July Tax Alert

Article

Welcome relief for taxpayers: the next chapter in the feasibility journey

Tax Alert - July 2020

By Patrick McCalman, Vyshi Hariharan and Mahi Kumar
 

The Government is moving ahead with welcome reform to the deductibility of feasibility expenditure. On 4 June 2020, the Government introduced the Taxation (Annual Rates for 2020-21, Feasibility Expenditure, and Remedial Matters) Bill (the June Bill). The June Bill introduces measures which allow deductions for certain expenditure related to unsuccessful and abandoned assets or business models, as well as, immediate deductions for certain de minimis expenditure as a compliance cost saving measure.

Discussions regarding deductions for feasibility expenditure have spanned a number of years, with initial consultation beginning in 2004 and the original interpretation statement (IS 08/02) being released in 2008. Since then, following the Trustpower judgments of the courts, Inland Revenue released IS 17/01: Income tax – deductibility of feasibility expenditure in February of 2017 (which replaced IS 08/02).

IS 17/01 provides guidance in relation to feasibility expenditure incurred as an ordinary incident of business and which is recurrent in nature. Broadly, it states that a deduction is allowed for such feasibility expenditure, provided the expenditure was not directed towards a specific capital project and / or was so preliminary as not materially advancing or making tangible progress towards a specific capital project (refer our previous Alert article). The current proposals are intended to sit alongside guidance in this interpretation statement.

Since the Trustpower case and the release of IS 17/01, stakeholders have been seeking a revision of the tax rules. An example of where review has been sought is in relation to expenditure on unsuccessful or abandoned projects or investments, where taxpayers would have received depreciation deductions had the project gone ahead, but simply did not because the project was abandoned before it met the definition of depreciable property. Officials undertook consultation and developed some options for reform, outlined in the discussion document Black hole and feasibility expenditure released in May of 2017.

Key features of the proposed measures

The proposed changes in the June Bill allow taxpayers a deduction for expenditure incurred in the 2020-21 and later income years in completing, creating or acquiring property that would be depreciable property (including depreciable intangible property) or revenue account property either if:

  1. Progress on the asset is abandoned such that the property is not completed, created, or acquired. In this case, deductions meeting the required conditions will be spread in equal proportions over a five-year period, starting from the income year in which progress on the property is abandoned.

    Where abandoned property is later completed, the deductions allowed under (1) above would be ‘clawed back’ by treating the amount previously deducted as income in the year the property is completed, created or acquired. 

  2. The total expenditure is NZD 10,000 or less for the income year. In this case, an immediate deduction is allowed. 


While the proposed changes override the capital limitation, taxpayers would still be required to satisfy the general permission and the other general limitations. These measures would not apply where a deduction was allowed for the expenditure under any other provision of the Income Tax Act 2007.

Deloitte comment

The Government acknowledges that the status quo on the treatment of feasibility expenditure is inefficient and is acting as a barrier to businesses committing to expenditure on developing assets when uncertainty exists as to whether that asset would be completed.

Helpfully for taxpayers, the proposed measures widen the net of expenditure that would be deductible. Therefore, these measures are most certainly a step in the right direction. There are however some areas of the proposals that should be considered further, and if addressed by Officials, could provide relief and clarity to taxpayers. We discuss these below.

  1. The requirement for the general permission to be met
    According to the Commentary on the June Bill, the changes are being implemented to support the Government’s economic strategy. They are intended to ensure tax is not a barrier for businesses seeking to invest in new projects or assets (unless there is an explicit denial of deductions - for example, where the taxpayer is not expecting to incur an economic loss on the asset, such as land).

    Contrary to this sentiment however is the requirement for taxpayers to first meet the general permission to be allowed a deduction under the proposed measures – i.e. for expenditure to be deductible under these measures there must be a sufficient relationship or nexus between the expenditure and the taxpayer’s business, or income-earning activity. Those familiar with the Trustpower judgements and IS 17/01 will recall that this principle means that if the expenditure is incurred as preliminary or preparatory expenditure before the commencement of a business or an income earning activity, there will not be sufficient nexus and the expenditure would not meet the general permission.

    Given the Government’s intended policy underlying the proposals, and in light of the current environment where businesses are ‘pivoting’ in new directions to respond to the impact and uncertainty surrounding COVID-19, the requirement to meet the general permission may restrict the ability of these measures to encourage and support the Government’s economic strategy. We would welcome the Government relaxing this requirement.

  2. Application date for expenditure incurred
    The proposed changes are drafted to apply to expenditure incurred in the 2021 income year and later years. Therefore, expenditure incurred prior to the 2021 income year would not be deductible under these measures, even if the project or asset itself is abandoned in the 2021 income year. As noted above, given the current environment and uncertainty surrounding COVID-19, and with taxpayers ‘pivoting’ in new directions to survive, expenditure relating to many projects being abandoned at the moment in pursuit of other opportunities would have been incurred prior to the 2021 income year, and would not be deductible under these measures.

  3. Determining the asset – what about abandoned components?
    Where expenditure incurred relates to a component of an item of depreciable property, and the component itself is abandoned, but the item of depreciable property is completed (with an alternative component), it is unclear whether a deduction would be allowed for expenditure relating to the abandoned component under these measures or whether expenditure relating to the abandoned component should be capitalised to the cost of the depreciable property and depreciated. This uncertainty in treatment can be dealt with by issuing guidance on this matter or further clarifying the legislation.

  4. Apportionment of expenditure
    The proposed changes are not intended to apply to expenditure relating to a project or asset which is not expected to decline in value (e.g. land). Where taxpayers incur expenditure on a project that would have, if completed, resulted in depreciable property or revenue account property, as well as an asset that was not expected to decline in value, it is unclear whether a taxpayer can apportion the expenditure and claim a deduction under these measures for expenditure relating to depreciable property or revenue account property. This uncertainty in treatment can be dealt with by issuing guidance on this matter or further clarifying the legislation.

Next steps

A submission date has not yet been set for the June Bill. However, we expect that submissions would close before Parliament rises for the election in August 2020. It will be interesting to see what changes (if any) are made as a result of submissions. Please contact your usual Deloitte advisor if you have any questions or would like assistance with making a submission.

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