10 August 2023

What are the implications of removing GST from fresh fruit and vegetables? Considering the supply chain effects, input tax deductions, and the unintended consequences of this approach, it might not be the straightforward solution it appears to be, unless Government zero-rates.

Whilst the Government has not announced any changes about removing GST from fresh fruit, vegetables, or food generally, public speculation on the change suggests it could help reduce food costs. However, despite the ostensibly well-meaning intentions, this idea can lump unwanted compliance costs on businesses and could invite unintended consequences, not achieving its objective of lowering food prices.

Let’s illustrate this with a simple example and explore some of these potential unintended consequences.

Our retailer Mr Fruit and Vege purchases one lettuce for $1 + GST ($1.15) and retails it for $2 + GST ($2.30). If the law removes GST from the sale price, you might assume that the price drops by 30 cents or 13%, which sounds great, but isn’t exactly accurate.

While this approach may have worked with reducing petrol prices, petrol excises are only at the pump, not the supply chain as is the case with food.

In this case, Mr Fruit and Vege will buy one lettuce at $1 plus GST of 15 cents. When a business purchases trading stock subject to GST on sale, it claims the 15 cents on its purchase as a deduction in its GST return against the 30 cents GST that it is required to pay Inland Revenue when the lettuce sells. In this way, only the value added (the retailer’s margin) is taxed. However, if GST is removed on the sale of the goods, it means that Mr Fruit and Vege does not get the input tax deduction of 15 cents.

Assuming the retailer cannot claim the GST it has paid, i.e., the 15 cents, this eats into Mr Fruit and Vege’s sales margins and thus the money he must pay on outgoings. So, the retailer now makes 85 cents instead of the prior $1. To ensure net margins and profits remain the same, Mr Fruit and Vege will add 15 cents to the sale price of the lettuce. It now goes from $2 plus GST to $2.15 with no GST. The cost reduction to the purchasing public is already effectively halved.

However, this is just the retailer. Let’s assume the grower also can’t claim GST inputs as its sales are not subject to GST under the considered scenario of changed rules, where fresh fruit and vegetables is not subject to GST. This means the grower must increase prices by the GST incurred on all non-food items involved in production. The same applies to the wholesaler. This cascades the costs of unclaimed GST through the supply chain.

Consequently, the lettuce for which Mr Fruit and Vege once paid $1, could now cost (say) $1.05.

So, where the GST component of the item at the retailer was 30 cents, removing GST at best drops the price of the lettuce by 15 cents or 6.5%. However, because of the ‘GST cascade’ up the food chain, the lettuce could now cost Mr Fruit and Vege $1.05, which together with the retail margin added means the lettuce is going to retail at $2.20 with no GST. The vaunted 15% saving is reduced to one third.

Given the fluctuating price of food items due to variables including increasing grower and transport costs, the price of fresh food items increases and decreases by far more than these sorts of slim margins as a matter of course. For example, a major news outlet reports a kilogram of loose tomatoes cost $15.05 in August 2022, rose to $18.32 in September, fell to $7.83 in October, and slipped further to $5.71 by January.

To overcome this, the government could allow Mr Fruit and Vege to claim the 15 cents GST input tax credit. However, this means allowing an input tax claim with no corresponding output tax payable. That is, Mr Fruit and Vege deducts 15 cents from its GST liability while paying no GST on the product sale. This is known as a zero rating. While the government could zero-rate just retailer sales, this begs the question of what a “retailer” is and places the full onus on the end seller to pass the GST content back to the public. In the interests of delivering fresh fruit and vegetables free of GST, sales of fresh fruit and vegetables up the supply chain needs to be zero rated. This makes for a more robust system as it ensures all supplies of fresh fruit and vegetables are GST free. To return to our example, it would mean Mr Fruit and Vege would pay only $1 for the lettuce and retail this with the normal margin added at $2.

While that sounds great, it causes a big problem for the government, as it results in another big hole in its tax revenue.

Big problem for the government

GST applies to all end-user consumers of goods and services and is a great revenue-raising tax. If the government can’t balance its books, there are only two options: borrow or raise taxes elsewhere.

Even if GST is removed on fresh food, twilight zone questions immediately emerge. How are things classified? For example, are frozen corn kernels “fresh” like the corncobs in the vege department? Is canned corn “fresh”?

If taken off all food, are there further boundary issues? Is a bottle of fizzy drink classified as food? What about bags of sugar and flour? This is the unintended consequence visiting, and it isn’t ‘theoretical’. Exactly these questions have tied up Tax Offices elsewhere in lawsuits, provided fertile ground for lobbyists, and tied up in Gordian knots more than one government and multiple industries.

Finally, if we remove GST from food items, why stop there? It becomes hard for any government to retain GST on other necessities such as toiletries or health products and the like.

To that end, while everyone sympathises on food prices, we would encourage the Government not to amend the GST system. In my opinion, New Zealand’s GST regime is relatively simple, and this keeps revenue collection efficient and minimises administrative costs.

To navigate the complexities of your tax strategy, contact our team of specialists today.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex Group Limited. This document contains general information and is not intended to constitute legal or taxation advice. If you need legal or taxation advice, we recommend you speak to a qualified adviser.