Black hole and feasibility expenditure a Government discussion document. 6 July 2017

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1 Black hole and feasibility expenditure a Government discussion document 6 July 2017

2 6 July 2017 Black hole and feasibility expenditure proposals C/- Deputy Commissioner, Policy and Strategy Inland Revenue Department PO Box 2198 Wellington 6140 Dear Cath and Peter Black hole and feasibility expenditure proposals Thank you for the opportunity to comment on this discussion document. General Comments We support the broad policy direction proposed for the tax treatment of feasibility expenditure and other black hole expenditure following the Supreme Court decision in Trustpower Limited v Commissioner of Inland Revenue (2016) 27 NZTC (Trustpower). In our view, it will be critical for the new rules to be clear and simple. We believe this can be achieved if the tax rules follow the IFRS accounting standards. Summary Our submissions are: In our view, feasibility expenditure should be defined in the same terms/using the same approach as the IFRS accounting standards and not redefined for tax purposes. We support the proposal to allow non-ifrs taxpayers a deduction for feasibility expenditure if the IFRS standards would be met, had they been applied. We believe it would be appropriate to have a de minimis rule for the deduction of feasibility expenditure. 1

3 The deductibility of expenses incurred when an asset or project is partially abandoned should be considered. The application date of the proposals should be retrospective from the date of the Trustpower decision. When finalised, it would be helpful if Inland Revenue issued appropriate guidance on the new rules and policies. Our submissions are discussed further below. Definition of feasibility expenditure Paragraphs of the discussion document considers how feasibility expenditure may be defined. Paragraph 3.8 states that in substance the definition will be: expenditure to determine the practicability of a proposal, prior to commitment to developing the proposal. We support the introduction of a definition of feasibility expenditure. However, it should be limited to expenditure to determine the practicability of a proposal. It appears that the criteria prior to commitment to developing the proposal in the proposed definition seeks to redefine the term as it is used in Interpretation Statement 17/01: Deductibility of feasibility expenditure. It also appears to be different from the material advancement or tangible progress test referred to in Figure 2 on page 8 of the discussion document. Adding another test would lead to uncertainty and increase the risk of challenge or dispute. We consider there would be no need for another test if the tax treatment simply follows the IFRS treatment. Therefore we do not support this additional limitation proposed in the definition. In our view, significant uncertainty will arise with a test that seeks to identify when a taxpayer commits to developing a proposal. We assume that this proposed test is intended to be different (much earlier than) the prior to commitment test under the pre-trustpower interpretation statement (IS 08/02: Deductibility of feasibility expenditure Tax Information Bulletin Vol 20, No 6 (July 2008): 12). It also appears that the focus of the proposed test is a commitment to develop rather than a commitment to acquire or develop an asset. 2

4 The key issue with the proposed definition is that, in practice, feasibility expenditure is incurred over time and there are a number of decision points when commitments will be made to further progress the analysis of whether a proposal is practicable. It will be extremely difficult to determine a particular point in time when a commitment can be said to be made to developing the proposal ; and this will be just as difficult as determining when there is material advancement or tangible progress. The point in time when there is a commitment to developing a proposal could be before or after material advancement or tangible progress is made; however, we think it would most likely be before. We believe a clearer and simpler approach would be to: retain the first part of the proposed definition; and adopt / follow the IFRS accounting standard principles set out in paragraph 3.15 of the discussion document in relation to when expenditure is expensed or capitalised. That is, feasibility expenditure means expenditure to determine the practicability of a proposal. This expenditure will be deductible if it is incurred before it is probable that future economic benefits associated with the item/project flow to the taxpayer and is expensed under IFRS. The expenditure will be capitalised if it is incurred after this point and is capitalised under IFRS. Our alternative suggestion would be consistent with the proposal to allow IFRS taxpayers to follow the IFRS rules to determine the deductibility of feasibility expenditure. Also taxpayers would not be required to apply another test to identify whether there has been a commitment to developing the proposal. Furthermore, we believe that the proposed exclusion from the definition of feasibility expenditure of expenditure that would form the cost of depreciable property is not required; nor is it appropriate. The IFRS tests for expensing or capitalising an amount should be followed for all feasibility expenditure. This would assist in reducing compliance costs that would otherwise arise from having to determine different cost bases of an asset for accounting and tax purposes. See our submissions below under deduction of expenditure on abandoned assets. Non-IFRS taxpayers and de minimis We support the proposal to allow non-ifrs taxpayers to deduct feasibility expenditure if the IFRS accounting standards would be met, had they been applied. In addition, we consider it would be appropriate to also have a de minimis rule for non-ifrs 3

