Chapter 9 – Compulsory zero-rating of land
- Relationship between sections 5(23) and 78F when land is incorrectly treated as zero-rated
- Non-taxable supply incorrectly treated as zero-rated
- Date of deemed supply under section 5(23)
- Taxable period for adjustment when a second-hand goods deduction has been incorrectly claimed by purchaser of zero-rated land
- Date of output tax adjustment under section 20(3J)
9.1 The GST Act requires a supply that wholly or partly consists of land to be zero-rated if the supply:
- is made by a registered person to another registered person who acquires the supply with the intention of using the goods and services for making taxable supplies; and
- 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 connected with them by blood relationship, marriage, civil union, de facto relationship or adoption.
9.2 This chapter consults on several suggested technical amendments to address situations where the current compulsory zero-rating of land rules appear to produce flawed outcomes or the timing of when the relevant provision applies could be improved. These scenarios include:
- Clarifying the relationship between sections 5(23) and 78F where land is incorrectly treated as zero-rated.
- Non-taxable supplies of land that have been incorrectly treated as zero-rated.
- The date that the deemed supply under section 5(23) should occur on.
- The taxable period for the adjustment when a second-hand goods deduction has been incorrectly claimed by purchaser of zero-rated land.
- The date of output tax adjustment under section 20(3J) which applies when a person acquires zero-rated land that they intend to use for both taxable and non-taxable purposes.
9.3 Where the land zero-rating rules are incorrectly applied to treat a supply as zero-rated, the purchaser of the land is required to return GST on the supply under section 5(23). Section 5(23) provides that if a supply of land is incorrectly zero-rated and this fact is discovered after the date on which the transaction was settled, the recipient of the supply is treated as though they were a supplier making the supply of land on the date of settlement.
9.4 Section 78F requires the recipient of the land to notify the supplier whether at the date of settlement they will be a GST-registered person and are acquiring the land with an intention to make taxable supplies and do not intend to use the land as a principal place of residence for themselves or an associated person.
9.5 It is not clear how section 5(23) interacts with the requirement in section 78F for the recipient of the land to provide information to the supplier.
9.6 We propose making an amendment to clarify that section 5(23) applies to place the output tax liability on the purchaser, in cases where a vendor incorrectly zero-rates land (as a matter of fact), regardless of the information that was provided (or not provided) by the recipient of the land under the section 78F disclosure requirement.
9.7 The policy concern that the business-to-business zero-rating of land rules were trying to address was phoenix fraud by the vendor. The GST liability should be placed on the purchaser whenever a supply of land was incorrectly zero-rated because that still enables Inland Revenue to recover the unpaid GST if the vendor ceases to operate, as the purchaser has a valuable asset (land) and is likely to continue their taxable activity. This approach is also consistent with the original policy proposal for addressing phoenix fraud which was to introduce a reverse charge mechanism on the purchaser (this was later changed to a zero-rating mechanism in response to submissions).
9.8 The proposed amendment would provide certainty that the purchaser is always liable for any GST output tax liability. However, we acknowledge that the proposed approach places a lot of risk on the purchaser.
9.9 In particular, it could lead to unfair outcomes in some cases where a vendor has unilaterally and incorrectly zero-rated the supply contrary to the purchaser’s section 78F information disclosure, either by mistake or by a deliberate act to shift the output tax liability onto the recipient of the land. This may occur because the vendor is “trying to get it right” and thinks that the recipient’s statement is either wrong or is likely to change. It also includes the situation where the vendor simply ignores the recipient’s statement (despite the statement being correct).
9.10 We note that these issues can be resolved through the contracts between the parties. For example, if the contract price is expressed as “plus GST (if any)” the vendor will have nothing to gain from zero-rating the supply, so any incorrect zero-rating will be because they have simply made a mistake. With a plus GST (if any) contract price, the purchaser will have agreed to assume contractual liability to pay an additional amount for any GST. Therefore, if section 5(23) applies, the purchaser will pay the GST to Inland Revenue but will also be eligible for an input tax credit to claim back this additional GST.
