Business tax changes announced
Tax Alert - October 2019
By Robyn Walker and Brendan Ng
The Government has announced changes to two major tax issues that have been consistently causing businesses problems, as part of a business package to help New Zealand companies innovate and grow. These are:
- Allowing a deduction for feasibility expenditure for businesses; and
- Relaxing the loss continuity rules.
While the Government is yet to release much detail on these two issues, as an initial comment this announcement is very pleasing to hear, as both these issues have caused businesses to stumble in the past. These changes should remove barriers to expansion in the tax system and allow businesses to grow and evolve, without being unnecessarily hindered by the tax system.
The announcements were made as part of the release of the Government’s Economic Plan, and in the press release Minister of Finance Grant Robertson stated “This is about creating an environment where businesses are encouraged to innovate and become more productive – even if some of those ideas don’t work out.” The two proposals are summarised below.
Deduction for feasibility expenditure
The Government has proposed that businesses will be able to deduct ‘feasibility expenditure’ in their tax returns, with the deduction to be spread over a period of 5 years. An immediate deduction will be available if the total qualifying expenditure is less than $10,000 (expected to be calculated on an annual basis).
Under the current tax system, businesses are denied an immediate deduction for most expenditure associated with exploring whether to invest in a new asset or business model. This expenditure is often referred to as “feasibility expenditure”, being the expenditure to determine the practicability of a proposal, prior to commitment to developing the proposal. Feasibility has been a hot topic the last few years, with the Supreme Court’s Trustpower judgment and subsequent release of interpretation statement IS 17/01 Income Tax – Deductibility of feasibility expenditure.
The Commissioner’s current position is that only early stage feasibility expenditure is immediately deductible. This position is set out in paragraph 129 of IS 17/01 (emphasis added):
“Therefore, in the Commissioner’s view, expenditure is likely to be deductible in accordance with the Supreme Court decision if it is of a type incurred on a recurrent basis as a normal incident of the taxpayer’s business and it satisfies one of the following:
- the expenditure is not directed towards a specific capital project; or
- if the expenditure is directed towards a specific capital project, the expenditure is so preliminary as not to be directed towards materially advancing a specific capital project – or, put another way, the expenditure is not directed towards making tangible progress on a specific capital project.”
The result of this position is that much of what ordinary business practice would consider to be feasibility expenditure, is not immediately deductible for tax purposes because it materially advances or makes tangible progress on a specific capital project. Whether there is a tax deduction available at all hinges on whether the project successfully results in a depreciable asset – if a project fails or is abandoned there is no tax deduction available in many instances. This position limits a business’ ability to grow and innovate, by placing a tax barrier on innovation and diversification, as well as attempts to increase productivity by spending money to look at better ways of doing things.
At this stage it is unclear what further consultation will be held on this proposal (noting that consultation had taken place in 2017), prior to legislation being put before Parliament in early 2020. However the first question is how qualifying expenditure / feasibility expenditure will be defined. Currently there is no existing tax definition for feasibility expenditure, other than by proxy through the test in IS 17/01 described above.
Determining what is feasibility expenditure is in part a line drawing exercise. Before the release of IS 17/01, the test was whether the expenditure was incurred before the point at which a definitive commitment had been made to proceed with a project (i.e. expenditure before the point of commitment was feasibility expenditure and therefore deductible, anything beyond this was capital in nature and had to be capitalised to an asset).
Changes to tax loss continuity
The Government’s second proposal is to review and change New Zealand’s tax loss continuity rules, to make it easier for businesses to attract investment and get off the ground. At this stage there is very little detail about what this will involve, other than the fact that there will be further public consultation.
Currently, if a company is in a tax loss position, that loss can be used to reduce its taxable income in future income years, but only subject to a shareholder continuity threshold of 49% being maintained. This means that a company’s tax losses are forfeited if there is a more than 51% change in the ownership of the company. As a result, when companies are raising capital to fund further growth and development, the shareholder continuity requirements are often breached and tax losses are forfeited.
The impact of this is that it can be difficult to attract new investment, as the forfeiture of tax losses reduces the attractiveness of an investment and must be weighed up against the benefits of the new capital. The rule also affects decision-making regarding the amount and timing of capital-raising and disincentivises growth, innovation and risk-taking.
New Zealand’s current tax loss continuity rules are out of step with other countries around the world, particularly Australia who use a “same or similar business test”, in addition to a shareholder continuity test. In Australia, tax losses may be carried forward if either test is met, allowing for greater flexibility in investment and innovation. Under a “same or similar business test” a company can carry forward losses despite changes of ownership, provided the company carries on the same type of business.
The Government hasn’t specified whether it would consider a test like the “same or similar business test” or whether the shareholder continuity threshold will be lowered. It is worth noting that in its Final Report the Tax Working Group specifically noted “the Group does not recommend an extension of loss-continuity rules from one based on shareholding to one based upon a ‘same or similar’ business test, as is the case in Australia.”
In the joint press release by Minister of Finance Grant Robertson and Minister of Revenue and Small Business Stuart Nash, there was a notable focus on the application of the changes to loss continuity to “start-ups”, to make it easier for start-ups to attract investment and get off the ground. At this stage it is unclear whether the changes to loss continuity would have wider application to all businesses, however we would consider that the same benefits apply regardless of the maturity and size of a business.
If it is proposed to limit the changes to start-ups, there will be some significant definitional issues in relation to what can be regarded as a ‘start-up’, and at what point a business moves from being a ‘start-up’ to something more. In our view, any such distinction will only add complexity and uncertainty into the tax rules, and it would be preferable that the change in rules will apply to all businesses. The review of the tax loss continuity rules will include public consultation, and we expect that this issue will be drawn out then.
What’s next for each of these proposals?
The feasibility expenditure changes are to be included in a taxation bill to be introduced into Parliament in early 2020, so that the changes can apply from the 2020/21 income year onwards. This will mean that it is important that businesses are in a position to distinguish any qualifying expenditure so that a deduction can be taken. This will obviously depend on the form of the legislation and how qualifying expenditure is defined. Taxpayers will have the chance to comment on the proposal through the normal parliamentary processes.
The tax loss continuity changes will be consulted on later in 2019, under the normal consultation process for tax policy changes. The existing R&D tax loss cash out rules are also expected to be reviewed as part of this process. At this stage, this is a ‘watch this space’ proposal, however it will be important for affected businesses to get involved in the consultation process to ensure that the rules are developed practically and appropriately.
If you have any questions in relation to either of the proposals, please contact your usual Deloitte tax advisor.
October 2019 Tax Alert contents
· Business Tax changes announced