Roberts and Associates Accountants Newmarket Auckland
Inside this edition:
- Section CB 13 – Significant Expenditure and Land Subdivisions.
- Tax Depreciation – One More Reason to Use the “Pooling Method”.
- Recent Disputes with IRD
- Foreign Superannuation Withdrawals – New Tax Regime
- Latest Tax Updates
- SECTION CB 13 – SIGNIFICANT EXPENDITURE AND LAND SUBDIVISIONS
The Inland Revenue has released new QWBA 15/02 entitled “Income Tax – Major Development or Division – What is “Significant Expenditure” for Section CB 13 Purposes?”
The release of the above QWBA is a timely reminder of the importance of considering the application and effect of section CB 13 of the Income Tax Act 2007 (“the section”). As a quick recap, the section applies in the following circumstances:
- A person disposes of land and the amount derived is not income under any of the other land taxing provisions; and
- An amount is derived from carrying on an undertaking or scheme (not necessarily in the nature of a business); and
- The undertaking or scheme involves development of land or the division of the land into lots, which is commenced more than 10 years after acquisition; and
- The development or division work involves significant expenditure on specific kinds of work; and
- The residential land, business premises and farm land exclusions do not apply.
This provision in contrast to section CB 12 only applies to divisions that involve significant expenditure and are commenced more than 10 years after acquisition and then only the development profit is taxed i.e. the taxpayer gets a deduction for the value of the land immediately before the division starts.
When determining if there has been significant expenditure, one must consider:
- What expenditure should be included; and
- When expenditure will be significant.
- WHAT EXPENDITURE SHOULD BE INCLUDED
The following expenditure has to be included:
- Other physical developmental work not already listed in section CB 13(1)(b)(iv) such as paving, retaining, sewage piping, power cabling, demolition, and site clearing; and
- Other developmental work that is not physical work on the land such as preparation of zoning application, the drawing of engineering plans and specifications for roads, preparation of sub-divisional plans and the provision of estimates.
Expenditure that can be excluded includes work that is purely division work on or relating to the land such as surveying related to division of the land (as opposed to surveying related to development of the land) and preparation and deposit of subdivision, unit title, or flat plans.
It is also important to distinguish expenditure on the construction or erection of buildings (excluded) compared to expenditure for development in context of preparing the land for an intended use (included).
An important exclusion is that a person’s time, effort, and use of their own machinery is excluded. However actual monetary expenditure on any such “effort” will have to be apportioned and taken into account. In addition, future expenditure not yet incurred on the undertaking or scheme is also excluded.
- WHEN EXPENDITURE WILL BE SIGNIFICANT
Expenditure on the undertaking or scheme has to be considered in totality and in the context of the project. To this end, the value of the expenditure in absolute dollar terms and relative to the pre and post development value of land will be important factors in determining if the expenditure is significant. This implies that each development or division work has to be considered on a case by case basis and will be a matter of fact and degree.
- Significantly increased expenditure from higher regulatory standards would normally be reflected in a higher post-development value of land. As such, higher regulatory costs would not by themselves be a contributing factor in the determination of significant expenditure;
- Council contributions for additional community and network infrastructure would not be taken into account;
- Expenditure can be significant in absolute terms even though it is not in relative terms (and vice versa). This shows the importance of consideration of the context of the development or division; and
- Extent of physical work is important, however the main emphasis should be placed on expenditure.
The application of section CB 13 is not as clear-cut as some of the other land provisions and the answer to whether proceeds are taxable will ultimately depend on the facts and the context of the development. It is important to realise that the section can apply to smaller scale subdivisions provided the expenditure is significant.
We recommend that you contact us if you have any questions for any past, present or future planned development or subdivision work to ensure you get your tax obligations right. The Inland Revenue is more focused than ever on land transactions given their significance as a source of additional tax revenue.
- TAX DEPRECIATION – ONE MORE REASON TO USE THE “POOLING METHOD”
Use of the Pooling Method (“pooling method”) is not very common among taxpayers since its introduction in 1993. The diminishing value (“DV”) method tends to be the method of choice for low cost assets due to its simplicity.
Depreciation on pooled assets is calculated on the basis of the average of the asset pool for the year (i.e. opening plus closing balance of the pool divided by two).