5 taxpayers. This would simplify the rules for small to medium sized enterprises (SMEs) and minimise compliance costs. Paragraph 3.28 of the discussion document suggests that if a de minimis threshold is included, the appropriate level would be $10,000 (to match the de minimis thresholds for legal and research and development expenditure). We consider that it would be appropriate for the threshold for feasibility expenditure to exclude shareholder-employee costs incurred. When SMEs undertake feasibility work it is common practice for that work to be carried out by the shareholder-employees. While they are remunerated by shareholder salaries their remuneration does not commonly include reward for work on feasibility projects. Furthermore, we believe it would be impractical to require an estimate to be made of the time shareholderemployees spend on feasibility activities, or to require identification of other costs associated with this work. Excluding shareholder employee costs from the de minimis threshold would recognise how most SMEs operate. Deduction of expenditure on abandoned assets Paragraph 3.29 of the discussion document proposes to allow a deduction for certain expenditure incurred that would form part of the cost of an item of depreciable property. The proposed criteria that would need to be satisfied are: the item would have been depreciable property if it had been completed; the item is abandoned before it is available for use; and the person recognises the expenditure as a loss under NZ IAS 36.8 (impairment of assets), or the person had not previously recognised the expenditure as the cost of an asset under NZ IAS 16.7 (asset recognition). The above would be simple in the case of a project that has been abandoned entirely and all of the assets are fully impaired for accounting purposes. The concepts are more difficult to apply if the project involves/creates a number of distinct assets, or if a part of an asset is impaired in different accounting periods. A project can produce a number of distinct assets that together make a bigger asset (this being the overall objective of the project). In this situation it would not be unusual for a part or parts of an asset to be impaired for accounting purposes over different accounting periods. These 4

6 circumstances are likely to give rise to dispute, for example: if an asset is partially impaired for accounting purposes can the part that is impaired be treated as a separate asset for tax purposes and the related expenditure deducted? is there abandonment when an asset is partially impaired? These questions may also arise in the context of a project. For example, a project is undertaken to develop an infrastructure asset. The cost incurred so far is $3M. On review, it is decided that part of the project be abandoned as the plans needed to change and some of the costs did not add value to the ultimate project. The costs relating to that part amount to $1M. Under the proposals, it is uncertain if the $1M would be deductible (it is difficult to determine whether the abandoned part of the project is a separate asset or whether there has been abandonment of the asset). In our view, any impairment under IFRS (including partial impairment) prior to an asset being available for use should be tax deductible. This would allow the cost of the asset for accounting and tax purposes to be aligned. Alignment would be consistent with the proposed approach for the tax treatment of feasibility expenditure, and also result in a material reduction in compliance costs. We consider that it is appropriate to allow a deduction for partial impairment as it recognises the decline in value of the asset (an underlying principle of the depreciation rules). A deduction for impairment could be subject to recapture if the asset is ultimately sold (another principle of the depreciation rules). Allowing a deduction for partial impairment can be viewed as accelerated depreciation that recognises the decline in value that has already occurred prior to the asset becoming available for use/depreciable. We agree that it should not matter whether impairment relates to a depreciable asset or a nondepreciable asset. The expenditure incurred on the asset is directed to the derivation of business income through the expected use of the relevant asset. Therefore, a deduction should be available if a capital asset does not ultimately result from the expenditure; otherwise this would be black hole business expenditure. Paragraphs of the discussion document states that the tax system is economically neutral when it denies deductions for unexpected capital losses, provided that it also leaves untaxed unexpected capital gains. In our view, this rationale is relevant only where the 5

7 expenditure does in fact result in a capital asset. If it does not, there is simply expenditure incurred in the pursuit of business income which ultimately does not give rise to an asset of a capital nature. In incurring this expenditure the taxpayer is not seeking to obtain a non-taxable capital gain (if they were it would not be a capital gain); rather, the taxpayer is seeking to generate an asset which will generate future business income. Where an asset does not ultimately arise, any expenditure which might otherwise be capital in nature has clearly declined in value and the expenditure should be deductible. Application date In our view, the application date for the proposals should be retrospective to the date of the Trustpower decision (27 July 2016). This case changed the interpretation of the law as it was understood and applied by both the Commissioner and taxpayers. Furthermore, a retrospective application date to the date of the Trustpower decision would remove the creation of three different sets of rules for the tax treatment of feasibility expenditure: the commitment test, the material advancement/tangible progress test, the IFRS test. This outcome would be unnecessarily complex. Guidance A consistent interpretation by all divisions of Inland Revenue will be critical to the success of the proposals. To assist with this we encourage Inland Revenue to include examples in the Commentary to the Bill illustrating the application of the new rules. This would clarify Parliament s intention and support both taxpayers and the Commissioner with compliance. Please contact us if you wish to discuss our submission. Yours sincerely Stephen Rutherford Senior Tax Advocate Lindsay Ng Senior Tax Advocate Chartered Accountants Australia and New Zealand Level 1, Carlaw Park, Nicholls Lane, Parnell, PO Box 3334, Shortland Street, Auckland 1140, New Zealand P charteredaccountantsanz.com Chartered Accountants Australia and New Zealand ABN (CA ANZ). Formed in Australia. Members of CA ANZ are not liable for the debts and liabilities of CA ANZ.

However there are a number of issues that should be addressed to give the document greater coverage and clarity. These we set out below:

However there are a number of issues that should be addressed to give the document greater coverage and clarity. These we set out below: 26 May 2017 Public Consultation c/ - Manager, Public Rulings Inland Revenue PO Box 2198 Wellington Dear Jane PUB00249 Fringe Benefit Tax Motor Vehicles Thank you for the opportunity to comment on the above