Chapter 4 - Legislating for Business-to-Business Neutrality
4.1 This chapter makes suggestions for improving the neutrality of certain business-to-business transactions. These are:
- replacing the going concern rules with an expanded set of rules that are applicable to a wider range of transactions; and
- ensuring input tax deductions are not denied for nominee and related transactions.
4.2 The supply of goods as a “going concern” may be zero-rated under the GST Act if the parties agree to treat the supply as such.
4.3 The purpose of the going concern rules is to:
- remove the cashflow cost to businesses, in what are generally high-value transactions, of financing the GST component of the purchase price for the period between making payment for the goods and when the entitlement to deduct input tax arises; and
- reduce the risk to the government of a GST-registered person charging GST on the sale of goods and retaining the tax component.
4.4 Despite these objectives, the application of the going concern rules has been an area of uncertainty – for example, most GST cases before the courts have concerned disputes about whether a going concern was supplied. Changes made to the rules in 1995 and 2000 have improved the operation of the going concern rules and gone some way to reducing the number of disputes in this area. However, concerns about the rules remain.. For example, the definition of a “going concern” in section 2 of the GST Act requires that the supplier carries on, or is carrying on, a taxable activity, or part of a taxable activity that is capable of separate operation, up to the time of its transfer to the recipient. If the transaction does not comply with these requirements, the supplier can face an unexpected GST liability and the risk of shortfall penalties and use-of-money interest. These consequences have prompted some to suggest that the operation of the rules should be reconsidered.
4.5 These concerns suggest that the rules are unlikely ever to provide legislative certainty in all cases.Therefore the following suggestions for achieving and extending the policy behind the rules are considered:
- suspending the liability for GST on certain transactions, with consequent denial of input tax to the purchaser; and
- “domestic reverse charging” whereby the liability for tax is shifted to the purchaser, who would also deduct the self-assessed GST.
4.6 The options seek to ensure a GST-neutral outcome for both going concerns and a wider range of transactions involving significant assets when the risks associated with GST may be particularly high.
Suspending GST liabilities on business-to-business supplies
4.7 Suspending the requirement to charge GST on a transaction would be similar in principle to the operation of a retail sales tax. GST would be suspended when goods and services are supplied between GST-registered businesses, with the effect that the tax is not charged and the GST-registered recipient is unable to deduct input tax (because no GST has been charged).
4.8 To prevent goods and services leaving the revenue base untaxed, there would be a need to verify and certify the status of the purchaser and retain evidence supporting the decision to suspend the charging of GST (for example, exemption certificates). Because these requirements could be onerous on businesses and because of the risk of evasion we do not favour this option.
“Domestic reverse charging” – shifting the tax obligation onto the recipient
4.9 An alternative option, referred to in this paper as “domestic reverse charging”, involves shifting the obligation to charge GST from the GST-registered supplier to the GST-registered recipient. It would require the recipient of the goods and services, who would need to be registered for GST at the time of supply, to self-assess GST on the purchase and deduct, if entitled to do so, input tax in the same taxable period.
4.10 The advantage of domestic reverse charging is that GST neutrality is achieved in a manner consistent with the credit-invoice method. Businesses would benefit from a more certain rule and the carrying cost of GST would be reduced. For Inland Revenue, the risk of refunding an input tax deduction on a transaction when there is a risk that GST will not be paid would be similarly reduced.
4.11 A similar system has recently been implemented in the United Kingdom to deal with fraudulent transactions involving the supply of mobile telephones, computer components and other electronic goods.
4.12 It is suggested that the current “going concern” rules be removed. The wider domestic reverse charge mechanism would be introduced with application to transactions involving:
- going concerns;
- extremely high-value transactions – for example, supplies of goods and services when the value of the transaction exceeds, say, $50 million (excluding GST); and
- improved or unimproved land irrespective of value.
4.13 These transactions have been identified because they may pose a cashflow risk to both GST-registered persons and the government. The suggested approach would have mandatory application to these transactions when both the supplier and the recipient were registered for GST. In the case of transactions between associates, we may need to consider the extent to which both the supplier and the recipient should be treated as registered for GST.
4.14 The objective of domestic reverse charging would be to eliminate the cashflow consequences created by GST and provide a mechanism to ensure that business-to-business taxable supplies between GST-registered persons are neutral. Accordingly, GST-registered recipients will not face a delay between paying GST on the supply and claiming the related input tax deduction.
4.15 It is also expected that the suggested approach would remove the need for GST-registered persons to obtain Inland Revenue’s approval to set off the supplier’s GST liability against the recipient’s input tax entitlement.
4.16 No exceptions or exclusions would be provided other than for cases when neutrality is not an appropriate outcome (for example, financial services, exports and supplies to final consumers).
4.17 Special time-of-supply rules are likely to be needed to determine the time when the purchaser would be required to self-assess GST. It is suggested that the time of supply should be treated as the settlement date for the transaction, although we are aware that this would need to be carefully defined. Consideration would also need to be given to valuation rules. Using the GST-exclusive value of the contract or agreement for the sale of the goods and services could be a good starting point. Submissions are invited on how these suggestions could be developed to provide sufficient legislative certainty.
4.18 The following example illustrates how the suggested domestic reverse charge mechanism might work.
Example: How the proposed domestic reverse charge mechanism might apply
Company B acquires land from Company A with the intention of using the land to develop a new branch office to facilitate the supply of car parts to the upper South Island.
Company A confirms that Company B is registered for GST, and the transaction is subject to the domestic reverse charge mechanism. The GST-registration numbers of the parties to the transaction and the fact that it is subject to the domestic reverse charge mechanism are confirmed in the agreement for sale and purchase. The agreed value of the land is $800,000 excluding GST.
