On 5 November 2009 the Government released a discussion document, "GST:  Accounting for land and other high-value assets" ("Discussion Document"), which proposes some significant changes to the GST rules.  The main proposals are outlined below.  Draft legislation for some of the proposals accompanies the Discussion Document.

Introduce a domestic reverse charge shifting GST liability from supplier to recipient 

A domestic reverse charge ("DRC") is proposed to apply to transactions involving land, going concerns (which would no longer optionally be zero-rated) and other goods/services with a GST exclusive value of $50 million or more.  A GST registered recipient would be required to self assess and return GST on the transaction, with normal GST rules governing the availability of an input tax credit.  The DRC would not apply to "progressive" or "periodic" supplies between non-associates such as under construction contracts or leases, nor to mortgagee sales.  A party representing themselves as being GST registered would be liable for GST under the DRC even if not actually registered.

The proposal is partly in response to revenue loss concerns where GST remains unpaid by an insolvent vendor but the purchaser has claimed an input tax credit, as well as where phoenix-type fraud and GST accounting basis mismatches are involved.  From a taxpayer's perspective, it seeks to eliminate the cashflow cost that GST can represent in what should be GST "neutral" transactions (including in a variation/cancellation scenario).  It is intended that the DRC be triggered when payment in full is made on settlement of a transaction - as opposed to when a deposit is made - although the draft legislation accompanying the Discussion Document does not achieve this.

The DRC represents a fundamental change in GST policy.  In some circumstances it will helpfully eliminate GST funding cost.  In other cases, however, it will shift what is currently an Inland Revenue risk (ie what would contractually have been a vendor risk) to the purchaser.  A purchaser is unlikely to be in the best position to determine the appropriate GST treatment of a transaction, particularly where a vendor has been making a mixture of taxable and non-taxable supplies.

Under the proposed DRC, the purchaser is exposed to Inland Revenue for the GST charge (including interest and penalties) if it gets the treatment wrong.  Even if the purchaser has contractual protection in the form of representations from the vendor, recovery from the vendor may not be feasible.  The compulsory nature of the proposed DRC ignores the fact that parties may wish to allocate GST risk wholly or partly to the vendor.  It also assumes that a purchaser can obtain sufficient information from a vendor so as to be certain of the GST treatment of a transaction.  In our view an "opt out" mechanism should be considered.

Further work will also be required to ensure that the DRC works appropriately for a transaction that involves a nominee.  It is also possible that business sales of less than $50 million in value that do not strictly fall within the "going concern" definition cannot benefit from the DRC, meaning that the revenue loss and funding cost concerns remain for those transactions.

Expand the circumstances in which GST liability is shifted to a mortgagee

Where a lender sells a property under a power of sale to satisfy a debt owed by a borrower, under current GST rules the obligation to account for GST is shifted from the borrower to the lender.  In response to an apparent rise in what the Discussion Document describes as "de facto mortgagee sales" (under which a sale is presented as being conducted by the borrower, in circumstances where it has been arranged "in substance" by the lender), it is proposed to widen the ambit of the mortgagee sale GST rules to include situations in which a lender has "initiated and/or controlled" the sale.  

The Discussion Document outlines a number of criteria, any one or more of which would bring a sale within the mortgagee sale rules.  Some of the criteria would already bring a sale within existing GST rules governing mortgagees in possession.  In this respect the Discussion Document does not appear to recognise the difference between a mortgagee sale and a situation in which the mortgagee enters into possession.  Other criteria seem to set a low threshold for establishing that a sale has been initiated and/or controlled by a mortgagee.  The Commissioner will have a discretion to disapply the expanded mortgagee sale rules, if the sale is "more in the nature of a genuine mortgagor sale".

These are significant changes, improving the Commissioner's priority in an insolvency, at the expense of other creditors.  The discretion is a powerful one, effectively permitting the Commissioner to determine his priority in relation to a financially distressed taxpayer.  In our view this proposal warrants a great deal of further consideration and consultation.

Replace the "change in use" adjustment regime with an apportionment approach 

Currently a full input tax deduction may be claimed for GST paid on goods and services acquired for the principal purpose of making taxable supplies.  No deduction is allowed if the goods and services are not acquired for that principal purpose.  Under this approach, on-going adjustments are subsequently made to reflect the correct mix of taxable and non-taxable use. 

