GST Direct: Bringing you the latest GST and Customs developments

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1 GST Direct: Bringing you the latest GST and Customs developments March 2018 Issue 32 What s in this issue: Low value goods and GST What could be in store for New Zealand? When do you have a taxable activity? What we are seeing with property transactions

2 Low value goods and GST What could be in store for New Zealand? 1 The issue of GST and low value goods (LVG) has been debated for a number of years with officials from both Customs and Inland Revenue having spent considerable time trying to tackle the issue. This particular issue continues to be an area of focus for the new Labour-led Government and this is reflected in the Government s request that the Tax Working Group (TWG) consider the issue. We therefore expect that the TWG will include some comment on the imposition of GST on LVGs as part of their report, which is also expected to cover other GST matters. What is the problem? Currently, imports of goods below the current LVG threshold are not subject to import duty or GST. The LVG threshold is minimum taxes of $60, which equates to goods value of $225-$400 (as some goods are not subject to duty). While the policy rationale to have a LVG threshold may have been sound in the past (the cost of collection being more than the revenue collected), the increasing ease with which we are able to purchase goods offshore means that we need to revisit the current rule and re-examine whether it is still good policy. One particular area of concern is fairness. Specifically, the pricing advantage that is afforded to offshore sellers by having no New Zealand GST collected on the sale and ultimate importation of goods. While there may be a number of factors that contribute to the pricing of goods by offshore and domestic sellers, tax should not be one of those factors. The issue of GST and LVG is a good example of the need for us to continue to challenge the current framework to ensure that it remains fit-forpurpose in the modern environment. This need to challenge current thinking and be agile in forming solutions is more relevant than ever in our rapidly changing digital world where how we do business is morphing all the time. The recent remote services rule is an excellent example reflecting successful changes made to our GST legislation to deal with the changing business and consumer landscape. The requirement for foreign suppliers with no physical presence in New Zealand to register and return New Zealand GST on supplies made to New Zealand consumers is a move away from the traditional model which generally looks to the physical presence of the supplier and not the consumer. The issue of GST and LVG is a good example of the need for us to continue to challenge the current framework to ensure that it remains fit-for-purpose in the modern environment.

3 While there had been initial concerns as to the success of implementing such a rule, the tax that Inland Revenue has collected would suggest otherwise. When the remote services rule was being developed it was estimated that there was a revenue leakage of approximately $40 million of revenue a year, however with over 160 registrations the rule has generated more than $125 million of annual GST to date and it is expected this will continue to climb. The success of the remote services rules would suggest that businesses understand the world in which they operate is changing and therefore their view of where they need to pay tax may also be changing. This is consistent with the OECD and various countries (including New Zealand) continuous focus of eliminating base erosion and profit shifting practices in ensuring businesses are paying their fair share of tax. What could the potential solutions be? It is generally recognised that the issue of GST and LVGs purchased from offshore suppliers is more complex in nature than those that arise in relation to the purchase of remote services. This is evident from the fact that a number of countries have chosen to park the issue of LVGs even though they are looking to implement a remote services rule. The only exceptions are Australia and Switzerland Australia will start applying Australian GST to the sale of LVGs into Australia from 1 July In brief, LVGs (AUD1,000 and under) supplied by offshore suppliers to Australian private consumers will become taxable supplies for Australian GST purposes. Therefore, if the offshore supplier s GST turnover exceeds the registration turnover threshold of AUD 75,000 it is required to register for GST in Australia. Where supplies of LVGs are made through an Electronic Distribution Platform (EDP), the GST liability shifts to the operator of the EDP (generally online marketplaces that act as intermediaries for the offshore supplier). Australia s solution to the issue of GST and LVGs is commonly referred to as the vendor collection model. The Australian Productivity Commission s inquiry into the Collection model for GST on Low Value Imported Goods found that the vendor collection model was the most feasible model to adopt at this time when compared to other potential collection models, which all have more significant drawbacks. Australia will start applying Australian GST to the sale of LVGs into Australia from 1 July 2018.

