Chapter 7 - Input tax and adjustments for change-in-use

7.1 New Zealand’s current approach to accounting for the taxable and non-taxable use of assets on which GST is paid has been described by commentators and some submissions on the officials’ issues paper as being complex and confusing. Other issues concerning the approach have been raised by the Court of Appeal decision in the Lundy[5] case, which involved land being used concurrently for taxable and non-taxable purposes. The concepts behind imposing GST on mixed use and change-in-use assets may not be sufficiently transparent for many taxpayers, and the fact that adjustments may be required for an indefinite period may result in tax and compliance costs.

7.2 Currently, GST-registered persons may claim a full input tax deduction for GST paid on goods and services acquired for the principal purpose of making taxable supplies. Any non-taxable use of those goods and services that takes place is treated as a taxable supply by the registered person, and output tax is charged accordingly. In this way, goods and services that are, in effect, self-supplied are treated in the same manner as other supplies.

7.3 Conversely, GST-registered persons cannot claim a deduction if goods and services were not acquired for the principal purpose of making taxable supplies. If the goods or services are used for a taxable purpose, the goods and services are deemed to be supplied to the person to the extent of that use, and input tax is deductible accordingly.

7.4 The approach in an apportionment system, on the other hand, seeks to apportion the initial input tax deduction received by GST-registered persons in relation to goods and services according to their actual use. This is a commonly used approach in other countries, including Australia. The aim of apportionment rules is not to charge GST on any non-taxable use of goods and services, but simply to provide a mechanism to ensure that the deduction claimed by a taxpayer corresponds with the actual taxable use of the goods and services.

7.5 The officials’ paper did not recommend introducing an apportionment approach to New Zealand because of:

• the need to accurately ascertain a taxable use on acquisition;
• the possibility that the adjustment calculations may be too complicated; and
• the need to keep continuous records of change-in-use.

7.6 Instead, the paper suggested a modified change-in-use adjustments approach.

7.7 The majority of submissions on the officials’ paper considered that the changes suggested in the paper would not simplify the change-in-use adjustment rules, but in fact would complicate them further. Many submissions advocated rules similar to the apportionment rules used in Australia, the perception being that the Australian approach is simpler. Submissions commented that calculations using this approach would be no more complicated that those under the current system.

7.8 The apportionment approach may be conceptually simpler than the current adjustment approach as it uses a single valuation measure when making any adjustment. The underlying concept used in the apportionment approach – that a person should be able to claim only as much input tax as reflects relative use – is easy to understand. If the number of adjustments that a taxpayer would have to make is limited, some of the concerns outlined in the officials’ paper would be removed.

7.9 On the basis of the feedback, the government proposes replacing the change-in-use adjustment rules with the cost-based apportionment approach.

7.10 The wholesale shift to an apportionment approach will provide transparency in the objective of making adjustments by putting taxpayers in the position they would be in if they could correctly predict the actual taxable use of their assets at the outset.

7.11 The rest of this chapter discusses the shape that the apportionment rules would take. It is envisaged that, if they are introduced, the rules would apply to assets acquired after the date of enactment.

7.12 This chapter does not explicitly outline the effect of the changes on the application of the reverse charge for imported services but submissions on this are welcome.

The apportionment of input tax deductions on acquisition

7.13 Under the proposed apportionment approach, the portion of a deduction that a person should be entitled to must correspond with the extent to which the asset is used for taxable purposes.

7.14 Taxpayers must estimate the extent of the intended taxable use of an asset at the time of claiming an input tax deduction and claim the deduction only to that extent. If the estimate subsequently proves to be correct and the person on an ongoing basis indeed uses the asset for the taxable purpose to the extent stipulated, the person will not be required to make any further adjustments.

7.15 The proposed rules seek to achieve as much “first instance” accuracy as possible by requiring recipients to make fair and reasonable estimates on the intended taxable and non-taxable uses of acquired goods and services. The estimates could be made on the basis of any records that are available, previous experience, business plans or other suitable methods. The exact method of working out the extent of an intended taxable use of goods and services will largely depend on the nature of the goods and services in question. For example, if an acquired asset is a car which is intended to replace an existing car used in the business, the logbook for the previous car could be a reasonable method of stipulating the intended use of the purchased car.

7.16 The situation may arise when different parts of a supply have different uses. For example, a person may buy property consisting of land and a few buildings with GST having been charged by the vendor on the whole supply. Although most of the purchased assets are to be used for the taxable purpose of running a farm, one of the buildings may be intended to be used exclusively as residential accommodation, which is a non-taxable purpose. Under the proposed changes the purchaser will be required to apportion the GST deduction on the acquisition by reference to the intended taxable use of the purchased supply. They would need to ensure that they do not claim the part of the deduction that relates to the building that is intended to be used as private accommodation. This would be done by comparing the value of the building with the total value of the purchased supply.

7.17 By requiring a registered person to make an apportionment in this manner on acquisition, the proposed rules would affect situations similar to those considered by the Court of Appeal in CIR v Coveney[6], which are currently dealt with under the GST Act by treating a dwelling as a separate supply.

