Chapter 4 – Apportionment and adjustment

• Change of use wash-up calculation (non-land assets)
• Zero-rated supplies of going concerns
• Apportionment of land
• Other ways to simplify the apportionment and adjustment rules

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4.1 The apportionment and adjustment rules apply when a GST-registered person uses or intends to use goods and services for both taxable and non-taxable purposes. For example, a contractor that acquires a car for both their contracting business and private travel will only be able to claim input tax credits for the intended taxable use of the car.

4.2 Following acquisition of an asset, the GST-registered person must annually compare the intended taxable use of an asset with the actual taxable use of an asset. If there is a difference the person must make an adjustment to either claim extra input tax credits or pay output tax to reflect the actual taxable use of the asset.

4.3 This chapter discusses a number of issues with the apportionment and adjustment rules and suggests some possible solutions. We would also like feedback on further ways in which the apportionment and adjustment rules could be simplified and improved.

Change of use wash-up calculation (non-land assets)

4.4 Section 21FB of the GST Act contains a wash-up calculation that requires a registered person to claim or pay the full input tax credits for an asset when they switch the use of that asset to one hundred percent taxable or non-taxable.

4.5 The rationale for the wash-up calculation is to reduce compliance costs for taxpayers by reducing the number of adjustments they need to perform.

4.6 Without the wash-up calculation the number of adjustments a taxpayer needs to make will depend on the type and value of the asset (see section 21G). For non-land assets a taxpayer must perform two adjustments for assets valued between $5,000 and $10,000, five adjustments for assets valued between $10,000 and $500,000 and ten adjustments for assets valued over $500,000. Alternatively, for non-land assets a taxpayer may choose the relevant number of adjustment periods based on the estimated useful life as determined by the tax depreciation rates determinations set by the Commissioner. For land there is no limit to the number of adjustments required.

4.7 For a change in use to one hundred percent taxable, the wash-up formula entitles a taxpayer to a full input tax deduction less any actual deduction already claimed for that asset. For a change in use to one hundred percent non-taxable, the wash-up formula requires a taxpayer to pay as output tax an amount equal to the actual deduction claimed for that asset. The terms “full input deduction” and “actual deduction” are defined by paragraphs 21FB(a) and (b) respectively.

4.8 In order for an asset to be subject to the wash-up rule its use must be changed to one hundred percent taxable or non-taxable and this total taxable or non-taxable use remain unchanged for an unbroken period of the remainder of the adjustment period in which the change in use occurred, and the entirety of the following adjustment period.

4.9 This section considers a number of issues with the change of use wash-up calculation for non-land assets. Issues with the wash-up calculation for land are discussed later in this chapter.

Issue 1: Wash-up adjustments are disproportionately large

4.10 For non-land assets the wash-up calculation results in adjustments that are disproportionately large. This is because the wash-up calculation does not take into account any business or private consumption of the asset that has occurred prior to the wash-up being performed. In addition, the wash-up calculation does not take into account any change in value of an asset that may have occurred.

4.11 For assets that have had a change in use to one hundred percent taxable, the wash-up requires the taxpayer to claim all the input tax (less any input tax already claimed) for the asset. The concern is that taxpayers can effectively use and “consume” an asset for private purposes over a period of years and then enjoy full input tax recovery upon a subsequent change to full taxable use. Therefore, the wash-up calculation does not tax the non-taxable usage prior to the change to full taxable use.

4.12 Conversely for assets that have had a change in use to one hundred percent non-taxable, the taxpayer is required to pay as output tax all the input tax they have claimed for the asset. As the wash-up calculation does not take into account prior taxable use, it therefore results in over-taxation of assets that are switched to one hundred percent non-taxable use.

Issue 2: Wash-up can only be used for changes of use to one hundred percent or zero percent taxable

4.13 Section 21FB only applies to a complete change of use to either one hundred percent taxable or one hundred percent non-taxable use. However, if a registered person permanently changes their use of an asset to something other than one hundred percent taxable or one hundred percent non-taxable, they are required to perform the full number of yearly adjustments as required under section 21G.

4.14 Discussions with business groups have indicated that allowing the wash-up to be performed after a permanent change in use to something other than one hundred taxable or non-taxable would reduce compliance costs.

Issue 3: Usual adjustment provisions not switched off following wash-up calculation

4.15 Section 21(2) of the GST Act provides an exception from the requirement to make an adjustment if one or more exceptions apply. However, there is no exception from the requirement to make an adjustment for goods and services that have been subject to the wash-up calculation under section 21FB.

