Topic 6

LECTURE OVERVIEW
General principles of deductions
General permission
General limitations
Specific limitations


Common examples of deductions
Motor vehicle expenses

GENERAL PRINCIPLES: DEDUCTIONS & DEPRECIATION


Use of home office expenses
Payments to spouse
Starting business expenses


Claiming of losses
Depreciation
Methods and rates
Depreciable assets other than land and buildings
Land and buildings 2

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DEDUCTIONS: GENERAL PRINCIPLES

DEDUCTIONS: GENERAL PRINCIPLES Core Provisions: Income Tax Act 2007

Part D: Rules on deduction e.g.  Subpart DA: General Rules/Permission & Limitations  Subpart DC: Deductions for employee or contractor


S BC 3: Annual total deductions = taxpayer’s total

expenditure

deductions for corresponding income year

 Subpart DB: Specific deduction rules for expenditure types  Subpart DE: Deduction of motor vehicle expenditure  Subpart DO: Deduction - Farming & aquaculture  Subpart DV: Expenditure specific to certain entities


S BC 4: Annual gross income – annual total deductions =

net income/loss
S BC 5: Net income – prior losses = taxable income

Part E: Timing of deductions e.g.  Subpart EC: Valuation of livestock  Subpart EE: Depreciation


S BD 2: an amount is a deduction 3

DEDUCTIONS: GENERAL PRINCIPLES

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DEDUCTIONS: GENERAL PERMISSION - Sec. DA 1(1)

General Principles

The general permission provides for the deduction of two types of expenditure or loss to the extent it is:


Deductions are expenses/losses (including depreciation loss)

allowed against assessable and/or excluded income in calculating taxable income

(a)

First Limb - Incurred in deriving assessable and/or excluded income or

(b)

Second Limb - Incurred in carrying on of a business for the purpose of deriving assessable and/or excluded income


No deduction is allowed unless deductibility is granted under Part D

of the Act; s DA 3 allows for specific sections within Part D to override the general permission
S DA 1(1) is the main general permission dealing with deductibility

of expenditure or loss

To be deductible the expenses must satisfy the nexus test between the expenditure/loss to the derivation of assessable and/or excluded income


S DA 2 sets out the general limitations i.e. non-deductibles 5

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DEDUCTIONS: GENERAL PERMISSION

DEDUCTIONS: GENERAL PRINCIPLES


“to the extent”

Principles from case law:


indicates that an item of expense may be apportioned between a


Expenditure or loss must have been incurred and the

deductible and a non-deductible amount

taxpayer must be committed to the expenditure before it can be said to have been incurred


Incurred [NZT, 8.2.3]
Has elements of both obligation and timing
Closely related to the accounting concept of “recognition”, i.e. when it

is probable that a consumption of benefits has occurred or will occur following the expense, and reliably measured
Definite commitment and quantum reasonably established


Expenditure or loss is deductible in the income year in

which it is incurred except in the case of financial arrangements which are caught under the accruals rules


An expense or loss may have been incurred for more than

one purpose .. only portion relating to assessable and/or excluded income is deductible. Therefore, apportionment may be necessary


Nexus test [NZT, 8.2.4, p 304] i.e. sufficient (and relevant) connection or relationship between the expenditure/loss and the income-generating process or activity

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DEDUCTIONS: GENERAL PRINCIPLES

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DEDUCTIONS: GENERAL PRINCIPLES


There does not have to be a direct relationship between

the expenditure and the income; it is deductible if it is, in terms of ‘common sense and business realities’, necessary for carrying on the business [Europa Oil (1974), NZT p 267]


Deductibility does not depend upon assessable income

arising in the same income year


For an item to be deductible in a particular period, the

liability must be established or reasonably determined [Mitsubishi Motors case (1995), NZT p 301-302] before the end of that period


The expenditure does not have to be an actual cash

disbursement before it is deductible; as long as there is an outlay in money or money’s worth


The expenditure does not have to be incurred in NZ


No double deductions allowed [BASF NZ Ltd case (1997)]


Whether or not an amount is assessable in the hands of


Expenditure incurred as a pre-requisite to earning income is

the recipient is irrelevant in determining the deductibility by the payer 9

not deductible. Likewise, those incurred after the cessation of a business 10

SOME COMMON BUSINESS DEDUCTIONS

DEDUCTIONS: GENERAL PRINCIPLES

Legal fees (NZT 8.6.9 ): generally covered by general permission e.g.

