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Inland Revenue

Tax Policy

Chapter 2 - Domestic reverse charge

Proposed change

This chapter discusses the proposed introduction of a domestic reverse charge which would apply to transactions involving land and other high-value assets.

2.1 The June 2008 officials’ paper canvassed options for better ensuring a GST-neutral result in connection with the supply between businesses of land and other high-value assets.

2.2 The options discussed included suspending the liability for GST on certain business-to-business supplies or, using a mechanism known as a domestic reverse charge (DRC), shifting the obligation to charge GST from the supplier to the recipient in certain circumstances.

2.3 Submissions on the officials’ paper indicated a level of support for a domestic reverse charge but were concerned about the likely complexity of the rules necessary to support its application. Some submissions suggested that zero-rating should be considered as an alternative option to the DRC, arguing that zero-rating is more consistent with the current GST framework. This chapter analyses these two options and proposes introducing a DRC which would apply to land, going concerns and transactions with a GST-exclusive value exceeding $50 million.

Current problems

2.4 The government is concerned that, in business-to-business transactions, GST neutrality for businesses and the government is not always occurring as it should. This is of particular concern in transactions involving land and high-value assets. For example:

  • Businesses can and do incur costs if GST has to be accounted for before payment is received from the customer. This can occur, for example, where the transaction occurs towards the end of the vendor’s return period.
  • Providing GST refunds can pose a risk to the government’s revenue base if the refund does not give rise to a payment of GST by the other party involved in the transaction. Of particular concern are phoenix-type fraud and deliberate accounting base mismatches.
  • Zero-rating the supply of going concerns can lead to an expectation by the parties to the transaction that no further GST is payable on the transaction. This expectation can be unfounded if the facts do not support that the supply was a “going concern”.
  • Because the rules that apply to the supply of a going concern are in effect not mandatory, it is possible for a financially stricken supplier to sell its business as a standard-rated supply. This creates a revenue loss for the government if the GST is unpaid by the supplier but an input tax deduction is claimed by the recipient.

2.5 In situations involving a risk to the tax base, use of the general anti-avoidance provision or, in the case of fraud, prosecution action, may be available. Using litigation to resolve matters of avoidance is, however, expensive in terms of taxpayer, Inland Revenue and the courts’ resources and the outcome may not necessarily be consistent with good policy. Even if the outcome of litigation provides useful interpretive guidance and a level of certainty, it is often not timely.

2.6 The government therefore considers that additional legislation is needed to address the concerns outlined.

Objectives of the domestic reverse charge

2.7 The government’s preferred option is the introduction of a DRC to apply to land and other high-value transactions between GST-registered persons. The main feature of the DRC would be to require the recipient of goods and services to self-assess GST on goods and services acquired from another registered person, and allow the recipient to deduct input tax if entitled to do so, in the same taxable period.

2.8 The specific objectives of the DRC would be to:

  • Remove the cashflow concerns for the parties to an affected transaction for the period between which the tax is paid and the input tax deduction is allowed. (This is because the recipient would be able to offset the GST payable and the input tax deduction in the same taxable period.)
  • Reduce the risk that the supplier faces an unexpected GST liability in the event that a transaction is incorrectly zero-rated, as could occur if a registered person sells a zero-rated going concern to an unregistered person that they believed was registered.
  • Limit the involvement of the supplier if the contract is varied, cancelled or otherwise does not proceed.
  • Reduce the revenue risk to the government arising from a genuine or structured business failure. (The recipient, having acquired the goods and services in all likelihood for an ongoing taxable activity, would be less likely than the supplier to exit the GST system.)

Application of the domestic reverse charge

2.9 The proposed DRC would apply to transactions between registered persons involving the supply of land, going concerns, and goods and services with a value of $50 million or more.

2.10 As outlined earlier, the recipient of a supply of goods and services, being a registered person, would be required to self-assess and return GST in the taxable period in which the supply was made. An input tax deduction would be available to the recipient in the same taxable period if the goods and services were acquired for the purpose of making taxable supplies.

2.11 The DRC would apply irrespective of whether either GST-registered person made predominantly exempt supplies. The change-in-use adjustment rules or the apportionment rules (in the form proposed in chapter 7) would need to be applied if the goods and services were used for a mixture of making taxable and non-taxable supplies. Supplies to unregistered persons would continue to be subject to normal GST rules.

2.12 The supplier would not be liable for GST normally charged on the goods and services in question. However, the supplier would still be treated as making a “taxable supply” of goods and services to preserve existing input tax entitlements. Transactions to which the DRC applies would need to be expressed as “exclusive of GST”.

