Zero-rating land transactions
In November 2009, the Government released the discussion document, GST: Accounting for land and other high-value assets, which proposed a number of changes to the GST Act that would address certain GST base risks and improve the operation of the GST system more generally. The main risk to the tax base identified in the discussion document was “phoenix” fraud schemes, typically between associated entities, that involve Inland Revenue refunding GST to one party with no corresponding payment being made by the vendor because the vendor deliberately winds up their business before making payment.
The discussion document recommended a domestic reverse charge. However, most submitters expressed a preference for zero-rating as it would give rise to fewer compliance costs. That is the option that has now been adopted since, under this mechanism, the accounting obligations of the parties would in most situations remain virtually unchanged from the previous legislation.
GST-registered vendors will be required to charge GST at the rate of 0% on any supply to a registered person involving land, or in which land is a component, if at the time of settlement:
- the recipient intends to use the goods for making taxable supplies; and
- the supply is not a supply of land intended to be used as the principal place of residence of the recipient or a relative of the recipient.
Other features of the new rules include:
- a definition of “land” which largely follows the definition used for income tax purposes but which excludes most commercial leases;
- an obligation for the purchaser to advise of their registration status and intentions in respect of the land; and
- special rules to deal with situations when a supply is either incorrectly zero-rated or incorrectly standard-rated.
The new rules will apply to goods supplied on or after 1 April 2011.
For transactions entered into before 1 April 2011 but for which the time of supply is on or after that date, the supplier has the option of treating the transaction as being governed by either the current GST rules or the new rules (section 11(1)(8C)).
New section 11(1)(mb) provides that a GST-registered person must zero-rate a supply if the supply wholly or partly consists of land, and:
- is made to another registered person; and
- the recipient acquires the goods with the intention of using them for making taxable supplies; and
- the supply is not a supply of land intended to be used as a principal place of residence of the recipient of the supply or a person associated with them under section 2A(1)(c) (that is, their relative).
To be a zero-rated supply, the above conditions for zero-rating must be satisfied at the time of settlement of the transaction (new section 11(8B)). If any of these conditions are not satisfied at the time of settlement, the supply should be taxed at 15%.
If land is supplied as part of a larger supply, the whole supply is zero-rated. For example, if land is supplied as part of a business being sold as a going concern, under the new rules the supply of the going concern is zero-rated in its entirety. To ensure that the zero-rating rules apply to services supplied as part of a transaction that includes land, new section 5(24) treats these services as a supply of goods.
The requirement that the recipient must intend to use the goods for making taxable supplies may be satisfied even if the recipient does not intend to use the goods wholly for making taxable supplies. Thus, the supply may be zero-rated in its entirety even if the recipient intends to use the goods partly for making non-taxable supplies. It should be noted, however, that in these circumstances the purchaser will be liable to account for the output tax on the non-taxable use of the goods under new section 20(3I) (see the section of this special report on the new apportionment rules for more details).
The zero-rating rules do not apply to supplies of land intended to be used as a principal place of residence of the recipient of the supply or a relative of the recipient (section 11(1)(mb)(ii). If a “principal place of residence” is included in a larger supply of real property, amended section 5(15) requires the supplier to treat the supply of the residence as a separate supply from the supply of any other real property included in the supply. These provisions clarify that a supply of the principal place of residence is not subject to the zero-rating rules. This should prevent registered persons, such as sole traders, from using their GST-registered status to zero-rate the purchase of their family home.
Meaning of “land”
A supply will only be zero-rated under section 11(1)(mb) if it is a supply of land. A new definition of “land” in section 2(1) of the GST Act includes an estate or interest in land, a right that gives rise to an interest in land and an option to acquire land or an estate or interest in land.
“Land” includes the ground within the territory of New Zealand, whether below or above the water, and things of a permanent nature situated on the ground, such as buildings or any other structures that become a fixture and thus part of the land. “Land” does not simply mean the physical ground, but the nature of the right involved in the ownership of land.
In common law, all land is held by the Crown and rights in respect of land held by subjects are derived directly or indirectly from the Crown. The bundle of rights held by subjects in respect of land is described as “an estate in land”. The largest estate possible is an estate in fee simple but any number of smaller estates may exist at the same time as an estate in fee simple, and each of those estates may be sold or otherwise dealt with.
