The tax trap for farm homesteads
12 May 2022
The sale of the farm homestead could now be subject to GST, at least partially, following a recent tax law change made to clear up confusion around an interpretation statement released by the IRD in 2020 in relation to the GST treatment of Residences and Other Real Property.
The updated interpretation statement (IS 20/05) stated that GST registered people that used residential properties for mixed purposes, such as for GST taxable purposes and private purposes, would have to treat the sale of the property as subject to GST in full. However, they would be allowed a GST input tax credit on sale for any unclaimed GST. A classic example of this is a farmhouse, which is often used to conduct the business affairs of the farm.
According to IRD’s interpretation statement, if a farmer used their farmhouse for the taxable activity of farming, such as using an office in the homestead for the farming business, then the sale of that dwelling would be subject to GST.
This position threw many farm sales into doubt as it was a complete U-turn from IRD’s previous policy position on the same issue published in November 1996 which was much clearer: that a farmhouse will generally be a supply of a private or exempt asset and not subject to GST.
The change in how IRD were interpreting the law created a great deal confusion and caused Government to look at whether a law change was appropriate. The good news is the law has now been updated to clarify things. The bad news is the law change has not altered the position that IRD will treat the sale of the farm homestead as a GST taxable supply.
What the law change does do is offer some relief by allowing a deduction from output tax payable that relates to the private use portion of the asset. For example, if 20% of the homestead was used as part of the farming business and 80% for private purposes, an adjustment to the output tax of 80% will be allowed. However, that still leaves output tax payable on 20% of the current value of the property, which essentially creates a greater tax burden for many farmers. Clearly, this is a less preferable position by Inland Revenue compared to their 1996 stance, which was that the farm homestead is predominantly a private asset and should be outside the GST system.
Vendors of farms who find themselves in this position have a few options. You could sell the farm homestead on a “Plus GST if any basis” and add GST to the homestead. However, a purchaser may not be prepared to fund this, at which point the issue will be one for negotiation. Or, you could cease using the farm homestead as part of the farming business or change the ownership structure. Unless there is any backtracking from Wellington over the issue, this would be the cleanest way of mitigating this position.
For those purchasing the farm, if a decision is made at the time of purchase to use the farm homestead as part of the farming business, claiming a GST input tax credit for the anticipated business use should be considered. Of course, there will be many differing factual situations, such as when a farm is leased, and people should always discuss this with their tax consultant before signing any sale and purchase agreement.
A paper released in March 2022 indicates that IRD policy is considering restoring the law completely to the outcomes prior to IRD’s change of interpretation in 2020. But, until a law change is made (which could be 12 months or more away), IRD’s 2020 published view of the law that these sales are taxable for GST purposes, remains a real trap for farm owners.