We are often asked to clarify the compulsory zero rating rules that apply to all land transactions between GST registered people.

With tourists flocking back 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.

The compulsory zero rating rules (CZR) were introduced during the GFC because the government became concerned 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 three criteria were met, and in so doing eliminate 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.

CRITERIA DETAILS

For zero rating to be compulsory, the three criteria are:

1. both parties must be GST registered

2. the buyer must undertake they will be using the property in a GST taxable activity

3. the buyer must undertake that the property will not be their principal place of residence.

Many readers will be familiar with the standard sale and purchase agreement. It has been updated numerous times and seeks to capture all the undertakings needed for parties to gain clarity on the status of the contracting parties’ GST registration and the undertakings necessary to meet the CZR criteria. The key section of the agreement for this is the schedule one: GST warranties. This section should be completed in full whenever GST is a feature of the contract. 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.

PLUS GST BASIS

A GST registered vendor who is selling a property that is part of their taxable activity will generally want to negotiate on a “plus GST basis”. This is because they have a GST liability on disposal 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 property trading. He has GST registered his activity and has purchased and sold two properties from unregistered vendors. In both cases he used an Inclusive of GST contract and was able to get GST refunds on acquisition using the second-hand good rules that allow a claim when a property is sold from an unregistered vendor to a registered buyer who will use the property in their taxable activity.

His third deal involved a purchase from a GST registered builder on-selling a spec build project he can’t complete. The builder confirms in the contract he is GST registered and that the property is part of his taxable activity. Joe insists on a contract that is inclusive of GST, assuming this will mean the contracted price includes the full 15 per cent GST the builder will have to pay.

IRD AUDIT

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 it. Joe then settles the purchase and submits his claim for the 15 per cent GST that he assumes is included in the contract price.

IRD audit his GST claim and quickly determine that because the vendor builder is GST registered and Joe gave all the undertakings required, the contract is compulsorily zero rated.

This means the price includes GST at the rate of zero, not 15 per cent. Accordingly, Joe has no refund and the vendor has no payment. Joe protests he would not have paid as much for the property had he known the GST was at the zero rate. The vendor simply smiles and walks away. Joe is left with the realisation that he has already blown any margin he may have made on the project before he is out of the starting blocks.

It’s important to come to grips with the second-hand good rules for GST and the impacts of the zero-rating rules. Many serviced apartments and short-term rentals are sold by GST registered vendors who are subject to GST. Never assume a vendor is not GST registered, insist on the agreements being completed fully, and be aware of the GST status of the other party and whether the contract is inclusive of, or plus GST. Always seek professional advice first.