Tax Talk | Inland Revenue revisiting GST apportionment

If there is anything that causes an accountant to prematurely age and wish they could give the “too hard” basket back, it has to be GST apportionment.

Time to read: 10 mins

The rules are challenging to navigate, often create absurd results and ultimately result in significant compliance costs for little benefit to either taxpayers or the government. In 2020, Inland Revenue released a paper on GST issues more broadly and now it has released a discussion document that goes into more detail on the change-of-use rules. We discuss some of the key proposals below:

Removal of assets from taxable activities

We previously discussed the issue of certain farmhouses and the houses of sole traders entering the GST net as the result of an IRD ruling in June 2020. This issue has caused significant confusion and risk to vendors and purchasers, and the discussion document proposes to fix the problems.

In summary, the plan is to allow taxpayers to elect whether an asset should be in the GST net or not. Don’t get too excited, the rule would not apply to all assets, just capital assets, and further, only capital assets that are not used for the principal purpose of making taxable supplies.

Here is an example of the current problem. Person A purchased a farm in 2010 in their own name. The farm cost $3 million plus GST, with the dwelling and curtilage valued at $1 million, and the balance of the farm at $2 million. Person A and their family reside in the dwelling. The supply of the dwelling and curtilage is outside the scope of GST, and the balance of the farm has GST of 0% applied to the sale.

While the farm is owned, the accountant for Person A advised them to claim the maximum income tax expenses they could, which included expenses for a home office. This means that the farmhouse has now entered the GST net, and Person A is able to claim GST on the cost of the farmhouse to the extent that it is being used as a home office – let’s assume this is 20%. However, Person A's accountant is not aware of this rule and does not claim anything in relation to the farmhouse, only the GST portion of rates and phone etc.

In 2021 the farm is sold for $5 million plus GST with a value of $2 million attributed to the dwelling and curtilage. Person A now has a new accountant who has a GST specialist division. The GST specialists advise that Person A needs to split the supply of the farm in two, one supply for the dwelling and curtilage, one for the rest of the farm. As the dwelling and curtilage has entered the GST net, GST will need to be charged at 15% on that part of the supply, and 0% on the remainder. In addition, as Person A has not yet claimed GST on the 20% which they used for business purposes, they can do so on the sale of the farm. In fact, on the sale of the farmhouse, Person A can claim all the GST on the cost of the farmhouse, but will need to return GST on the sale.

GST paid on the cost of the farmhouse was $130,434, but GST of $260,869 arose on the sale and has to be returned. This taxes the private portion of the dwelling and curtilage, which is not fair.

The Bill currently before the House, and expected to pass soon, helps with this unfairness by giving the vendor a GST credit on the market value of the private use. In other words, in our example above, GST can be recovered on cost on 20% of the dwelling and curtilage, and on the market value of the 80%. This means only the home office portion has been subject to GST. The rule is being backdated to February 2020, which makes it incredibly difficult to advise clients what to do at present, because there are two different sets of rules that could apply.

The proposal in the discussion document, which is to be backdated to 1 April 2011, would certainly make things simpler in the future. It would allow the vendor to elect for the dwelling and curtilage not to be subject to GST, which preserves the position as it was prior to the IRD ruling in June 2020, and also protects people who took an approach consistent with it.

The IRD should be commended for attempting to fix this issue. There is unfortunately no easy fix, and advisors need to be very careful about how they advise their clients to act.

De minimis

One of the chief issues with the current GST apportionment rules is that relatively minor adjustments need to be accounted for in GST returns. Assets with even a minor amount of private use (for example, smartphones, laptops and work tools) need to have their use constantly monitored to ensure there is no breach of the apportionment thresholds – a rule that is often ignored or, if not ignored, creates significant and unnecessary compliance costs.One of the chief issues with the current GST apportionment rules is that relatively minor adjustments need to be accounted for in GST returns. Assets with even a minor amount of private use (for example, smartphones, laptops and work tools) need to have their use constantly monitored to ensure there is no breach of the apportionment thresholds – a rule that is often ignored or, if not ignored, creates significant and unnecessary compliance costs.
Inland Revenue is proposing that certain classes of assets would be removed from the apportionment and adjustment rules. These would include:

  • Assets purchased for less than $5,000 (GST exclusive) would be subject to a principal purpose test
  • A 20% de minimis, which would mean the assets of a GST registered business that are used less than 20% for taxable activities would be considered non-taxable. No GST would be claimed on purchase and no GST would be returned on disposal
  • An 80% rounding-up rule. Similar to the 20% de minimis, this would mean the assets of a GST-registered business that are used 80% or more for taxable activities would be deemed to have full taxable use

Inland Revenue is also proposing that an adjustment would only be required where there is a greater than 20% change in use (it is presently the lesser of 10% and $1,000 of GST). This would mean only major changes in the use of an asset would result in GST adjustments, thus substantially reducing compliance costs.