The pooling method works as follows:
- Taxpayers “pool” low-cost or low-value assets with a maximum cost or written-down value of $5,000 (previously $2,000) at acquisition or at beginning of the year and depreciate the “pool” as if it were a single asset;
- Only DV rates can be used for pooled assets;
- Assets have to be used 100% for business (or liable for FBT if less than 100% use); and
- The lowest DV rate applying to any asset in the pool has to be used to depreciate the entire
The $5,000 (GST exclusive where GST registered) threshold value has been recently increased from $2,000 by The Income Tax (Maximum Pooling Value) Order 2015 effective for the 2015/16 and later income years. The higher value now offers greater incentive to pool assets and delay recognition of depreciation recovery income.
The benefit of the pooling method can be demonstrated using the following example shown in tables 1 and 2. The example demonstrates the increased deductions achieved using the pooling method net of depreciation recovery income.
Some important points about the calculation method:
- Optimum results achieved when the pool consists of assets with DV rates as close to each other as possible. There is no limit to how many pools a taxpayer can operate. Therefore if there are many individual pool-able assets then the taxpayer can create pools to match DV rates;
- The entire proceeds from any asset disposed from the pool is subtracted from the “Ending adjusted TBV” so depreciation recovered is deferred compared to the non-pool rules where excess proceeds over book value are taxable;
- If the value of the pool is negative at end of the income year, then that amount is depreciation recovery income.
- There is no monthly apportionment for number of months assets are owned.
- Assets that have been previously depreciated under DV method can be added to a pool during a year if opening TBV does not exceed $5,000 (from the 2015/16 income year).
The above rules then limit the kinds of assets that should be added to a pool. Assets that if sold are expected to sell for more than their initial cost should be excluded as capital gains effectively get treated as depreciation recovered
Where taxpayers have many assets with similar DV rates and where the assets are not expected to be realized for greater than initial cost, taxpayers should consider using the pool method for depreciating assets as depreciation deductions may be greater than if assets are depreciated using the standard DV method.
- RECENT DISPUTES WITH INLAND REVENUE
3.1 INTEREST DEDUCTIONS AND SHAREHOLDER LOANS
In a recent dispute which went to conference, the IRD had maintained that interest reimbursed by a company to its shareholder was not deductible on the basis that there was no nexus with the income earning process, that the private limitation applied, and in particular that the interest was not incurred because there was no written loan document which obligated the company to pay interest to the shareholder. Briefly, the facts were that more than 10 years ago the taxpayer sold an unincorporated business into a company and then proceeded to refinance the mortgage on his home by having the company borrowing money to repay the debt that it owed him for the sale of the business. Some years later this debt was again refinanced with a different bank. This time the loan was taken out by the shareholder and the proceeds advanced to the company. No documentation was put in place to evidence the loan between the shareholder and the company but the bank statements and solicitor’s statements showed quite clearly that the shareholder had re-mortgaged his home and advanced the funds to the company. It did not help matters that the accountants had shown this new loan on the company’s balance sheet as being a loan from the bank rather than the shareholders. The investigators placed particular reliance on Brown v CIR (2014) NZHC 1599 where an interest deduction claimed by a chartered accountant was disallowed as the accountant had paid interest in relation to monies borrowed by his family trust which had on-lent the funds to the chartered accountancy company. At conference, the IRD accepted that there was a nexus to the income earning process and that indeed the interest was incurred by the taxpayer and therefore the deduction sought by the taxpayer was valid. IRD did however request that the advance be properly documented and of course we duly obliged.
