Section DB 2 - reverse charge rules

Section DB 2 of the Income Tax Act 2007

Generally, expenditure incurred in deriving assessable income is available as a deduction. Sometimes GST paid can be a real cost to business, even if they are GST-registered. The amendment clarifies that irrecoverable output tax incurred on reverse charge supplies since the introduction of the reverse charge rules is able to be deducted for income tax purposes.

Key features

Section DB 2 of the Income Tax Act 2007 (and equivalent provisions in the Income Tax Acts 2004 and 1994) has been amended to ensure that GST output tax on services that are subject to the reverse charge rules for imported services is available as a deduction for income tax purposes, provided the underlying services were also deductible.

Background

Currently, section DB 2(1) of the Income Tax Act denies an income tax deduction for both input tax and GST paid by the taxpayer to the Commissioner. Although this provision generally produces the desired result, it does not work when a GST-registered person is deemed to supply goods or services to themselves. Until recently, the only example of this enforced "self-supply" was the change-in-use adjustments made when a taxpayer who acquired goods or services for the principal purpose of making taxable supplies uses the goods or service for non-taxable purposes. To recognise that the output tax on these supplies is a real cost to the taxpayer (that is, it cannot be offset by input tax), section DB 2(2) of the Income Tax Act specifically allows it as a deduction.

Since 1 January 2005, when certain services are imported into New Zealand, the GST Act requires the New Zealand resident to treat itself as the supplier of those services (as well as being the recipient) and account for GST accordingly. This is another example of "self-supply" and is conceptually identical to the change-in-use adjustments. However, unlike the change-in-use rules, there is no specific provision in the Income Tax Act to allow any irrecoverable output tax incurred on the self-supply to be allowed as an income tax deduction. As a result, arguably, the general rule in section DB 2(1) applies and the taxpayer is denied a deduction, despite the fact that the expenditure is "real" in an economic sense. This anomaly potentially creates a discrepancy in income tax treatment between services that are sourced in New Zealand (and therefore not subject to the reverse charge) and those that are sourced offshore.

The amendment clarifies that irrecoverable output tax incurred on reverse charge supplies since the introduction of those rules is able to be deducted for income tax purposes.

Application date

The change applies from 1 January 2005, the date the reverse charge rules were introduced. This provides certainty going forward and provides taxpayers with comfort that Inland Revenue will not adopt a strict interpretation of section DB 2 for the intervening periods.