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Goods and Services Tax Explained

GST Explained

Along with Income Tax, Goods and Services Tax (GST) is the main compliance obligation for New Zealand businesses.

The major difference between the two taxes is that Income Tax comes out of your business profits while GST comes out of the end consumer’s pocket. Businesses do not pay GST but collect it and hand it over to IRD.

So how does it work?

Taxable Supplies

When a business sells goods or services, it generally must charge GST to its customer by adding GST to its prices. Supplies of goods or services subject to GST are “taxable supplies”. If you are carrying on a business, profession or non-profit activity, and selling goods or services on a regular basis, then you are carrying on a taxable activity and those goods or services are taxable supplies.

Certain supplies are exempt from GST and are therefore not taxable supplies. These include domestic rent, wages and salaries, company director fees and private sales. Most products and services provided by businesses however are taxable supplies.

GST Rates

GST is generally charged at the standard rate of 15%. For example, you’re a consultant and charge a client $500 for your services. You are required to add $75 ($500 x 15%) GST and charge your client $575. You collect the $75 on behalf of the government and pay it to IRD when you file your GST return.

Certain supplies are zero-rated, meaning they have GST charged at 0% rather than 15% including:

  • Exported goods or services
  • Sales of a business as a going concern
  • Land sales where both the buyer and seller are GST registered and the land is used in a taxable activity

E.g., if your consulting services above were provided to a client in Australia, providing the services did not relate to NZ based property, they can be zero-rated. You will charge your Australian client $500 only collect no GST.

Zero-Rating versus GST Exempt

Zero-rating is different to GST exempt. If you make zero-rated supplies, they are still part of the GST regime. You are just charging GST at zero percent instead of 15%. If you make exempt supplies, the whole activity is outside of the GST regime. You are not making taxable supplies.

The difference matters because a business providing zero-rated supplies can be GST registered and claim back GST on its expenses, as discussed below. An organisation or individual providing exempt supplies only, cannot be GST registered.

GST on Expenses

While a GST registered business collects GST on sales, it also pays GST to its suppliers. Its suppliers will also be passing this GST onto IRD.

Because GST is a tax on the final (non-GST registered) consumer and not the business, a GST registered business can claim back the GST paid to its suppliers. Therefore, a GST registered business does not have any actual GST cost, just the burden of administering the collection and payment of GST.

Filing GST Returns

A GST registered business both collects GST from its customers and pays GST to suppliers. The difference between the GST collected and the GST paid is the net amount of GST to be paid over to IRD.

Presuming a business is charging 15% GST on all its sales and is making a profit (sales exceed expenses), then it will collect more GST than it pays. In this case, the business will pay the excess GST collected to IRD. If the business pays more GST to suppliers than it collects from clients, it will get a refund of the excess GST paid out.

Example

As discussed below, a business will have a GST period of either one, two or six-months. Let’s assume a small bike repair business has a two-monthly GST period. In the month following the end of each two-month period, the business must file a GST return covering the GST activity in the period including the GST collected on sales, GST paid on expenses, and the net GST collected to be paid to IRD.

For the GST period covering Apr and May 2018, the business must file a return by 28 Jun 2018. This will include all GST collected and paid in the two months from 1 Apr to 31 May 2018. The net GST collected must be paid by the return due date.

Example GST Return

Sales including GST 115,000

GST content of sales 15,000

Purchases including GST 38,333

GST content of purchases 5,000

GST to pay to IRD $10,000

GST Registration

To register for GST, a business must have a taxable activity. I.e., it must have a regular activity of selling taxable supplies.

When the business’ sales value exceeds $60,000 over a 12-month period or is likely to exceed $60,000 over the following 12 months, the business must register for GST. A business with sales under $60,000 can remain unregistered or register voluntarily.

Voluntary GST Registration

There are three considerations for a small business with sales under $60,000 to weigh up when deciding whether to register for GST.

First, a GST registered business must add GST, generally at 15%, to its prices.

If the business’s customers are other GST registered businesses, then this should not matter as the business customers will claim the GST back.

Alternatively, if the business’s customers are the end consumer (private individuals) and therefore not GST registered, the GST is a direct cost to them. The customer will pay a certain price regardless of whether it includes GST or not, so effectively, the business must wear the cost of the GST by returning it out of the sales price.