Capital v. Revenue
Capital expenditure not deductible; s DA 2(1)
Tests developed through case law: “enduring benefit” being


borrowing money used in deriving assessable income
obtaining or renewing leases
grant, maintenance or extension of a patent


“Enduring benefit” must be of a capital nature if:

Covered within specific provisions and which overrides the general permission.

the favoured






From 1 April 2009, s DB 62 allows a deduction for legal expenses if the amount is equal or less than $10,000. Note that this section overrides the capital limitation but the general permission must still be satisfied

Character of advantage and its lasting qualities; Manner in which it is used, relied upon or enjoyed (recurring?); and Means adopted to maintain it

NOTE: To be deductible within the scope of the general permission the


Refer to NZT 8.4.2, p 312 -321. 11

costs must be related to the income earning process, not the capital structure

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SOME COMMON BUSINESS EXPENSES

SOME COMMON BUSINESS EXPENSES

Use of home: “Home office” [NZT 8.6.8]

Payments to spouse, civil union or de facto partners: s DC 5 [NZT 16.3.8]


Business portion of domestic expenses deductible

against taxpayer’s income (other than employment income)


No deductions unless:
approved by the Commissioner of Inland Revenue
payment is for genuine services rendered
remuneration paid is reasonable


Examples of deductible expenses:
light, heat and power
repairs and maintenance
interest on mortgage
insurance
depreciation

i.e. prior approval from IRD is important before deduction is made.


Based on % of size of “office” to the whole house 13

SOME COMMON BUSINESS EXPENSES

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SOME COMMON BUSINESS EXPENSES Motor Vehicles (NZT 8.5.7)

Telephone & tolls
Deduction based on general permission provision &


Deduction covered under general permission in


Business based at home; 50% allowed automatically if


expense deduction and depreciation allowable on

IRD policy (TIB Vol 5, No 12, May 1994, p 2)

conjunction with Subpart DE

one telephone

business usage based on actual records establishing business use (ss DE 2 and DE 6 to 11)


More than 50% deductible if this can be established
if no records Commissioner may limit deduction to a


If two lines or more then 100% of commercial rental

maximum of 25% (s DE 4)


Tolls generally based on actual usage 15

SOME COMMON BUSINESS EXPENSES

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FBT vs. ENTERTAINMENT REGIME

Entertainment Expense (NZT 8.5.6)

Employees receiving benefit of an ‘entertainment’, listed in s DD 2 [NZT 18.9.9), may raise FBT liability if:
Benefit is not consumed/enjoyed in the course of employment duties, and either


Certain specified types are only 50% deductible
Other business related are fully deductible
Private expenses not deductible e.g. lunches with friends


Examples that are fully deductible
Expenses on food and drink
While travelling on business (some exceptions)
At promotions open to public
At certain conferences





Lists of ‘deductible’ and exempted entertainment in ITA, Subpart DD [NZT 8.5.6]


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Employee has discretion over when to consume or enjoy the benefit, or Benefit is enjoyed outside of NZ 18

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FBT vs. ENTERTAINMENT REGIME

FBT vs. ENTERTAINMENT REGIME Example Toy Ltd provides an overseas holiday for the sales representative who has been successful in growing sales in the financial year. The sales representative is entitled to take their family on a two week holiday on the Gold Coast. The employee may take holiday at any time within the next 12 months. Entertainment expenditure or FBT regime?

