How a common GST mistake cost a client $450,000

  • How a common GST mistake cost a client $450,000
  • NZ tax residents must report income on worldwide basis
  • Labour’s tax policy announcement does nothing for inequality or the inequities in the tax system


GST is frequently touted as a simple tax, and I think that’s partly because there’s only one rate and it applies across the board on almost all goods and services consumed in New Zealand. But like any taxes, it has a number of hooks in it which frequently trip people up.

Some of these hooks shouldn’t be tripping people up because they’ve been known about for some period of time. But surprisingly, I still come across this particular issue time and again. And it’s really quite concerning that it still does happen.

The issue will almost invariably involve land. It’s where someone has purchased land from an individual and then decides that it’s perfect for a development activity or whatever, and then sells that across to a company or sometimes a trust which is registered for GST which then claims an input tax credit.

This is where things go off the rails.  The issue is that the supply from the individual/another company who initially purchased the property to another party which is “associated” with it means that for GST purposes, the GST input tax claim that can be made is limited to the amount of GST paid by the first person.

Now, this provision, section 3A of the GST Act, has been in place since October 2000. It applies to transactions between “associated persons” which given the wide definition in the associated persons rules is very likely applicable when there are common shareholders/trustees/settlors.

What section 3A is designed to do is to stop someone buying a property then on selling it at an inflated price to an associated GST registered entity, which then picks up an increased input tax credit. And the rule basically says that the GST input tax is limited to the amount paid by the original purchaser. And since that purchaser often purchases it off a non-GST registered person, that amount is nil.

And I see this quite a bit. I’m surprised some lawyers and accountants haven’t really got across a measure which is now 20 years old.

The latest example I’m trying to describe is that the individual purchased the property, and then after advice from a lawyer – that for asset protection and business purposes – it would probably be better that the land be sold to a company to carry out the proposed development. That itself is not unreasonable advice. Problem was the lawyer overlooked the impact of GST and the client who is new to New Zealand didn’t get tax advice at the right time, which is another common mistake.

The company actually did get an input tax credit and refund of $450,000. You might well ask why did the Inland Revenue let a GST input tax claim of that amount go through? Fair question but it’s a complicated story.

Anyway, Inland Revenue then took a further look at it and then said, “Oh, no, you’re not entitled to that refund”. So now the client has to find $450,000 dollars and pay it back. They’re not best pleased which is understandable. And I think that is something that should provoke some fairly sharp questions between the client and their lawyer. But it is a common issue I keep seeing.

So, the golden advice here is get advice from your accountant and other advisors before you make the acquisition or get into the project. If you don’t, because you’re trying to save on professional fees, you might well find that trying to save two or three thousand dollars in advice has, like this particular client, just cost you $450,000. Get advice on any GST related transaction because GST has a lot more hooks to it than people realise.

I have a couple of other GST cases going on at the moment where people who said they were GST registered turned out to be not registered, or vice-versa and that has got lawyers at ten paces throwing writs at each other over whose client picks up the GST warranty.

NZ residents must report global tax income

Moving on, another common error I come across is people misunderstanding their income tax obligations where they have assets in more than one jurisdiction. I frequently encounter a position where a New Zealand tax resident also has property or other income source in the United Kingdom, Australia, wherever, and has been complying with that jurisdiction’s requirements to file a tax return.

This often happens involving assets in the UK. A person might have to file UK a tax return because they’ve got a rental property over there. But although they’ve complied with their UK obligations, they overlook the fact that as tax residents of New Zealand, their income is reportable taxable on a global basis. So they should be reporting the UK income here as well.

And that’s the bit that often gets forgotten about. Most people seem to be aware there’s a rule against double tax. And they seem to think that by filing a tax return in the country in which the property is situated, they have met their obligations and it’s only taxable in the country in which it’s situated. It’s not, it’s taxable worldwide.

Inland Revenue issued in July a very good Interpretation Statement 20/06 which sets out all the rules overseas rental properties. But I daresay this particular case won’t be the last time I’ll come encounter a situation where someone has reported income overseas, but not in New Zealand.

And it’s a good insight into always try and catch up regularly with your clients and take the opportunity to ask questions, because more often than not, if you don’t ask, you don’t find out. And then something happens after which everyone is going “Oops!” and no one is terribly happy about how that plays out.

Labour’s tax policies

And finally, last week, Labour announced their proposed income tax policy, increasing the top income tax rate to 39% for income in excess of $180,000. This has not been terribly well received, partly and very obviously from those who are likely to be affected. They’re not going to be happy about that. And that’s understandable. Who likes paying more tax? Let’s be frank about it.

But also, more importantly, leaving aside partisan issues such as Labour activists saying it’s too timid, the interesting issue to me is how other people have come out and said it really doesn’t do anything to address the issues of inequality and distortions in the tax system. It’s also been dismissed as just a drop in the ocean in terms of addressing deficits.

There’ve been two such articles in the past week that raised these issues. The first was from Jonathan Barratt a senior lecturer in taxation at Te Herenga Waka — Victoria University of Wellington. And he basically said that both Labour and National are really not doing anything to address questions of inequality. The tax base is too narrow, it benefits the wealthy and punishes the poor. And his key point was that neither major party seems to want to do anything about it.

