Over the past 18 months Inland Revenue (IRD) has issued a number of technical statements setting out its view on how income tax and GST applies to residential houses that are used to derive income, such as from use as an Airbnb. The most recent IRD statement raised a few eyebrows and in this article we explain why.
To provide some context, at one end of the spectrum if one private individual sells their family home to another, GST is unlikely to apply. At the other end of the spectrum, if a GST registered business sells a hotel to another the transaction is likely to be subject to GST (although at 0 percent). However, as you encounter different scenarios and move along the spectrum you end up in a grey area where it can be unclear whether GST applies or not.
GST applies to the sale and use of commercial dwellings – those in which the occupant does not have ’quiet enjoyment’, for example, hotels, motels, homestays, farmstays, hostels, and other short-stay accommodation providers. But, what about a private family bach that is also used to derive Airbnb income. Technically, accommodation in an Airbnb is caught for GST purposes. However, in most cases the income does not exceed the compulsory GST registration threshold of $60,000 per year, so the owners can choose not to register and stay outside the ‘GST net’.
On 26 June, IRD released interpretation statement (IS) 20/05 which describes how GST applies to the sale of a dwelling that is included within a wider supply of land.
A classic example is the family farm comprised of farmland and a farmhouse. For decades, the standard GST treatment applying to the sale of a farm has been to
split it into two components:
1. The working farmland is treated as the sale of an asset that is subject to GST.
2. The farmhouse is treated as a separate supply that is exempt from GST, because it has been used as the farmer’s private ‘family home’ (or as the supply of an exempt residential rental property if it was used by a farm worker).
The above approach is considered by IRD to be an ‘oversimplification’. Instead, IRD is of the view that GST should apply if the house has been used as part of the farming activity. IRD’s view lies in a long-standing tradition in which farmers could claim income tax deductions in relation to a portion of farmhouse expenditure. This was formalised in IS 17/02, where an automatic deduction for 20 percent of the expenditure related to the farmhouse is allowed as it effectively acts as the ’farm office’ from which the farming operation is managed. By claiming the deduction, IRD consider that the farmhouse has been used to make taxable supplies. Therefore, the sale of the farmhouse is also subject to GST. As the farmhouse is treated as a separate supply and is typically used as a residence by the purchaser it does not qualify for zero-rating and GST becomes payable at 15 percent.
So to recap, IRD have asserted that GST will apply to the full value of the farmer’s home at 15 percent. Logic would suggest that even if this conclusion is correct, which we do not think it is, then GST should only apply to the portion of the house that has been used for the farming activity… but IRD’s view is that this is not how the rules currently work.
To illustrate IRD’s view, consider the following scenario:
• Rob is retiring after 30 years of dairy farming.
• He is GST registered and has agreed to sell the family farm for $15m, including a substantial farmhouse valued at $1.5m.
• When Rob purchased the farm the farmhouse was valued at $500k.
In line with IRD’s guidance from IS 17/02, Rob claimed income tax deductions for 20 percent of the expenses relating to the farmhouse. As a result, IRD are of the view that the farmhouse has been used to make taxable supplies and Rob is required to pay GST on its sale. On Rob’s GST return he discloses the $1.5m sale and the applicable GST amount of $195,652 (3/23rds of $1.5m). Rob is able to claim an offsetting deduction tied to his 80 percent proportion of private use, but the amount is limited to the original cost of the house, i.e. $65,217 (3/23rd of $500k). A net GST liability of $130,435 arises, being GST on the full $1m increase in the value of the farmhouse.
Not only does this approach differ markedly to current practice and could give rise to pricing disputes, but we also disagree with IRD’s view. We hope that in time, reason will prevail, but in the meantime we are left in a position of uncertainty.
The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.