Material advancement and tangible progress on feasibility expenditure
Tax Alert - June 2017
After many years (and many tax articles) of analysing the tax deductibility of feasibility expenditure based on Inland Revenue interpretation statements and case law, we have moved to a new phase of determining whether it is feasible to change the law to deal with black hole and feasibility expenditure.
On 25 May 2017, the Government released a discussion document Black hole and feasibility expenditure for consultation. This document seeks to move the law on from the current position (refer to our March 2017 Tax Alert) to a brave new world where the tax system does not create economic distortions and tax consequences are not an obstacle to businesses innovating and pursuing opportunities for growth.
This represents material advancement and tangible progress on this long standing issue.
Before delving into the detail, it’s important to note there are no application dates proposed in the document, instead submissions are sought on why the application date shouldn’t just be the date of enactment of the resulting legislation (which would probably still be a minimum of 12-18 months away).
We suggest a retrospective application date back to 27 July 2016 (the date of the Supreme Court judgment in Trustpower) would be appropriate in the circumstances.
What is proposed
The discussion document contains two main proposals:
- For live projects: applying International Financial Reporting Standards (IFRS) accounting treatment to feasibility expenditure; i.e. allowing a deduction for feasibility which is expensed under IFRS, and deferring the deduction of expenditure capitalised under IFRS until depreciation deductions are available.
- For abandoned projects: allowing a deduction for previously capitalised expenditure that would have been part of the cost of a depreciable asset, had the project not been abandoned. A deduction would be available in the year in which the amount is fully expensed under IFRS rules (i.e. there has been a total impairment of the asset).
Critical to the new rules is understanding what constitutes “feasibility expenditure”. The document doesn’t go so far as to provide a draft definition for comment, rather it provides the substance of the proposed definition, being “expenditure to determine the practicality of a proposal, prior to commitment to developing the proposal”. This definition takes us back to the “good old days” prior to the Trustpower cases, but still leaves the potential for continued ambiguity and disputes unless “commitment” is itself defined.
The document notes there will need to be some exclusions from the rules, such as where there are existing rules that already specifically allow deductions. It is also suggested that any expenditure on a capital project that would not be able to be depreciated should be excluded from the rules, on principle. Fortunately this notion is dismissed on the basis that it may be impossible to determine this during early stage feasibility. This sensibly leaves open the ability for expenditure kicking the tyres on potential business acquisitions (which could take place through the purchase of assets or shares) to fall within the rules. However, the document suggests that feasibility should not include expenditure that would form part of the cost of depreciable property, if the proposal is successful. Rather such expenditure would either be depreciated (if successful) or dealt with under the new abandoned project proposals if unsuccessful.
The position under current rules is best illustrated in a graph taken from the document. Under current rules until a project has reached the point that there is an asset “available for use” (and therefore depreciable), if the project is abandoned any capitalised expenditure becomes black hole expenditure.
Figure 1 Feasibility expenditure in a project timetable - "material advancement or tangible progress" formulation – Taken from Black hole and feasibility expenditure: a Government discussion document (page 8)
Under the proposed rule, the capitalised expenditure would be an allowable deduction when it would have formed part of an item of depreciable property had it been completed. To qualify the item would need to be totally impaired under NZ IAS 36.8 or NZ IAS 16.7. The deduction would not be limited to feasibility expenditure but would also cover a range of other costs that had been capitalised to the asset that is abandoned.
In the event the impaired asset is reinstated as an asset in the future, any amount previously deducted would need to be returned as income.
Not using IFRS?
For businesses not using IFRS, it is proposed that taxpayers can apply the same rules provided the IFRS standards would have been met, had they been applied.
Submissions have been called for and remain open until 6 July 2017. We encourage you to consider whether these proposals adequately address black hole issues your business faces and make a submission. For more information
June 2017 Tax Alert contents
- Material advancement and tangible progress on feasibility expenditure
- New Zealand implications of Australian debt pricing decision
- Good news: resident withholding tax compliance issues relating to dividends are now resolved for companies
- Business Transformation – where are we now?
- GST best practice: a timely reminder
- Mileage rate released by Commissioner of Inland Revenue
- A snapshot of recent tax developments