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Proposed GST domestic reverse charge…a good idea?

GST is a hazardous tax, not only for taxpayers, but also for the Government. Unlike income tax, the Government has a commitment to refund GST, and this part of the GST mechanism leaves the tax open to manipulation.  The hazard is greatest where the assets are the most expensive.  The domestic reverse charge mechanism will to an extent reduce the risk the Government faces from being ripped off through the GST system in relation to the most expensive items being traded in our economy.

Is a domestic reverse charge a good or bad idea and why is this important?  It is important because it is likely that this will form part of the New Zealand GST landscape in the future.  The recently released Government discussion document “GST: Accounting for land and other high value assets” proposes a domestic reverse charge for supplies of land, going concerns and the supply of assets in excess of $50m.  It is also a good idea, because the law relating to the supplies of going concerns is unfortunately not as clear as it could be.  The domestic reverse charge is likely to remove this uncertainty.

What is a domestic reverse charge?

What is a domestic reverse charge?  For those familiar with GST, it is the domestic version of the international reverse charge.  For those not familiar with GST, the reverse charge is a mechanism whereby the normal charge of GST is reversed.

In the normal GST scenario the supplier will charge the purchaser GST, and return this GST to the IRD.  If the purchaser is registered for GST, that purchaser will be able to claim the GST so paid as a refund.  The reverse charge works by substituting the normal treatment where the supplier charges GST with the purchaser charging itself GST as if it were the supplier.  So, from a GST perspective, the same person is treated as making and receiving the supply.  If that person were able to get all its input tax credits back then the GST position is neutral.

The proposal is for this domestic reverse charge to replace the current going concern zero rating provisions, and in addition apply to the supply of land and high value goods or services.

Some points on the domestic reverse charge

How would the domestic reverse charge be better than what we have now?  In relation to going concerns, we would still have the problem of deciding what qualifies and what does not, as we have with the current going concern provisions.  However, these definitional issues will be ameliorated by the provisions also applying to land and other high value assets.

The problem most frequently encountered is where there is a mistake of fact about a going concern transaction.  This mistake causes a transaction that would otherwise fall within the zero rating provisions to fall within the standard rating provisions, and consequently result in an underpayment of GST.  This is most acute where the sale of land takes place, and it is not clear whether that land forms part of a business and can therefore be zero-rated as the supply of a going concern.  Treating the supplies of land and going concerns in the same way would remove the potential risk of the mistake about fact from having any impact on the taxpayer’s GST position.  This part of the proposals should be applauded.

The domestic reverse charge is not only of benefit to taxpayers; it is also of benefit to the Government, because it reduces the Government’s risk of being ripped off.  In Europe recent experience has proved that the indirect tax systems are particularly prone to fraud, for example, refer to the very well publicised carousel fraud or missing trader fraud experienced there.  The inherent problem with indirect tax is that it is collected by taxpayers on behalf of the Government, and as such, taxpayers are often tempted not to hand over the tax collected.  This is what happens with carousel fraud, and a domestic reverse charge essentially removes this inherent risk from the GST system.

Some practical implications of the introduction of the domestic reverse charge are that the well known and understood GST clauses of the ADLS contracts would have to be re-written, and re-interpreted.  The time of supply rules will become more complex as special rules are needed to ensure GST is accounted for correctly.  In addition, the mortgagee sale provisions will be excluded from the application of the reverse charge, and some new provisions will apply for debit and credit noting purposes.

Is the domestic reverse charge a step in the right direction?  On balance, it would appear so.  The addition of land and high value assets will increase the scope of what is now the going concern zero rating provisions, and this will in turn allow for better operation and less uncertainty regarding these provisions.  In tax policy the trade-offs are usually between fairness and complexity.  This proposal will certainly result in a fairer treatment for taxpayers and the Government, but the complexity of the whole GST Act is likely to increase.

For other articles relating to New Zealand law refer to our firm’s New Zealand Lawyers blog.

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