The treatment of GST on late-payment fees and penalty or default interest is a puzzling issue, writes Craig Macalister in Taxing Times.
Though we have had GST since 1986, the GST treatment of late-payment fees and penalties et al has always caused a little confusion.
However, with a law change on its way, the rules are supposed to be a little clearer. This change will also give businesses that charge late-payment fees the opportunity to think about switching to penalty interest.
What is the situation now? This is the confusing part as Inland Revenue disagrees with itself. Thus, depending on whom you talk to at IRD, you may be treating late-payment fees as subject to GST or GST-free. In terms of penalty interest, this is GST-exempt and is comparatively free of doubt.
What will the situation be on and after January 1, 2013? Late-payment fees imposed on or after January 1, 2013 will be subject to GST if the underlying supply is taxable. Penalty interest continues to be GST-exempt.
IRD is promoting the change to the law to confirm late-payment fees are subject to GST on taxable supplies, to overcome the problem that an IRD legal view prepared by one of its many hands (let's call it the left hand for argument's sake), said that late-payment fees are not subject to GST. This disagreed with published material prepared by the right hand of IRD, which said such fees are subject to GST.
Having different “hands” of IRD disagreeing with itself is not uncommon in my experience, and, as is often the case in these situations, a change in the law is inevitably required to resolve the matter. In the commentary on the tax bill containing the change, IRD states:
“The proposed amendment is a result of a recent interpretation of the law which concluded that no GST is chargeable on late-payment fees. This interpretation is inconsistent with the policy of a broad-based tax, and with Inland Revenue's public interpretation which has been that late-payment fees are subject to GST whereas penalty interest is not.”
Interestingly, many GST purists would say that charging GST on late-payment fees is not a valid policy response, as a late-payment fee has no connection to the underlying supply of the goods or services. Many readers may find themselves agreeing with this. In response, IRD said:
“A flat late-payment fee can be viewed as the on-charging of administration costs that a business incurs in chasing payment for the underlying taxable supply. In this respect, it is in effect an increased charge for the goods and services provided and should be subject to GST in the same way as the underlying supply.
"Charging GST on late-payment fees also provides consistency with transactions involving prompt payment discounts - GST being built in as a charge in those transactions if payment is late.”
Thus, to cut a long story short, the change to confirm that late-payment fees payable on taxable supplies are subject to GST will come in on January 1, 2013. So, for businesses not charging GST in these circumstances, a change will be required.
The good news is that IRD have accepted that businesses may decide to switch from charging late-payment fees on overdue accounts to an interest-based charge that is GST-exempt. According to IRD, this is a business decision that will now be aided by a clearer understanding of the rules. So, provided IRD doesn't disagree with itself again, affected businesses may want to rethink whether they impose late-payment fees or penalty interest on overdue accounts.
» Craig Macalister is tax principal at accounting firm WHK. He can be contacted on 03 211 3355.
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