Income tax and GST treatment of grants clarified

In the last month, Inland Revenue has released some helpful draft Interpretation Statements on the tax treatment of grants and subsidies. PUB0044: Income Tax – Government payments to businesses (grants and subsidies) considers how sections CX 47 and DF 1 of the Income Tax Act 2007 apply to grants and subsidies for the purposes of income tax. Meanwhile, its sibling PUB00425: GST – Section 5 (6D): Payments in the nature of a grant or subsidy looks at how section 5(6D) of the Goods and Services Tax Act 1985 applies to grants and subsidies for the purposes of Goods and Services Tax (GST).

Both draft statements provide welcome clarifications on several issues that have caused confusion.

Income Tax

In the Income Tax Act, sections CX 47 and DF 1 (the provisions) work together to make sure grants and subsidies are tax neutral — meaning there is no tax incentive or disincentive when grants or subsidies are applied for. Section CX 47 treats grants and subsidy payments as non-taxable, whilst section DF 1 treats business expenses funded by grant or subsidy payments as non-deductible.

To qualify as a grant or subsidy, one or more of the following characteristics is required:

• It is paid gratuitously (without obligation) out of public funds by the Crown or another public body
• It is paid to further objectives in the public interest
• It is often made to public, charitable, or private bodies to confer benefits on third parties
• It is made to promote or encourage an industry or enterprise
  

The provisions apply when all of the following criteria are satisfied:

• A payment is from a local authority, public authority, or public purpose Crown-controlled company.
• The payment is to a person for a business that the person carries on.
• The payment is in the nature of a grant or subsidy or is a grant-related suspensory loan. A grant-related suspensory loan is made by a public authority, not designated as a specific suspensory loan, and must include the term that the liability of the borrower may be wholly or partly remitted or must have been granted by the Rural Banking and Finance Corporation of NZ (now ANZ) as a West Coast drainage or irrigation suspensory loan
• The corresponding expense is one for which the business would be allowed a deduction if section DF 1 did not apply. The term ‘corresponding’ is to be understood in its ordinary meaning in the context or purpose of the grant provisions. Income subsidies remain taxable because the payments do not correspond to a deductible expense.
  

Excluded payments include loans under the Small Business Cashflow Scheme, loans under the Research & Development Loan Scheme, Research & Development tax incentive transition support payments, and Research & Development tax loss credits granted under subpart MX of the Income Tax Act.

The draft interpretation statement has been, in part, issued to address four areas of uncertainty. First, when the grant or subsidy payment is not for any specific expenditure. Second, when the payment is not spent in the year it is derived. Third, when funds are left over after all the expenses the payment was made for have been spent. Fourth, the question of when the provisions apply.

General v specific expenditure

On the first point, the Commissioner acknowledges that grant or subsidy payments can be made for specific or general expenses. The conclusion reached is that as long as the payments and the expenditure it funds correspond to each other (meaning there is a relationship between the two), then sections CX 47 and DF 1 apply. This means the payment can be made for specific or general expenditure, provided the payment is used to fund deductible or depreciable expenditure.

Timing of the expenditure

On the second point, the Commissioner considers that it doesn’t matter if a grant or subsidy payment is derived in one year but not spent until a later year. The provisions still apply as long as the expenditure corresponds with the payment. It is noted that the Commissioner expects the expenditure to be incurred within a reasonable timeframe, and it is perhaps unfortunate that there is no further discussion on what is considered a reasonable timeframe.
The provisions can also apply to payments reimbursing expenditure. However, when a deduction has already been claimed on this expenditure, earlier assessments must be amended to reverse out these deductions.

Surplus funds

On the third point, section DF 1 states that the amount of the deduction denied is equal to the amount of the payment received. If the expense exceeds the payment amount, a deduction is still allowed for the excess. But suppose there are surplus funds not spent on the relevant expenditure that corresponds with the grant or subsidy payment. In that case, the Commissioner expects that the surplus will be spent on other deductible expenses or depreciable property. Therefore, deductions will be denied on these deductions to the full value of the surplus payment.

