Changing depreciation rates – when is it acceptable?

Tax Alert - February 2015

Inland Revenue recently released a draft Question We’ve Been Asked (QWBA), QWB0131: Income Tax – Changing to a different depreciation rate for an item of depreciable property. This draft focuses on situations where a taxpayer who is already using a depreciation rate for an item of depreciable property can change that depreciation rate.

The correct approach for choosing depreciation rates at the outset is often misunderstood.  The depreciation rules require a taxpayer to use the depreciation rate that applies to their item of depreciable property. In the Commissioner’s view, the Income Tax Act 2007 contemplates only one depreciation rate applying to the item.  In other words, taxpayers can’t simply choose a more beneficial rate if it seems that more than one asset class “may fit” an item.  It is a matter of correctly identifying their item and then finding the item description that “most accurately describes” the item of depreciable property.  The correct approach is to look at the asset class descriptions in the industry and asset categories in the Table of Depreciation Rates.  Generally if there is an asset class description (other than a default class) in the appropriate industry category that applies to the item, the depreciation rate for that asset will be the applicable rate and there is no need to look at the asset categories.

The QWBA considers five instances where the depreciation rate that a taxpayer uses in respect of an item of depreciable property can be changed:

  1. There is a change in legislation that means a different depreciation rate applies to the item.
  2. The taxpayer changes from using a special rate to using the economic rate or provisional rate that applies to them.
  3. The Commissioner sets a new depreciation rate that applies to the item of depreciable property.
  4. The taxpayer has been using an incorrect depreciation rate.
  5. The depreciation rate is no longer applicable due to a change in circumstances.

Once it is established that a taxpayer is required to change their depreciation rate, the issue then becomes when the new rate will apply from. The draft states that, depending on the circumstances leading to the rate change, the change may be prospective or retrospective.

Most of the circumstances covered by the QWBA will have a prospective application once the change is made. The exception is the circumstance where the taxpayer has been using an incorrect rate.  The statement notes that if a taxpayer has used an incorrect depreciation rate, they are required to change to the correct applicable rate.  In this situation, the taxpayer will be required to follow the usual procedures provided in the Tax Administration Act (TAA) for the correction of errors:  

  • Section 113A of the TAA provides for the correction of minor errors in subsequent returns.  For example, if the net tax effect of using the wrong depreciation rate is $500 or less for each income year, the errors can be corrected in the current income tax return with fixed asset schedule adjusted accordingly.
  • If the requirements of section 113A are not met, the taxpayer can make a voluntary disclosure or make an application to the Commissioner under section 113 of the TAA where the Commissioner has discretion to amend assessments to ensure correctness.

The QWBA confirms that “using an incorrect depreciation rate” includes where a taxpayer does not use the rate for the asset class that most accurately describes the depreciable property – specifically this can include where the more accurate rate is more beneficial (e.g. a specific rather than default class rate) than a current (but arguably applicable) rate.

Overall, the statement provides useful guidance and the examples are practically relevant for most situations that will commonly arise in this regard.

Submissions close on this draft on 20 February 2015.  For further information about this item please contact your usual Deloitte advisor.

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