standard-rated when it should have been zero-rated.

The information that the supplier must obtain under proposed section 78F consists of:

  • the recipient’s registration details;
  • confirmation that the recipient is acquiring the goods with the intention of making taxable supplies; and
  • confirmation that the goods are not intended to be used as a principal place of residence of the recipient or a relative of the recipient.

These requirements will, for the most part, be met through completion of the standard sale and purchase agreements, in which the purchaser would verify these matters.

Section 78F(2), however, requires confirmation from the vendor of the above and submitters have expressed concern about the vendor’s ability in this respect. Subsections (3) and (5), which are also of concern to submitters, outline a number of consequences that may arise if this information is not obtained in the first instance, or is incorrect.

Officials agree that information requirements should be as easy to comply with as possible, and compliance with the requirements should not generally have regard to the intentions or behaviour of either the vendor or purchaser.

Officials therefore recommend an alternative approach that does not require an examination of whether the vendor has made sufficient enquiries to obtain the information. The alternative approach would recognise that the vendor will have either:

  1. obtained all the information to zero-rate and the information is correct; or
  2. for any reason, not obtained all the information or obtained incorrect information.

If the purchaser is in fact registered for GST and has met the other tests, zero-rating has achieved the right outcome. Such purchasers have the incentive to provide the correct information otherwise they will risk GST being charged at the standard rate.

It is for the second situation that the legislation may need to provide further clarification of the parties’ obligations. In this situation, the vendor could either zero-rate the transaction (because they believe the information to be correct even though it later transpires that it is not) or charge GST at the standard rate (which would be the usual expected outcome).

Information not correct/not obtained and the vendor zero-rates

If the vendor zero-rates the transaction but the information was incorrect and the transaction should have been standard-rated, clause 6 of the bill (proposed section 5(23)) imposes the obligation on the purchaser to register and pay GST. As noted later, however, proposed section 5(23) would be amended to apply to all situations in which the transaction should not have been zero-rated. It would require the purchaser to register for GST but allow for deregistration without further tax cost once the tax had been paid.

Information not correct/not obtained and the vendor standard-rates

If the vendor standard-rates the transaction one of two outcomes could result:

  • the purchaser is not registered and/or does not meet the other tests; or
  • it transpires that the purchaser is registered for GST and meets the other tests.

If the purchaser is not registered for GST and/or does not meet the other tests, standard-rating has achieved the right outcome.

If the transaction is standard-rated but should have been zero-rated because the relevant tests were in fact met, the vendor will have overpaid GST and should be able to recover it from Inland Revenue in the usual manner – using the process in the GST legislation of providing credit notes. (We recommend later in this report that the credit note provision, section 25, should be amended to explicitly apply in these situations.) The purchaser will not be entitled to an input tax deduction since the position under the legislation is that the transaction is zero-rated. It is the legislation that determines that a transaction is zero-rated, not the written representation of the purchaser, which merely enables the vendor to decide how the transaction should, in the first instance, be treated.

Recommendation

That the Submissions be accepted. Officials further recommend that:

  • in subsection (2) of proposed section 78F, the reference to the supplier having to “confirm” the information in question be replaced by a reference to the supplier being able to rely on the written representation of the recipient;
  • in subsection (2) “registration details” be replaced with “registration status”; and
  • subsections (3) and (5) of proposed section 78F be omitted.

 

ALTERATION OF AGREED PRICE

Submission
(Corporate Taxpayers Group)

Section 78E (alteration of agreed price in relation to a supply mistakenly believed to be of a going concern) should be amended to refer not only to section 11(1)(m) (“going concern” rules), but also to the proposed section 11(1)(mb) or to zero-rating in general.

Comment

Officials consider that if the vendor, based on incorrect representations by the purchaser, does not zero-rate the transaction and GST is paid, this can be dealt with under section 25 of the GST Act which provides the credit note mechanism (and which we later recommend should be amended to provide more certainty about its application).

Recommendation

That the submission be declined.