Example from IRD
A business provides drinks for employees for the weekly staff get-together.
This benefit is not subject to fringe benefit tax, as the employees can only enjoy the drinks at a set time, arranged by the employer. The cost of the drinks is 50% deductible for income tax.

The expenditure is exempted entertainment as the travel is undertaken outside of NZ. The expenditure is a benefit, provided in respect of or in relation to the sales representative’s employment, and subject to FBT regime. Employer will be able to deduct the full cost of the expenditure as a cost of employment. 20

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Which regime applies?

DEDUCTION : LOSS OFFSET/CARRY FORWARD Losses (Subpart IA):

Are the following fringe benefits?
A Christmas party for staff members held at the local golf club.
Same as above except held in the office staff room.
Entertainment allowances/reimbursements.
A company provides a shareholder-employee with free dinner vouchers.

Natural Persons:
Offset against other assessable income in current income year
Excess to be carried forward and offset against future assessable income
No time restriction except at death

Companies: (Also refer to Topic 10)
Offset against other assessable income in current income year – ‘carry

forward’ and/or ‘grouping’ provisions


Excess to be carried forward and offset against future assessable income
Strict requirements apply as governed within ITA 2007

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DEPRECIATION: SUMMARY GENERAL PRINCIPLES: DEPRECIATION (Subpart EE) For Tax Purposes:
depreciation is an allowance for the anticipated diminution

the value of an asset due to fair, wear & tear over the expected life of the asset
recognises that an asset used in the derivation of assessable income becomes obsolete despite normal repairs


From 1/4/93 a deduction for depreciation, i.e. depreciation loss, is based on economic rates
The deduction is a statutory entitlement
Claiming of depreciation loss is mandatory, i.e. legal obligation unless taxpayer elects otherwise
The right to deduct depends on “ownership”

For Accounting purposes:
Meaning of “owned” vs. acquired


defined as a “systematic allocation of depreciable amount

of an asset over its useful life” - NZ IAS 16 23

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DEPRECIATION: SUMMARY

DEPRECIATION: SUMMARY


Three methods of calculating depreciation deduction:


Amount of deduction depends on “used or available for use”


diminishing value
straight line
pool method


Depreciation deduction is available on “depreciable property” used in the derivation of income referred to in s DA 1(1)


The choice of methods is left to the taxpayer, and
taxpayer may change the methods of depreciation from one year to the next
New methods of calculating the economic rates from the 2005-06 income year and after


In year of disposal no depreciation loss is claimable except in the case of a building

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DEPRECIATION:SUMMARY

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DEPRECIATION: SUMMARY


Taxpayers have a right, by law, to apply for a different rate of depreciation


‘Loading’ of 20% on the economic depreciation rates of new qualifying assets (other than buildings)


Taxpayers may depreciate (most) assets between two approaches (DV or SL)
For assets with low values taxpayers can apply the ‘pool’ method
If Cost or Adjusted Tax Value (ATV) ≤ $2000


Assets costing ≤ $500 can be written in the year of purchase
On application to IRD assets which can no longer be used can be written off

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DEPRECIATION: SUMMARY

DEPRECIATION: SUMMARY
On disposal/sale the resulting difference between the disposal/sale price and ATV is either income (taxable depreciation recovered) or deductible loss


Certain intangible assets and land improvements may be depreciated


A separate treatment applies for buildings


Each category and type of assets has its own particular depreciation rate


Tax treatment of compensation received for damaged assets – NZT 9.6.5


Loose tools to be treated like other assets i.e. capitalised if cost > $500
GST Registered persons depreciate based on GST exclusive price 29

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SALE OF DEPRECIABLE PROPERTY OTHER THAN BUILDING

EXAMPLE ON DIMINISHING VALUE (DV) Purchased car on 1 Oct 2008 Balance date 31 March 2009 Car (assume second-hand) cost Year 1: 20% DV (6/12) Adjusted tax value (ATV) Year 2: 20% DV (12/12) ATV Year 3: Sale of asset