When apportionment of input tax on acquisition not required

7.18 In keeping with the existing rules, it is proposed that a GST-registered person will not be required to apportion input tax if, on the date of acquisition, the registered person has reasonable grounds for believing that the total value of all exempt supplies the person will make in the 12 months after the acquisition will not be more than the lesser of:

• $90,000; or
• 5% of the total consideration for all taxable and exempt supplies to be made in the 12-month period.

7.19 Therefore, if a GST-registered person acquires goods and services that are, to a minimal extent, used for making exempt supplies, and the above conditions are satisfied, the person will generally be able to claim the full input tax deduction.

Subsequent adjustments of input tax deductions

When adjustments are not required

7.20 In periods following the initial input tax deduction claim on acquisition, taxpayers will be required to make further adjustments if the actual taxable use of an asset is different from the intended taxable use of the asset.

7.21 Taxpayers will not, however, be required to make further adjustments in three important circumstances:

• the actual use of goods and services differs from the use estimated on acquisition by 5% or less. Once the 5% threshold is exceeded, the taxpayer will not be able to rely on this exemption in subsequent years;
• the goods and services are purchased for a value that does not exceed $1,000; or
• if the total value of all exempt supplies the person made were not more than the lesser of $90,000 or 5% of the total consideration for all taxable and exempt supplies in the 12-month period to which the adjustment relates, the person will not need to make adjustments to the extent the goods and services are applied for the purpose of making exempt supplies.

When further adjustments must be made

7.22 Under the apportionment model, a GST-registered person will have to track the extent to which the asset is actually used for taxable purposes. Unless the stipulated exclusions apply, the person will be required to make an adjustment, at the end of the taxable period closest to their next balance date, when the extent to which the asset is used for taxable purposes is different from the intended taxable use of the asset.

7.23 To provide certainty to taxpayers and increase the simplicity of the proposed rules, the maximum number of adjustment periods during which adjustments may be required to be made will be limited. The taxpayer can choose a method to identify the maximum number of adjustment periods for an asset by reference to either the estimated useful life of the asset, as specified in the depreciation rates tables in the Income Tax Act Determinations, or by reference to the following GST-exclusive value bands of goods and services:

• $1,000 or less – none;
• $1,001 to $5,000 – two adjustments;
• $5,001 to $499,999 – five adjustments;
• $500,000 or more – ten adjustments.

7.24 Each adjustment will be required to be made annually to coincide with the taxpayer’s taxable period which is closest to the taxpayer’s balance date.

7.25 The proposed limitations on the maximum number of adjustment periods will not extend to land and the requirement to make adjustments for any change of use of land will run indefinitely. This is because land does not depreciate and can be held for long periods of time.

Calculating adjustments

7.26 Under the proposal, adjustments will have to be made for an asset where there is a difference between the actual use of the asset for taxable purposes (“actual taxable use”) and its intended use for taxable purposes (“intended taxable use”).

7.27 The “actual taxable use” of goods and services is the extent to which they were applied for a taxable purpose during the period starting at the time the goods and services were acquired, and ending at the conclusion of the relevant adjustment period.

7.28 The “intended taxable use” of goods and services will be either:

• the intended application for a taxable purpose, as predicted at the time of acquisition and on the basis of which the deduction was claimed; or
• if an adjustment has already been made, the actual taxable use of the goods and services as calculated for the purposes of the previous adjustment.

7.29 Both the actual and intended taxable uses of goods and services must be expressed as percentages.

7.30 If the actual and intended taxable uses of goods and services differ, and none of the exemptions apply, then a taxpayer will have to perform calculations to identify the effect of the difference on the input tax deduction. Thus, if the taxpayer’s actual taxable use of an asset is higher than the intended taxable use of the asset, the taxpayer will be able to claim the outstanding part of the input tax deduction under the formula:

full input tax deduction x (actual taxable use LESS intended taxable use)

7.31 Conversely, if the actual taxable use is less than the intended taxable use, then the taxpayer will have to return some of the input tax deduction using the formula:

full input tax deduction x (intended taxable use LESS actual taxable use)

Finding the extent to which an asset is used for taxable purposes

7.32 In most situations, an asset may only be used for either taxable or non-taxable purposes at one point in time. For example, a person may purchase a motor vehicle both to deliver goods as part of the person’s business and for private purposes. When the person uses the vehicle to deliver goods, the vehicle is being used exclusively for the taxable purpose. When the person uses the vehicle to drive on weekends, the vehicle is used exclusively for the non-taxable purpose. By keeping a logbook, the person may record and identify the total taxable use of the vehicle during the relevant adjustment period.

7.33 In some circumstances, however, an asset may be used for taxable and non-taxable purposes at the same point in time. These situations are most common in the property sector. For example, new residential premises may be advertised for sale and, in that way, used for a taxable purpose. Pending an offer, the advertised premises may be simultaneously leased as a residential dwelling and used for an exempt purpose. The question arises to what extent the premises are being used for the taxable purpose.