 

PURCHASERS’ OBLIGATIONS TO ACCOUNT FOR OUTPUT TAX IF A SUPPLY WAS INCORRECTLY ZERO-RATED – PROPOSED SECTIONS 5(23), 20(4B) AND 51B(4)

Clauses 6(2), 13, 15 and 17


Issue: Implications of incorrect zero-rating


Submission
(Russell McVeagh)

New section 5(23) deems a recipient to make a supply chargeable at the standard rate if they have provided incorrect information relating to whether they are GST-registered. It is submitted that the provision should also apply if the recipient has provided incorrect information regarding their intentions in relation to land.

Comment

In situations when a zero-rated supply is made to an unregistered person, the person, without further legislation, would acquire the supply free of GST. Proposed sections 51B(4) and 5(23) will therefore require the person to register for GST and to account for the output tax on the supply.

If a recipient of a zero-rated supply is already registered for GST, but does not satisfy the other requirements of section 11(1)(mb) (that is, they do not intend to use the land for making taxable supplies or intend to use the land as a principal place of residence), the proposed apportionment rules in section 20(3I) would require them to account to Inland Revenue for the non-taxable use of the goods and services. As a consequence, the recipient would be required to account for the output tax on the supply under that provision.

However, to ensure that the consequences of not satisfying the zero-rating requirements are all in one place, officials agree that section 5(23) should be amended to apply to all situations of incorrect or insufficient information being provided.

Recommendation

That the submission be accepted.

 


Issue: Requirement for purchaser to register


Submission
(New Zealand Institute of Chartered Accountants)

Under new section 5(23) of the GST Act, a purchaser supplying incorrect information to a vendor is treated as though they were a supplier making a supply that is chargeable with GST at the standard rate. It seems unnecessary to require the purchaser to also register for GST under section 51B(4) to recover a payment of a GST amount.

Comment

The registration of unregistered purchasers who incorrectly purchase land at a zero-rate is necessary to ensure that a payment of output tax made by the purchaser under section 5(23) can be processed by Inland Revenue’s accounting systems.

To ensure that the purchaser does not suffer any unexpected costs from the compulsory registration, the bill should allow for an immediate deregistration of the purchaser without further tax liability once the tax has been paid.

Recommendation

That the submission be declined. However, officials recommend that once the tax is paid, the purchaser should be able to deregister without incurring any further tax liabilities.

 

Issue: Timing of registration under section 51B(4)


Submission
(Ernst & Young)

Clarification is needed regarding the time at which recipients are to be treated as registered under section 51B(4) and making taxable supplies under the proposed new section 5(23).

Comment

Since the ultimate recipient of the supply may not be known until the time of settlement, it may not be known before then whether the decision to zero-rate the transaction is correct. Therefore, a recipient will be treated as making a supply under section 5(23) at the time of settlement. Section 5(23) should be clarified to that effect.

Officials also consider that the proposed section 51B should clarify that a recipient is treated as registered from the date of the supply made under section 5(23), and not from the time when the original supply was made, if different.

Recommendation

That the submission be accepted.

 

Issue: Entitlement to input tax


Submission
(Ernst & Young)

The proposed input tax denial in section 20(4B) in respect of supplies made under section 5(23) should be qualified to ensure that recipients of section 11(1)(mb) supplies are not precluded from claiming input tax if they become GST-registered after the GST time of supply under section 11(1)(mb).

Comment

When a supply of land which should have been standard-rated is zero-rated, new sections 51B(4) and 5(23) require the recipient to register for GST and account for the output tax on the supply. To ensure that the newly registered recipient does not immediately claim back the GST paid as an input tax deduction, new section 20(4B) denies them a deduction in relation to the supply. Having accounted for GST under section 5(23), officials have recommended that the recipient will be deregistered at no further cost.
Officials accept that if a recipient, having been required to account for output tax under section 5(23), later registers for GST and starts using the goods and services in question for making taxable supplies, they should be allowed an input tax deduction in respect of those goods and services under the new apportionment rules proposed in this bill. Officials’ responses to the Submissions on the proposed apportionment rules recommend that the legislation be clarified to ensure that an input tax deduction is allowed in these circumstances.

Recommendation

That the submission be accepted.

 


ADMINISTRATION OF THE ZERO-RATING REGIME


Issue: Searchable register of GST registered persons


Submissions
(New Zealand Institute of Chartered Accountants, PricewaterhouseCoopers)

The law should allow a searchable register of GST-registered persons to be established so that taxpayers or their tax agent can identify the GST-registration status of either party. This will assist in reducing compliance costs for taxpayers transacting in land.