Estates may be freehold or less than freehold, for example leasehold. For the purposes of the new rules, leases are excluded from the definition provided that they are leases of dwellings or they are commercial leases for which:
- the supply is made periodically; and
- 25% or less of the total consideration specified in the agreement, in addition to any regular payments is paid or payable under the agreement in advance of or contemporaneously with the supply being made.
The exclusion will ensure that commercial leases that do not require high one-off payments and which are unlikely to be used for phoenix fraud purposes are not caught by the new rules. The definition also expressly excludes mortgages.
Although a person who has an estate will often have a right of immediate possession of the land, it is not a necessary component of having an estate in land. For example, an estate may exist if it gives a person a right of possession at some future time or is contingent on an event that may or may not take place.
An “interest” in land includes both legal and equitable estates. By including equitable estates in land, the definition includes interests in land that are recognised and enforceable under the rules of equity – for example, equitable easements or restrictions on the use of land.
One of the rights that may be granted by a person with a legal interest in land is a “profit a prendre” – that is, a right to enter another person’s land and take some profit from the soil. Common examples of profit a prendre are the right to mine for minerals or a right to harvest timber.
“Land” also includes a right or an option to acquire land or an estate or interest in land.
Lastly, the new definition includes a share in the share capital of a flat-owning or office-owning company, as defined in section 121A of the Land Transfer Act 1952. This aims to prevent such structures being used for fraudulent purposes.
A supply that wholly or partly consists of land is a zero-rated supply if, at the date of settlement, the recipient is a registered person, acquires the goods with the intention of using them for making taxable supplies, and the supply is not a supply of land intended to be used as a principal place of residence of the recipient or their relative.
New section 78F seeks to assist the supplier in identifying this information in order to apply the correct GST treatment. Thus, if a supply wholly or partly consists of land, section 78F(2) requires the purchaser to provide, at or before settlement, a written statement to the supplier whether at the date of settlement:
- they are, or expect to be, a registered person; and
- they are acquiring the goods with the intention of using them for making taxable supplies; and
- they do not intend to use the land as a principal place of residence for them or a person associated with them under section 2A(1)(c) (their relative).
This information must be provided to the supplier in writing. It is expected that the requirements of this section will be incorporated into standard sale and purchase agreements. In that case, the written statement could simply be by way of ticking (or not) the relevant criteria.
Since the tests in section 11(1)(mb) must be satisfied on settlement for the zero-rating rules to apply, the information provided by the purchaser may be provided on a prospective basis – that is, on the basis of the best prediction of the recipient’s circumstances at the time of settlement. For example, if a purchaser is not registered for GST but intends to register before settlement, they may indicate on their statement that they expect to be registered for GST. Furthermore, if the purchaser who contracts with the supplier does not intend to receive the land themselves but nominates or intends to nominate a third party to receive the supply, the purchaser may make representations on behalf of the nominated person (section 78F(5)).
If a supply of land is made by a lender to whom section 5(2) applies, the purchaser must provide the information required by section 78F to the lender rather than the borrower – for example, the mortgagee under a mortgagee sale.
Having received a written statement from a purchaser, the supplier may rely on the statement to either standard-rate or zero-rate the supply (section 78F(3)). If the statement indicates that the conditions in section 11(1)(mb) are or will be met, the supplier may zero-rate the supply. If the statement indicates otherwise the supplier may standard-rate the supply..
In some circumstances, the vendor may believe that the information provided by the purchaser is not accurate. In these situations, the legislation provides flexibility for the vendor to adopt the GST treatment that they consider to be correct. For example, if, in contrast to the purchaser’s claims the vendor is aware that the purchaser will use the property in question as their principal place of residence, they may but are not obliged to choose to standard-rate the supply. In a commercial transaction it is reasonable to assume that the vendor is unlikely to unilaterally adopt a GST treatment different from the one indicated by the purchaser’s representation without first consulting the purchaser.
Once a written statement is provided, the supplier is not required to make any further enquiries regarding the purchaser’s circumstances.
If the purchaser either refuses or for any other reason has not provided a written statement regarding their GST registration status and intentions in respect of land, the supplier should standard-rate the transaction.
If a supply is zero-rated under section 11(1)(mb), new section 75(3B) requires the supplier to maintain sufficient records to enable the following particulars in relation to the supply to be ascertained:
- the name and address of the recipient; and
- the registration number of the recipient; and
- a description of the land; and
- the consideration for the supply.