A new apportionment-based approach is proposed, which seeks to apportion the initial input tax deduction up-front, according to the anticipated use of goods/services.  GST registered persons would be required to estimate the extent to which they will use goods or services for making taxable supplies, and this would form the basis of the up-front input tax credit.  Annual adjustments would be required (subject to certain exceptions) where the actual taxable use differs from the previously intended taxable use.  It is proposed that the new apportionment system would apply for assets acquired after the date of enactment.

Clarify the definitions of "dwelling" and "commercial dwelling" 

The supply of accommodation in a "dwelling" (which excludes a "commercial dwelling") is exempt from GST.  It is proposed that the definition of dwelling be narrowed, applying where a person occupies premises as their principal place of residence, and has exclusive possession of the premises - the focus being on the nature of the accommodation provided rather than the functional nature of the premises.  The intent is that the "dwelling" concept should constitute a narrow exemption from the broad GST base, only applying where there is a reasonable level of substitutability between renting and owning a home.  For example, under the amended definition, renting out a holiday home for a few weeks would no longer constitute the provision of accommodation in a dwelling.

A further proposal is to expand the "commercial dwelling" definition (and so the categories of taxable accommodation) to include homestays, farmstays and bed-and-breakfast establishments.  The fraught area of serviced apartments is to be addressed by specifically including these within the commercial dwelling definition if they are managed/operated by a third party, involve some degree of services in addition to the accommodation (such as a laundry service etc), and where the occupant does not have an exclusive right of possession.  Serviced apartments not satisfying those criteria may still fall within the general "commercial dwelling" definition.

Although the "dwelling" and "commercial dwelling" boundary by its nature will inevitably remain grey in some cases, the attempt to clarify the distinction is to be welcomed.  This is particularly so in the area of serviced apartment/unitised hotel developments, which rely on clear and neutral GST treatment for their funding.

Clarify transactions involving nominations - focus is on economic substance rather than form 

The GST treatment of transactions involving nominations has been uncertain for some time.  Under the proposal, in a bare nomination where the party that signs the sale and purchase agreement settles the transaction, there would be one supply for GST purposes between the vendor and that purchaser.  Where, instead, the nominee settles the transaction by paying the purchase price there would be one supply between the vendor and the nominee.  Where the nominee settles the transaction but the purchaser contributes to the purchase price (eg pays the deposit) the default rule would be one supply to the purchaser.  The parties would be able to opt out of this default rule and treat the transaction as involving one supply to the nominee, allowing the nominee to claim the input tax credit (it is not clear what information would need to be retained by a nominee in order to claim the credit). 

Again, this is a welcome proposal.  However, further work is needed in addressing the situation where the time of supply - crystallising GST consequences of a transaction - is triggered before a nomination has been made.

Submissions on the Discussion Document are due by 18 December 2009.  To view a copy of the Discussion Document, please click here.

The facts

Foodstuffs (Wellington) Co-operative Society Limited v CIR (High Court, Wellington, CIV 2009-485-1224, 28 October 2009, Simon France J) concerned the acquisition by Foodstuffs of all of the shares in North Island Dairy Company Holdings Limited ("North Island Dairy") in late 2003 and subsequent amalgamation of that company with three other companies.  The companies were amalgamated on 1 January 2004.  Kapiti Fine Foods Limited was the amalgamated entity ("Amalgamated Company").

The substantive tax issue and the Court's decision

Foodstuffs claimed a deduction for the purchase price of the shares on the basis that they had been purchased for the purpose of sale or other disposal, and were therefore "trading stock" and "revenue account property".  Under the form of amalgamation in question (section 222 of the Companies Act 1993) the shares in North Island Dairy (which was one of the amalgamating companies, but not the amalgamated company) were deemed to have been cancelled "without payment or other consideration".  Foodstuffs therefore claimed a deduction for the $2.3 million cost of the shares in North Island Dairy, but recognised no income arising from the deemed cancellation of those shares on amalgamation.

The Commissioner conceded that the shares were "trading stock", but considered that section GD 1(1) of the Income Tax Act 1994 ("1994 Act") applied to treat Foodstuffs as having received consideration on disposal of the shares (ie when cancelled upon amalgamation) for an amount equal to their market value.  The Commissioner assessed Foodstuffs on the basis that the market value of the shares was their purchase price - namely $2.3 million - and also imposed a 20% penalty for taking an unacceptable tax position.