2.13 It is envisaged that the agreement for sale and purchase of property would be the main document to support suppliers’ and recipients’ obligations under the DRC. The agreement will be required to contain the core details about the supplier and the recipient, including their respective GST registration numbers, their respective names and addresses, and details about the transaction, including its value (excluding GST).

2.14 Inland Revenue would not have recourse to the supplier in the event that the recipient does not account for GST, provided the supplier has complied with and retained the prescribed information as outlined above.


2.15 The DRC would apply to the identified group of transactions in the following way:

  • Land: The DRC would apply to all transactions involving the supply of land, including a freehold interest or an option to acquire land. In situations when land is supplied along with other goods and services such as livestock, and the transaction is not a going concern, a further rule may be needed. Separately identifying each asset supplied under the contract would create additional transaction costs and complexity, unless the supplier and recipient had entered into separate contracts for the separate assets. It is therefore proposed that, in circumstances when a bundle of goods and services is supplied and land and buildings are the predominant feature of the supply, the DRC will apply to the entire contract.
  • Going concerns: The DRC would apply to the supply of a taxable activity or part thereof that is a “going concern”. The current zero-rating rules applicable to the supply of going concerns would be repealed. While the question of what constitutes a “going concern” would remain open to interpretation in some cases, the requirement that the taxable activity must be carried on until the time of transfer to the recipient, and the inherent difficulties that this sometimes causes, would be removed. (Australia is considering the introduction in 2010 of a domestic reverse charge which would similarly replace its going concern rules.[2])
  • Other high-value assets: the DRC would apply to supplies of goods and services with a value of $50 million or more, excluding GST. This limits the extension of the DRC in other cases to infrequently occurring transactions that could, if the GST treatment is not neutral, create significant tax risks for businesses and a revenue loss to the government.

Time of supply

2.16 The current “time of supply” rules largely relate to activities carried on by the supplier – for example, when the supplier issues an invoice or when payment is received for the supply of goods and services. The current rules may not provide a recipient to whom the proposed DRC applied with enough certainty on when to self-assess and return GST. For example, the supplier might create an obligation to return GST without the recipient’s knowledge. If this resulted in GST not being returned in the correct taxable period, the recipient could be subject to shortfall penalties and use-of-money interest.

2.17 To prevent this from happening, it is proposed that, when the DRC applies, the time of supply would be the date when payment for the supply is required to be made to the supplier. The time of supply would be triggered when the supplier requires full payment to settle the contract, not payment by a deposit.

2.18 “Payment” will not be limited to the transfer of cash and will include other situations when contractual obligations are discharged, such as with a vendor mortgage. It may be that separate rules will need to apply to transactions between associated persons, where the parties have the ability to delay “payment”, however this is defined. Any separate rule would only need to apply in circumstances when the output tax from the transaction exceeds the input tax able to be claimed by the recipient (for example, when the registered recipient purchases the goods or services for the purpose of making exempt supplies).

When the contract provides for more than one recipient

2.19 Nominee transactions and other transactions involving more than two parties will give rise to the question of which party must apply the DRC. It is proposed that, for the purpose of the DRC, the liability for GST would be on the party named in the contract as being the recipient of the goods or services. If the contract provides for two or more recipients, the DRC obligation would fall on the recipient that physically receives the goods and services or has ownership or entitlement to them.

Recipient deemed to be registered

2.20 The registration rules will also be amended to treat any recipient that purports to be registered for GST as registered on the day the supply is treated as made under the DRC. While the recipient will still have an obligation to self-assess and return GST, no input tax deduction will be allowed if they are unable to establish a taxable activity and that the purchase was used for making taxable supplies. Recipients that do not return the GST may be subject to use-of-money interest and shortfall penalties in these circumstances. The need for additional anti-avoidance provisions will be further considered.

Post-sale adjustments

2.21 Subsequent changes to a supply that is subject to the DRC will not alter its operation. In all cases when there is an adjustment to the price of the goods and services supplied, the supplier would remain responsible for issuing a debit or credit note. The recipient will be required to reflect the GST consequences of the change in the taxable period in which the debit or credit note is received.

2.22 For example, if intellectual property is sold for an agreed price of $58 million and it is later agreed that the price should be adjusted down to $42 million, the transaction would remain subject to the DRC. The supplier would provide a credit note to reflect the $16 million adjustment to value and the recipient would reflect the GST effects of the adjustment in the taxable period in which the credit note is received.

2.23 If the reverse situation occurs – for example, the initial price for intellectual property, such as a trademark, is $48 million but is later adjusted upwards to $53 million – the DRC rules would not retroactively apply to the transaction.