Consequences of incorrect GST treatment
In some situations, the GST treatment of the transaction elected by the supplier may be found to be incorrect. The consequences of this will depend on whether the mistake is discovered before or after settlement.
Correction of GST treatment before settlement
For a supply to be zero-rated, the conditions for zero-rating in section 11(1)(mb) must be satisfied at the time of settlement. Since the time of supply may occur before a transaction is settled, the supplier will need to determine whether the supply should be standard-rated or zero-rated at that earlier time. As discussed earlier, this determination will usually be made on the basis of the written statement provided by the purchaser.
Before settlement the parties may become aware that the GST treatment applied to the transaction thus far is not correct.
For example, on signing the sale and purchase agreement the purchaser may have informed the supplier that they will be registered at the time of settlement. The supplier zero rates the transaction as a result. Before settlement, the purchaser may decide to nominate a third person to settle the transaction. The nominated person indicates that they will not be registered at the time of settlement.
Conversely, the parties may become aware of circumstances that indicate that a transaction should be zero-rated rather than standard-rated.
In both cases, since the crystallisation of the correct GST treatment in respect of the supply occurs at the time of settlement, the new zero-rating rules do not impose any obligations on the parties to change the initial GST treatment of the supply before settlement. Nevertheless, the parties may voluntarily agree to correct the GST treatment to avoid the consequence of being incorrect, as outlined below.
If GST has already been accounted for to Inland Revenue by the supplier, the correction may be done under section 25 of the GST Act, which allows the supplier to issue a credit note to adjust the tax payable by the supplier. Thus, if a supply was standard-rated when it should have been zero-rated, the supplier will be able to deduct the GST already paid to Inland Revenue and the purchaser will be required to account for the amount of any deduction incorrectly claimed in respect of the supply. Alternatively, if a supply was zero-rated when it should have been standard-rated, the supplier would be required to account for the GST. Generally the purchaser will not be able to claim a deduction in respect of the supply since if they are registered for GST and intend to use the goods in making taxable supplies (requirements for obtaining a deduction), standard-rating is unlikely to be the correct treatment.
Section 25 has been amended by the Taxation (GST and Remedial Matters) Act to explicitly allow suppliers to issue debit and credit notes in the context of the zero-rating rules.
Max, a registered vendor, agrees to sell land to Geoff for $500,000 plus GST, if any. Geoff informs Max that he does not expect to be registered for GST at the time of settlement and does not have any intention to use the land for taxable purposes.
Before settlement, Max issues a tax invoice on the basis that the GST of $75,000 is chargeable in respect of the supply. The tax invoice triggers the time of supply and Max accounts for the amount of GST to Inland Revenue.
Following the time of supply but before settlement, Geoff tells Max that he has decided to nominate Paul to settle the transaction. Paul informs Max that he will be registered for GST at the time of settlement, will use the land for making taxable supplies and will not use it as his or his relative’s principal place of residence.
The parties want to ensure that the correct GST is achieved before settlement. Therefore, Max issues a credit note under section 25 and deducts the amount of GST already paid to Inland Revenue ($75,000).
Robert, a GST-registered property developer, agrees to sell land to Graeme, who is not registered for GST, for $1 million plus GST, if any. In the sale and purchase agreement Graeme specified that on settlement he will be registered for GST, will acquire the property with the intention of using it for making taxable supplies and will not use it as his or his relative’s principal place of residence. As a result, the parties treat the supply as zero-rated under section 11(1)(mb).
Before the date of settlement, Robert issues a tax invoice, thereby triggering the time of supply. Since Robert treats the transaction as zero-rated, he does not account for any GST to Inland Revenue.
Following the time of supply but before settlement, Graeme informs Robert that his circumstances have changed and that he will not be registered for GST at the date of settlement. As a result, the correct GST treatment of the transaction would be to standard-rate the supply.
The parties want to ensure that the correct amount of GST is accounted for before settlement. Robert issues a debit note under section 25 and accounts to Inland Revenue for the GST amount of $150,000. Since Graeme is not registered for GST, he is not able to claim any input tax deduction.
Correction of GST treatment after settlement
In some situations the correct GST treatment may be unknown until after the transaction has been settled. The consequences of incorrectly standard-rating or incorrectly zero-rating the supply are set out below.