As an alternative, or a concurrent change, a certification approach could be adopted that requires the vendor and the purchaser to certify their GST registration status (or that of their nominee if applicable) on the contractual documentation. (New Zealand Institute of Chartered Accountants)
Consideration should be given to updating Inland Revenue’s systems and processes to allow suppliers to validate GST registration numbers provided by customers. For example, Inland Revenue should be able to provide the recipient’s registration details at the request of the supplier. (PricewaterhouseCoopers)

Comment

Owing to the Commissioner’s obligations to maintain secrecy regarding taxpayer-related information, it is not currently possible to establish a public register of GST-registered persons.

Officials consider that owing to the proposed relaxation of vendors’ obligations to identify purchasers’ details (as proposed in this report), vendors should not suffer substantial compliance costs as a result of the zero-rating rules.

Recommendation

That the submissions be declined.

 

Issue: Possible tax base risks


Submission
(Corporate Taxpayers Group)

The Group acknowledges that the proposed changes resolve officials’ principal concerns with “phoenix” transactions. However, there is a risk that fraudulent GST activity has, in effect, only been moved to another area.

Specifically, the GST risk has moved to sales by a commercial vendor to the end consumer when false declarations are made by the purchaser regarding their registration status and intentions in relation to land.

The Group suggests that Inland Revenue consider other non-tax legislative measures for penalising vendors that entice purchasers to misrepresent that they are GST registered or otherwise avoid the requirements of section 78F.

Comment

Officials acknowledge the submitter’s concern and consider that adequate policing will be necessary to minimise the risk of zero-rating rules being used inappropriately. At this stage, officials are not recommending the inclusion of any specific measures in the bill to deal with this potential issue, but will monitor the situation.

Recommendation

That the submission be noted.

 

Issue: Inland Revenue advice


Submission
(New Zealand Institute of Chartered Accountants)

NZICA submits that material should be made available warning purchasers of arrangements that involve them registering for GST when they are acquiring land, or using their GST registration as a means of acquiring land inappropriately at a zero rate.

Comment

Officials agree that Inland Revenue advice for taxpayers will be beneficial for ensuring a smooth transition into the new rules.

Recommendation

That the submission be accepted.

 

INTERACTION OF ZERO-RATING RULES WITH THE “GOING CONCERN” RULES

Clause 10


Submission
(Ernst & Young)

Sales of businesses which include a transfer of land could be zero-rated under the proposed section 11(1)(mb) (zero-rating of land) or the existing section 11(1)(m) (sale of a going concern). Clarification of the interaction of the proposed section 11(1)(mb) and the existing section 11(1)(m) is required.

Comment

The new zero-rating rules will apply to any supply that involves land. This will affect many supplies of going concerns, as these frequently involve transfers of land. This will remove the need to determine whether a going concern is being supplied and to meet the other requirements for zero-rating a going concern in these cases.

It is expected that the zero-rating rules will be easier to apply then the going concern rules as, among other things, the parties will not have to establish the existence or otherwise of a going concern or decide whether to apply the new provisions (as they are mandatory). Therefore, a specific exclusion from the going concern rules is not necessary.

Recommendation

That the submission be declined.

 

OTHER DRAFTING MATTERS


Issue: Treatment of services supplied as part of a transaction involving land


Submission
(Corporate Taxpayers Group)

Since the proposed zero-rating changes may apply to supplies consisting of both goods and services, and section 11 applies only to goods, consideration should be given to inserting a provision (similar to section 5(21) in the GST Act) that would treat any services provided as part of a transaction involving land as “goods”, in order to fall within proposed section 11(1)(mb).

Comment

Officials agree with the submission but note that the exact wording is a drafting matter.

Recommendation

That the submission be accepted.

 

Issue: Minor drafting matters


Submissions
(New Zealand Institute of Chartered Accountants, PricewaterhouseCoopers, Russell McVeagh)

A number of technical changes need to be made to the current draft legislation. The majority of those are minor drafting matters that are needed to ensure that the legislation works as intended.

Comment

Officials have considered all the changes proposed in the Submission and agree that most of them are necessary. They will be raised with the bill’s draftsperson.

Recommendation

That the submissions be noted.