Articles by Matthew Gilligan
Whilst it has almost been six months since the new zero rating provisions for land transactions came into force, at GRA we are still seeing quirks and issues emerge as practitioners and property traders/investors come to grips with the new rules. In today's article I want to examine two scenarios that those of you who are property trading should be wary of.
In scenario one a property trader has identified a potential trade property that is on the market for $200,000 including GST (if any). The trader thinks that they could spend $20,000 making renovations and then sell it for $260,000. The trader understands that they will need to return GST on the $260,000 but anticipates making GST claims on the $200,000 purchase price and the $20,000 renovation costs, leaving a margin of circa $35,000 after GST and before income tax.
Following this, the trader submits an offer for $200,000 including GST. The offer is accepted and our trader starts to look forward to renovating and making the $35,000.
However, prior to settlement the trader seeks advice in relation to the GST treatment of the purchase and discovers that the vendor is a GST registered trader themselves. This means the transaction of selling the land from the GST registered vendor to our GST registered trader is a zero rated transaction for GST purposes. The $200,000 purchase price "inclusive of GST (if any)" now includes GST applying at a rate of 0%. As a result, our trader who anticipated having a GST refund of $26,000 in relation to the purchase of the property now has no GST refund. Suddenly the $35,000 pre-tax profit is eroded because GST still has to be accounted for on the sale (note that we are assuming that the sale here does not occur to yet another GST registered party but it is a retail sale to an owner-occupier/residential investor).
The moral of the story here is to know your vendor. If the vendor is GST registered and selling the property as part of their taxable activity, and you are similarly GST registered and buying it for a taxable activity, the GST component is zero. In such a scenario you need to offer what you perceive as the GST exclusive value of the property - which in this case is $174,000 (being the $200,000 less the anticipated $26,000 refund that you are now not getting).
You can also consider including a clause in a contract making them warrant that not only are they not registered now but they will not be at the time of settlement, and should they breach that warranty then the purchase price is reduced to reflect the fact that you will not get your GST input claim.
In scenario two we are looking at a property trader who is selling a property bought for trading purposes. Our property trader is approached by a prospective purchaser who explains that they are GST registered and looking to buy the property in order to apply it towards a taxable activity (for example use as a commercial premises). The purchaser therefore explains that they are willing to offer $400,000 inclusive of GST. Our property trading vendor wants to clear $400,000 excluding GST and therefore had anticipated selling it to a retail investor for circa $460,000 so that after they had paid their $60,000 GST they still had $400,000. This GST registered purchaser convinces our vendor that because its going to be a zero rated transaction they can sell it for $400,000 "including GST" because the GST component will be zero and our vendor will clear $400,000. The vendor accepts the purchaser's overtures and enters into the sale and purchase agreement.
Subsequently the purchaser changes their mind in terms of the use of the property. They advise the vendor that they are now nominating a non-GST registered entity that will be buying the property for non-GST purposes (i.e. residential rental or to occupy as a residence). This is disastrous for the vendor because now the $400,000 which was anticipated to include zero GST in fact includes GST at a standard rate, meaning that our vendor has to account to the IRD for $52,000 in GST out of the $400,000 sale price.
If you are a vendor, you could make the price “plus GST” instead of “inclusive of GST”. If the contract is plus GST then a purchaser will have to pay GST at the standard rate if they change their mind (having initially said they will be GST registered).
Another strategy is to include a clause in the sale and purchase agreement whereby the purchaser warrants that they will remain GST registered at settlement and the transaction will be a zero rated transaction, and if they breach that warranty then the sale price is increased by 15% to compensate you as vendor for the fact that you will now need to account for GST.
Both of these scenarios illustrate the importance of understanding the circumstances of the other party in land transactions. They also show that if circumstances change, you can be placed at a disadvantage.
As always, we recommend you seek advice on your particular transaction. Every transaction is different and you need to be vigilant in checking the terms of your sale and purchase agreement. The above is comment of a generic nature only and should not be mistaken for specific advice in relation to any transactions you are involved in. Contact us at GRA for advice on 09 522 7955.
If you are worried about any of these issues related to GST and zero rating, contact us at GRA - phone +64 9 522 7955, email [email protected], or come and via our online form.
Thank you for presenting an excellent course in your Property School 101 over the last 6 weeks. We really enjoyed it, gained good value from it plus the necessary confidence and knowledge to move forward in the property market. We will be in touch, soon, for a review of our trusts and entities to ensure we have these established properly to fully protect both our assets and income and to gain full advantage. All the best. - John
Investing in residential property?
If you're investing in residential property, seeking to maximise your ability to succeed and minimise risk, then this is a 'must read'.
Matthew Gilligan provides a fresh look at residential property investment from an experienced investor’s viewpoint. Written in easy to understand language and including many case studies, Matthew explains the ins and outs of successful property investment.