The Commissioner's concession that the shares were trading stock is significant.  While the short-form amalgamation procedure in section 222 of the Companies Act 1993 provides for shares in amalgamating companies (other than the amalgamated company) to be cancelled, without payment or other consideration, that is a mechanical step rather than going to the legal effect of the amalgamation.  The legal effect of an amalgamation is that the amalgamating companies "continue as one company" (section 219), a point that is stressed in the leading New Zealand decision concerning the legal consequences of amalgamation (Carter Holt Harvey Ltd v McKernan [1998] 3 NZLR 403).  Section 225 of the Act describes an amalgamation as effecting a "conversion" of shares in the amalgamating companies - which is consistent with the notion that upon amalgamation  the amalgamating companies continue but in a different form.

This being so, it is difficult to see how a person acquiring 100% of the shares in a company with a view to amalgamating the company with other wholly-owned group companies can be said to have acquired the shares with the dominant purpose of disposing of them.  On the contrary, the dominant purpose is to retain, in the acquirer's business, the rights represented by those shares, albeit that the form of those rights is converted as a result of the amalgamation.  The Commissioner's concession that Foodstuffs had acquired the North Island Dairy shares for the dominant purpose of selling or otherwise disposing of them is for that reason surprising.

The concession is also noteworthy in light of the recent judgment in Westpac Banking Corporation v Commissioner of Inland Revenue (High Court, Auckland, CIV 2005-404-2843, 7 October 2009, Harrison J), in which the Commissioner seemed to take a contradictory position to his approach in Foodstuffs.  In Westpac, the Commissioner argued that property could only be purchased for the "purpose of selling or otherwise disposing of it" within the terms of the 1994 Act if the taxpayer did so intending to derive a profit or gain on resale or later disposal.  In the present case, it was never Foodstuff's purpose or intention to derive a profit or gain from the cancellation of the shares.

However, as the Commissioner conceded that the shares were trading stock, the Court was required to consider whether section GD 1(1) applied to treat Foodstuffs as having received consideration of $2.3 million for "disposal" of the shares on amalgamation.  Foodstuffs argued that section GD 1(1) applies only in cases where there is a disposal from a transferor to a transferee and that, as there was no such relationship in the present case, section GD 1(1) could not apply.   In support of this interpretation, Foodstuffs referred to the current equivalent to section GD 1 in the Income Tax Act 2007 ("2007 Act") - section GC 1 - which does require such a relationship.  Foodstuffs argued that section GC 1 of the 2007 Act was never intended to effect a substantive policy change and therefore section GD 1(1) should be read in the same way as the equivalent provision in the 2007 Act.

In response, the Commissioner argued that historical provisions cannot be read by reference to their current equivalents, and that section ZA 3 of the 2007 Act (which provides for the intended effect of the 2007 Act provisions in relation to the 2004 Act predecessors) only allows the use of old provisions to clarify ambiguities in the new provisions and not vice versa.  Therefore, section GC 1(1) of the 2007 Act could not be used to read into section GD 1(1) a requirement for a disposal from a transferor to a transferee.  In any case, the Commissioner argued that section GC 1 was "a mistake which needs fixing".

The Court found in favour of the Commissioner and did not consider that section GD 1(1) required a disposal from a transferee to a transferor.  In reaching this decision, it is clear that the Court was influenced by the alleged "windfall" that the Commissioner argued Foodstuffs would obtain if the Court adopted Foodstuffs' interpretation.

The penalties issue

Foodstuffs did however succeed in having the 20% penalty quashed.  The Court held that the scope of section GD 1 and its intended application were far from settled, and that it would be incorrect to impose a penalty because Foodstuffs had a tenable argument.  In reaching this decision the Court observed that the drafters of the 2007 Act appear to have taken the same mistaken position.

To view a copy of the case, please click here.

In Rotorua Regional Airport Ltd v CIR (High Court, Wellington, CIV-2008-485-2524, 12 November 2009, Mallon J), Rotorua Regional Airport Limited ("RRAL") applied to the High Court for a declaration that GST was not payable on a development levy of $5 charged to passengers departing from Rotorua Airport.  The central issue was whether the development levy paid by departing passengers was in consideration for a service supplied by RRAL, for GST purposes.  If it was, then RRAL was required to account to Inland Revenue for GST in respect of the levy.