9.11 Section 5(23) will achieve the correct result in circumstances where a supply of land has been incorrectly zero-rated as a result of the registration status of the purchaser (that is, the purchaser is not registered for GST or does not acquire the goods and services for the purpose of making taxable supplies). However, an anomalous result arises where a supply is incorrectly treated as zero-rated owing to the vendor’s registration status or by way of oversight as a result of the vendor carrying on both taxable and non-taxable activities. This anomaly is illustrated in example 24.
Example 24: Property sold was held in trust unrelated to trust’s taxable activity
The M Trust carries on a taxable activity and is GST-registered, but also has property holdings unrelated to the taxable activity which relate to residential accommodation for the beneficiaries.
The property is sold for $1 million plus GST if any to Chris who acquires the land to make taxable supplies. Chris does not intend to use the land as a principal place of residence for himself or any person associated with him under section 2A(1)(c) and is not associated with any of the trustees of the M Trust.
Matthew, the trustee of M Trust treats the supply of the land as zero-rated. It is discovered after settlement of the transaction that this is an error.
Section 5(23) applies to treat Chris as making a supply of the land in the course or furtherance of a taxable activity for $1 million. Chris is therefore required to account to Inland Revenue for output tax of $150,000. As Chris is acquiring the land for the purposes of making taxable supplies, he will be able to claim $150,000 as input tax, meaning that the net cost of the land to him is $1 million.
However, the supply should not have been subject to GST at all in the first place. Instead, Chris should have been entitled to a second-hand goods input tax deduction of $130,434.78 (assuming that Chris is not associated with Matthew or any of the other trustees of the M Trust under section 2A(1)). This would have made the net cost of the land to Chris $869,565.22.
This position cannot be rectified by re-characterising the transaction correctly. This is because if it is found after settlement that the supply was incorrectly zero-rated, the transaction is not re-characterised; instead, section 5(23) applies to deem a taxable supply made by Chris.
9.12 This issue may also arise when the Commissioner of Inland Revenue cancels the vendor’s registration (after the date of settlement) with retrospective effect to the date of settlement or earlier. In these instances, the transaction may be incorrectly treated by the vendor as zero-rated on the date of settlement (this treatment being incorrect as a consequence of the retrospective deregistration, as the retrospective deregistration would mean the vendor was not a “registered person” on the date of settlement).
9.13 An amendment could be made so that, where it is discovered after the date of settlement that section 11(1)(mb) was incorrectly applied by the vendor and the relevant supply is in fact not a taxable supply, section 5(23) does not apply and the original supply is instead re-characterised to be a non-taxable supply.
9.14 As mentioned above, section 5(23) treats the purchaser as making a taxable supply on the date of settlement. This means the resulting output tax is attributed to the taxable period in which the original supply was made. This can be contrasted with the credit and debit note provisions in section 25, where the liability to pay output tax does not arise until the parties have become aware of the need to adjust the output tax returned and input tax claimed.
9.15 Where the purchaser is acquiring the goods and services for the purpose of making taxable supplies, there is no rule deeming the input tax deduction to also arise in the period in which settlement occurred. The practical effect of this is that the recipient of the supply is required to issue themselves with a tax invoice in respect of the supply they are deemed to make under section 5(23), and then claim an input tax deduction in a later period. The timing difference means that in the period in which settlement occurs, the recipient will have underpaid GST, even though the net effect of the transaction is GST-neutral.
9.16 An amendment could be made so that the recipient of the incorrectly zero-rated supply is treated as making a supply on the date that it becomes apparent that the original supply was incorrectly treated as zero-rated.
Taxable period for adjustment when a second-hand goods deduction has been incorrectly claimed by purchaser of zero-rated land
9.17 Section 25AB of the GST Act is designed to ensure that the rules dealing with changes in the consideration for a supply of second-hand goods apply correctly to deductions claimed by a GST-registered purchaser of second-hand goods.
9.18 When the terms of a contract for the supply of goods or services are varied (for example, by a discount being subsequently offered), the supplier may be required to issue a debit or credit note to the recipient if the supply is taxable. This triggers obligations on both the GST-registered supplier and a GST-registered purchaser to correct their tax position.
9.19 This requirement did not work well when a supply of second-hand goods was not a taxable supply. Although a second-hand goods deduction was available for a GST-registered purchaser (to the extent that they used the goods for making taxable supplies), the debit and credit note rules did not clearly apply to correct the purchaser’s GST position where the consideration for the goods changed.
