GST and financial services

1. GST and financial services (the New Zealand experience) Marie Pallot Policy Advice Division Inland Revenue New Zealand

2. 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

3. 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

4. Background continued • Taxation (GST, Trans-Tasman, Imputation and Miscellaneous Provisions Act 2003) • Enacted 25th November 2003 (but didn’t apply until 1 January 2005) • Administrative guidelines issued October 2004 • Reference material available at www.taxpolicy.ird.govt.nz

5. 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

6. The New Zealand financial services sector • Banking and insurance industries represent about 6% of New Zealand’s 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

7. 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

8. Treatment of B2B financial services: before and after Before: Financial services Output tax No input tax No output tax No input tax Output tax No input tax Final Final Business Business Business Business Bank Bank consumer consumer A A B 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 B B A A C C

9. Treatment of B2B financial services: before and after Result = Financial services B2B transactions are GST neutral in the same way as other B2B transactions 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

10. Treatment of B2C financial services Result = Financial services B2C transactions are undertaxed, although denial of input tax credits to the financial services provider addresses this to an extent Output tax No input tax No output tax No input tax Bank Business Business Final Final Bank A A Consumer Consumer

11. 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)

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

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