In the 2022-23 Annual Rates Platform Economy and Remedial Matters Bill, IRD discuss in detail the GST and apportionment rules. An interesting amendment is the addition of S 14(4) which will allow GST registered persons to treat the supply of certain goods as exempt supply. Let’s look at this in detail. This will impact to all those taxpayers who have mixed use of Land and GST is claimed on the purchase.
What is the purpose of S 14(4)?
The proposal intends to align the GST rules with current GST practices for GST registered persons who have minor use of private goods in the course of their taxable activity. The proposed exemption would only apply to goods, as it is meant to be used for tangible assets like land, dwellings or vehicles that are more likely to be used in a minor capacity to make taxable supplies than intangibles like trademarks or intellectual property that are more likely to be used exclusively or primarily for taxable purposes when acquired by registered persons. By limiting the exemption to goods, it is made clear that the products must be sold or otherwise disposed of in order for the exemption to be valid. When land or housing is provided via a lease, the provision of the lease should be governed by the standard GST regulations rather than being subject to the proposed exception.
How can goods qualify as exempt supply?
In order to qualify as an exempt supply, the goods must fulfil the following requirements:
- The goods cannot have been acquired for the principle purpose of making taxable supplies
The principle purpose is the main, primary and fundamental purpose for which the goods have been acquired at the time of purchase.
- The goods have not been used for the principle purpose of making taxable supplies
This means that the primary and fundamental use of the goods from the time of purchase until disposal should not have been in relation to the taxable activity. Rather have been used as private exempt goods.
This also means that the goods cannot be sold in the course of furtherance of their taxable activity e.g., trading stock.
- The goods have not been acquired as zero-rated supplies under S 11(1)(m) or (mb)
In order for S 11(m) to apply, the taxpayer must have acquired a taxable activity, or a part of a taxable activity, that is a going concern at the time of purchase and is capable of continuing as a going concern. For S 11 (mb), the registered person must have acquired land with the intention of using it to make taxable supplies.
In most cases, where 11(m) or (mb) is met, land or assets purchased will have been acquired for the principal purpose of making taxable supplies.
In some cases, however, the purchaser’s taxable use of the goods, while sufficient for the supply to qualify as a zero-rated supply under section 11(1)(m) or (mb), may be minor and secondary to their non-taxable (exempt or private) use of the goods. Therefore, the supply of the goods would satisfy the requirements of proposed new section 14(4) other than paragraph (d).
A second suggested change would enable the registered person to return output tax that is equal to the whole nominal GST amount in order to account for these circumstances.
The proposed new section 14(4)(d) exclusion for products purchased as zero-rated goods would no longer be applicable if the registered person made this output tax adjustment. Despite the fact that the person purchased the products as a zero-rated supply, making the output tax adjustment would place them in the same situation as someone who purchased standard-rated or used goods but did not claim an input tax deduction at the time of purchase.
Example: Acquiring a holiday home as a zero-rated supply of land (provided by IRD)
Gavin is a registered person who acquires a holiday home from another registered person. Gavin’s principal purpose for acquiring the holiday home is to use it for his own private recreation (and not as his principal place of residence). However, because Gavin also intends to use the holiday home for a secondary and more minor purpose of making taxable supplies of guest accommodation, he acquires the holiday home as a zero-rated supply under section 11(1)(mb) for $1m (rather than a standard-rated supply of $1m plus $150,000 of GST, which would have been the price had section 11(1)(mb) not applied to the supply).
Under proposed new section 20(3J), if Gavin intended to use section 14(4) to make his future disposal of the holiday home an exempt supply, he could choose to return output tax of $150,000, being the full amount of the nominal GST component. If he did this, section 14(4)(d) could then be satisfied for a future disposal of the holiday home.
Alternatively, Gavin can choose to return the smaller amount of $105,000 output tax under section 20(3J) based on his 70% expected non-taxable use of the holiday home at the time he acquires the holiday home. However, if he does this, a future disposal of the holiday home would not qualify for the exempt supply rule in section 14(4)(d) as he would not have returned the full amount of the nominal GST component on acquisition of the zero-rated supply of land.
- No previous deductions have been claimed for the goods under S 20(3)
Deductions under S 20(3) include:
- Input deduction at the time the goods were acquired
- Subsequent deduction after applying the adjustment rules to the goods at the end of the persons adjustment period
- Deductions for other goods or services that were acquired to make substantial improvements to the goods being supplied.
If any have been claimed, the exemption will not apply. Registered persons would still be in compliance with S 14 if input deductions have been claimed for overheads or operating costs that aren’t an integral part of the goods.