When are the provisions applicable?

On the fourth point, the Commissioner believes that sections CX 47 and DF 1 apply to make a grant or subsidy payment non-taxable when it is derived, with derived generally meaning the moment the business can keep the payment. When payments are made conditionally, a business does not derive the payment until the conditions are met, although obligations that do not require repayment if not met are not included.

Finally, keeping good records showing how the payment has been spent and that the deductions corresponding to the payment have been denied is good practice. Keeping the payment in a separate account may assist with this.

The deadline for consultation on this issue statement is 16 May 2023.

GST

Under section 5(6B) of the Goods and Services Tax Act 1985, if a grant or subsidy is paid to a person in respect of their tax liability, then that payment is deemed to be a consideration for a supply of goods and services as part of the taxable activity. If the person is GST-registered, they must account for output tax on this amount.

For section 5(6D) to apply, the payment must meet the following criteria:

• There must be a payment in the nature of a grant or subsidy; and
• The payment must be made on behalf of the Crown or by any public authority; and
• The payment must be made to either:
  • A person in relation to or in respect of that person’s taxable activity; or
  • A person for the benefit and on behalf of another person in relation to or in respect of that other person’s taxable activity
    

There is some crossover between the two statements. Notably, the legislation refers to a payment “in the nature of” a grant or subsidy, meaning payments that are not technically grants or subsidies can be captured under section 5(6B). The same is true of sections CX 47 and DF 1 in the Income Tax Act.

Exclusions include social welfare benefits, payments made for a person’s personal use and benefit, payments declared by an Order in Council not to be a taxable grant or subsidy for the purposes of section 5(6D), and anything that appears on a Schedule to the Goods and Services Tax (Grants and Subsidies) Order 1992 list of payments that are not taxable grants or subsidies for the section’s purpose.

The payment must be made in relation to or in respect of that person’s taxable activity. The Commissioner expects the Court would interpret this link widely, although does not believe it to be a significant issue because the accountability requirements on the Crown and public authorities will make it clear if there is a link.

Under section 5(6D)(b), the section will apply if a person is receiving funds on behalf and for the benefit of a third party. If the recipient of the payment is not the intended beneficiary, the ultimate recipient will have to account for GST. The challenging part is determining if a person is receiving funds on behalf of and for the benefit of a third party, which will vary depending on the specific facts of the case. The outcome will likely differ under section 51 in the case of separately registered branches or divisions of a person registered for GST.

An important thing to note is that if a person who is not GST-registered receives an amount from a grant or subsidy, and this receipt means they cross the GST registration threshold of $60,000 per annum, they will need to register for GST and pay output tax on the payment. This is generally a “backwards-looking” test from the end of a month where the total value of supplies in that month and the preceding 11 months exceeds $60,000. However, a proviso may apply if the grant or subsidy was a one-off payment, and the Commissioner does not believe the value of supplies in the next 12 months will exceed $60,000. In this case, there is no need to register for GST, and the person is not liable for GST output tax.

Another proviso may apply when a person spends the grant or subsidy payment on replacing any plant or capital asset used in their taxable activity. Whilst the person is still deemed to have made a supply upon receiving the grant or subsidy, if the proviso applies the supply may not be considered towards the GST threshold. This is conditional on being able to prove the grant or subsidy was paid on the sole condition that it was used to replace a plant or capital asset.

One final thing to note is that while PUB00425 replaces several previous statements on the application of section 5(6B), statements relating to Treaty of Waitangi settlements are not replaced.

The deadline for consultation on this issue statement is 23 May 2023.

Given the Government has paid out significant amounts in grants, both related to COVID-19 and the recent North Island flooding the advice contained in these two draft statements will be helpful clarification for many taxpayers. Now is a good time to stop and check that any grants or subsidies received have been treated correctly.

Your usual Deloitte advisor would be happy to help if you have any questions.

May 2023 - Tax Alerts