7.34 To reduce uncertainty on how apportionments between taxable and non-taxable uses should be made where there is a concurrent application of land as described above, specific rules are proposed to deal with these situations. These would be similar to a method of determining the extent of a taxable purpose in circumstances when newly constructed premises that are held for sale are leased before sale, as stated by the Australian Taxation Office in its ruling (GSTR 2009/4).

Calculating concurrent taxable/non-taxable use

7.35 The suggested method for apportioning concurrent taxable and non-taxable uses of assets such as land is to compare the values of the taxable and non-taxable uses. This can be achieved by using the formula:

Consideration for the taxable supply
____________________________________________________
Consideration for the taxable supply plus
consideration for the non-taxable supply

7.36 The “consideration for the taxable supply” is the sale price of the asset, unless the sale was to an associated person, in which case the consideration for the taxable supply would be the market value of the asset at the time of the sale. If the asset has not been sold, the “consideration for the taxable supply” is the market value of the asset at the time of the adjustment.

7.37 The “consideration for the non-taxable supply” is the extent to which the value of the asset is attributable to the non-taxable purpose. In relation to land, the “consideration for the non-taxable supply” is either the rent received during the relevant period or, if the land was applied for private purposes or to an associated person, the market rent that could be received if the land was rented out.

7.38 If, at any point in an adjustment period, an asset is not used for taxable purposes at all, a taxpayer would have to make further calculations to identify the taxable use of the land in the adjustment period.

The sale of goods and services for which full deductions were not claimed

7.39 On the disposal, or deemed disposal, of an asset that has been subject to the apportionment rules, output tax based on the full consideration for the supply would still need to be accounted for. However, under the proposed rules, a registered person may be able to claim an additional deduction if they have not claimed all of the input tax incurred on the acquisition of the asset.

7.40 Any additional input tax (when added to the deductions already taken) will not be able to exceed the full deduction that would have been available on acquisition if the goods and services had been acquired exclusively for taxable purposes.

7.41 The formula for calculating the adjustment will be:

tax fraction x consideration x (1 – (actual input tax deduction claimed/full input tax on acquisition))

7.42 The “actual input tax deduction” will include any subsequent adjustments for change-in-use up to the last adjustment made before the sale.

7.43 “Consideration” is the consideration received. In circumstances where the sale is to an associated person, or on deregistration, the “consideration” will be the open market value of the asset.

7.44 If an asset appreciates in value, a person will be able to recover the full deduction that the person could have obtained on acquisition. If an asset depreciates in value, the person will be able to recover less than the difference between the full deduction and the claimed deduction, as the person’s non-taxable use of the asset will have been partly responsible for the depreciation of the asset.

7.45 The sale adjustment will not arise if the asset is not sold in the course or furtherance of a taxable activity.

7.46 It should be noted that by allowing the recovery of the deduction in the manner described, the final sale adjustment does not take into account that the taxpayer’s non-taxable use of an asset may have negatively affected the sale price of the asset and, therefore, may have reduced the output tax that will be returned to the government. It is not, however, proposed to require taxpayers to calculate the value of the asset lost to non-taxable uses, as doing so would introduce a further layer of complexity to the rules.

Second-hand goods input tax adjustments

7.47 GST-registered persons can deduct input tax on the purchase of second-hand goods from unregistered persons, even though GST is not directly charged on that supply. The deduction is intended to recognise the GST paid when the unregistered supplier acquired the goods.

7.48 Currently, two separate methods for calculating input tax deductions for second-hand goods exist, depending on whether the second-hand goods purchaser is associated with the supplier of the goods. A GST-registered person buying second-hand goods from an unassociated person receives an input tax deduction based on the lesser of one-ninth of the amount paid to acquire the goods or the market value of the goods. On the other hand, the input tax entitlement of a GST-registered person buying second-hand goods from an associated unregistered person is limited to the lesser of the GST component (if any) of the original cost of the goods to the supplier, one-ninth of the purchase price, or one-ninth of the open market value. The latter method was introduced in 2000 to prevent, among other things, the second-hand goods deduction from being claimed when GST had not previously been paid in relation to the asset.

7.49 The officials’ paper discussed the tax-base risks arising from a small minority of taxpayers attempting to use the change-in-use adjustments provisions (which provide both the cost and market value options) to effectively circumvent the second-hand goods restriction for transactions between associated persons.

7.50 This concern will be removed if the apportionment approach proposed in this chapter is adopted. Under the proposed apportionment rules, a taxpayer making adjustments will not be able to claim more input tax deductions than he or she would be entitled to on acquisition. Therefore, if the taxpayer is not entitled to an input tax deduction on acquisition of a second-hand asset, or is limited to a deduction based on the GST cost, the taxpayer will be similarly limited in relation to any deductions under the proposed adjustment provisions.

5 (2005) 22 NZTC 19, 637.

6 CIR v Coveney (1995) 17 NZTC 12,193.