Chapter 3 - B2B options for New Zealand

3.1 Chapters 1 and 2 established that GST is not designed to impose a real fiscal cost on businesses – be they resident or non-resident – other than in certain defined instances when businesses are treated as if they were final consumers. This chapter considers how B2B neutrality might best be achieved in practice.

3.2 Different countries adopt different models to create a neutral outcome for non-resident businesses, each with its own strengths and weaknesses.

3.3 While there are other approaches, the three most common ways of achieving B2B neutrality appear to be:

• Zero-rating certain supplies;
• extending a non-resident business’s ability to claim input tax credits, while retaining a broad ability to register for GST; and
• allowing non-resident businesses to claim refunds for input tax incurred without the need to actively register for GST.

3.4 There is already some flexibility in our GST system to cater for non-resident businesses. For example, if a non-resident business were to incorporate a New Zealand subsidiary and register that subsidiary for GST, it is often possible for the subsidiary to acquire New Zealand goods and services and then export “finished” goods and services to its non-resident parent. This structure allows the subsidiary to claim input tax for the supplies received and to zero-rate the supply to the parent. The net position is that the subsidiary obtains a refund and neutrality across the group is achieved. The following options therefore need to be considered in light of the fact that an existing structure – albeit one that may come at a higher compliance cost – is available in many cases.

Zero-rating

3.5 Extending the current zero-rating rules could take two forms: either a broad-based system, under which all supplies to non-resident businesses can be zero-rated, or a more focussed system under which only those services of most concern from a neutrality perspective would be specifically zero-rated.

3.6 If more focussed rules were introduced, they would be likely to target specific industries – an approach that is largely unprecedented in the GST Act. The targeted industries would be those that appear to be “unfairly” required to charge GST on supplies to non-resident businesses. In this respect, the Government could, in zero-rating particular activities, be regarded as “picking winners”.

3.7 A broader approach that minimises these distortions across industries is therefore preferable, even though it is likely to give rise to a greater fiscal cost.

3.8 Strengths of zero-rating

• Zero-rating is consistent with the destination model and with how the Act currently deals with goods and services that are exported. Having a system that aligns the treatment of all exports is simpler and more transparent.
• Zero-rating is a mechanism that is familiar to New Zealand businesses. The familiarity of the system may arguably also reduce compliance costs to non-resident businesses.
• Zero-rating would result in minimal administrative costs for Inland Revenue. The reporting requirements would fall on existing registered persons, so there would be no increase in the number of taxpayers registered for GST or otherwise filing with Inland Revenue.

3.9 Weaknesses of zero-rating

• Under a broad-based system, zero-rating rules could fail to create the level of certainty anticipated. Although the policy may be clear, there will always be areas of contention from “borderline” activities. The fact that the scope of section 11A(2) itself has been litigated shows that rules designed to prevent confusion can themselves end up being disputed.
• Any rules will also be vulnerable to shifts in behaviour in the types of supplies made. A definition of certain activities would be fixed in time and may not be adequately “future-proofed”. Such rules are more likely to require future amendments than general, principles-based legislation.
• Irrespective of how the relevant rules are drafted, they may not alleviate the GST cost altogether. These “gaps” would result in GST being a cost to a non-resident business when the same GST charged to a resident business may be able to be deducted as input tax.
• Importantly, an expanded zero-rating system may push potentially large compliance costs onto New Zealand suppliers. The New Zealand-resident supplier may be required to identify each customer and determine the appropriate GST treatment on a transaction-by-transaction basis. For suppliers that do not deal exclusively with non-resident businesses, this could be extremely difficult to administer. A New Zealand service provider would have to establish not only that their client was a non-resident, but also that they were consuming the services purely for business purposes.
• When a supply is zero-rated, the output tax that would have been chargeable on that supply is immediately “lost” from the GST system. This makes any mistakenly zero-rated supply difficult for Inland Revenue to identify and recover. The GST Act would make the supplier in such cases liable for output tax not charged on the relevant supply. This would increase costs for New Zealand suppliers, forcing them into rigorous checks to determine whether the supply should be zero-rated and being financially penalised if they get it wrong. Risk-averse suppliers may resort to standard-rating all supplies, thereby defeating the objective of any revised rules.

Enhanced registration system

3.10 A variation on the current system that could promote B2B neutrality would be to retain the broad ability to register, but couple it with more generous rules around claiming input tax (“an enhanced registration system”).

3.11 This would be similar to the rules that operate in Australia where, generally speaking, a registered person is entitled to an input tax credit for GST incurred to the extent that the acquisition is made in the carrying on of an enterprise (“enterprise” being a broadly similar concept to “taxable activity”).[4] There is no requirement for the acquisition to relate to supplies made in Australia. Therefore, non-residents that acquire goods or services that attract Australian GST, but make few or no supplies in Australia, may often end their tax period in a net refund position, with the result that the net GST cost of their Australian activities is not an economic burden on the business.