2.24 Another situation involving adjustment is when views about the nature of the supply change. For example, assets supplied as a going concern would be taxed under the DRC. If it is later determined that the supply is not of a going concern, the GST treatment of the transaction would not need to be retroactively altered.

2.25 There may be other situations when the DRC should have applied but was not considered at the time the contract was entered into. An amendment to section 78E is proposed that would address these situations.


Progressively supplied goods and services

2.26 An exception to the compulsory application of the DRC would apply when the contract provides for successive payments over a number of taxable periods. There are two reasons for excluding periodic payments from the scope of the DRC:

  • GST-registered persons whose businesses do not principally involve making taxable supplies could face large GST liabilities without the ability to fully offset the payment with a matching input tax deduction. This is because the DRC will require the payment of GST at an earlier time than would occur under the current rules. The periodic consumption of the relevant goods and services as contemplated by the contract would not be properly recognised by the GST Act in this case.
  • In situations when the contract makes provision for periodic payments, the revenue risk is perceived by the government to be lower. It is less likely that the transaction would be one-sided as there is an intention between the supplier and the recipient to maintain an on-going relationship over the contract period.

2.27 Changes are therefore proposed that would switch off the DRC and allow goods and services to be treated as progressively and periodically supplied when the contract provides that payment is to be in instalments. Supplies covered by the exception would continue to be taxed under the ordinary GST rules. The exception will not apply to progressive supplies between associated persons which are the subject of a separate “time of supply” rule.

The DRC and sales in satisfaction of debt

2.28 The DRC would not apply to taxable supplies made when goods are sold in satisfaction of a debt under section 5(2).

2.29 The rules dealing with sales in satisfaction of debt shift the obligation to account for GST on a mortgagee sale from the mortgagor to the mortgagee. The rules ensure that goods owned by registered persons cannot exit the GST base without GST being accounted for.

2.30 The rules apply independently from the rest of the GST Act. Persons selling goods to repay a debt are required to complete a special GST return. These sales are unable to be zero-rated as “going concerns”.

2.31 The government considers that sellers of goods to which section 5(2) of the GST Act applies should not be able to use the DRC because it would confuse the differing purposes of the two sets of rules. The DRC requires that both the supplier and the recipient are registered for GST and is therefore limited to business-to-business transactions. On the other hand, section 5(2) is concerned with whether a supply of the goods would be a taxable supply if sold by the borrower. The rules do not require the seller to be registered for GST.

Alternative option: zero-rating

2.32 The government has also considered an alternative option, recommended in some submissions, to zero-rate certain supplies instead of proceeding with the DRC.

2.33 Currently, supplies of going concerns between registered businesses are zero-rated in order to meet similar objectives to those outlined earlier in this chapter, including:

  • eliminating the cashflow cost to purchasers when financing the GST for the period between making payment and receipt of the GST refund; and
  • reducing the risk of fraud if a vendor charges GST on the sale of a business but retains the GST component.

2.34 Submissions argued that zero-rating business-to-business supplies is a preferable option for a number of reasons, including:

  • it is widely understood by GST-registered persons;
  • it effectively results in a zero-liability for GST and preserves the supplier’s right to deduct input tax; and
  • it is consistent with the general operation of GST and would require less legislative change.

How would zero-rating work?

2.35 If zero-rating were to apply to the supplies of goods and services proposed for inclusion in the DRC, suppliers would need to confirm (and hold evidence) that the recipient of the goods and services is registered for GST. Beyond that, no additional compliance obligations would arise. Like the DRC, zero-rating creates a GST-neutral position between the supplier and the recipient.

Arguments for not zero-rating

2.36 Zero-rating has the effect of deferring the immediate collection of GST on a supply of goods and services. This deferral could be a problem for Inland Revenue if there are a significant number of instances when, at a later point, it turns out that the supply should not have been zero-rated. For example, the goods and services may have been provided to a final consumer, but the supplier has since deregistered or no longer exists. Seeking payment of GST from the recipient, as proposed under the DRC could, on the other hand, address this concern.

2.37 In other situations, the supplier may agree to a GST-inclusive price for a supply of goods and services on the understanding that the supply is zero-rated. In these situations, Inland Revenue may become involved in a dispute with either or both parties if the correct treatment becomes unclear and the recipient has claimed an input tax deduction but the supplier has not paid GST because of the earlier understanding.

2.38 For these reasons, the government considers that business-to-business neutrality is best achieved using rules that shift the obligation to charge and return GST onto the recipient.


2 See Australian Government Response to Board of Taxation Review of GST Administration, 12 May 2009.