4 We explore the various collection models in more detail below. Vendor collection model As the name suggests, the GST liability generally will sit with the offshore supplier under this model. This is effectively the same model adopted in relation to the remote services rule. However, despite the acceptance of such a model for remote services, significant feedback was provided to the Australian government when this model was first tabled as the collection model for LVGs. The key areas of concern included that the reliance on voluntary registration from offshore suppliers would mean the model is less effective and that offshore suppliers will face significant burdens collecting GST. The feedback resulted in the Australian Productivity Commission s inquiry referred to above. Despite the key concerns, the Australian Productivity Commission still found the vendor collection model to be the most appropriate at the current time. Specifically, it will have the impact of improving the tax neutrality between imported and domestically retailed goods, and avoiding disruptions to consumers when importing the goods. Transporter model A transporter based collection model would require the delivery agent (e.g. postal operator, express carrier or other commercial agent) to collect and return the GST. It is envisaged that this model could capture more revenue as the GST liability will lie with a person within the country. However, the feasibility of such a model could be hampered by the domestic customs declaration process and in the case of Australia, this was what stymied the development of this option further. Specifically, Australia still relies on a paper based declaration. Ensuring the transporter has the required information could also be an issue. As such, the view was that this model would impose high administrative and compliance costs, and could cause inconvenience for consumers. Border collection model This model would effectively extend the current collection model for high value goods. A key issue with this model is that the likely cost of collection will generally outweigh the revenue collected. As a result, this collection model has often been disregarded and considered as unworkable in relation to LVGs given the significant administrative and compliance costs it would entail. Furthermore, this model would also likely result in significant delay in the delivery of the goods to consumers.

5 Financial intermediary model The financial intermediary model would require the GST to be collected by banks, credit card providers and other financial intermediaries when the payment is made by the consumer for the supply of goods. In some countries there was some backing for this model. There were seen to be positive features such as the legal liability for GST collection would generally fall on entities that have a presence in the country of import. Furthermore, there is also scope for the better use of data and information technologies to monitor enforcement at modest cost. However, the challenge of this model is that there is an assumption that current payments systems capture and transmit sufficient information for the financial intermediary to assess the GST liabilities. The current systems simply do not capture enough information to make the model feasible. While payment system upgrades are allowing for greater information capture and transmission, the most common payment methods for cross border purchases are unaffected, and the diversity of payment options presents additional challenges. Therefore, it is difficult to see how this model could be implemented in the near future and it would also place an unfair burden on the banks and financial intermediaries. Purchaser self-assessment model This model would require the consumers themselves to return GST on the import of LVGs. Such a model would be a significant departure from the conventional GST collection model whereby it is generally not the purchaser but the supplier that has the GST liability. The supplier model is generally more efficient as it is easier to require one person to register and return GST on all the supplies they make as opposed to requiring every one of the customers to register. This would be the case under a purchaser self-assessment model. What about New Zealand? Given the recent successes of the remote services regime, there is real merit in considering the vendor collection model in New Zealand. The argument that offshore suppliers would not voluntarily register in a foreign country seems to be diminishing as more and more countries start adopting foreign vendor collection models in the collection of GST, especially in the area of intangibles. It will be interesting to see the level of compliance by foreign suppliers of LVGs in Australia when their new rules come into effect from 1 July We would expect New Zealand officials to keep a close eye on the developments as they continue to consider the most appropriate approach to adopt. The international trend (such as in Europe) is to move towards vendor collection models. There are likely to be thousands of offshore sellers of goods (compared with several hundred remote services sellers) so it is important to make sure that registration and compliance is made as easy as possible. OECD has also recommended that countries could consider flexible features such as using the vendor model in combination with an intermediary model (for small to medium sellers) and using fast track processing and/ or the bulk-shipper scheme. It is also likely that New Zealand will consider whether the minimum LVG threshold should be based on minimum taxes or value of goods - the latter would make processing at the border easier. In our view, the vendor registration model is worth considering for New Zealand, especially given the alignment to our remote services rules. Such a model is also broadly in line with international initiatives in this area, particularly with Australia as well as the European Union, which is also planning to implement something similar.

