Taxwise: Pitfalls of GST for associates

By DENHAM MARTIN*

A recent case serves as a reminder of the GST pitfalls when associated parties supply goods or services to each other.

The meaning of "associated parties" is defined in the GST legislation and includes such groupings as relatives (within the fourth degree of relationship) and partners in a partnership. The extent of this concept, and proposed changes to it, was discussed in this column in late July.

A free supply of goods or services between non-associates will generally have no GST consequences, but a free supply between associates (or a supply for cheaper than market value) can impose a liability on the supplier to pay GST to Inland Revenue.

The obligation imposed on associates to pay GST in these circumstances is calculated on the basis of the open market value of the supply. This means that although the supplier has received nothing for making the supply, she or he may be liable to pay Inland Revenue GST on what would be the open market value of the supply. In cash terms, the supplier is "out of pocket."

In the case mentioned, the application of this rule had the effect of deeming persons who were not registered for GST to be registered, as the open market value of the free supply they were making was worth in excess of $30,000 per annum. At that level, the non-registered persons were liable to register for GST and, having not registered, were deemed registered.

The non-registered persons were family members who held farmland as tenants in common and made the land available to partnerships that were carrying on a farming business. The family members were partners in the partnerships. The partnerships received the land rent-free.

The court found that the family members were acting as joint venturers in supplying the use of land to the partnerships. As such, they were an unincorporated body in terms of the legislation.

That unincorporated body conducted a taxable activity in that the land was made available on a continuous and regular basis (the free supply of land by the unincorporated association of family members to the partnerships).

As the parties to the supply were associates, a valuation of the fair market rental of the land was used to establish that the taxable activity of land rental was at a value that exceeded the registration threshold of $30,000 per annum.

Although Inland Revenue did not seek GST on the "rental" supply of the farmland to the partnerships (because those amounts would have been offset by input tax claimed by the partnerships), GST was levied on the ultimate sale of the farmland.

This was levied because GST is payable on "anything done in connection with the commencement or termination of a taxable activity."

The sale of the land by the family members at the termination of the supply to the partnership was regarded as something done in connection with the termination of the taxable activity of land rental.

Given that proposed amendments to the existing "associated persons" tests in the GST Act, contained in the Taxation (Annual Rates, GST & Miscellaneous Provisions) Bill will, except in limited cases, substantially widen the associated persons tests, cases such as this are likely to become more common.

People who make supplies of goods and/or services for no consideration or for less than a market rate of consideration need to consider carefully who they make those supplies to.

Failure to recognise the GST exposure where such supplies are made to associates will not only result in the supplier having to pay penalties and use of interest.

* Denham Martin is the principal of Denham Martin & Associates, lawyers specialising in taxation advice and related matters.