GST - Major changes on the horizon

By Jeanne du Buisson and Allan Bullôt

A discussion document on ‘GST: Accounting for land and other high-value assets’ has been released. It explores changes to the GST regime to reduce GST risks to the Government for transactions between businesses. The Government considers it is losing at least $50 million per annum, predominantly from land transactions with insolvent property developers.

This discussion document follows the June 2008 issues paper and the submissions that followed. The proposed changes will see the most significant changes to GST since the financial services changes in 2005.

The most significant proposal in this document is the introduction of a Domestic Reverse Charge (DRC) mechanism that is proposed to apply to transactions involving land, transfers of a ‘going concern’, and other high-value transfers (over $50 million). The Government is concerned with the risks of not collecting GST, particularly on transactions involving land.

Of concern to the Government are large GST claims but with no corresponding output tax payments, principally due to Inland Revenue having a lower priority for the GST debt from an insolvent GST registered vendor, than the priority held by a secured creditor. A DRC tries to eliminate this problem.

How does it Work?

The DRC is proposed to be compulsory and would shift the obligation to charge and return GST from the vendor to the purchaser in certain circumstances. The purchaser would account for the output tax and claims the input tax simultaneously and the vendor would not be liable for output tax. This would eliminate cash flow issues for both the vendor and purchaser typically associated with paying/claiming back GST, but will also ensure that GST refunds are not paid without the corresponding output tax payment.

The diagram below illustrates the difference between the existing GST regime and the treatment under a DRC:

As shown, the purchaser is no longer required to pay the GST component to the vendor under the proposed regime. The purchaser claims input tax at the same time as accounting for the output tax liability. It is proposed that the DRC be mandatory for the following transactions between GST registered persons:

• Land
• The sale of a business as a going concern
• High-value transactions (over $50 million excluding GST)

Our Thoughts on the DRC

The driving reason behind the introduction of a DRC is Inland Revenue’s perception of a significant loss of GST on transactions undertaken by insolvent property developers, and this is the reason for the proposals being compulsory. From a practical perspective the DRC will have the same impact for secured creditors of insolvent GST registered vendors as would occur if the priority for GST due to Inland Revenue was increased over the priority of the secured creditor.

We support the introduction of a DRC on a voluntary basis as a simplified and cheaper alternative to the current practice of using GST offsets for high value asset transfers between GST registered entities.

However the compulsory nature of a DRC may introduce additional uncertainty for some transactions, particularly where there are questions on whether a supply is indeed a “going concern” or not. Given going concern questions have generated more GST court cases than any other issue in New Zealand GST, the proposed DRC approach for going concerns seems to be a step backwards from a practical perspective. By removing the requirement for the parties to agree in writing that there is a transfer of a going concern we are arguably back in the bad old days of having uncertainty as to the GST treatment of significant transactions, something that should be avoided.

We disagree with the use of the $50 million criteria for compulsory DRC and instead would propose that there be a voluntary option to use a DRC for transactions not involving land or going concerns above a certain value.

There are a number of other more detailed aspects of the proposed DRC, including the time of supply rules, which will also likely need to be altered.

The proposed changes will have wide reaching impact if implemented and will require substantial changes to the GST accounting systems of many businesses. The DRC proposal is a significant change with broad application. While aspects of a DRC are positive, the compulsory nature of the change will cause issues.

Other Proposals 

The issues paper also proposes, amongst others, the following:

• The existing change-in-use adjustment would be replaced by an approach that would apportion GST input tax credits in line with the actual use of goods and services. In general these changes will be an improvement on the current GST change-in-use provisions.
• Extending the application of the special rules for GST and mortgagee sales by adopting a form over substance approach. Again this is an area the Inland Revenue considers has been subject to abuse by property developers and their financiers and Inland Revenue have previously commented that changes were required in this area.
• Clarifying the GST treatment of accommodation in certain commercial dwellings such as serviced apartments.
• Altering the operation of certain anti-avoidance provisions in respect of long term sales of assets above $225,000. This proposal may create a timing advantage for Inland Revenue for vendors on the invoice basis and while not likely to be a significant issue in practice if the DRC is introduced, should be opposed on grounds of principle.

Way Forward

Deloitte is involved in on-going discussions with Inland Revenue on these proposed GST changes. Submissions close on 18 December 2009. If it goes ahead, we expect the DRC to be included in the early 2010 Tax Bill.

If you have any queries on the proposed changes, please contact your Deloitte tax advisor or one of our specialists in the Indirect Tax Team.