Significant GST apportionment changes on the horizon

Tax Alert - September 2022

Authors:

Allan Bullot

Sam Hornbrook

By Allan Bullot, Sam Hornbrook & Rachel Hale

The existing GST apportionment rules in the Goods and Services Tax Act 1985 (“GST Act”) are extraordinarily complex and it is with (mainly) delight that the Taxation (Annual Rates for 2022-23, Platform Economy and Remedial Matters) Bill includes wholesale changes to simplify these rules. As with everything to do with GST the devil is in the detail and some of the changes remove and replace complexity with a new type of complexity.

It is interesting to note that some of the proposed changes are in many respects “out with the old and in with the… older” – for example, partly reintroducing the ‘principal purpose’ test (that many might not have realised was removed in 2011), and potentially allowing property developers to ‘remit’ GST on residential rental income (as a proxy for their GST adjustment). Everything comes back into style if you wait long enough.

What are the GST apportionment rules and why are they changing?

Where an asset is used for both business use (known as taxable use) and non-taxable use (that is, private use or making exempt supplies, such as financial services or residential accommodation), the person can only deduct a percentage of the total input tax. GST is collected on the non-taxable use of an asset by denying a portion of the input tax deduction. This is known as GST apportionment. You can find a high-level summary of the adjustment requirements currently in force in a previous Tax Alert article.

Inland Revenue notes that “the current GST apportionment and adjustment rules may create uncertainty, complexity, unintended consequences, or undue compliance costs.”

This is an understatement. The proposed changes are intended to simplify things - however, as is often the case with tax, there will still be complexity under the new rules, including in relation to when they apply as some are retrospective to 1 April 2011 and 30 June 2014, some apply from the date of enactment (expected to be late March 2023), and others will apply from 1 April 2024.

Do these rules apply to me?

Examples of taxpayers who need to consider these rules include:

Anyone purchasing land that is intended to be used to make taxable supplies;
Property owners using properties for a dual purpose (e.g. purchased for development but used for residential rental prior to sale);
Financial service providers;
Aged care sector (retirement villages);
A sole trader using assets for personal use (a work car for personal use).

It will be important to ensure there is a clear understanding of how the updated GST apportionment regime will apply to your business and how your GST obligations may change as a result of these changes. If you are a GST-registered business that is currently required to carry out GST apportionment adjustments, or if your business activities involve both taxable and exempt supplies, you need to understand how these rules will apply.

What are some of the key changes I need to know about?

Principal purpose test – out with the old and in with the… older

One of the key changes is the reintroduction of the ‘principal purpose’ test for assets costing $10,000 or less (GST exclusive). At a high level, this rule will mean that GST-registered businesses will not need to carry out an apportionment calculation in respect of goods or services costing less than $10,000 and that have some element of mixed-use. Examples that might fall into this category include computers and low-value vehicles owned by sole traders.

Where these goods or services are acquired for the principal purpose of making taxable supplies, any minimal private use can be ignored and the GST-registered business can claim a full input tax deduction. Conversely, where goods or services are acquired for the principal purpose of private use, but there may be some taxable use, no input tax deduction will be available with respect to the taxable use (with no requirement for subsequent adjustments or for future disposal of the asset to trigger a GST liability).

Inland Revenue hopes these changes will reduce the cost of compliance for GST-registered businesses. However, it will be important to carefully consider whether the goods or services have been acquired for the principal purpose of making taxable supplies (or private use) as the principal purpose test does not necessarily mean a simple 50% use test. The longer-term overall purpose is key and there is historic case law in this area that may need to be revisited.

The principal purpose test will not apply to taxpayers who have an apportionment methodology agreed with Inland Revenue.

New disclosure requirements for assets acquired from 1 April 2024

Inland Revenue will impose obligations to disclose additional information upfront when land, aircraft and pleasure craft are acquired as part of a taxable activity. The rationale for this is to ensure that Inland Revenue has clear information about when a taxpayer is acquiring the high value asset so that any GST input credits (or benefit of and zero-rating) can be recouped in the event that the asset stops being used as part of a taxable activity (for example, Inland Revenue will be able to make enquiries if a taxpayer acquired a boat for running charter tours but starts filing consistent nil returns).

This new rule will apply from 1 April 2024, and Inland Revenue will be working out how to exempt taxpayers from being required to disclose information where they are at low risk of using an asset for exempt or private purposes.