3.2 UNREPORTED COMPANY INCOME BANKED BY SHAREHOLDER
In an entirely different dispute the IRD had maintained that unreported cash sales which had been banked in the shareholder’s personal bank accounts but subsequently, for the most part, transferred to the company and treated in the company’s accounts as advances from shareholders, were in fact income of the shareholder and not the company. The result of having under-reported income was that the company had tax losses and assessing the shareholder for the unreported income would have resulted in a significant tax liability and arguably an incorrect imposition of tax. In the alternative, the Commissioner argued that if the unreported income was not remuneration for services, then the amounts taken were a transfer of value under section CD 4 (1) of the ITA 2007 i.e. a dividend. We referred the IRD to their own Standard Practice Statement O5/O5 concerning retrospective adjustments to salaries paid to shareholder employees where at paragraph 12 it states “it is considered that shareholder/employee salaries are generally irreversible, unless a genuine error has been made”. Therefore on this basis we maintained that the Commissioner had no basis for treating the amounts taken as employee remuneration as that would necessitate a retrospective adjustment to the company’s financial statements for remuneration that had never been approved. We noted that the very reason why Standard Practice Statement O5/O5 was limited to retrospective reductions in remuneration is because a retrospective increase could not be said to have been incurred. The dividend argument was somewhat more difficult to negate but we argued that as the vast majority of the monies that had been un-reported were subsequently deposited into the company or expended by the shareholder for the benefit of the company, that in fact there was no transfer of value because section CD 5 (1) (b) carved out of the dividend rules consideration provided back to the company by the shareholder under the arrangement by which a shareholder received money or monies worth. Following conference and our written submissions the IRD decided to not assess the shareholder. It should be noted however that even if a shareholder’s current account is in credit, if the shareholder banks company income in their own personal accounts and that income is not reported in the company’s accounts, such income will ordinarily be assessable to the shareholder.
3.3 TRANSFER PRICING – FINANCIAL ARRANGEMENTS
A foreign associate of a New Zealand company which was wholly owned by non-residents had made a substantial advance to the New Zealand company to acquire NZ real estate. No interest had ever been paid on the loan but rather simply accrued each year and credited to a separate account from the loan. Interest was only calculated each year on the original advance. The loan agreement was silent on the capitalisation of interest. The CIR maintained that the interest rate was not arms-length. We argued that the effective interest rate had to be calculated not solely by reference to the original loan but also by reference to the original loan and the amount of interest outstanding at any given point in time and that in addition, in determing what an appropriate arms-length rate was, the fact that no payments had ever been made also needed to be taken into account. Our arguments prevailed.
- TAXING FOREIGN SUPERANNUATION WITHDRAWALS
From 1 April 2014, withdrawals of foreign superannuation are subject to a new receipts based taxation regime. That is, lump sum withdrawals made on or after 1 April 2014 are taxed in a way that accounts for the tax that should have been paid on an accrual basis. We provide a brief overview below:
- Interest in a foreign superannuation scheme acquired by a NZ tax resident person prior to 1 April 2014 remains liable for tax under the FIF rules, if compliance with the FIF rules was maintained throughout the period of ownership.
- If compliance with FIF rules was not maintained then the new regime will apply to withdrawals after 31 March 2014 and no credit for tax paid under FIF regime will be allowed.
- A 15% tax option is available for withdrawals between 1 January 2000 and 31 March 2014 for tax payers who did not comply with their tax obligations pre 1 April 2014. Under this option 15% of the amount withdrawn is taxable and must be returned no later than the March 2015 income year.
- No tax is imposed on withdrawals made within four years from the date a person’s NZ residence commences. The exemption period will end if person become non-resident during the four years.
From 1 April 2014, an income tax liability applies to a NZ resident taxpayer who derives lump sum amounts from a foreign superannuation scheme first entered into when the taxpayer was a non-resident. Two methods available are:
- The schedule method (default method), or
- The optional formula method (a more complex method restricted to interests in defined contribution schemes only).
The schedule method formula is super withdrawal x schedule year fraction (%). The fraction is located in schedule 33 of the Income Tax Act 2007 and basically taxes an increasing proportion of the withdrawal amount the longer the person has been a NZ tax resident.
The formula method is far more complex and requires a series of calculations. The formula method requires market value data and other information that would not normally be readily available to a taxpayer. However, if the information is able to be obtained, the cost of getting the data required to perform the calculation may well outweigh the benefit of a lower calculated assessable income amount under the formula method.
We have developed a work paper that will calculate the assessable amount once the required data is entered, so if you need to ascertain whether a calculation should be undertaken under the formula method to minimise the tax payable please contact us.
- LATEST TAX UPDATES
- Use of Money Interest (UOMI) rates increased effective 8 May 2015:
- Underpayments: 9.21% (from 8.40%)
- Overpayments: 2.63% (from 1.75%)
- Tax depreciation – Pooling Method – maximum pooling value of an asset increased to $5,000 from $2,000 effective beginning of 2015/16 income year.