Inland Revenue (IR) has been scrutinising capital-raising transactions involving IPOs and bond issues. IR has traditionally taken the view that the share or bond issue (to raise capital) is an exempt supply of a financial service.
Using this analysis, a business that makes taxable or partially taxable supplies is unable to deduct in its GST return any GST charged on capital-raising costs, such as GST on legal fees and valuation work.
Businesses have argued that if all their sales are taxable (either at 15% or zero-rated) they must be able to recover GST on all their costs. Under New Zealand case law, a business is only a tax collector for the government and should not bear the incidence of any GST. In this context, businesses have argued that the share or bond issue is not relevantly a supply for GST purposes and can be ignored. The favoured stance in New Zealand has been to run the Kretztechnik line of argument out of Europe but to no avail until, of course, the release of the September 2015 issues paper. The issues paper specifically endorses the Kretztechnik case.
Some businesses have relied on specific zero-rating rules for GST recovery - for example, offshore zero-rating for offshore capital/debt issues or under New Zealand's unique business-to-business (B2B) financial services zero-rating rules. However, zero-rating is not always possible in a domestic capital-raising, and this has resulted in a cash cost due to the irrecoverable GST.
The impact of the zero-rating rules has meant that GST on costs associated with raising capital from offshore sources can be claimed (as securities are issued to non-residents) but GST on domestic capital-raising costs cannot be claimed. This is an odd policy outcome and creates market distortions.
The issues paper has changed the course of IR's thinking in a way that will be welcomed by businesses. The commentary in the issues paper canvasses both sides of the argument, such as whether a share or bond issue results in a supply for GST purposes. The conclusion reached, on balance, is that a fully taxable business should be able to recover GST on the costs associated with a capital-raising. The main reason for this is that capital-raising costs are seen to be the same as any other business costs. Therefore, GST recovery should be determined based on the underlying taxable activity of the business and the share/bond issue ignored.
The law will be changed to disregard the usually-exempt issue of equity or debt securities when a business is raising capital.
Any law change will be prospective only and is likely to apply from April 2017. Submissions are due on October 30 2015.
This is a welcome GST policy law change. The tax policy solution is the correct one and the GST treatment of domestic and offshore capital-raisings will be aligned.
Businesses raising capital will appreciate the certainty presented in the issues paper and will no longer have to consider ways to mitigate - such as through zero-rating - the cash cost of lost GST deductions. The GST change will also have the impact of removing a market distortion that arises due to the different GST treatment between domestic and offshore capital raisings.
Eugen Trombitas is a partner at PwC New Zealand.
