Change of use adjustments explained
Decision date: 10 November 2005
Case: The Commissioner of Inland Revenue v Lundy Family Trust and Behemoth Corporation Limited
Act(s): Goods and Services Tax Act 1985
Keywords: Change of use adjustments, property developers, residential renting, apportionment between taxable and non-taxable purposes, cost of the supply.
Summary
The Commissioner's appeal was partially dismissed.
Facts
This case related to adjustments under the old section 21(1) of the Goods and Services Tax Act 1985 ("the Act"). The two Disputants, a company and a trust, had purchased a number of properties for the purpose of property development. GST input credits were obtained. The properties were subsequently let out as residential dwellings (an exempt activity section 14(c)). The properties however, remained on the market for sale at all times.
The Commissioner and the Disputants agreed that adjustments were required under section 21(1) of the Act. The parties differed, however, as to the amounts of the adjustments and as to whether the Disputants were entitled to a further input tax credit once the properties returned to the taxable activity (normally when they were sold).
In the Taxation Review Authority ("the TRA") and the High Court the Commissioner was unsuccessful and the matter was appealed to the Court of Appeal.
In the Court of Appeal the Commissioner argued that there should have been an adjustment for each good or service supplied. That meant there must be an adjustment for the cost of the land and the buildings and the service costs (but acknowledged that it was too late for the land to be adjusted for in relation to these taxpayers). With respect to service cost the Commissioner was referring to rates and insurance etc.
Decision
Section 21(1)
When a property is acquired for the principle purpose of making taxable supplies (in this case property development), but is then applied for some purpose other than making taxable supplies (in this case residential renting), then section 21(1) requires an adjustment to be made reflecting that non-taxable purpose.
In essence, section 21(1) is a mechanism for ensuring claw back of unwarranted input tax credits where they are no longer related to a taxable activity.
Where residential renting is the non-taxable purpose for which the property is being applied, the property itself is the good that is deemed to be supplied under section 21(1). Pursuant to section 10(8) it is the lesser of the cost or market value of that property that is used to determine the appropriate value of that deemed supply (in the present case it is the "cost" of the supply that was relevant).
In terms of calculating the cost of the deemed supply the Court accepted that a taxpayer could make a one-off adjustment (which was suitable when there had been a total change in purpose) or periodic adjustments (which was suitable where the original taxable purpose continued to exist along with the subsequent non-taxable purpose).
Where periodic adjustments were made, these must relate to the costs of those goods or services (the properties in this case) or the lower market value. It was also stated that any periodic adjustments made could not exceed that cost.
In this case it was correct for the taxpayers to make periodic adjustments as the principal purpose remained making taxable supplies (property development).
The Court also acknowledged that the legislation provided no guidance on how the value of the deemed supply was to be calculated. The Court, noting this, accepted that the Commissioner's submission that depreciation was a suitable method of approximating the cost of the buildings and also the land between the periods. The Court concluded that both land and buildings are applied for the residential renting and the buildings are effectively no more used up than the land is.
This only deals with spreading the cost of buildings and land between the relevant periods and there still needs to be an apportionment between taxable and non-taxable uses for the particular periods. The Court acknowledged that this caused conceptual difficulties as where, in this case, the properties were applied 100% for both the taxable purpose and the non-taxable purpose.
The Court then turned to consider periodic service costs such as rates and insurance. The Court stated that it considered these costs quite different from the acquisition costs. The Court considered the key question in this regard to be whether in each taxable period the goods or services (the rates etc) have been acquired for the principal purpose of making taxable supplies. If that is the case section 21(1) adjustments will then be required to the extent that those goods or services are applied for a non-taxable purpose.
In the present case, because the taxpayer's principal purpose continued, an input tax deduction was available in regards to the service costs associated with the properties. However, to the extent that those service costs related to both purposes, an adjustment under section 21(1) was required. The Court considered that an apportionment of 75/25 would recognise that the principal purpose remained the sale of the properties.
The Court then noted that this analysis was arguably different to that which the Commissioner had pursued when assessing and therefore the Court invited the Commissioner to file further submissions on whether this change of stance should be accepted.
Section 21(5)
The Court finished off by dealing with to what extent any section 21(5) adjustments were required. The Court stated the purpose of section 21(5) is to allow input tax credits where goods and services have not been acquired for the principal purpose of making taxable supplies, but only to the extent that they are applied for a taxable purpose. The Court concluded that where section 21(1) adjustments had been made, section 21(5) would act to restore that input tax deduction where the goods or services are again applied to a taxable purpose.
The Court also agreed with the TRA and High Court that there was nothing in section 21(5) that makes any distinction between periodic adjustments and one-off adjustments. Therefore section 21(5) could claw back either where applicable.
Date published: 10 Oct 2006
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