4.16 As such, it appears that a registered person is required to continue to perform adjustments for goods and services that have had a complete change of use and have been subject to the wash-up under section 21FB.

4.17 We are proposing to introduce an exception to the requirement to perform adjustments when the wash-up has been performed.

Proposal: New wash-up formula

4.18 To address the first two issues above we propose changing the formula for the change in use wash-up calculation for non-land assets. The proposed new formula is:

Time remaining × (Full input tax deduction × Current use - Actual deduction)
Total time

4.19 This formula would apply for both changes to 100% taxable use or 100% non-taxable use. It would also apply for any permanent change of use to something between 0% and 100% taxable.

4.20 Full input tax deduction and actual deduction would both have their current meanings.

4.21 Current use would be the percentage taxable use of the asset since the change of use.

4.22 Total time would be defined as the total amount of time from acquisition of the asset until the end of the last adjustment period that would be required under section 21G in the absence of the wash-up. Time remaining would be calculated by subtracting from total time the amount of time from acquisition of the asset until the end of the adjustment period in which the change of use occurred.

4.23 As with the existing formula, the proposed wash-up formula would apply if the use has been changed and remains unchanged for the remainder of the adjustment period in which the change of use occurred, and the adjustment period following the period in which the change of use occurred.

4.24 Under the proposed formula, the result under the wash-up is the same as if the person had instead used the standard change in use provisions for the remaining adjustment periods (ignoring the restrictions to performing adjustments under section 21(2)). This is illustrated in examples 4–6.

4.25 We are seeking feedback on the proposal to amend the wash-up formula for non-land assets in the manner described above.

Zero-rated supplies of going concerns

4.26 Under section 11(1)(m) of the GST Act, the sale of a going concern from one registered person to another may be zero-rated if the supplier and the recipient agree.

4.27 Issues arise with this rule when the recipient of the going concern intends to use the supply for both taxable and private or exempt purposes. Zero-rating the supply of a going concern means that there is no input tax to apportion. As a result, any exempt or private use of the going concern is not correctly accounted for.

4.28 In contrast, under the zero-rating of land rules any private or exempt use of zero-rated land is effectively taxed. Section 20(3J) requires the purchaser to determine the nominal amount of GST they would have incurred if the supply was standard rated and return as output tax the proportion of this nominal GST relating to private or exempt use.

4.29 We are proposing to introduce a similar provision to section 20(3J) that would apply to zero-rated supplies of going-concerns. In example 7, such a provision would have required Gordon to return $3,750 in GST if he and Shanae had agreed to zero-rate the sale of the business as a going concern.

Apportionment of land

4.30 Some apportionment and adjustment issues mainly affect land rather than other assets. This is because land is different from most other assets in that it tends to appreciate in value. Furthermore, it is common for land to be used for a mix of taxable and non-taxable purposes given it is often used privately or for the supply of accommodation in a dwelling.

4.31 Issues with the apportionment and adjustment rules for land are discussed in the next section.

Concurrent use of land

4.32 A special apportionment rule in section 21E of the GST Act applies where a GST-registered person is concurrently using the same piece of land with a dwelling for both a taxable (development) and non-taxable (supply of accommodation in a dwelling) purpose.

4.33 The rule applies in the adjustment periods prior to the sale of the property and adjusts the input credits that can be claimed on the property based on the ratio of taxable use to total use.

4.34 This rule was developed in response to issues raised by the Court of Appeal decision in Lundy (2005) 22 NZTC 19 at 637, which involved land being used concurrently for taxable (advertised for sale) and non-taxable (supply of accommodation in a dwelling) purposes. In that case a developer bought houses intending to develop and quickly sell them. The developer was initially unable to find buyers and so rented out the houses until they were able to find a buyer. As the developer was using the land concurrently for both taxable and exempt activities, they could not apportion their inputs based on time or space.

Scope of section 21E

4.35 The rule was developed under an assumption that the concurrent use of the land would only be for a short period of time (a few adjustment periods) prior to the sale.

4.36 However, the rule can also apply in situations in which there is a concurrent use of land for a long period. For example, the concurrent use of land rule may apply if a property developer rents out houses but has a well-developed plan to sell them in 20 years. In this situation it may be argued that they are passively using the land for taxable purposes as they are holding it for future sale at the same time as they are actively using the land for the non-taxable use of supplying accommodation in a dwelling.

4.37 Note that section 21E would not necessarily apply even if there is a well-developed plan to sell the land. Whether or not there is concurrent use would depend on all of the facts of an arrangement.