We support all of these changes as they would significantly simplify the apportionment rules.

Landing on a better result for land?

The rules governing GST and land can currently give a nightmarish result for taxpayers, as the above example illustrates. Aside from the home office and holiday home examples outlined above, there are other scenarios where GST apportionment issues arise – especially where the same premises are used to make taxable supplies of commercial accommodation as well as being used to make exempt supplies of accommodation in a dwelling, for example a retirement village and care facility.

The first issue is around the definitions of “dwelling” and “commercial dwelling”. As the sharing economy has come more to the fore, these definitions have been stretched to the limit. Inland Revenue is proposing that the definition of dwelling be replaced with “residential accommodation services”. The definition of commercial dwelling would be replaced with “commercial accommodation services” which would have a more general definition to encompass much of what falls in the current commercial dwelling definition.

Where a single piece of land is used predominantly for either residential or commercial accommodation services, then the owner would be able to make an irrevocable election to deem all the accommodation services to be of one type. An example of this might be a hotel that provides some accommodation to its employees – the hotel would be able to elect for the entire complex to be treated as commercial accommodation for GST purposes.

Again, this is a very sensible proposal, and one we support.

Exempting sales of dwellings?

When a GST-registered business owns land that they use to make taxable supplies, the sale of that land is usually itself a taxable supply – regardless of what the land is used for. For example, the sale of a farm including a farmhouse would be a taxable supply where the farmhouse is used in the taxable activity. Inland Revenue is proposing to make the sale of a house an exempt supply unless the GST-registered business developed the land with an intention to sell it (for example, a property developer).

An additional proposal would limit input tax deductions being claimed for the purchase of a holiday home and any capital improvements unless the GST-registered business supplied taxable accommodation services to guests of at least $60,000 per annum, with supplies made to associated persons being ignored in this scenario.

Inland Revenue is proposing to retain and widen the existing rules around land with a mix of dwellings and commercial spaces – so the farm and farmhouse would continue to be treated as separate supplies.

We support this proposal. There are situations where the complexities associated with mixed supplies of dwellings and non-dwellings are not solved by the ability to elect for the asset to be outside the GST net. For example, in situations where the dwelling is being used for the principal purpose of making taxable supplies. We think the above proposal is a useful solution to exclude these types of situations from the complexity of complying with GST as well.

What about developers?

GST is currently very complex for property developers, especially when they purchase a property and rent it out as a dwelling – perhaps while they are planning the development. Complex apportionment calculations are required in such situations and often developers simply leave a property vacant to avoid having to undertake such calculations.

A proposal would see a full input tax claim able to be made by property developers when they commence physical work on the property development. A different proposal would allow property developments to make a full input tax claim at the time the land was purchased, but they would need to sell the property within 36 months, with extensions being possible at the discretion of Inland Revenue.

We think this is also a very sensible proposal.

Other tweaks

Several other tweaks are proposed, including:

  • Reducing the number of adjustment periods
  • Expansion of application of “the wash-up rule” (this is where a GST-registered business experiences a change to either 100% taxable use or 100% non-taxable use of an asset)
  • Repeal the mixed-use asset rules
  • Repeal the concurrent use of land rules
  • Allowing a wider range of approved apportionment methods

Comment

We support most of the proposals in the discussion document. IRD should be congratulated for thinking outside the box and coming up with some real cost-saving initiatives. In addition, the change would also make it more cost-effective to develop land, and in some marginal cases, this may mean land is developed that otherwise would not have been.

One issue with the proposals is that in the absence of the law being passed, and the retrospective effect of it, advising clients in the interim is going to be challenging. If you are in this space you need to talk with a specialist in the area, as it is becoming too complex for generalist accountants to deal with. With the large amounts of money usually at stake for land transactions, specialist advice is a must.

If you wish to make a submission on the Inland Revenue paper, or have any queries regarding GST apportionment, please contact your Baker Tilly Staples Rodway advisor.

DISCLAIMER No liability is assumed by Baker Tilly Staples Rodway for any losses suffered by any person relying directly or indirectly upon any article within this website. It is recommended that you consult your advisor before acting on this information.

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