9.20 Section 25AB applies to a supply of second-hand goods to a registered person when the GST-registered purchaser claimed a second-hand goods deduction, and the amount of the claimed deduction exceeds the correct amount as a result of one of the following events:
- the supply has been cancelled;
- the nature of the supply has been fundamentally varied or altered;
- the previously agreed price of the goods changes, whether through the offer of a discount or by other means;
- the goods (or part of those goods) supplied have been returned to the supplier; or
- the compulsory zero-rating of land rules were incorrectly applied to the supply, so that the supply was not treated as zero-rated when it should have been.
9.21 In these circumstances, section 25AB requires the purchaser of the goods to return the excess amount of the deduction claimed as output tax for the taxable period in which one of the events referred to above occurred.
9.22 Requiring the adjustment to be made in the taxable period in which the event occurred should lead to the correct result where the relevant event is the cancellation of a supply, decrease in the amount of consideration for a supply or the return of goods or services. In these cases, the purchaser should be aware of the occurrence of the relevant event when it happens.
9.23 A problem with this requirement however arises in the following scenario:
- A person supplies land to a GST-registered purchaser who intends to use the land for making taxable supplies. The purchaser will not use the land as a principal place of residence for themselves or for a natural person associated with them under section 2A(1)(c).
- The vendor is not registered for GST at the date of settlement, but as at that date, has a liability to register for GST. Therefore, in terms of the definition of “registered person” in section 2(1) of the GST Act, the vendor is a “registered person” at the date of settlement. The conditions for zero-rating are therefore met, but the purchaser would not know this at the time of settlement.
- Based on the vendor’s representation that they are not GST-registered, the purchaser claims a second-hand goods credit for the acquisition of the land. This means the purchaser underpays the amount of GST they are liable to return for that period.
- The Commissioner discovers that the vendor should have been registered and registers the vendor, back dated to before the date of settlement.
- Section 25AB therefore requires the purchaser to make an output tax adjustment for underpaid GST (equal to the amount of the second-hand goods deduction claimed on the acquisition of the land).
9.24 The issue is that section 25AB(2) requires the adjustment to be made for the taxable period in which the relevant “event” occurred (which in this case is the incorrect application of the land zero-rating rules to the treatment of the supply, so that it was not zero-rated when it should have been). This would lead to the purchaser incurring debit interest for the excess deduction claimed.
9.25 While in some cases the purchaser may be able to recover these interest costs (along with the amount of the denied second-hand goods deduction) from the vendor, this is not an ideal policy outcome. This result would be particularly problematic in cases where the GST return for the taxable period in which the supply was made was time-barred, resulting in a revenue loss to the Crown.
9.26 The requirement that the GST-registered purchaser make an output tax adjustment for the taxable period in which the event occurred could be replaced with a requirement that the adjustment be made for the taxable period in which it became apparent that the amount of input tax deducted was incorrect.
9.27 If a person acquires zero-rated land that they intend to use for both taxable and non-taxable purposes they must calculate and return the portion of the nominal GST component relating to non-taxable use as output tax. Section 20(3J) requires the recipient of the zero-rated land to calculate and return the output tax for the non-taxable use of the land on “acquisition”.
9.28 It is not clear when acquisition of the land occurs for the purposes of section 20(3J). For instance, acquisition may be viewed as occurring at the time of supply, settlement, unconditional contract or at some other time. Section 20(3J) should therefore be clarified to make it clear exactly when the recipient must calculate and return output tax for the portion of the nominal GST component that relates to non-taxable use.
9.29 Time of supply seems to be an appropriate time in which the recipient should have to return the output tax. If the land was not zero-rated, the supplier would have to return output tax for the taxable period in which the time of supply occurred (assuming they use the invoice or hybrid accounting basis). Therefore, using time of supply as the trigger for when an output tax adjustment is required to be made under section 20(3J) would ensure that output tax is returned at the same time, regardless of whether the land is zero-rated or not.
9.30 Officials suggest that this amendment should apply for supplies made on or after 1 April 2011, being the date that the compulsory zero-rating of land provisions came into force, but submissions are invited on whether application from the date of enactment may be more appropriate.
Questions for submitters
- What are your views on these issues and the suggested solutions?
- Are there other policy or practical issues with the compulsory zero-rating of land rules which officials should consider?