From this perspective, being GST registered is a disadvantage unless all customers are GST registered businesses in which case it doesn’t really matter.

Second, a GST registered business can claim GST back on its expenses. A non-GST registered business cannot. From this perspective, being GST registered is an advantage.

Third, a GST registered business must file GST returns, account for GST on all transactions and keep invoices and relevant records for seven years. From this perspective, being GST registered is a disadvantage although it does encourage better record-keeping and up-to-date accounts.

My suggestion is that if your customers are private individuals, it is probably not worth being GST registered until required to. If your customers are businesses, it may be worth registering.

GST Registration Options

When you register for GST, you choose a GST period and an accounting basis. The period is the length of time each GST return covers. The accounting basis is the method of calculating your GST liability or refund for that period.

GST Period

You file a GST return for each GST period which can be one month, two months or six months. Whichever period you use, your GST return is generally due by the 28th of the month following each period end.

Monthly

Larger businesses with an annual turnover exceeding $24 million must file monthly. Anyone else can file monthly but most choose to file less frequently.

A monthly period may be a good choice is you regularly have GST refunds and want to receive them sooner. An example is a service provider exporting services to overseas clients and zero-rating them. They will not collect GST on sales but will still pay GST on NZ expenses.

Two-monthly

Available for any business with an annual turnover below $24M.

Two-monthly is the most common GST period for small businesses. A two-month period helps to keep your accounting up to date on a regular basis, coding transactions when they are still reasonably fresh in your memory. It is also a good time period for combining processing your transactions with preparing regular management accounts to monitor your business performance.

Six-monthly

Available for any business with an annual turnover below $500,000.

This is a common choice common with small service businesses such as solo consultants who do not have many transactions and prefer to only file two returns a year.

The GST collected over six months can be substantial. This means you have the use of that money in the meantime, or can earn interest on it, but also makes it easy to get in trouble if you don’t ensure it is available to pay your GST by the due date.

Example

Ken’s drafting services has six-monthly periods ending in September and March. For the period ending 30 Sep 2018, Ken files a GST return accounting for GST collected and paid on all transactions from 1 Apr 2018 to 30 Sep 2018. The return and any GST payment are due by 28 Oct 2018.

GST Accounting Basis

You must choose an accounting basis, or method, for calculating your GST payment or refund in each return. There are three options:

  1. Payment basis
  2. Invoice basis
  3. Hybrid basis

Payments Basis

Businesses with a turnover under $2 million can use a payment basis.

Most small businesses choose this method as it is generally simpler and more closely matches cash flow.

Under this method, you return GST to IRD that was collected from customers, and reclaim GST on expenses paid to suppliers, during the period. Any unpaid invoices at the period end are ignored. This means that you should have the GST on hand at the due date as you have already collected it.

Depending on your accounting systems, it is usually easier to calculate GST under the payments method than the invoice or hybrid methods. You can total up all GST included receipts and payments from your bank statements or cashbook system to prepare your return.

Invoice Basis

Businesses with an annual turnover exceeding $2 million must use this method, while smaller businesses can opt to.

Under the invoice basis, your account for GST on sales and purchases incurred, or invoiced, during the GST period regardless of whether they have been paid or not. Generally, this means paying GST sooner to IRD as most businesses have more outstanding amounts owed by customers (on which to return GST) than outstanding amounts owed to suppliers (on which they can claim GST). I.e., most business’s debtors exceed their creditors. Unless all your sales are settled promptly, you will be paying GST to IRD that you have not yet collected from customers.

Hybrid Basis

This is a combination whereby you return GST on sales on an invoice basis but claim GST on purchases on a payments basis. This generally provides the worst of both as you will be paying GST on sales yet to be collected but only claiming GST on purchases once paid. Any GST registered business can use this method, but it is not common.

Should you be a GST Registered Consultant

Should You be a GST Registered Consultant?

If you are starting out as a consultant, you may or may not have to be GST registered. If it is not required, it may or may not be to your advantage to register voluntarily. This article explains why.

How does GST work?

Goods and Services Tax (GST) is collected by GST registered consultants (and other businesses), from their clients, and passed onto IRD. GST registered consultants also claim back, from IRD, the GST content of their expenses. When a consultant’s GST collected on fees exceeds GST paid on expenses, the excess is paid to IRD. If GST paid exceeds GST collected, the shortfall is refunded by IRD.