Example 1: Dwelling with a minor use in a registered person’s taxable activity (provided by IRD)
Rebecca is a registered person who acquired a dwelling that was not a zero-rated supply when it was acquired. She did not claim deductions under section 20(3) for the cost of acquiring the dwelling or of any subsequent capital improvements to the dwelling. Although part of the dwelling is used to run Rebecca’s taxable activity of farming, the dwelling’s principal purpose is a private residence. Rebecca claimed input tax deductions for certain overheads and operating costs, such as insurance, utilities and local authority rates, based on the percentage that these services were used to make taxable supplies. Under the proposed amendments, when Rebecca sells the dwelling, she would be able to elect to treat the sale as an exempt supply of goods as it meets the requirements of the proposed new section 14(4).
Example 2: Dwelling where deductions are claimed for taxable use (provided by IRD)
Vincent is a registered person who acquired a dwelling for $920,000 from an unregistered person. Vincent intends to use 20% of the dwelling (a dedicated office) to make taxable supplies for his GST-registered consulting business. He therefore claims an input tax deduction of $24,000, which is 20% of the GST fraction of the purchase price. He later spends $23,000 (including GST) on substantial renovations (replacing the windows, carpet and blinds) to improve the office, which he uses exclusively to make taxable supplies for his consulting business. Vincent claims a deduction for the $3,000 of input tax paid for the renovations.
The dwelling would not qualify for the exemption in proposed new section 14(4) because relevant deductions were taken for the goods under section 20(3). A deduction was claimed on acquisition, and deductions were also claimed for substantial improvements that became an integral part of the dwelling.
Because the dwelling is partly used to make taxable supplies, it will be a taxable supply when sold. Vincent can claim an additional deduction under section 21F for the non-taxable percentage use of the consideration he receives when he sells the dwelling. In this case, the office used to make taxable supplies comprised 20% of the use of the dwelling. If Vincent sold the dwelling for $1.15m, he would return output tax of $150,000 and could claim an adjustment under section 21F for an additional deduction of $120,000. The net GST he would return on the sale would be $30,000.
Use of new Section 14(4)
It is typically not necessary to reveal or inform the commissioner that you have chosen to regard the supply of the qualifying goods as an exempt supply. Instead, you simply do not take into account the GST that was paid on the asset (by not claiming deductions for the secondary taxable use and not returning output tax on disposal). There is however an exception to this under the transitional rule.
The new proposed exempt supply rule in S 14(4) will have a retrospective application date from 1 April 2011. This means if a registered person has previously taken a tax position consistent with the requirements of S 14(4), it will become correct once the bill is enacted. E.g., a person that had not included their dwelling as part of a taxable activity even if it was partly used to make taxable supply.
However, in cases where the registered person has already returned output tax on goods they sold or disposed of before that date, the supply of those goods would remain a taxable supply.
Transitional rule for certain goods acquired before 1 April 2023
Proposed new S 91 will create a transitional rule that allows registered persons to return output tax that does not satisfy proposed section 14(4) so the goods may qualify as exempt supply on disposal. The transitional rule will apply for 24 months between 1 April 2023 and 1 April 2025.
S 91 would apply when a registered person has acquired the goods before 1 April 2023 and previously claimed a deduction for the goods or acquired them as zero-rated.
The registered person can elect to return output tax based on previous taxable use or taxable use percentage of nominal GST component, provided that the goods were not acquired with the principle purpose of making taxable supplies.
In order to prevent the registered person from having to keep track of their actual taxable usage and make adjustments at the end of their adjustment period for any products, amendments have been proposed to S 21(2).
New regulations are proposed in sections 91 or 14(4). This is a reflection of the fact that in order to apply these new regulations, the individual would have had to have either not have claimed input tax deductions or returned a certain amount of output tax. This leaves them in the same net GST position as someone who has no taxable use for the goods. When someone does not use their items for a taxable purpose, no adjustments are required.
Amendments have also been proposed for S 5(15) to extend its scope so that it applies to a supply of real property that has goods the registered person has chose to treat as exempt supply under S 14(4). IRD anticipate that the relevant goods will usually be a dwelling such as a second house that is not a main home, holiday home or a dwelling used to provide temporary worker accommodation. As these dwellings aren’t a principal place of residence, under the current rules they would not be treated as separate supply. The amendments seek to ensure that such dwellings are treated the same as dwellings that are the principal place of residence.
Required Adjustment Periods
The Bill proposes amendments that would require only ten adjustment periods for land and would reduce the number of adjustments required for certain other assets by increasing the relevant asset value thresholds.
Deeming the disposal of an asset to be a taxable supply
- An asset for which a registered person has previously claimed a taxable use
Under the current rules, it is unclear whether it may be unclear whether a disposal of a valuable asset, such as land, is a taxable supply when the registered person is no longer using the asset to make taxable supplies, or when they previously claimed they had a taxable use of the asset but did not in fact use the asset to make any taxable supplies. The proposed rule would effectively broaden the scope of the existing deeming rule in section 5(16), which applies to dwellings for which a registered person has claimed a deduction under section 20(3).
