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Inland Revenue

Tax Policy

Section DB 2 - reverse charge rules

(Clauses 29(1), 90 and 104)

Summary of proposed amendment

A technical change is being made to section DB 2 of the Income Tax Act 2007 (and the corresponding provisions in the Income Tax Acts 1994 and 2004) to ensure that GST output tax on services that are subject to the reverse charge rules for imported services is available as a deduction for income tax purposes (provided the underlying services were also deductible). This amendment corrects an anomaly for taxpayers who arguably are not able to deduct this GST at present, despite it representing a real economic cost to business.

Application date

The change applies from 1 January 2005, the date the reverse charge rules were introduced.

Key features

Section DB 2 is being amended to ensure that output tax, to the extent that it is not offset by input tax credits attributable to the supply, is deductible in the following circumstances:

  • the output tax arises under the rules related to the reverse charge for imported services; and
  • the underlying services are themselves able to be deducted.


Currently, section DB 2(1) of the Income Tax Act 2007 denies an income tax deduction for both input tax and GST paid by the taxpayer to the Commissioner. The economic effect of this provision is that a taxpayer is denied a deduction for all output tax it receives as a supplier, less any input tax able to be claimed for its own expenses. Although this economic effect is generally desirable, it does not work when a GST-registered person is deemed to supply goods or services to themselves. Until recently, the only example of this enforced “self-supply” was when a taxpayer who acquired goods or services for the principal purpose of making taxable supplies used the goods or service for non-taxable purposes (known as a “change in use adjustment”). To recognise that the output tax on these supplies is a real cost to the taxpayer (that is, it cannot be offset by input tax), section DB 2(2) specifically allows it as a deduction.

Since 1 January 2005, when certain services are imported into New Zealand, the GST Act 1985 requires the New Zealand resident to treat itself as the supplier of those services (as well as being the recipient) and account for GST accordingly. This is another example of “self-supply” and is conceptually identical to the change in use adjustments. However, unlike the change in use rules, there is no specific provision in the Income Tax Act 2007 to allow any irrecoverable output tax incurred on the self-supply to be allowed as an income tax deduction. As a result, arguably, the general rule in section DB 2(1) applies and the taxpayer is denied a deduction, despite the fact that the expenditure is “real” in an economic sense.

This anomaly potentially creates a discrepancy in income tax treatment between services that are sourced in New Zealand (and therefore not subject to the reverse charge) and those that are sourced offshore.

The amendment will apply from 1 January 2005 (the application date of the reverse charge rules that are the root of the problem), to provide certainty going forward and provide taxpayers with comfort that Inland Revenue will not adopt a strict interpretation of section DB 2 for the intervening periods.