6 When do you have a taxable activity? What we are seeing with property transactions 2 To avoid an unexpected GST bill or lawsuit, vendors and purchasers should be fully aware of the GST implications of every property transaction they enter into, and take steps to ensure they are protected in the event Inland Revenue challenges their GST status. When undertaking any venture, determining whether you must register for GST is a crucial step. Registration depends on whether or not you have a taxable activity. A taxable activity is defined in the GST Act as any activity which is carried on continuously or regularly and involves, or is intended to involve, the supply of goods and services to another person for consideration. For many people, this issue of whether or not you have a taxable activity comes up in the context of property transactions. This is also the area that has given rise to the most litigation on what constitutes a taxable activity. It comes up in particular in the context of: Subdivisions. Situations where land is sold after undertaking development work. Where property is bought and then sold within a short period of time. Newman Court of Appeal decision a oneoff subdivision was not a taxable activity The landmark case on what amounts to a taxable activity in relation to property is the Court of Appeal s decision in Newman v C of IR (1995) 17 NZTC 12,097. Newman was a GST registered builder who completed a one-off subdivision involving the division of a single section into two, including some electrical and drainage work. Inland Revenue ruled that the subdivision and subsequent sale of the property was a taxable activity and assessed Newman for GST on the sale. The case ended up going all the way to the Court of Appeal and the Court overturned Inland Revenue s assessment, ruling that the subdivision could not be regarded as a continuous or regular activity and therefore Newman was not carrying on a taxable activity in respect of the property. The activity was a one-off. The minimal development work involved was also considered relevant. Following the Newman decision, Inland Revenue released a policy statement expressing the view that a subdivision into two lots, with no development work, would not by itself amount to a taxable activity. A taxable activity would be more likely to arise if a greater number of lots were created, the development work was more extensive, or there was a greater commitment of time and money to the project. A taxable activity is defined in the GST Act as any activity which is carried on continuously or regularly and involves, or is intended to involve, the supply of goods and services to another person for consideration.

7 Recent developments For many years, advisers have felt fairly confident about where the dividing line sits between an activity that does not amount to a taxable activity and one that does. Although fact dependent, a one-off small scale subdivision or development should not be a taxable activity. But lately the issue seems to have become murkier. Inland Revenue has increasingly been challenging the GST status of unregistered persons selling property. We also hear of situations where Inland Revenue has agreed, upon request, to register people in respect of very small scale developments. Conversely, we see situations (discussed further below) where Inland Revenue seek to deny GST refunds on the basis that the taxpayer does not conduct a taxable activity. Inland Revenue has also challenged a purchaser s claim there is a taxable activity when it is likely that a future sale of the developed property or assets (e.g. trees) may take some time to eventuate. These cases are always fact specific. Inland Revenue no longer seem to have a clear policy on taxable activity, or perhaps struggle to apply their policies consistently. This makes it more and more difficult for taxpayers to assess their GST position, and for advisers to advise with confidence in this area. Uncertainty in the tax system can never be a good thing. Not just a problem for vendors of land. Purchasers also beware! In the past, if Inland Revenue sought to backdate a vendor s GST registration and apply GST to a sale of land, this would have meant the vendor would be assessed with GST on the transaction. It would then depend on the pricing terms of the contract for sale as to whether the cost of that GST would be borne by the vendor or the purchaser (depending on whether the price was inclusive of GST or plus GST (if any)). However, the issue has become more complex since the introduction of the compulsory zero-rating of land (CZR) rules. We have covered the CZR rules in several previous issues of GST Direct. CZR requires a supply of land from a GST-registered person to another GST-registered person (who acquires the property with the intention of using it to make taxable supplies and not as a principal place of residence for themselves or an associate) to be zero-rated for GST purposes. If CZR does not apply vendor problem: If Inland Revenue asserts that the vendor should have been GST-registered and backdates this registration, a vendor of land will still be assessed with a GST liability if CZR does not apply. This will be the case where the purchaser of the land is not another GST-registered person or does not acquire the property with the intention of using it to make taxable supplies. If CZR applies purchaser (or nominee) problem: However, if CZR applies (because the sale is from one GST-registered person to another), this should not give rise to a tax liability for the vendor. This is because the sale of the land would have been zero-rated for GST. That is, GST would apply, but at 0% - so there would be no GST for the vendor to pay. But it is likely to detrimentally affect the purchaser. A GST-registered purchaser such as a developer, who buys land from an unregistered vendor, will usually make a secondhand goods GST input tax claim in respect of the purchase. The purchaser will factor in the GST refund that will arise as a reduction in the cost of the land. However, a secondhand goods claim cannot be made if the supply of the land was subject to GST, even at 0% under the CZR rules.

