GST and deposits – be wary!
How are you GST registered to deal with any land sale?
Farmer Freddy is relieved that issuing Barney with a warning for arriving to work late has done the trick. Barney always arrives on time now and he's even had Freddy over to taste his Thai cooking!
The next morning, while Freddy's lying on the couch recovering from his meal chez Barney (Freddy found the red curries a little hotter than his standard fare), his lawyer calls to tell him that $50,000 has just been deposited into his trust account for Freddy. He wants to know what it's for.
"Oh yeah" says Freddy, "I was meaning to talk to you about that. I've sold the run-off to Doug from down the road for $500,000 - his lawyer drafted the agreement. The $50,000 must be the deposit he was going to pay when the agreement went unconditional. Settlement's at the end of May next year."
"How did you deal with the GST on the sale?" asks the lawyer.
"Well, I know I'm registered for GST, and I figured the sale was part of my business, so I made sure that the price was plus GST."
"Yes but what basis are you registered on?" asks the lawyer.
The lawyer explains that if Freddy is registered on the invoice basis then he must account for all of the GST on the sale in his next GST return after the time of supply has been triggered.
The time of supply is triggered on the earlier of Freddy issuing a tax invoice or receiving any payment (such as the deposit). Since the deposit has been paid to Freddy's lawyer and the contract is unconditional, IRD considers that Freddy has received the deposit because it has been applied to his benefit. Therefore, the time of supply has been triggered.
In this case, Freddy will need to account for all of the GST due on the sale in his next GST return: One-ninth of $500,000, which is $62,500. He will be able to use the $50,000 deposit, but poor Freddy isn't going to get the rest of the money until May 2010!
But if Freddy had specified a GST date in the agreement, he could have required Doug to pay him all the GST due on the sale before Freddy's next GST return was due.
However, if Freddy is registered on the payments basis, he will only need to account to the IRD for the GST due on the deposit in his next GST return - that is $6,250.
The rest of the GST will be due when he is actually paid the rest of the purchase price.
Freddy will need to be careful that his GST return is not prepared based only on his bank statements though. Since the contract was unconditional, he will still need to account for the deposit in his next GST return even if the money is still held by his lawyer.
"Crikey dick" thinks Farmer Freddy as he hangs up the phone. "I'd better check how I'm registered straight away. But first, I'll just have another cup of tea."
The content of this document is necessarily general and readers should seek specific advice on particular matters and not rely solely on this document.
If you would like further information on any of the topics in this document, please contact your usual Auld Brewer Mazengarb & McEwen adviser.