Late payment fees

Sections 5(25) and (26) of the Goods and Services Tax Act 1985

Key features

Prior to this rule change there was some confusion surrounding the GST treatment of certain late payment fees. New sections 5(25) and (26) have been added to clarify that GST generally applies to fees for the late payment of an account in the same way as the underlying supply to which the fee relates.

Background

Previously there was some confusion over whether a late payment fee was:

• a taxable supply, subject to GST;
• default or penalty interest, exempt from GST; or
• an amount that represented liquidated damages or a penalty that was not a "supply" at all for GST purposes.

Late payment fees being subject to GST is consistent with a broad-based tax. In this respect, it is important to differentiate between late payment fees, which can be seen as an increase in the consideration of the underlying goods and services, and default or penalty interest, which is an exempt financial service.

New section 5(25) makes this distinction clear by specifically excluding penalty or default interest from the ambit of the supply. This means that, to the extent an amount consists of such interest, that portion will continue to be exempt.

What is a late payment fee and what is interest will always be determined on a case-by-case basis. For example, if a late payment amount is expressed as a percentage of an outstanding invoice, this may not always mean that the late payment amount is interest. It will depend on whether the late payment amount exhibits enough of the characteristics of penalty or default interest to be categorised as such. It is anticipated that most "one-off" fees will be captured by section 5(24) irrespective of how they are calculated. However, there will always be scope for part of any upfront fee to be categorised as interest if there are compelling reasons for doing so.

The majority of late payment fees will be charged in instances when there are regular billing arrangements between the supplier and recipient (it is unlikely that credit would be extended without a regular billing arrangement or some commercial history between the parties). It is therefore expected that the tax invoice documenting the late payment fee will simply form part of a subsequent invoice for "regular" goods or services provided. When such an arrangement is not in place, a separate invoice for the late payment fee will need to be issued in order to allow the recipient to claim an associated input tax deduction.

Although the late payment fee is, from a policy perspective, an increase in consideration for the underlying goods and services, the mechanics of section 5(25) mean that the late payment fee is a separate supply. The normal time of supply rules will apply to treat the late payment fee as being supplied at the time of the subsequent invoice, so the credit/debit note provisions in section 25 will not apply.

New section 5(26) clarifies that the tax treatment of the late payment fee will follow the treatment of the underlying supply, be this fully taxable, zero-rated or exempt. For example, if the late payment fee was in relation to an exempt financial service, the late payment fee will itself be exempt. If the fee is in relation to a composite supply or more than one supply, part of which is taxable and partly exempt, the GST on the fee should proportionately (by value) follow the treatment of the underlying supply/supplies.

Application date

As this amendment confirms existing policy, and the practice of the majority of registered persons, the application date is 1 April 2003. However, to recognise the fact that some registered persons currently do not charge GST on late payment fees, if a person has previously adopted a regular practice of not charging GST, they must apply the new rules only to fees charged by them from 1 January 2013.