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GST remedial issues paper released for comment

Author: Vlad Skibunov

In December 2012, Inland Revenue released an officials’ issues paper on GST titled “GST Remedial Issues”.  As the name suggests, the issues paper is concerned with the GST rules which are considered by Inland Revenue as requiring clarification or not operating as intended.  As such, subject to one very important exception on “unjust enrichment”, the issues paper does not raise significant policy questions.

Overall, we consider that the proposals in the issues paper strike the correct balance between offering practical answers to some of the compliance-related concerns currently faced by taxpayers and fixing some of the legislative gaps left following the introduction of the new zero-rating of land rules and apportionment rules in 2011.  

In this context, it is unfortunate that the issues paper also includes the proposal to introduce an unjust enrichment rule that would require a “supplier” to issue a credit note where there is no supply for GST purposes.  This proposal interferes with the freedom of contractual parties to agree on their own contractual terms and may be viewed as a revenue-gathering exercise by Inland Revenue.

In summary, the issues paper deals with the following topics:

  • Credit notes when GST is mistakenly accounted for where there is no supply for GST purposes.
  • Application of the hire-purchase time-of-supply rule to land transactions.
  • Treatment of directors’ fees.
  • Consequential and remedial amendments following the introduction of the apportionment rules.
  • Consequential and remedial amendments following the introduction of the zero-rating for land rules.
  • Consequential and remedial amendments following the changes to the definitions of “dwelling” and “commercial dwelling”.


Below, we discuss some of the more interesting proposals suggested in the issues paper.

Credit notes

Credit and debit notes are issued by suppliers to reflect that the payment for a supply may have been incorrectly stated and to allow the issuer to adjust their position accordingly.  However, the requirement to issue a credit or debit note only applies where there has been a supply of goods or services by a registered person.  For example, where a registered person issues an invoice on the assumption that a supply subject to GST has taken place and it is later determined that the payment is not in respect of any “supply” for GST purposes, the supplier is not required to issue a credit note.

Officials are concerned that where GST was charged by the supplier and accounted to Inland Revenue and it is later determined that no supply has taken place, the supplier will be able to recover the output tax from Inland Revenue without passing it on to the person who they consider has economically suffered the “GST” cost.  Officials consider that this will provide the supplier with a windfall gain.

The Inland Revenue’s solution proposed in the issues paper to this perceived problem is to require a supplier to issue a credit note in situations when the GST treatment of a supply has been incorrectly accounted for.

The proposed solution would likely operate – and officials acknowledge it – as a general unjust enrichment rule in practice.  In its suggested form, we find it difficult to justify and support the introduction of such a rule. 

Firstly, the proposed solution attempts, for practical purposes, to dictate contractual terms governing obligations of parties to a transaction rather than letting them agree on their own contractual terms.  Thus, the pricing and payment issues are contractual matters and depending on the contractual terms, one of the parties will bear the risk of GST charged on a supply.  For example, if a price is expressed as inclusive of GST because the supplier incorrectly believed that the supply would not be subject to GST, the supplier will bear the cost of GST if the GST is eventually charged on the supply. 

Secondly, as is indicated in the above example, the rule would apply asymmetrically by practically helping the “recipient” to recover the incorrectly paid GST without providing any assistance to the supplier with recovering any GST charged on a supply which was previously considered not to be  subject to GST.

For these reasons we consider that an “unjust enrichment” rule would not only be unnecessary, but also unfair.

Treatment of directors’ fees

Where an employee is engaged as a director by a third-party company who is not their employer and the employee is required to reimburse the employer (which may be a company, trust or a partnership) for the directors’ fees received, the employer is required to account for output tax on the reimbursement payments.  The proposal deals with the concern that in these circumstances neither the director nor the third-party company are able to recover the GST component because the director is not carrying on a taxable activity and the third-party company does not have direct relationship with the employer.  The outcome is that supply is not GST-neutral and one of the entities will bear the GST cost. 

In practice, to ensure that the GST does not become irrecoverable cost, some employers have sought to agree directly with third-party companies to be paid “compensation” for permitting the employee to be a director, therefore allowing the third-party company to claim the input tax deduction.  There is some doubt that this approach is entirely effective.  The solution proposed in the issues paper would extend the ability of the third party company to claim input tax deductions to situations where it has no direct relationship with the employer, by specifically allowing the employer to issue a tax invoice for the fees.  This is a good clarification and reflects common practice.

