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Discussion document released proposing to reform the tax treatment of black hole and feasibility expenditure

Home Insights Discussion document released proposing to reform the tax treatment of black hole and feasibility expenditure

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Published on: June 26, 2017

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Introduction

As announced in the Government's 2017 budget, a discussion document proposing to reform the tax treatment of feasibility expenditure, and certain other "black hole" expenditure, was released on 25 May 2017. These proposals seek to address situations where expenditure results in an economic cost to a taxpayer, but no tax deductions arise for the taxpayer (whether immediately, or over time by way of depreciation of a capital asset).

The need for these reforms gained momentum following the Supreme Court's restrictive interpretation of what constitutes deductible feasibility expenditure in the Trustpower v Commissioner of Inland Revenue SC 74/2015 [2016] NZSC 91 decision. Broadly, there are two areas of proposed reform:

  1. Expenditure that meets the proposed definition of "feasibility expenditure" will be deductible or capitalised in accordance with International Financial Reporting Standards ("IFRS") principles.
  2. Expenditure that would have been deductible over time (ie depreciable) if the expenditure had resulted in an asset, will be deductible.

We briefly summarise each of these two welcome reforms below.

Feasibility expenditure

It is proposed that an immediate tax deduction would be allowed for feasibility expenditure that is not recognised in the balance sheet for IFRS purposes. Where an amount of feasibility expenditure is capitalised for IFRS purposes, a deduction will still be available in the event that there is total impairment loss under IFRS, provided that the project is abandoned.

Central to this proposal is the concept of "feasibility expenditure". The Government is seeking to define the term in a manner that does not undermine the existing capital/revenue framework, and currently proposes that it will cover expenditure incurred by a taxpayer for determining the practicability of a new proposal, prior to commitment to developing the proposal. There would also be specific exclusions where the expenditure:

  1. would form part of the cost of depreciable property if the proposal were successful; or
  2. has already been addressed in the tax legislation (for example, expenditure incurred for the purpose of applying for the grant of a resource consent).

The Government is also considering whether a de minimis rule should be included, pursuant to which feasibility expenditure that meets the general permission would be deductible if it is below a certain threshold (regardless of IFRS treatment).

Abandoned asset

Expenditure that would form part of the cost of an item of depreciable property is excluded from the proposed definition of "feasibility expenditure". Tax deductions would normally arise in respect of such expenditure in accordance with the depreciation rules. However, the potential for "black hole" expenditure arises where the item of depreciable property does not come into existence for whatever reason (for example, where the project is abandoned).

It is proposed that a deduction will be allowed where a person incurs expenditure that would form part of the cost of an item of depreciable property if completed, but the item was abandoned before it was available for use. This is provided the person either recognises the expenditure as an impairment loss under IFRS, or had not previously capitalised the cost under IFRS.

This proposal goes further than covering expenditure that would be feasibility expenditure if not relating to a depreciable asset, and covers all expenditure that would form part of the cost of an item of depreciable property. However, where capitalised costs are to create (or are intended to create) an asset that is not expected to decline in value, such expenditure will remain non-deductible in accordance with general capital/revenue principles.

A provision will apply to claw back deductions where an impairment/abandonment is reversed.

Non-IFRS taxpayers

The proposals are heavily linked with IFRS principles. Where a taxpayer does not apply IFRS for financial reporting purposes, it is proposed that the tests will require that the relevant IFRS standards would be met if they had been applied by the taxpayer.

Public feedback

The reforms are still at an early stage and the Government is seeking feedback on a number of aspects. Broadly, feedback is sought in respect of the definition of "feasibility expenditure", whether the use of IFRS principles is appropriate and sufficiently clear, whether there should be a de minimis, and any reasons why the reforms should not be prospective.

The closing date for submissions is 6 July 2017.

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