The development levy was charged under section 4A of the Airport Authorities Act 1966.  Mallon J first considered whether the wording of this section meant that RRAL could only charge a levy for the use of the airport's facilities (ie a charge for a supply of services), rather than for the development of new facilities.  Her Honour held that this was not the case, and that the section permits the imposition of charges on airport users for services and facilities they are not actually using, such as facilities yet to be developed.  The relevant question was whether the development levy was "in fact" paid for the supply of services by RRAL.

Mallon J then reviewed relevant principles arising from case law, including the following:

1. GST is levied in respect of "supplies", and is therefore a tax on transactions rather than on receipts or turnover.
2. GST is charged on the supply of a good or service, and while services are broadly defined to mean anything which is not goods or money, to be a service there must be something provided.
3. There must be a nexus between the consideration and the supply of goods or services on which the GST impost may arise.
4. It is crucial to ascertain the legal rights and duties which are actually created by the transaction into which the parties entered.

Applying the above principles, Mallon J stated that the wording used with regard to the development levy (ie the passengers "purchased" a "ticket" to confirm they had paid the levy) was not determinative of the actual legal nature of the transaction.  Nor did her Honour consider that the use of funds received from the levy was relevant.

Her Honour held that the payment of the development levy enables departing passengers access to the aircraft, because if the levy was not paid then passengers would be denied access (ie RRAL could deny access as owner of the facilities).  Mallon J rejected RRAL's argument that this was merely a means of enforcing payment, deciding that payment for access demonstrated a nexus between the payment and services provided by RRAL (being the use of the Rotorua Airport facilities).  Having received the levy as consideration for its services, RRAL could then apply it to fund improvements. 

Given Mallon J's finding that RRAL collected the development levy from passengers to whom it supplied services (and as consideration for those services, for GST purposes), the development levy was subject to GST.

To view a copy of the case, please click here.

In Federal Commissioner of Taxation v Tasman Group Services Pty Ltd [2009] FCAFC 148 (22 October 2009) the Full Federal Court of Australia recently considered whether a subsidiary was a permanent establishment of its foreign parent company.  The case was decided in the context of Australia's commercial debt forgiveness rules.

The taxpayer, SBA Foods Pty Ltd ("SBAF", since renamed Tasman Group Services Pty Ltd), was an Australian incorporated and tax resident wholly owned subsidiary of a Japanese corporation, Sumikin Bussan Corporation Limited ("SBC").  SBC made several loans to SBAF to fund the acquisition of a meat processing and exporting business, and subsequently made further loans to provide SBAF with working capital.  Several of SBC's employees were seconded to managerial positions in SBAF. 

The Court ultimately held that the commercial debt forgiveness rules applied to a forgiveness of debt which occurred when SBC sold the shares in SBAF to a third party, Tasman Group Holdings Pty Ltd.  In confirming certain values for the purposes of those rules, SBAF would be assumed solvent unless "forgiveness of the debt was a CGT [capital gains tax] event [for SBC] involving a CGT asset [of SBC] having the necessary connection with Australia".  One issue before the Court was, therefore, whether SBC's assets had the "necessary connection with Australia", which in turn depended on whether the debts owed by SBAF were "used [by SBC] at any time in carrying on a business through a permanent establishment in Australia".

At paragraph 56 of its judgment the Court summarised the principles for determining whether SBC had a permanent establishment in Australia as follows:

While it may be accepted that the business was being financed by SBC, this does not inevitably lead to the conclusion that SBC was carrying on the business.  It is a trite proposition that, where a subsidiary, even if wholly owned by a parent company, carries on a business, the business is that of the subsidiary not the parent.  Irrespective of how closely it may monitor the business activities of the subsidiary, the parent does not itself carry on those activities but is engaged in the separate business of a parent or holding company which is, normally, the receipt of income in the form of dividends from the subsidiary.

SBAF made two arguments.  First it argued that SBC carried on business through a permanent establishment in Australia through SBC's seconded employees, who managed and supported SBAF's operations at SBAF's Australian head office.  The Court rejected this, upholding the Commissioner's submissions that "at its highest, SBC's business in Australia was the supply of executives" and that SBAF (not SBC) carried on the meat processing and exporting business.  In this regard, the Court also noted the commercial arrangements which included a fee payable by SBAF to SBC in respect of the secondees, interest payments by SBAF to SBC for which SBAF claimed deductions for Australian tax purposes, and SBC's arrangement of its taxation affairs - all of which were inconsistent with SBC having a permanent establishment in Australia. 

