Something we’re often asked to clarify are the compulsory zero rating rules that apply to all land transactions between GST registered people.
With tourists flocking back to New Zealand and renewed interest in holiday let properties and serviced apartments (which are generally subject to GST), it’s important to gain an understanding of these rules. It’s particularly important if you haven’t had to deal with GST on your property investment journey before.
The compulsory zero rating rules (CZR) were introduced during the GFC. The government had become concerned that deals were slipping through the cracks, with refunds being issued to buyers where insolvent vendors were unable to make the corresponding GST payment on land transactions.
The solution was to apply zero rating to all land transactions between GST registered parties where certain criteria were met. This eliminated the risk of the government being caught in the middle with a refund due on one hand and no ability to recover the GST owing on the other.
For zero rating to be compulsory, the three criteria are…
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Both parties must be GST registered.
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The buyer must undertake that they will be using the property in a GST taxable activity.
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The buyer must undertake that the property will not be their principal place of residence.
Many of you will be familiar with the standard form sale and purchase agreement, which has been updated numerous times. It seeks to capture all undertakings necessary to gain clarity on the status of the contracting parties’ GST registration, and also the undertakings necessary to meet CZR criteria. The key part of the agreement is the schedule 1 GST warranties section. This should be completed in full whenever GST is a feature of the contract in question.
Despite the contract being designed to capture all relevant information, it’s surprising how often GST poses difficulties and creates misunderstandings when negotiating property deals.
There are a couple of key things to understand.
A GST registered vendor selling a property that’s part of their taxable activity will generally want to negotiate on a ‘plus GST basis’. This is because they have a GST liability when they sell the property and must look to charge GST and pass it to IRD unless the transaction is zero rated.
On the other hand, buyers often believe that an ‘inclusive of GST’ contract is safest for them. Problems arise when there are misconceptions about what rate of GST applies to an ‘inclusive of GST’ contract.
Consider this example.
Joe is new to the game of property trading. He has GST registered his activity and has so far purchased and sold two properties from unregistered vendors. In both cases he used an ‘inclusive of GST’ contract. This meant he was able to get GST refunds on acquisition using the second-hand good rules, which allow a claim when a property is sold from an unregistered vendor to a registered buyer who will use the property in his taxable activity.
However, his 3rd deal involves a purchase from a GST registered builder who is on-selling a spec build project he now can’t complete.
The builder confirms in the contract that he’s GST registered and that the property is part of his taxable activity. Joe insists on a contract that‘s inclusive of GST, assuming this will mean the contracted price includes the full 15% GST that the builder will have to pay.
Joe completes the schedule one declarations and confirms he is registered, will use the property in his own taxable activity, and will not reside in the property. He then settles the purchase and submits his claim for the 15% GST he assumes is included in the contract price.
IRD audits his GST claim and quickly determines that because the vendor builder is GST registered and Joe gave all the undertakings required, the contract is compulsorily rated.
This means the price includes GST at the rate of zero, not 15% – so Joe receives no refund and the vendor has no payment. Joe protests that he would not have paid as much as he did for the property had he known the GST was at zero rate. The vendor simply smiles and walks away.
Joe is left with the sobering realisation that he’s already blown any margin he may have made on the project before he’s even out of the starting blocks.
So, the lesson here is to come to grips with the second-hand good rules for GST and the impacts of the zero-rating rules on your contracts.
Remember that most serviced apartments and many properties used for short term lets may be sold by GST registered vendors who are subject to GST.
Never assume that a vendor is not GST registered, insist on the Sale and Purchase agreements being completed fully, and be very conscious of the GST status of the other party and the significance of whether the contract is inclusive of or plus GST.
And most importantly, always take professional advice before entering the contract if you’re in any doubt about the GST issues associated with it. It’s safer to assume you might not know everything you need to know about how the GST rules operate!