Apportionment rules

A number of the proposals in the issues paper will affect owners of land who use or have used the land for making both taxable and non-taxable supplies.

Thus, officials propose that where a taxpayer has used the GST apportionment rules to apportion between the taxable and non-taxable uses of the land, the taxpayer will have to make a compulsory wash-up apportionment adjustment where the land has been used solely for a taxable or non-taxable purposes during two consecutive adjustments periods and the percentage actual use of the land over the course of their ownership of the asset is, respectively, over 90% or under 10%. 

This compulsory wash-up calculation would take the land out of the GST apportionment rules.  This is a positive development as currently where a taxpayer has apportioned input tax in respect of land between the taxable and non-taxable uses, the land will always technically remain subject to the ongoing apportionment rules obligations.  As such, the proposal will benefit taxpayers who intend to continue using the land for making solely taxable or non-taxable supplies, and therefore wish to take the land out of the GST apportionment rules once and for all. 

Unfortunately, considering that the issues paper states that the land may again become part of the apportionment rules if the owner subsequently changes the use of the land beyond the de minimis levels stipulated by the GST Act, the benefits of the proposal are less obvious where the exclusive use of the land for either taxable or non-taxable purposes is only temporary.  For this reason, we consider that although the rules are likely to be beneficial in many situations, they should not have a compulsory application but should apply at taxpayers’ discretion.

Another proposal in the apportionment rules realm relates to the non-taxable sale of land for which the vendor has claimed input tax deductions. 

The issues paper is concerned that there is a risk that a person may use land fully or partly for making taxable supplies and then devote it exclusively to a non-taxable purpose before disposal.  In these circumstances, the person will have claimed a full or partial input tax deduction for the land without charging the GST on the sale and without having to return any of the input tax which they have claimed.  It is therefore proposed to deem a supply of land to be in the course or furtherance of a taxable activity and therefore subject to GST when input tax has been claimed in respect of the land.  Vendors will be able to utilise the wash-up calculation in the GST Act, which could potentially provide them with further input tax deductions. 

The proposal, if implemented, would put an end to the discussion as to whether GST must be charged on supplies of land where the vendor has partially claimed input tax in respect of the land. 

Zero-rating of land rules

Following the introduction of the new rules in 2011, a taxable supply of land by a GST-registered vendor is subject to GST at the rate of 0% where the purchaser is registered for GST, intends to use the land for making taxable supplies and will not use the land as the principal place of residence for themselves or their relatives.

The GST Act also provides that where a supply which should have been subject to GST at the standard rate of 15% was incorrectly zero-rated under the zero-rating of land rules – for example, because the purchaser was not registered for GST or did not intend to use the land for making taxable supplies then the purchaser, rather than the vendor, must account for the output tax on the supply to Inland Revenue.  Furthermore, the legislation provides that the purchaser is denied the ability to claim an input tax deduction in respect of the supply – the assumption being that by being unable to satisfy all of the requirements for zero-rating of land, the purchaser would not be able to claim that input tax deduction even if the transaction was correctly standard-rated from the outset.

Although the rule limiting the ability to claim input tax deductions works as intended where the reason for the incorrect GST treatment of a supply is an error as to the GST registration circumstances of the purchaser, the rule does not provide a right outcome where a supply is incorrectly zero-rated as a result of a genuine mistake in respect of whether the supply actually involves “land”.  Thus, we have already seen a number of practical examples where due to the very wide definition of “land” in the GST Act, it was not immediately obvious whether or not a supply involves “land”.  In these situations, if the supply is zero-rated and it is later determined that the supply did not involve land and therefore should have been standard-rated, the purchaser would have to account for the output tax on the supply to Inland Revenue and would be prevented from claiming back the GST paid.  This outcome is incorrect from both the policy and practical perspective as the purchaser would be able to recover that GST if the supply was correctly standard-rated from the start.

As such, we are happy to see that officials have recognised the problem with the limitation on the ability to recover input tax deduction rule and propose to amend it to allow the recovery of the input tax to the extent that the purchaser uses the goods for making taxable supplies.

Next steps

The comments above outline some of the more far-reaching proposals in the GST remedial issues paper.  We recommend that businesses consider these and other proposals in the issues paper and decide whether any of them have sufficient effect for them to warrant making submission.

Submissions can be made until 1 March 2013.  After considering submissions, officials will make recommendations to the Government and legislative change will follow in due course.  Please contact your usual advisor to discuss your tax position or if you wish to be involved in submissions.

Tax Alert February 2013 contents


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