Secondly SBAF argued that SBC carried on business through a permanent establishment in Australia as a holding company, managing and financing its Australian subsidiary.  The Court also rejected this argument.  It did not accept that any such business was carried on through a permanent establishment in Australia.

Finally, as an alternative basis for its decision, the Court considered the requirement that, to have the "necessary connection with Australia", SBC must have "used" the SBAF debts in carrying on a business through a permanent establishment in Australia.  The Court held that although the lent funds were "used" by SBAF in Australia, this did not mean that the debts arising from the lending were "used" by SBC in Australia.  The Court stated that:

...the use by SBC of the assets constituted by the debts consisted of receiving interest payments or debiting SBAF in respect of its liability and extending from time to time the date for repayment of principal or interest. That was analogous to the use made by a banker of assets represented by loans to its customers and if there was a permanent establishment through which the business in which the use occurred was carried on, that establishment was in Japan.

This aspect of the case turned on the definition of "permanent establishment" under Australia's domestic law, but as regards New Zealand may be relevant to the "permanent establishment" definition in New Zealand's double tax agreements.  While the definition of "permanent establishment" differs from one double tax agreement to the next, this case serves as a reminder that a parent company is a separate legal entity from its subsidiaries, and that a subsidiary is not a permanent establishment of its parent simply because the parent monitors or controls it.

To view a copy of the case, please click here.

Legislation aimed at tackling offshore tax abuse, through increased transparency, enhanced reporting and stronger penalties, was introduced to the United States House of Representatives on 27 October 2009.  Once enacted, it is intended that the Foreign Account Tax Compliance Act of 2009 ("Bill") will raise US$8.5 billion in US tax over the next ten years.

The Bill will impose significant withholding tax penalties on non-US entities that do not disclose holdings in them by US individuals or firms.  It is expected that most entities will disclose the required information to avoid paying the penalty tax.

Key features of the Bill include the following:

1. Non-US financial institutions will have to agree to disclose identifying details, account balances and details of account movements of their US clients (including certain US persons and foreign entities with substantial US ownership) or face a 30% withholding tax on income from their US assets.  
2. Non-US non-financial entities will have to disclose the name, address and tax identification number of any US person that owns more than 10% of the entity or face a 30% withholding tax on income from their US assets.
3. Individuals and entities will have to disclose non-US financial assets worth US$50,000 or more (or face a penalty).  The statutory limitation period will be increased from three years to six years where there is a substantial omission from a tax return of income derived from offshore assets.
4. Tax or investment advisors will have to disclose the identities of any clients they assist in buying off-shore assets, as well as information relating to the assets purchased. 
5. Existing sanctions on bearer bonds that are able to be purchased by US investors will be extended to all bearer bonds issued by a US issuer - including those marketed to non-US investors.  The US government will be prevented from issuing bearer bonds.  It has also been suggested that non-US issuers may be exposed to the 1% US excise tax on bearer bonds - even in the case of a non-US offering - and that some clarification in that respect would be welcomed.
6. It will become easier for the US Department of Treasury to proceed on the basis that non-US trusts have US beneficiaries (which imposes various reporting obligations on the trust).
7. Dividend equivalent payments that are included in notional principal contracts and paid to non-US investors will be subject to the 30% dividend withholding tax.

The Bill omits proposals from an earlier bill that would have allowed the US government to "blacklist" tax haven countries and effectively bar their financial institutions from interacting with US banks.  It is a continuation of efforts by the US to reduce tax evasion by US citizens and increase transparency in the international banking activities of US citizens.

To view a copy of the Bill, please click here.

During their recent fourth session, the Tax Working Group discussed New Zealand's present company tax system, possible alternative company tax systems, and the inbound interest allocation (ie thin capitalisation) rules.

To access the web page relating to the fourth session of the Tax Working Group, please click here.

In a series of special reports, Inland Revenue has provided an early release of guidelines that will be published later this year in the Tax Information Bulletin on the reforms contained in the recently enacted Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009.  The special reports relate to the following issues (to view a special report, please click on the appropriate link below):

1. the new rules for taxing CFCs and foreign dividends;
2. the new definitions of "associated persons";
3. GST changes relating to the emissions trading scheme;
4. remedial amendments made to the (now repealed) research and development tax credit regime; and
5. the new voluntary payroll giving scheme.

This publication is included in Russell McVeagh's website on the Internet: www.russellmcveagh.com

The transmission/publication is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance to any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact:

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