No depreciation in year of disposal
Gain (depreciation recovered = income) is lesser of
total depreciation allowed previously
sale price > adjusted tax value
Loss on disposal
sale price < adjusted tax value

$20,000 2,000 $ 18,000 3,600 14,400 $ 15,000

Gain on sale

$

600

 No deduction for depreciation loss in year of sale  $600 is depreciation recovered and is assessable income in year of sale 31

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BUILDINGS

EXAMPLE ON STRAIGHT LINE (SL)


No 20% loading
Can use DV or St. line
No depreciation on land

Car bought 1 Oct 2008 Balance date 31 March 2009

Car (assume second-hand) cost Year 1: 15% SL (6/12) Adjusted tax value Year 2: 15% SL (12/12) ATV Year 3: Sale of asset Loss on sale

$ 20,000 1,500 $ 18,500 3,000 $15,500 15,000 $ 500








No deduction for depreciation loss in year of sale

Cannot be pooled Can claim depreciation in year of sale loss on sale cannot be deducted Gain on sale (depreciation recovered) is taxable, lower of
original cost - adjusted tax value or


Taxpayer is entitled to a deduction for Loss on sale in year of

disposition.


sale price - adjusted tax value 34

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EXAMPLE ON STRAIGHT LINE (SL):BUILDING Building bought 26 June 2007

EXAMPLE ON DV: BUILDING Building bought 26 June 2007

Building Cost $ 250,000 (GST exclusive) Year 1: SL 2% (10/12) 4,167* ATV (31/3/08) $ 245, 833 Year 2: SL 2% (12/12) 5,000* ATV (31/3/09) $ 240,833 Year 3: Asset sold 5/5/09 $260,000 Part year’s depreciation $ 833* ATV @ 5/5/09 $ 240,000 Gain (loss) on sale {$260,000 - $240,000} $20,000 Depreciation recovered (*) 10,000 income Capital gain on sale $ 10,000 non-taxable 35

Building Cost

$ 250,000 (GST exclusive)

Year 1: 3% DV(10/12) 6,250* ATV (31/3/08) $ 243,750 Year 2: 3% DV(12/12) 7,312* ATV (31/3/09) $ 236,438 Asset sold 5/5/09 $260,000 Part year’s depreciation (2/12) $ 1,182* ATV @ 5/5/09 $ 235,256 Gain (loss) on sale {260,000 -$235,256} $ 24,744 Depreciation recovered Capital gain on sale

14,744 income $ 10,000 non-taxable 36

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New Economic Rates

EXAMPLE ON POOLING METHOD


Rationale
Assets which are affected:


Pool 1 had ATV at 1/4/08 of $18,000


Short-lived plant and equipment purchased on or after


Three assets purchased for $2,000 each

1/4/05 with a residual value < or = to 13.5% of cost


Say lowest DV rate applicable 22%

- an accelerated double declining method of calculation


Buildings purchased after 19/5/05 - new method reduces the previous economic rates

Adjusted value at 1 April 2008 $18,000 Purchased during the year $ 6,000 $24,000 Depreciation: 22% x (18,000 + 24,000) /2 = $ 4,620 ATV 31 March 2009 $19,380


Computation of economic rates
See TIB Vol 18(5), pp. 65-68

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NEW ECONOMIC RATES

NEW ECONOMIC RATES

Plant and Equipment

Buildings Formula for calculating DV rate: Formula for calculating SL rate:






1 / estimated useful life












Rental property - estimated useful life –50 years SL rate 1/50 = 2% DV equivalent 3% - per schedule 11

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2 / estimated useful life (i.e. Double Declining) Helicopter - estimated useful life – 20 years DV rate 2/20 = 10% SL equivalent 7% - per schedule 11 Laptop – estimated useful life – 4 years DV rate 2/4 = 50% SL equivalent 40% 40

DEPRECIATION: rates Depreciation rates applicable to each asset type is listed on the IRD website www.ird.govt.nz

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