11 July 2012

Commentary piece


Stop and smell the coffee – GST on late fees is coming




"GST is further changing and New Zealand businesses need to prepare now," is the message from PwC GST Partner Eugen Trombitas. Mr Trombitas warns businesses of the importance and impacts of the Government's changes to GST and how it will affect them.


What does this mean for New Zealand businesses? Let's take Danny, a typical 'never-pays-his-bills-on-time' customer and coffee addict who has an account at his local café. The monthly coffee account is $115 per month – the café owner accounts for GST of $15. Pretty simple, GST applies to a broad supply of goods or services (with limited exemptions) and is based on the price ($115 here). So, in our example, $15 of the agreed price goes to Inland Revenue.

If the café owner has terms with Danny stipulating that if he's late paying his monthly account he has to pay an additional $10 late fee, that $10 late fee is NOT subject to GST. Danny gets nothing in return for the late fee and the coffee price has not gone up by $10. The late fee is paid as compensation to the café owner for Danny breaching his contract terms. And, if Danny continues to go at a snail's pace on the payment front, the late fees will keep compounding. Importantly, the price of coffee, on which GST is payable, has not gone up - it's still the same. So, although Danny's paying more to the café owner (in late payment fees) the original GST charge of $15 also stays the same.

Skip forward to the proposed changes in the Government's Taxation Bill, introduced in September 2011 and about to get its second reading in Parliament, and the application of GST to Danny's payments works very differently. Once enacted, the Inland Revenue will charge the café owner GST on Danny's overdue account fees, who in turn, may consider passing this new charge onto Danny. Bad luck for Danny!

The proposed change will be applied retrospectively from 1 April 2003: meaning, it protects the tax base and prevents businesses making claims to Inland Revenue for any GST it may have previously charged on late fees.

Our firm, PwC New Zealand, and many others oppose the change because it extends the GST base by shifting it away from a tax on goods and services to a cash-flow tax. Late fees are not currently considered as a good or service because like coffee addict Danny, in our above example, the customer gets nothing in return. This position has previously been accepted by Inland Revenue, with many businesses having rulings from Inland Revenue confirming GST does not apply to any late fees charged.

Yet, when the Bill is passed late fees will now be taxed and our ‘best in class’ global GST reputation will be lost. New Zealand will be left out of line with best practice overseas, but for what benefit?

Is the law change worth it? In a word - we say "no". Apart from the new interpretation and compliance issues, the estimated annual GST to be collected amounts to just $2.5 million. Yet, businesses will incur significant compliance costs to change systems, such as: distinguishing between penalty interest (exempt) and fixed dollar late fees (taxable), issuing new tax invoices or debit notes, and deciding whether penalty terms of “$10 or 1%, whichever is the greater” (which are common) are exempt or taxable – just to name a few.

The proposed law leaves many unanswered questions, which we understand Inland Revenue will attempt to clarify, these include:

• when a late fee is charged, should this be supported by a debit note or a new tax invoice? This is important for business customers who need the right documentation to claim a GST deduction

• penalty or default interest under a contract to supply “services” is excluded, but there is no mention in this exclusion of contracts for the supply of “goods”. This means that late settlement interest on land transactions, which has never been subject to GST, is caught by the current wording of the proposal - this is an unintended outcome

• how should businesses determine late fees in respect of supplies with a mixture of taxable and exempt components (e.g. goods leases).

In more a welcome development, the Government has accepted submissions for an extended date of the new GST application to 1 January 2013 for those businesses who currently do not account for GST on late fees.

The Bill is expected to be enacted shortly and we hope clarification on some of these practical areas will be provided. Businesses need to start planning for the change now and consider what changes to systems, contractual terms and pricing will be necessary.

In summary, the key aspects of the law change you need to know are:

• Late fees will be treated as consideration for a supply of services and subject to GST (from 1 April 2003 unless the savings provision below applies).

• The GST treatment of late fees will follow the GST treatment of the underlying supply – this is a beneficial carve out for exempt and zero-rated supplies (e.g. financial services supplies).

• If businesses have adopted a regular practice of not accounting for GST, they will have until 1 January 2013 to change the GST treatment.

• Penalty or default interest is excluded in line with the existing exempt treatment in the GST Act.

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