3.12 Strengths of registration

• An enhanced registration system has the potential to provide comprehensive B2B neutrality. A non-resident business would be able to claim input tax for expenses incurred in New Zealand to the extent that the supply is used for its worldwide taxable activities.
• Non-residents would be operating under a similar system to residents, thereby enhancing the neutrality objective. If a non-resident business made no taxable supplies in New Zealand, they would be entitled to a refund of the relevant input tax. However, if the non-resident were to make some supplies in New Zealand, as a registered person, they would be required to account for output tax on those supplies. This means that a non-resident would not be able to obtain a competitive advantage by making supplies in New Zealand under the registration threshold (thereby not paying output tax yet still receiving neutral treatment for their inputs).
• An enhanced registration system would be complementary to existing Inland Revenue systems, as a non-resident business would be required to complete and file GST returns in the same way as any other registered person.
• An enhanced registration system would be similar to the system used in Australia. Having broadly similar rules could make it easier for Australian businesses to expand into New Zealand and for third-country businesses to operate in both jurisdictions.
• The GST system already contains most of the registration and input tax deduction provisions necessary to make an enhanced registration system work. Even though introduction of such a system would result in more GST-registered persons, it would not require complex new legislation to be introduced.

3.13 Weaknesses of registration

• In order to access input tax deductions, non-resident businesses would need to incur the compliance costs of registering for GST and filing periodic returns. These costs do not necessarily need to be large, particularly given developments in online registration and return filing. However, risk-averse non-residents may be unfamiliar with, and less trusting of the system and may consider it necessary to engage a New Zealand advisor to help with ongoing filing requirements.
  Asking non-residents to fully engage in the New Zealand GST system could be seen as a deterrent rather than just an administrative step towards eligibility for a refund. For example, businesses could be concerned that GST registration could give rise to New Zealand income tax issues.
• Although Inland Revenue has systems for allowing non-residents to register, administration costs would nevertheless increase in line with the increased number of registered persons.
• New Zealand’s current legislation has the basic mechanisms in place for non-resident businesses to register for GST, claim input tax and receive refunds. However, additional legislative safeguards to protect the tax base are likely to be necessary.

Direct refund system

3.14 A direct refund system would be largely similar to the way refunds are dealt with under the value added tax (VAT) system of the European Union (EU). GST and VAT systems are fundamentally similar. However, VAT has additional complexities. Whereas New Zealand’s GST system must differentiate between supplies made by and to non-residents and those by and to residents, VAT must deal with residents, EU member states and residents of other countries outside the EU.

3.15 An EU VAT directive requires member states to allow “third country” taxable persons a deduction for VAT incurred in connection with their taxable business activities.[5] This deduction generally takes the form of a direct refund if the person does not make taxable supplies within the relevant EU member state.

3.16 The refund system involves third-country taxable persons completing a separate application form seeking refunds for VAT incurred. The refund claim is usually made after the end of a defined period for expenditure incurred during that period.

3.17 Strengths of refund system

• Like an enhanced registration system, a refund system has the potential to create full neutrality between resident and non-resident businesses.
• A refund system is relatively easy to understand and is likely to be familiar to multi-national businesses, particularly those that incur GST or VAT costs in Europe.
• A refund system can be accessed on the basis of the need of the individual business, thereby eliminating the requirement for upfront registration and ongoing compliance costs.
• Following a European approach to administering a refund system may allow Inland Revenue to be more rigorous in processing refunds. This could be achieved by taking the refund system outside the requirement that refunds to registered persons be released within 15 days. Having longer for the review of refund applications could help prevent abuse of the system by giving Inland Revenue sufficient time to determine the legitimacy of claims submitted.

3.18 Weaknesses of refunds

• A refund system could be more likely to give rise to fraudulent refund claims than a system that requires non-resident businesses to register as a pre-requisite to obtaining a refund.
• If a non-resident was making supplies under New Zealand’s current $60,000 registration threshold, the tax base could be eroded by giving refunds without the corresponding collection of output tax. (We note, however, that under the UK system, payment of a refund is contingent on there being no supplies made within the UK other than those subject to reverse-charge rules. This effectively requires businesses that make domestic supplies to register in order to obtain a refund.)
• The administration costs of this option are likely to be high for Inland Revenue. New forms would be needed, and staff hired or retrained to ensure applications were processed and monitored appropriately and refunds issued in a timely manner. More significantly, a refund system may require new IT systems to be developed.
• Such developments could be seen as being counter to Inland Revenue’s programme of streamlining customer interactions and IT systems.

Conclusion

3.19 We consider that an enhanced registration system would provide the best balance between achieving B2B neutrality and protecting the revenue base. Although the refund model appears to have the advantage of accessibility and simplicity, it is also the option that would be likely to impose the highest administration costs on New Zealand and may be the most susceptible to abuse. A full zero-rating approach could give rise to substantial compliance costs for suppliers and would also be prone to greater legislative uncertainty.

3.20 An enhanced registration system is more neutral, in that it would bring non-residents into the New Zealand GST system to file returns and be subject to the same rules as a resident business. Inland Revenue would also have periodic returns from the non-resident, which would provide some assurance that any New Zealand GST obligations were being met on an ongoing basis. We do, however, recognise the importance of minimising business compliance costs under this approach.

4 See A New Tax System (Goods and Services Tax) Act 1999, Division 11.

5 Thirteenth Council Directive (86/560/EEC) of 17 November 1986 on the harmonization of the laws of the member states relating to turnover taxes − Arrangements for the refund of value-added tax to taxable persons not established in community territory.