4.38 The concurrent use rule was not intended to apply to situations in which the only taxable use was passively holding the land for future sale. Instead it was targeted at situations similar to the Lundy case in which land was actively being advertised for sale or had some other active taxable use whilst simultaneously being used for non-taxable purposes.

4.39 We therefore propose limiting the application of section 21E to not apply in situations where the only taxable use of the land in an adjustment period is holding the land for its eventual sale or development. If the only taxable use of land in an adjustment period is holding the land for its eventual sale or development, then the taxable use of the land during that period would be zero percent.

4.40 We are seeking feedback on the appropriateness of this proposal to limit the scope of section 21E.

Concurrent use apportionment formula

4.41 In addition to the scope of the concurrent use rule being broader than intended, the apportionment formula in section 21E(3) appears to be overly generous.

4.42 The apportionment formula in subsection (3) compares the expected consideration for taxable supplies (approximated by the current market value of the property) with the total consideration, where total consideration is the current market value of the property plus any rental income (or imputed rent) that has been received since the registered person purchased the property. This ratio of taxable use to total use is then used to determine the percentage of GST input credits which can be claimed on the property and expenses associated with the property.

4.43 As the market value of the property will generally be significantly more than the rental income received, this formula often allows a high proportion of GST input credits to be claimed. This may provide a registered person with a concurrent use of land a time value of money advantage over someone with a fully-taxable use of the land (that is, a property developer renting out the land as commercial accommodation while advertising it for sale), or someone with a fully non-taxable use of the land (that is, a residential landlord).

4.44 In addition, the existing formula in subsection (3) does not appear to calculate either the extent to which the use of land is taxable, or the extent to which the land holder’s purpose in using the land is taxable. As such, we consider that the apportionment formula in subsection (3) should be amended. Two options for amending the formula are discussed.

4.45 The first option would recognise that, as it is being entirely used for taxable purposes and entirely used for non-taxable purposes, the land is being equally used for both purposes. As such, the taxable use of the land for periods of concurrent use would be fifty percent. This option would appear to be consistent with a time and space apportionment approach.

4.46 The second option would attempt to calculate taxable use based on the benefit the registered person receives in using the land concurrently. This would be achieved by comparing, over the period the land is used concurrently, the taxable benefit the owner receives from the land with the total benefit the owner receives from the land. This would be calculated using the formula:

Consideration for taxable supply - Cost
Total consideration for supply - Cost

4.47 Consideration for taxable supply and total consideration for supply would maintain their current meaning.

4.48 Cost would be the market value of the land at the time the land began to be used concurrently.

4.49 Note that under the second option the proposed formula would not work if the land depreciates in value over the period of concurrent use. In these situations, the taxable use of the land over the period of concurrent use would be zero percent.

4.50 We are seeking feedback on whether the apportionment formula in section 21E(3) should be amended, and if so which of the two options discussed above is more appropriate. We are also seeking feedback on whether there are other options for amending the formula in subsection (3) that would be more appropriate than the two options discussed above.

Transitional rules

4.51 There may be some registered persons that own land that section 21E currently applies to but under the proposal to limit the scope of the rule would no longer have a concurrent use of land. This may result in them being required to make large adjustments to return input tax claimed on the land as their taxable use of the land going forward would be zero percent. We are therefore seeking feedback on whether any transitional rules are necessary to limit the impact of the change on these registered persons.

4.52 Any transitional rule would only apply when the registered person’s concurrent use of the land (as currently defined) began prior to 24 February 2020.

Disposal of land with a mix of taxable and non-taxable use

4.53 Section 21F applies when a registered person disposes of an asset which they have used for a mix of taxable and non-taxable uses and have therefore only claimed some of the GST they incurred when they acquired the asset.

4.54 Section 21F allows the registered person to claim as an adjustment the proportion of the output tax related to their non-taxable use. However, the amount of the adjustment is capped at the amount of GST paid by the registered person on acquisition of the asset.

4.55 For depreciating assets, the final adjustment under section 21F appears to achieve an appropriate result as the net GST returned on disposal of the asset will be equal to the taxable proportion of the asset’s use. This is shown in example 10.

4.56 However, for land, which often appreciates in value, the final adjustment under section 21F will often produce an inappropriate outcome.

4.57 The amount of the adjustment under section 21F is capped at the unclaimed portion of the GST paid by the registered person on acquisition of the asset. This cap on the adjustment means that, despite any non-taxable use, all the appreciation in value of land is treated as being related to the land’s taxable use.