Who can be GST registered

A business, or consultant, can generally be GST registered providing they sell taxable supplies. Taxable supplies are the sale of goods or services. If you are a consultant, you almost certainly are providing taxable supplies to your clients.

GST charged on consulting fees

GST registered consultants add GST to their fees charged to clients. With a couple of exceptions mentioned below, GST is charged at the standard rate of 15%. So, if a GST registered consultant charges $100 for their service, they generally add $15 GST and charge their client $115 including GST.

Zero-rated supplies

Certain taxable supplies are zero-rated, meaning GST is charged at 0% instead of 15%. Zero-rated supplies include:

  • exported goods or services
  • sales of a whole business as a going concern
  • sales of land from one GST registered person to another.

A GST registered consultant generally charges GST at 0% on services provided to overseas clients (exported), unless the services relate to property in New Zealand.

Exempt supplies

Certain types of supplies are exempt from GST. If you are in the business of providing these, you cannot be registered for or charge GST. Exempt supplies include:

  • salary or wages
  • residential rent
  • interest (whether paying it or receiving it)
  • most other financial services
  • sales of fine metals.

Should a new consultant register for GST?

If a consultant’s fees exceed $60,000 per year, they must register for GST. Even if their fees are likely to exceed $60,000 over the following 12 months, they must register.

If a consultant’s fees are less than $60,000, the consultant has the option of becoming GST registered or not. Voluntary registration may be worthwhile depending on the consultant’s circumstances.

Advantages of GST registration for consultants

The major advantage to a GST registered consultant is claiming back GST on business expenses. A non-GST registered consultant must wear the cost of GST of all GST inclusive expenses including:

  • Vehicle running costs
  • Computer equipment
  • Books and training costs
  • Office rental (offices are commercial rents so not exempt from GST like residential rents)
  • Big items like motor vehicles or even office buildings

Note however that once an asset such as a vehicle has been purchased by a GST registered consultant and the GST claimed, GST must be charged on a subsequent sale of the asset.

Disadvantages of GST registration for consultants

There are two potentially significant disadvantages to being GST registered: GST registered consultants must charge their clients GST and they have GST compliance requirements.

Charging GST to clients

Charging GST to clients may or may not be a problem depending on the type of client the consultant has.

For a consultant selling business to business (B2B) services, GST registration may not be a problem. The B2B consultant’s clients will generally be GST registered businesses themselves and can therefore claim back the GST. Paying a non-GST registered consultant $100 with no GST to claim back equates to paying $115 to a GST registered consultant and claiming back the $15 GST.

For a consultant selling business to consumer (B2C) services, GST registration is a problem. The non-business clients will generally be unable to claim back the GST content, so it does not matter to them whether the consultant is GST registered or not. If the maximum they will pay for a service is $100, the consultant will have to suck it up and return the GST content out of the $100. The GST registered consultant is wearing the GST cost.

For a GST registered B2C consultant, the costs of paying GST out of their sales will exceed the benefit of claiming GST on expenses unless their expenses exceed their sales and they are losing money. For B2C consultants, I suggest not registering for GST until you have to.

GST compliance requirements

The other disadvantage to GST registration is the compliance obligations. A GST registered consultant must prepare and file GST returns, make payments to IRD, prepare tax invoices for sales and collect tax invoices for purchases. These records must be kept for seven years. Of course, accountants or bookkeepers can do most of this for you and modern accounting software makes it a whole lot easier.

If a GST registered consultant breaches any of their obligations, they are exposed to IRD’s penalties regime which can be very costly.

Summary

If you provide taxable supplies exceeding $60,000 per year, you must register for GST. If your supplies are below $60,000 per year, you have a choice.

For B2B consultants, I would generally recommend registering voluntarily as the GST charges should not hurt your sales and you can claim GST on expenses. I would only suggest staying non-registered if the GST on your expenses are not worth the GST compliance hassles.

For B2C consultants providing services to non-GST registered people and organisations, I recommend remaining non-registered until you must register. It may be tempting to register if you intend claiming GST on a large business asset such as a vehicle, but ultimately, if you are successful, your sales will exceed your costs and the loss of 15% of those sales will exceed the 15% reclaimed on costs.