Supply incorrectly standard-rated
When a supply that should have been zero-rated is incorrectly standard-rated and the GST has been accounted for to Inland Revenue, the supplier will be required to use the credit note mechanism in section 25 to deduct the GST paid in respect of the supply. The purchaser would then be required to account for output tax in relation to any amount of input tax that they have incorrectly claimed in respect of the supply.
Sarah, a registered vendor, agrees to sell land to Brent for $200,000 plus GST, if any. Brent informs Sarah that he does not expect to be registered for GST at the time of settlement and does not have any intention to use the land for taxable purposes.
Before settlement, Sarah issues a tax invoice on the basis that GST of $30,000 is chargeable in respect of the supply. The tax invoice triggers the time of supply and Sarah accounts for the amount of GST to Inland Revenue.
Before settlement, owing to changes in Brent’s circumstances, he registers for GST. He also intends to use the land for making taxable supplies and does not intend to use it as his principal place of residence.
The parties settle the transaction. Since at the time of settlement all conditions in section 11(1)(mb) for zero-rating were satisfied, the supply should have been zero-rated rather than standard-rated.
Following settlement, Sarah issues a credit note under section 25 and deducts the amount of GST already paid to Inland Revenue ($30,000). Since Brent has not claimed an input tax deduction, he is not required to account for output tax in relation to the credit note adjustment.
Supply incorrectly zero-rated
When at any time after a transaction is settled it is found that the supply should have been standard-rated rather than zero-rated, new section 5(23) will treat the purchaser, at the date of settlement, as making a supply of the goods in question at the standard rate. The value of the supply under section 5(23) will be equal to the amount of the consideration for the original supply. Since the supply is treated as being made at the date of settlement of the underlying supply, the purchaser may be subject to use-of-money interest with any applicable penalties calculated from that date.
If the purchaser who is required to account for tax under section 5(23) is not registered for GST, they will be treated as registered from the date of the supply under section 5(23) and must apply to be GST-registered (new section 51B(4)). If the purchaser fails to apply for registration, the Commissioner of Inland Revenue will be able to force their registration.
New section 20(4B) denies a deduction to the person who is treated under section 5(23) as a supplier of goods. However, the person may be able to claim a deduction for the supply at a later date if they register for GST and use the relevant goods for making taxable supplies.
Once GST is accounted for, the purchaser may request that the Commissioner cancel their registration (new section 51B(5)). Under section 5(3) a person cancelling their registration must ordinarily account for the output tax on any goods and services forming part of the assets of a taxable activity carried on by the person. This rule could result in unfair and unintended consequences if it applied to deregistration of a person who was required to register under section 51B(4). Therefore, new section 51B(6) renders section 5(3) inapplicable if:
- the person seeks cancellation of their registration by the end of the taxable period in which they have accounted for the output tax under section 5(23); or
- the Commissioner agrees that section 5(3) should not apply.
Isla agrees to acquire land for $1 million plus GST, if any. In a written statement provided to the supplier, Isla indicates that she is registered for GST, intends to use the land for making taxable supplies and will not use it as her or her relatives’ principal place of residence. On the basis of these representations, the supplier zero-rates the transaction.
The transaction is settled on 1 July 2011. At the time the settlement Isla is not registered for GST.
Following settlement, Isla is treated as making a supply of the land on 1 July 2011 and has to account for the GST at the standard rate. Since Isla is not registered for GST, she must apply to be registered.
Once registered, Isla must account for the GST under section 5(23) on the value equal to the consideration for the original supply:
$1m x 15% = $150,000
Isla will not be able to claim an input tax deduction on the payment made under section 5(23) as this is denied under section 20(4B).
In the same taxable period in which she accounts for the output tax under section 5(23), Isla asks the Commissioner to cancel her registration. The Commissioner confirms the deregistration. By application of section 51B(6)(a), Isla is relieved from the requirement to pay any additional tax under section 5(3) on deregistration.
Transactions involving associated persons
An amendment has been made to section 3A (meaning of “input tax”) to limit input tax deductions for second-hand goods in relation to land acquired as part of an arrangement involving more than two associated parties and more than one supply (new subsection (3B)). If the section applies, the amount of input tax for the supply is limited to the amount accounted for as output tax for all supplies that are part of the arrangement. This section is necessary to ensure that the zero-rating rules are not circumvented by arrangements involving second-hand goods deductions.