GST Rules for Zero-Rating Property Sales

In the past, there have been some taxpayers that would sell a property between associated companies and avoid paying the GST.  The way this worked was the purchasing company would claim the GST but the vendor company would go into liquidation before paying that GST.  

The Government and IRD didn't like this so new rules were introduced on 1 April 2011 that made it compulsory for certain property transactions to be done on a zero-rated basis.  A zero-rated transaction is one where the vendor does not pay any GST to the IRD and the purchaser does not claim any GST from the IRD.  This way there would be less risk that the IRD would miss out on their money from a property transaction involving GST.

The property transactions that must be zero-rated is where property is sold from a GST-registered vendor to another GST-registered purchaser where the purchaser will be using the property in a taxable activity.  The standard sale and purchase agreement now incorporates the relevant questions to determine whether the property transaction must be zero-rated.

While the new GST zero-rating rules might be good for the IRD's point of view, it does raise some issues for property traders.  Here are some examples of the problems that this could cause so that you know what to be aware of:

Example 1

A property trader purchases a property from a non-GST registered person for $230,000 (they will claim $30,000 GST on this).  They then onsell the property on the same day to another GST-registered property trader for $241,500 making a $11,500 profit ($10,000 profit excl gst).

However, as the second transaction is between GST-registered entities and the purchaser is going to be using the property in its taxable activity, the sale price is actually recorded as $210,000 zero-rated.  This property trader is now $20,000 short of cash as they must pay $230,000 now and only $210,000 in return.  They would get their $10,000 profit on the trade until they file their next GST return when they will claim the $30,000 of GST on the purchase price which could take a few months.

Example 2

A property trader purchases a property for $230,000 inclusive of GST and intends to claim GST of $30,000 in the next GST return.  It turns out that the vendor is GST registered so that transaction must be zero-rated.  As the purchase price was including GST and the GST is nil, the property trader misses out on their GST refund but must still pay GST when that property is later sold.  To avoid this problem, the property trader needed to enter into the sale & purchase agreemen as $200,000 plus GST is any.

Example 3

A property trader sells a property for $200,000 inclusive of GST and intents to pay no GST as he believes that the purchaser is a GST registered entity that will be using the property in a taxable activity.  It turns out that the vendor is not GST registered so the transaction cannot be zero-rated.  As the purchase price was including GST, the property trader cannot recover the GST from the purchaser and must pay GST of $26,087 in the next GST return.  To avoid this problem, the property trader needed to enter into the sale & purchase agreement as $200,000 plus GST (if any).

Disclaimer: The above article is general in nature and we recommend you seek professional advice tailored to your specific personal situation.