4.58 Treating all the appreciation in value of land as relating to the taxable use of the land is appropriate in some circumstances. For example, a property developer may use land for some non-taxable purposes (that is, supplying accommodation in a dwelling) before they dispose of it. However, given their taxable activity is property development, the appreciation in the value of the land is likely to primarily relate to their taxable use of the land, rather than any non-taxable use. As such, capping the adjustment under section 21F to the unclaimed portion of the GST paid on acquisition of the land by the property developer is appropriate.

4.59 However, in other situations in which the use of land is both taxable and non-taxable, treating the entire appreciation in value of the land as relating to the taxable use does not appear to be appropriate. When the taxable use of the land does not include adding value to the land, such as having a home office or using a home or bach both privately and for providing short-term commercial accommodation, appreciation in the value of the land relates to both the taxable and non-taxable uses of the land. In these cases, the cap on the adjustment results in the disposal of the land being overtaxed. This is shown in example 11.

4.60 We understand that because of the cap on the adjustment in section 21F, some registered persons that have some taxable use of their home or bach are attempting to structure in such a way as to keep their land out of the GST base.

Proposal: Removing cap on adjustment for non-developers

4.61 To address the issue discussed above we propose removing the cap on the adjustment in section 21F for land that is disposed of by someone other than a property developer.

4.62 This would be achieved by removing the cap on the adjustment in section 21F for land unless, in the absence of any other taxable supplies the land is used to make, the supply of the land would still be considered as being made in the course or furtherance of a taxable activity. Examples 12–14 demonstrate how this would work.

4.63 In removing the cap on section 21F for land (except for property developers) we consider that section 5(18) would no longer be required. The proposal would have a broader impact than section 5(18) as section 5(18) only applies to disposals of dwellings and does not apply to disposals of commercial dwellings or other types of land. Furthermore, section 5(18) could apply to disposals by property developers and we consider this to be inappropriate as, for property developers, increases in the value of the land relate primarily to the taxable use.

4.64 We are seeking feedback on the proposal to remove the cap on adjustments in section 21F for disposals of land by someone other than a property developer.

4.65 At this stage we are not proposing to remove the cap on adjustments for any other appreciating assets. However, we are seeking feedback on whether there are any other situations where the cap on the adjustment should be removed when an asset appreciates in value.

Change of use wash-up calculation for land

4.66 As discussed above, the wash-up calculation in section 21FB applies when a registered person changes the use of an asset to one hundred percent taxable or one hundred percent non-taxable.

4.67 As there are no limits to the number of adjustment periods required for land under section 21G, the new formula for the change of use wash-up calculation proposed above would not apply for land. However, there are still some issues with the change of use wash-up calculation for land and these are discussed below.

4.68 For land, the wash-up calculation can result in adjustments that are disproportionately small. This is because the wash-up calculation is based on the cost of an asset rather than its market value and land tends to appreciate in value. This creates a concern that a taxpayer could reduce their output tax liability by switching the use of land to one hundred percent non-taxable and performing the wash-up prior to disposal.

4.69 Given the proposed changes to section 21F for non-property developers discussed above, the wash-up calculation in section 21FB may also result in a worse outcome for a person that changes their use of land to one hundred percent taxable, compared to if they had disposed and reacquired the land at its current market value.

4.70 As with non-land assets, the wash-up calculation in section 21FB can only currently be performed when the use of land has been changed to one hundred percent taxable or one hundred percent non-taxable. As such, a person who permanently changes the use of land to something between zero percent and one hundred percent taxable would need to perform yearly adjustments until they dispose of the land. This creates additional compliance costs.

Option 1: Deemed disposal and reacquisition

4.71 One option to address the issues discussed above would be for land to be treated as being disposed and reacquired at market value when the change of use wash-up is performed. For ease of compliance, the deemed disposal would be considered a standard rated supply.

4.72 This option could apply for both changes to one hundred percent taxable or non-taxable use and for permanent changes in use to something between zero percent and one hundred percent taxable use. Examples 15–17 illustrate how this would work.

4.73 One concern with this option is that it may impose compliance costs on registered persons in determining the market value of the land when they perform the wash-up calculation. However, the one-off compliance cost of determining the land’s market value may be less than the compliance costs of performing continual yearly adjustments after a permanent change in use. There is also a risk that obtaining an estimate of the land’s market-value could be open to manipulation.

4.74 We are seeking feedback on the appropriateness of this option to make the change in use wash-up for land a deemed disposal and reacquisition at market value.

