Draft COVID-19 guidance provides a refresher on tax deduction rules

Tax Alert - March 2022

By Robyn Walker & Dave Morris

While it may be hard to remember a time before masks, boosters and daily case reports, at the start of 2020 COVID-19 related expenses were highly unusual. Given the unfamiliarly of costs such as personal protection equipment (PPE) and managed isolation and quarantine (MIQ), there was some uncertainty as to whether these costs were tax-deductible. In response, albeit 2 years later, Inland Revenue has released guidance on the tax treatment of costs incurred from COVID-19 in the form of draft interpretation statement PUB00432 “Income Tax – deductibility of costs incurred due to COVID-19”. This item is a follow-up to a previous interpretation statement “Income tax and GST – deductions for businesses disrupted by the COVID-19 pandemic”.

It is worth noting at the outset that no law changes have been made to amend how the rules apply to COVID-19 related expenditure, that is, there have been no concessions or amendments to the general principles.

In essence, the draft Interpretation Statement restates general deductibility and capital versus revenue principles, as well as emphasising that just because a cost is unusual, or one-off doesn’t necessarily mean general principles won’t still apply.

As the guidance examines the basic principles of deductibility and the capital limitation it may be useful as a starting point when determining the deductibility of costs beyond those directly related to the pandemic.

General tax deduction rules

While potentially unaware of its technical name, most businesses will be aware of the “General Permission” in the Income Tax Act 2007. This is the gateway to obtaining a tax deduction for expenses before diving into the more specific rules and exemptions. Put in simplistic terms, the General Permission allows taxpayers a deduction for costs incurred in deriving income or carrying on a business for the purpose of deriving income. The draft interpretation statement accepts that businesses incurring costs to adapt to COVID-19 would usually have a connection to their income and will generally satisfy the General Permission.

However, the General Permission has some limitations to it, most notably the “Capital Limitation”, meaning that many costs of a capital nature cannot be deducted (although in some cases they can be allowed overtime as depreciation). The draft interpretation statement provides a concise, but useful summary of the capital limitation.

Application to particular costs

Employment costs

Since the advent of COVID-19, employers have incurred many unexpected employment costs including redundancy, legal fees and purchasing PPE. COVID-19 restrictions on travel have also meant employers have incurred costs that they would not normally of encountered when there was free movement between countries, such as MIQ stays and COVID-19 tests. It is acknowledged that the majority of these employee costs are still deductible as employee costs are by their nature linked to a business’ income. However, applying the previously described capital principles, employee costs are not deductible if they are for a capital project.

Legal fees, business interruption and premises

There is some discussion around legal fees that may be incurred in pandemic disputes, with the general capital limitation principals still applying, as well as the section DB 62 override for legal fees of $10,000 or less still being available.

As there have been many interruptions to business over the pandemic period, some temporary others more permanent, many may be wondering if they can still claim depreciation if assets are not being actively used in the business. In short, the answer is yes as long as the asset is available for use in the business and the business is being carried on. The guidance gives a good description of how to determine whether an asset is available for use but is less clear on how to determine if a business is being carried on (the previous guidance on business disruption should be referred to instead).

There have been many tenancy variations and disputes since the start of the pandemic. The guidance addresses this by noting the current deductions available for the surrender or termination of land leases and licenses. These are a series of tax rules which were introduced in 2013 which generally allow tax deductions for such costs, even if they would overwise be considered capital expenditure. Unfortunately, there are no similar rules for leases and licences of many other property types.

Finally, the draft interpretation statement explains that deductions are available for the relocation of a business as long as these costs maintain the existing structure of the business and are not expansionary.

The draft interpretation statement discusses legislation that has been in place over an extended period and it may be of limited additional utility to those already well versed in tax law, but it may serve as a useful reminder of the important concepts of deductibility and capital expenditure for others. Submissions on the draft interpretation statement close on 30 March 2022.

If you wish to discuss the deductibility of any COVID-19 expenses you have incurred, please contact your usual Deloitte advisor.

Did you find this useful?