I do have a view that the “Four legs good, two legs bad approach” to discussing taxation over the last 30 odd years hasn’t helped any constructive conversation in this matter. Also, property has become such an important asset for so many people where sometimes the untaxed growth in the value of the asset exceeds a person’s annual earnings, it’s therefore understandable people are reluctant to have that precious nest egg taxed.

Also coming out and having some fairly harsh, but fair, commentary on Labour’s tax policy was Geof Nightingale, of PWC, who’s been a previous guest of the podcast, but more importantly was a member of the last two tax working groups.

And he begins his article by calling it “Brief and predictable, but disappointing”. And he goes on to point out the 39% rate turns us back to the tax settings at the end of the 20th century when we last increased the top tax rate to 39% rate. The policy “makes the existing equity and efficiency distortions in our tax system worse and will have no significant impact on income or wealth inequality”.

Now, Geof was one of those who backed the introduction of comprehensive capital gains tax. What he’s pointed out here is that the increase in the tax rate to 39% is a progressive move but only in relation to employment and personal services income. It’s quite possible if you’ve got investment income, which is in a portfolio investment entity it’s taxed at 28% and it’s held in a trust it’s going be taxed at 33%.

I really do struggle to understand why Labour is not looking closely at the trust tax rate. It was known to be an issue the last time the top tax rate was 39%. But I suspect they may well come back to that if they get re-elected. There are anti avoidance measures in place, as Geof has said. But the whole point is that the zero percent rate on capital gains still applies and investment returns and capital gains because of the amount of money sloshing through the system now are likely to increase.

So, as he said, one solution is of course, a capital gains tax, which in his view and mine spreads the tax burden more equitably across the economy. And it could also allow lower personal tax rates. What’s often forgotten in the wake of what happened at the end of the Tax Working Group, was that lower tax rates were part of the whole package including capital gains tax. National of course will not do anything in that space. It’s saying it’s sticking to opposing capital gains tax and ruling out tax increases.

So Geof’s article was really quite swingeing in its criticism and fair enough in that regard. He concludes

Here we are then, a government that wants a second term faced with a major fiscal crisis but backed into the dead end of a 20th century tax policy. Predictable but disappointing.

Well, that’s it for this week. I’m Terry Baucher. And you can find his podcast on my website or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients. Hei konei ra!

Inland Revenue wins Frucor tax avoidance case in Court of Appeal

  • Inland Revenue wins Frucor tax avoidance case in Court of Appeal
  • New Inland Revenue guidance on taxation of crypto assets
  • Labour’s tax and small business election policies announced


Late last week Inland Revenue won a tax avoidance case in the Court of Appeal against Frucor Suntory New Zealand Limited.

The background facts are complicated, but basically the case involved an advance of $204 million dollars to Frucor in exchange for a fee and some convertible notes issued by Frucor to Deutsche Bank. There was a related party payment from Frucor’s then Singapore based parent for the purchase of the shares from Deutsche Bank.

Over a five year period Frucor paid Deutsche Bank $66 million dollars on an interest only basis. Inland Revenue argued to this was a tax avoidance arrangement and for the 2006 and 2007 income years disallowed deductions to the extent of $10.8 million and $11.6 million respectively.

Frucor won this case in the High Court in 2018, a decision which actually raised a few eyebrows in the tax advisor industry because it seemed similar to the arrangement struck down involving the big Australian banks about 10 years ago.

Unsurprisingly, Inland Revenue appealed and have now won in the Court of Appeal. Under the arrangement, Frucor had apparently achieved interest deductions totalling $66 million. But in the court’s view, it had not incurred a corresponding economic cost for which Parliament intended deductions would be available. $55 million as a matter of commercial and economic reality of the claimed interest was in fact a repayment of principal borrowed and not an interest cost. The Court concluded that the funding arrangement had tax avoidance as one of its purposes or effects and was this was not merely incidental to some other purpose. The overall purpose of the funding was provision of tax efficient funding to Frucor.

The only bright spot in this decision for Frucor is that the Court of Appeal agreed the High Court was reasonable to find that the shortfall penalties for a tax avoidance arrangement (which can be up to 100% of the tax avoided) should not have been imposed by Inland Revenue.

The key lesson here – and it’s going to be of importance looking forward if Labour forms the next government, given its announcement for a higher personal tax rate – is that the courts are still very much onside with striking down tax avoidance cases where they consider the arrangements are not seen to be in line with Parliament’s intention. And Inland Revenue has made aggressive use of tax avoidance provisions in section BG 1 of the Income Tax Act, and until Frucor’s High Court victory, it had not lost a case involving a tax avoidance matter for something like 10 years.

So aggressive tax planning is very much still under the gun for Inland Revenue and the courts are supportive of that approach, even though it might look as if all the necessary legal form has been satisfactorily met. So that’s just a warning for the times ahead. I think we’re going to see Inland Revenue make more use of anti-avoidance provisions in other areas as it returns to normal after its attention was diverted responding to the COVID-19 pandemic in the early part of this year.