Transition of goods outside of GST base

A proposal which will be of particular interest for those businesses who have mixed-use assets is the ability to elect for assets to be taken out of the GST net (to stop the future sale from being taxable). This will be of interest for holiday homes that are rented out short term. Under this election, previously claimed GST will be repaid, with the quid pro quo being that GST is not required to be returned on a future sale – which may be a preferrable outcome for appreciating assets which may be likely to be sold to non-registered purchasers. This rule will also apply to the land acquired as a zero-rated supply.

The application of this rule is complicated and is best illustrated with this example taken from the Bill commentary:

Acquiring a holiday home as a zero-rated supply of land

Gavin is a registered person who acquires a holiday home from another registered person. Gavin’s principal purpose for acquiring the holiday home is to use it for his own private recreation (and not as his principal place of residence). However, because Gavin also intends to use the holiday home for a secondary and more minor purpose of making taxable supplies of guest accommodation, he acquires the holiday home as a zero-rated supply under section 11(1)(mb) for $1m (rather than a standard-rated supply of $1m plus $150,000 of GST, which would have been the price had section 11(1)(mb) not applied to the supply).

Under proposed new section 20(3J), if Gavin intended to use section 14(4) to make his future disposal of the holiday home an exempt supply, he could choose to return output tax of $150,000, being the full amount of the nominal GST component. If he did this, section 14(4)(d) could then be satisfied for a future disposal of the holiday home.

Alternatively, Gavin can choose to return the smaller amount of $105,000 output tax under section 20(3J) based on his 70% expected non-taxable use of the holiday home at the time he acquires the holiday home. However, if he does this, a future disposal of the holiday home would not qualify for the exempt supply rule in section 14(4)(d) as he would not have returned the full amount of the nominal GST component on acquisition of the zero-rated supply of land.

Proposals in the Bill also allow a GST-registered person to elect to treat certain goods as being an exempt supply where the goods were not acquired for the principal purpose of making taxable supplies (even where there will be a small amount of business use). This change will be particularly relevant in the context of dwellings with a minor use in a registered person’s taxable activity (such as the use of a home office).

GST-registered persons will be able to elect to treat the sale of that property as an exempt supply and therefore will not be required to carry out a GST apportionment calculation in respect of the business use. While this is a positive change to the rules, care should still be taken as there are a number of requirements that must be satisfied to make the election (including having not previously claimed any partial input tax deductions in respect of the business use of the asset). Again, this change is illustrated in the following example taken from the Bill commentary:

Dwelling with a minor use in a registered person’s taxable activity

Rebecca is a registered person who acquired a dwelling that was not a zero-rated supply when it was acquired. She did not claim deductions under section 20(3) for the cost of acquiring the dwelling or of any subsequent capital improvements to the dwelling. Although part of the dwelling is used to run Rebecca’s taxable activity of farming, the dwelling’s principal purpose is a private residence. Rebecca claimed input tax deductions for certain overheads and operating costs, such as insurance, utilities and local authority rates, based on the percentage that these services were used to make taxable supplies.

Under the proposed amendments, when Rebecca sells the dwelling, she would be able to elect to treat the sale as an exempt supply of goods as it meets the requirements of the proposed new section 14(4).

Number of adjustment periods

There are changes to the number of adjustment periods required for mixed-use goods. The key changes in this area are:

The threshold for not requiring any adjustments increases from goods valued at $5,000 or less to $10,000 or less (as outlined above in relation to the principal purpose rule); and

Land (regardless of the value of the land) will now require a maximum of 10 adjustment periods only (under current law, the required number of adjustment periods for land is unlimited).

This land change is significant for long-term property owners who have both exempt residential rental and commercial leasing on the same site. The change is also significant for the retirement village sector where land is typically used for a mix of taxable and exempt purposes.

Whilst on the topic of adjustment periods, in situations where there is a permanent change of use, there will no longer be a requirement to make the permanent change over two adjustment periods – instead, the change will apply at the end of the adjustment period in which the permanent change in use occurs. This is great.

More flexibility in GST apportionment methodologies - another case of out with the old and in with the… older

Another change is that Inland Revenue will have the ability to approve a greater range of GST apportionment methodologies than can be approved under the current legislation. The key overarching requirement under the proposed change here is that any alternate apportionment methodology must be a ‘fair and reasonable method’ of GST apportionment (or proxy).

Of particular interest is that it appears Inland Revenue are open to allowing property developers to ‘remit’ GST on interim residential rental income prior to sale (as an alternative to having to make GST input tax apportionment calculations). This used to be fairly common practice and is a pragmatic outcome we support.

What should I do next?

Now is a good time to look at GST apportionment methodologies and seek advice from experts. Unexpected GST bills can be significant so it is worth looking at these rules closely. Reach out to your local indirect tax specialist for how we can help you navigate the proposed changes.