GST and financial services

1
GST and financial services

• (the New Zealand experience)

Marie Pallot Policy Advice Division Inland
Revenue New Zealand
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Introduction

• New Zealand recently introduced
• zero-rating of financial services supplied to
  businesses
• a reverse charge to tax imported services
  supplied to businesses
• Both measures apply from 1st January 2005

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Background

• New Zealand introduced GST on 1st October 1986
  with very limited exemptions
• Financial services were exempt (no input tax, no
  output tax) because
• interest is time value of money it is not
  consumed
• value of the service and interest are highly
  substitutable, making full taxation problematic
• Imported services were not taxed because the
  costs of doing so were thought to be too high
  relative to the revenue that could be collected

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Background continued

• Taxation (GST, Trans-Tasman, Imputation and
  Miscellaneous Provisions Act 2003)
• Enacted 25th November 2003 (but didnt apply
  until 1 January 2005)
• Administrative guidelines issued October 2004
• Reference material available at
  www.taxpolicy.ird.govt.nz

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Policy decisions

• Reason for zero-rating is that exemption is
  generally undesirable, and there is a need to
  reduce cascade effects
• Result more input tax credits to financial
  services providers
• The reverse charge is necessary to tax imported
  services with globalisation etc
• Both issues affect the financial services sector
  Government agreed to address them together
• Fiscal costs of zero-rating partially offset by
  the reverse charge

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The New Zealand financial services sector

• Banking and insurance industries represent about
  6 of New Zealands GDP
• Reserve Bank supervision of banks 18 registered
  banks
• Concentration of Australian ownership 5 largest
  banks which account for 87 percent of the banking
  system are Australian owned
• Wider concerns relating to the income tax
  treatment of banks reflected in the most recent
  tax bill

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Why limit zero-rating and reverse charge to B2B?

• Cascade effect is limited to B2B financial
  services transactions
• B2C is under-taxed but interest/fees
  substitutability leads to retaining exemption
  rather than taxation
• Some changes in telecommunications area and New
  Zealand keeping a watching brief on B2C
  imported services in other jurisdictions

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Treatment of B2B financial services before and
after
Before Financial services
Output tax No input tax
Output tax No input tax
No output tax No input tax
Final
Final
Business
Business
Business
Business
Bank
Bank
consumer
consumer
A
B
A
B
Cascades as not tax neutral for business
Other businesses
Output tax Input tax
Output tax Input tax
Output tax No input tax
Final
Final
Business
Business
Business
Business
Business
Business
consumer
consumer
A
C
B
A
C
B
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Treatment of B2B financial services before and
after
After Financial services
Output tax Input tax
No output tax No input tax
Output tax No input tax
Final
Business
Business
Bank
consumer
A
B

• Result Financial services B2B transactions are
  GST neutral in the same way as other B2B
  transactions

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Treatment of B2C financial services
Output tax No input tax
No output tax No input tax
Bank
Business
Final
Business
Final
Bank
A
Consumer
A
Consumer

• Result Financial services B2C transactions are
  undertaxed, although denial of input tax credits
  to the financial services provider addresses this
  to an extent

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Criteria for zero-rating financial services

• Suppliers of financial services must first be GST
  registered either on the basis that annual
  turnover exceeds NZ40,000 or voluntarily if a
  taxable activity
• Suppliers must elect to zero-rate
• Suppliers may zero-rate the supply of financial
  services to a customer only if the customer
• is registered for GST
• has a predominant activity of making taxable
  supplies (that is, 75 or more of supplies made
  by the customer are taxable supplies)
• A customer can be an individual business or a
  part of a group (a 66 ownership test)

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Calculation methods for zero-rating

• Whether a supply may be zero-rated must be based
  on either
• information from the recipient about their ratio
  of taxable and non-taxable supplies, or
• a method agreed with the Commissioner of Inland
  Revenue
• Administrative guidelines allow suppliers to use
  ANZSIC (industry classifications produced by the
  Department of Statistics) to make a reasonable
  assessment as to whether or not the 75 taxable
  supplies test would be met

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Apportionment

• Limited change to apportionment rules
• New Zealand adopts a principal purpose or
  change in adjustment basis for apportionment
• if more than 50 of supplies made are taxable
  full input tax credits are allowed, with periodic
  adjustments (output tax) to reflect non-taxable
  use
• if less than 50 of supplies made are taxable no
  input tax credit is allowed, but periodic
  adjustments (input tax) may be made to reflect
  taxable use
• Administrative guidelines clarify that for
  apportionment purposes the value of most
  financial services is based on the fee charged,
  or the net margin if there is no separate fee

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A supply by a financial services provider to
another financial services provider

• A supply between two financial services providers
  cannot be zero-rated BUT
• A specific formula allows a separate input tax
  credit to the supplier which reflects the
  relative business to private consumer ratio of
  the recipient financial services suppliers
  customer base
• The input tax credit can ONLY be claimed by the
  supplier based on a ratio given by the recipient

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Administrative issues

• Suppliers will need to review their customer
  classifications annually (or less often if agreed
  with the Commissioner)
• In general if suppliers have complied with the
  legislation and guidelines the Commissioner will
  not reassess so as to retrospectively adjust the
  level of input tax credit claimed

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Avoidance concerns

• Two main areas of concern were
• over-valuing financial services where the
  customer is related to the supplier so as to
  increase taxable (which includes newly
  zero-rated) supplies
• the ability to gain one-off input tax credits by
  substituting the principal purpose from one of
  making primarily non-taxable supplies to one of
  making primarily taxable (including newly
  zero-rated) supplies
• Both issues have been addressed by specific
  anti-avoidance legislation

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Reverse charge for imported services businesses

• Scope limited to businesses making exempt
  supplies (mainly suppliers of financial services)
• Main issue for New Zealand is charges by overseas
  head offices
• Charges are fully taxed with exclusions for
  salary and interest
• Head offices and New Zealand branches are treated
  as separate entities

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Ongoing issues for zero-rating

• Definition of financial services unchanged, but
  now pressure to widen it
• Main issue raised is the treatment of investment
  in shares currently not a financial service, as
  not a service
• If pure investment zero-rated, implications for
  individual investors
• Extent to which zero-rating affects the pricing
  of financial services to businesses

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Conclusion

• Zero-rating achievable in New Zealand because of
  particular factors
• relatively contained financial services sector
• elective regime
• compliance and administration costs reasonably
  manageable
• was introduced in the context of the reverse
  charge and wider banking reforms

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Conclusion continued

• Need to monitor the impact of zero-rating and the
  reverse charge in terms of
• fiscal costs
• other costs
• behavioural changes