8 Ling case We are aware of several recent situations where Inland Revenue has alleged that an unregistered vendor of land carried on a taxable activity in situations which (at least on the face of it) safely fall on what most tax practitioners would call the non-taxable side of the dividing line. This includes what appears to have been a simple buy and sell transaction within a short timeframe, as was the High Court case YL NZ Investments v Louise Ling (2017) 28 NZTC Inland Revenue registered the vendor retrospectively, after the transaction had completed. The purchaser was GST-registered and CZR applied, and this meant the purchaser could not claim the secondhand goods credit they had been anticipating. The vendor had warranted in the sale agreement that she was not GST registered, and the purchaser claimed under a breach of this warranty for the loss they had suffered in not being able to claim the credit. The case is interesting not only because the High Court allowed the purchaser s claim, but also because the Judge expressed the (obiter) view that the vendor, when she had merely bought and sold a property in a short period of time, was clearly carrying on a taxable activity. In our view, this comment contradicts settled case law principles and Inland Revenue s policy. Practical implications of Ling case The case highlights the onus on vendors to ensure they correctly state their GST status on the sale and purchase agreement. If they do not, or if Inland Revenue disagrees with their unregistered status, they may be liable to compensate a purchaser if the purchaser cannot claim a secondhand goods input tax credit. GST-registered purchasers need to be aware that their secondhand goods input tax credits are likely to be subject to Inland Revenue scrutiny, and this may include investigations into whether the vendor carried on a taxable activity. If the facts give rise to any concerns around the vendor s unregistered status, the registered purchaser should proceed with caution. Unless the Ling decision is overturned on the upcoming appeal, the purchaser may be able to claim for the loss of a denied secondhand goods claim through the courts which although not ideal, at least provides a remedy. Before signing a contract to purchase land, ensure that it adequately provides for this contractual remedy. We think there is also a need for Inland Revenue to publish updated practical guidelines on what should, and should not, constitute a taxable activity in the context of property transactions. We cannot tell from the facts available precisely what Inland Revenue s basis was for deciding the vendor had a taxable activity. Perhaps there were wider issues at play; hopefully in registering the vendor Inland Revenue considered additional factors (or other transactions) rather than the mere fact the property was bought and sold in quick succession. The case is subject to appeal.

9 Contact us If you have any questions regarding the issues covered in this publication, please contact your usual PwC adviser or a member of our GST team. Our team can help you by delivering practical GST and Customs solutions and effectively managing your indirect taxes risk. Auckland Wellington Eugen Trombitas T: E: eugen.x.trombitas@nz.pwc.com Phil Fisher T: E: phil.j.fisher@nz.pwc.com Catherine Francis Senior Manager T: E: catherine.d.francis@nz.pwc.com Ian Rowe Director T: E: ian.rowe@nz.pwc.com Waikato Hawkes Bay Taranaki Kazune Obata Manager T: E: kazune.s.obata@nz.pwc.com Hayden Farrow T: E: hayden.d.farrow@nz.pwc.com Michael Hinton T: E: michael.hinton@nz.pwc.com Michelle MacDonald Director T: E: michelle.d.macdonald@nz.pwc.com Sandy Lau Director T: E: sandy.m.lau@nz.pwc.com Annabel Duncan Senior Manager T: E: annabel.k.duncan@nz.pwc.com Josie Goddard Manager T: E: josie.r.goddard@nz.pwc.com Canterbury Brent Hulbert T: E: brent.hulbert@nz.pwc.com Otago Richard McKnight T: E: richard.mcknight@nz.pwc.com Henry Risk T: E: henry.c.risk@nz.pwc.com pwc.co.nz 2018 PricewaterhouseCoopers New Zealand. All rights reserved. PwC refers to the New Zealand member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. Disclaimer: GST Direct is intended as comment only and should not be relied upon or used as a substitute for professional advice. No liability is accepted for loss or damage incurred by persons who rely on this commentary. Professional advice should be sought in relation to any particular situation or circumstance.