- Assets sold after a non-taxable wash-up is performed
To address the risk of there being a possibility of tax avoidance in the current rules, the amendments propose new section 5(16B). Under this new rule, applied, the disposal of the relevant asset would be deemed by proposed new section 5(16C) to be made in the course and furtherance of a taxable activity carried on by the person (that is, it would be a taxable supply). The disposal could be the sale of the relevant goods or services, or a deemed disposal under another deeming rule (such as section 5(3), which deems the disposal at market value of any assets held by a person who ceases to be a registered person).
Expanding the ability to use the wash-up rule
- Allowing the calculation in the current adjustment period
S 21 of the GST Act provides a calculation that applies when a registered person to either 100% non-taxable or taxable use of an asset during the current and for following periods. If use of asset has changed to 100% use, then the wash up rules require the registered person to claim a full input tax deduction for input tax incurred at the time the asset was acquired. On the other hand, if use has changed to 100% non-taxable, then they are required to make output tax adjustments to repay previously deducted input tax.
It may be the case that some taxpayers have purchased business assets before they were registered for GST which they use to make taxable supplies after they have registered for GST.
- Allowing the calculation for any permanent change in use
An issue with the wash up rule is that it can only be used when there has been a change to either 100% taxable or 100% non-taxable use. This means the rule cannot be used for someone who’s use has changed to a percentage less than 100%, e.g., taxable use has changed from 90% to 20%. These people must gradually change their percentage use each period and so this imposes costs.
To reduce these costs, an amendment has been proposed to the wash up rule to allow it to be used for any permanent change to fixed percentage use.
Tōtara is a registered person that acquires an apartment building for $23m from an unregistered person. Tōtara will use 80 percent of the building to make exempt supplies of accommodation in a dwelling and lease 20 percent of the building as a commercial lease to Rimu, a registered person who uses these apartments to supply commercial accommodation of hotel units and serviced apartments. Tōtara claims a deduction for 20 percent of the $3m input tax on acquisition, or $0.6m.After 24 months, Tōtara negotiates a long-term commercial lease to supply 50 percent of the building to Rimu for Rimu to make taxable supplies of commercial accommodation. This will result in a permanent change to 50 percent of the apartment building being supplied by Tōtara for making taxable supplies for the foreseeable future. The new permanent percentage use is 50 percent and the actual use in the previous adjustment period was 20 percent, a difference of 30 percent additional taxable use. Under the proposed new section 21FB, Tōtara would be able to make an adjustment at the end of their adjustment period (on their next annual balance date) to deduct $0.9m, which is equal to 30 percent of the $3m of input tax on acquisition. They would include this adjustment in their first GST return filed after the end of their adjustment period.
Remedial amendment to wash-up rule for assets that were zero-rated when they were acquired
If a registered person acquires land as a zero-rated supply then changes there use to 0%, after performing wash up calculation in S 21FB they could have no output tax to return as their deduction would be 0. This is not what the policy intended to do and so a retrospective remedial amendment has been introduced. The amendment is proposed to take effect on 30 June 2014, the date the wash-up calculation was first introduced, to ensure the definition of “actual deduction” in section 21FB correctly accounts for land acquired as a zero-rated supply.
Allowing Inland Revenue to approve a wider range of apportionment methods
The apportionment and adjustment rules allow registered persons to apply to the Commissioner to agree on an alternative apportionment method. There is currently a requirement to apportion deductions based on their intended taxable percentage use or actual use in the current adjustment period, even if current use is temporary and incidental to their ultimate use of the goods/services.
To accommodate a wider range of methods, the bill proposes to remove this requirement. Th proposed amendments would retain the more general requirement that the alternative method provides “a fair and reasonable method” of apportionment or calculation adjustments.
Repealing the mixed-use asset rules in sections 20(3JB) and 20G
The mixed-use asset rules add complexity of another formula but have limited application. They only apply to certain assets and only when there is a mixture of private, taxable and unused days.
The Bill therefore proposes to repeal the current mixed-use asset rules in sections 20(3JB) and 20G. In cases where GST apportionment continued to apply to a registered person’s mixed-use assets, their GST input tax deductions and adjustments would instead be calculated using the same general GST apportionment rules that apply to other assets.
Prescribing an information disclosure requirement for GST persons claiming a taxable use on purchases of land, aircraft or pleasure craft
New section 61B is proposed to be introduced into the Tax Administration Act 1994. This section will provide the commissioner with the ability to prescribe a new type of information disclosure requirement when a person acquires land, a pleasure craft, or an aircraft with the intention of using it to make taxable supplies.
This is intended to assist IRD to better monitor and promote compliance by registered persons who have previously claimed large input tax deductions (or acquired zero-rated land) but no longer appear to be carrying on, a taxable activity. Proposed section 61B(1) would enable the Commissioner to prescribe and adjust the specific requirements to ensure the rules are practical and effective. It would allow the commissioner to set (and adjust) what information would be reported and the form and deadlines for the disclosure, including the start date for the first disclosure period.
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