Option 2: Updated formula

4.75 As an alternative, the existing wash-up adjustments for land could be maintained but the calculation amended to allow it to be used for permanent changes in use to something other than one hundred percent taxable or non-taxable. This would be achieved by replacing both of the current formulas with this formula:

"Full input tax deduction × Current use - Actual deduction"

4.76 Current use would be the percentage taxable use of the land since the change of use occurred.

4.77 This proposed formula would not address the concerns that the wash-up calculation for land can result in adjustments that are disproportionately small. However, to address the fiscal risk from someone reducing their output tax on disposal by performing the wash-up adjustment, a special adjustment rule would apply when land that has been subject to the wash-up after a permanent decrease in its taxable use is disposed of within five years of the permanent change of use occurring. This special rule would not apply when land is disposed of after the wash-up has been performed following a permanent increase in the land’s taxable use.

4.78 This rule would require the actual taxable use of the land since acquisition to be calculated and an adjustment made to claim input tax in line with this percentage. The supply of the land would then be a taxable supply (even if the use of the land had changed to zero percent) and section 21F would apply to the disposal of the land. Examples 18–19 demonstrate how this would work.

4.79 The special adjustment rule would also apply if a person ceases being a registered person within five years of the permanent change of use occurring.

4.80 We are seeking feedback on the appropriateness of the proposed new formula under this option. We are also seeking feedback on the proposed special adjustment rule to address the fiscal risk from someone reducing their output tax by performing the wash-up after a permanent decrease in the taxable use of land.

Zero-rated land

4.81 If either the existing wash-up calculation is maintained or the proposed calculation under option 2 is adopted a minor amendment would need to be made to the definition of “actual deduction”.

4.82 For the purposes of the wash-up calculation, “actual deduction” is defined in section 21FB(3)(b) as the “amount of deduction already claimed, taking into account adjustments made up to the end of the adjustment period referred to in subsection 1(c)(ii)”. This definition does not take into account any nominal deduction received for zero-rated land. In contrast, the definition of “full input tax deduction” does include the nominal GST component chargeable under section 20(3J)(a)(i).

4.83 We propose to update the definition of “actual deduction” to include a nominal deduction for the proportion of the nominal GST component not returned as output tax on acquisition of zero-rated land.

Other ways to simplify the apportionment and adjustment rules

4.84 We have also heard from many stakeholders that the apportionment rules can be complex and difficult to apply. As such, we are considering ways in which the apportionment and adjustment rules could be simplified.

4.85 Some possible ways in which the rules could be simplified are discussed below. We are interested in feedback on whether these ideas have merit and are worth exploring further. We also welcome submissions on any other ways the apportionment and adjustment rules could be simplified.

Understanding which rule is applicable

4.86 We understand that it may not always be easy for a registered person to determine which particular apportionment or adjustment rule applies to them. To assist in navigating these rules a signposting provision could be added at the beginning of the apportionment and adjustment section of the GST Act.

4.87 Alternatively, Inland Revenue could provide additional guidance material to assist taxpayers and their agents navigate the apportionment and adjustment rules.

De minimis thresholds for minor taxable use

4.88 The sale of an asset that has been used in a person’s taxable activity will generally be a taxable supply. This means that very minor taxable use of a good or service can make the eventual disposal of that asset a taxable supply.

4.89 A threshold for minor taxable use of an asset could be established, for example ten percent. If the taxable use of the asset is below this threshold and no input tax deductions have been claimed in relation to the asset, the disposal of the asset would not be considered as being made in the course or furtherance of a taxable activity.

4.90 A de minimis threshold for minor taxable use would mean that, when the taxable use of an asset is below this threshold a registered person could choose not to claim any input tax and would therefore not be required to perform any adjustments.

Accuracy of apportionment and adjustments

4.91 The current apportionment and adjustment rules require precise calculations of the taxable use of a good or service. However, the rules could instead require the taxable use of an asset be calculated to a certain level of accuracy, for example the nearest five percent.

4.92 This would mean that if the intended taxable use of an asset was 50%, but it is determined that during the first adjustment period the actual taxable use was 52% or 49% no adjustment would be required. Conversely, if the actual taxable use was 53% the taxable use of the asset would be considered 55% and an adjustment would be required.

4.93 We note that for high-value assets it is more important for apportionment to be accurate. Therefore, it may only be appropriate to allow taxable use to be calculated to a certain level of accuracy for assets acquired for less than a particular amount.

4.94 There are also some thresholds under which adjustments are not required. For example, adjustments are not required for goods and services under $5,000 (excluding GST), or if the difference between the percentage intended use and percentage actual use is less than 10 percentage points and the amount of the adjustment does not exceed $1,000. These thresholds could be amended to reduce the instances of adjustments being required.