The contract is signed on 25 August 2010, and settlement occurs on 11 October 2010. As this transaction involves the sale of land, the domestic reverse charging applies. 11 October 2010 is the date that the time of supply is triggered for GST purposes.
Under the reverse charge mechanism, Company A does not charge GST on the transaction. Instead, Company B records a liability for GST of $100,000 ($800,000 x 12.5%) in its GST return for October 2010. Company B claims a corresponding input tax deduction of $100,000 in the same GST return.
Both parties maintain a copy of the agreement for sale and purchase to support the GST treatment adopted.
The supplier’s obligations
4.19 Under the domestic reverse charge mechanism, the supplier would still be treated as making a taxable supply of goods and services in order to protect any input tax entitlements. The supplier would be required to confirm that the purchaser is registered for GST and retain supporting documentation.
4.20 If the supplier was unable to verify the registration number of the purchaser at the time of supply, the supplier would need to charge GST under the normal rules.
The purchaser’s obligations
4.21 As we have noted, the domestic reverse charge mechanism would shift the obligation to charge GST away from the GST-registered supplier to the GST-registered purchaser and the purchaser would be required to self-assess GST in the taxable period in which the transaction occurred. The GST-registered purchaser would, subject to holding a valid tax invoice or other relevant documentation, be able to claim an input tax deduction in the same taxable period for goods and services that were acquired for the principal purpose of making taxable supplies.
4.22 Regarding the documentation to support the domestic reverse charge, one option would be for the obligation to issue a tax invoice to remain with the supplier, notwithstanding the purchaser’s obligation to account for both output tax and input tax. Additional requirements would be that the registration numbers of both the supplier and purchaser are disclosed together with a statement that the transaction has been subject to the domestic reverse charge mechanism. If there was a delay in the issue of the invoice, however, the purchaser might suffer a delay in claiming the input tax deduction. This option may also have GST accounting system implications, and there is also the potential for error and confusion when the supplier is required to issue a tax invoice inclusive of GST but is not required to account for GST.
4.23 Another option is for the purchaser to create a buyer-created tax invoice to support the deduction of input tax. Again, the registration numbers of the supplier and the purchaser would need to be recorded on the invoice, together with a statement that the transaction was subject to the domestic reverse charge mechanism. This option would ensure that the purchaser had the documentation to support the deduction of input tax in the same taxable period in which the tax liability under the domestic reverse charge arose.
4.24 A further option is to dispense with the requirement for a formal tax invoice altogether and rely on the agreement for sale and purchase. If the agreement for sale and purchase contains the core details about the supplier and the purchaser (for example, registration numbers, names and addresses) and details about the transaction, including the value of the transaction and the date of settlement, this document could be sufficient to establish the supplier’s and purchaser’s obligations under the domestic reverse charge mechanism. This alternative would be broadly consistent with the proposal in the government discussion document Reducing tax compliance costs for small and medium-sized enterprises, to use documents produced in the ordinary course of business to support the deduction of input tax.
4.25 As the domestic reverse charge mechanism would represent a departure from the usual operation of the GST system, additional provisions are likely to be required. These would address, for example, the situation where a GST-registered person accidentally charges GST on supplies that should be subject to the domestic reverse charge mechanism.
4.26 Other situations that may need to be addressed include those where goods and services supplied using the domestic reverse charge mechanism might be subject to a post-sale discount or are returned.
4.27 Submissions on these matters are welcome.
Specific points for consultation – domestic reverse charge mechanism
- Submissions are invited on the practicality of the suggested domestic reverse charge mechanism and any specific rules necessary to ensure its effectiveness.
- Would the domestic reverse charge mechanism deal with the concerns identified in Chapter 3, including the cashflow impact GST has on high-value transactions?
4.28 In cases involving nominations, there may be uncertainty around who the recipient of the supply is and, therefore, who is entitled to deduct input tax. For example, depending on the interpretation adopted, a transaction involving a nominee or an assignee may involve either one or two supplies for GST purposes. Where the nominee pays the purchase price under a contract between the supplier and contractual recipient, the two possible supplies for GST purposes are one from the vendor to the purchaser under the original contract, and one from the purchaser to the nominee under the nomination agreement. The same analysis potentially applies in connection with assignments.
4.29 Although the argument that there may be two supplies in these situations follows the GST rules, it does not reflect the economic reality of there being a single supply and may also be inconsistent with our neutrality argument.
4.30 We are considering whether legislative clarification is needed for situations involving nominations and assignments. A change to the GST Act could be introduced for transactions involving nominations and assignments when the nominee or assignee pays the purchase price to the vendor. Under the suggested change, the goods and services would be treated as being supplied by the vendor to the nominee. As a result, the vendor would have to account for the GST, if any, and the nominee would have the right to demand a tax invoice from the vendor in order to deduct input tax on the value of the consideration paid for the supply.
4.31 The two-supply analysis would be treated as applicable in certain situations, such as when both the purchaser and the nominee have contributed to the purchase price or when the purchaser has already claimed an input tax deduction because a tax invoice has been issued by the vendor to the purchaser before the nominee becomes known.
Specific point for consultation – nominee transactions
Submissions are sought on possible amendments to the GST Act to clarify the position for transactions involving nominations and assignments.
32 Supplies received under this approach could be disclosed in box 5 of the GST 101 or GST 103 return and an offsetting input tax deduction would be allowed under box 11 (subject to the tax invoice requirements).
34 For different opinions on the topic among practitioners, see G Bracken, GST, Nominations and Assignments New Zealand Tax Planning Report, No 1, May 2005 and G Olding, GST Issues with Nominations and Assignments – Another View New Zealand Tax Planning Report, No 2, August 2005.