Taxing crypto assets

Moving on, Inland Revenue has issued some updated guidance on the tax treatment of crypto assets. There’s nothing especially new here. It is confirming that crypto assets are to be treated as a form of property and that in each case it will look carefully at what are the circumstances behind the acquisition and disposal of the relevant crypto asset.

The guidance does expand a little bit more on what we’ve seen previously in this area.

Inland Revenue has said very clearly that it will look at the purpose for acquiring the crypto assets. And it is pretty straightforward in saying that if your purpose when acquiring crypto assets was to sell or exchange them, you will need to pay tax when you do so.

Inland Revenue will look very carefully at your purpose at the time you acquire crypto assets. The guidance repeats the key point, which is often overlooked, that it is the purpose at the time of acquisition that matters. If that purpose changes later on, that is not relevant. If you plan on selling or exchanging your crypto assets at some time in the future, then you have a purpose of disposal. It doesn’t matter how long you plan to hold onto them before doing so. Your main purpose can be to sell or exchange them even if it takes a few years. Then, of course, you’ve got to have supporting evidence of what your intention was at the time of acquisition.

And one of the things the guidance points out is the nature of the crypto assets being acquired. And in particular, does it provide an income stream or any other benefits while being held? (By the way, benefits isn’t clearly defined). Now, Inland Revenue’s view is that if you have crypto assets that do not provide an income stream or any other benefits, this strongly suggests you acquired them for the purpose of selling or exchanging them. This is because the only benefit you get is when you sell or exchange those crypto assets. And that, by the way, is similar to Inland Revenue’s position on gold bullion.

But just because you’ve got crypto assets that do provide an income stream or other benefits, for example, staking, that doesn’t mean that you didn’t acquire them for the main purpose or sending of sale or exchange. Somewhat helpfully, there are a number of examples of how the Inland Revenue sees these rules working.

So the position to be mindful of if you’re involved in holding crypto assets, is that the default position is almost that any funds realised on a sale or exchange are going to be taxable. To counter that, you’re going to need to show good records at the time of acquisition of what your intention was and what type of assets you acquired.

But this is the current position and we have to work with it. And so my advice is be very clear in recording what your intention is when you acquire crypto assets. And if you haven’t done that, it’s too late. Inland Revenue’s default position with crypto assets is that any sort of exchange is going to be taxable.

Election 2020 tax policies

And finally, Labour has now come out and announced its tax policy, the centrepiece of which is a new top income tax rate of 39% applying to income above $180,000. It’s also said that there will be a freeze on fuel tax increases, no new taxes and no further income tax increases for the entire next term of government.

The other point it’s raised is, is it going to continue to work with the OECD to find a solution on the taxation of multinationals? It’s prepared to go ahead with the implementation of a digital services tax, which present projections estimate would raise between $30 and $80 million yearly.

As can be seen there’s not a lot of tax involved with multinational taxation, but it’ll be a popular measure because it’s something that keeps coming up in conversations I have with people on the issue of taxation. People are always saying multinationals should pay more. But they’re not a bottomless well, and opportunities to tax them are limited.

The digital tax space is where there could be some movement. But that’s very much dependent on how the OECD goes. And as I’ve mentioned in the past, the Americans have pretty much brought that particular pathway to stop earlier this year by basically saying they weren’t going to cooperate or be involved

With the proposed income tax rate increase to 39%, we’ve been there before. I thought if Labour was going to raise the top tax rate, it would be to 39% percent. Crossing the 40% threshold would be a psychological barrier too far. We haven’t had an individual tax rate of more than 39% for over 30 years. 1988 was the last time the tax rate was above 40% when it was 48% as I recall. It’s expected to raise 550 million dollars.

There’s already a lot of talk going around about making use of trusts and companies to get around the increase. My understanding is they’re going to look at trusts and the trust tax rate. Conceptually, the trust tax rate should really rise to be equal to the top personal tax rate. And that’s the story in Australia, the UK and the US as well. But my understanding is trusts will be looked at to find out exactly how many trusts really would be caught by that, because there are trusts settled for minors and orphans and other charitable or semi charitable purposes.

But even if nothing happens in that space, I’ll just remind you about the first item this week, the Frucor case and the Inland Revenue’s approach to tax avoidance. Last time we had tax rates at 39% we ended up with the Penny-Hooper decision. That’s the case involving dentists who used a company to trap income at the company tax rate, which was then 33% and then then lowered to 30% instead of the personal 39% rate was struck down as tax avoidance. You can see that happening again.

So, yes, Labour seems to have opened an opportunity for tax planning. But my answer to that would be ‘Proceed with great caution’, because Inland Revenue has a big stick in the form of an anti-avoidance provision.

The other thing of note from Labour is that it’s campaigning on extending applications to the Small Business Cashflow Scheme to 31st December 2023 for ‘viable’ businesses.  And it’s also promising to extend the interest free period of loans under the scheme from one year to two years, which would be very welcome for small businesses. Labour will also look at a permanent iteration of the scheme, which is something I would support.

That’s it for this week. Thank you for listening. I’m Terry Baucher and this has been The Week in Tax. Please send me your feedback and tell your friends and clients until next week. Ka kite āno.