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Feasibility expenditure to be deductible and loss continuity rules to be updated

Feasibility expenditure to be deductible and loss conti

Our latest Taxmail commentary on tax deductions for feasibility expenditure.

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“Black hole” feasibility expenditure to be deductible and loss continuity rules to be updated

In a surprise press release yesterday, the Ministers of Finance and Revenue have announced that proposals consulted on previously, and recommended by the Tax Working Group, to allow tax deductions for feasibility expenditure will proceed.

A tax bill to be introduced in early 2020 will:

  • Allow feasibility expenditure:
    • totalling less than $10,000 in a year to be immediately deducted for tax.
    • totalling greater than $10,000 to be deducted over 5 years, if the expenditure does not result in a tax deduction (i.e. is “black hole” expenditure presently). 
  • Change the shareholder continuity rules for tax losses to ensure they work for start-ups that are trying to attract new capital investment.
  • Review the R&D tax loss cash-up rules. (Those rules were introduced prior to the new R&D tax credit and the proposal currently before Parliament to make the credit refundable.)
     

Our initial thoughts on…

Feasibility and black hole expenditure    

Consistent with our view on the 2017 consultation, KPMG supports confirming the tax treatment of feasibility expenditure. The TrustPower Court decision narrowed considerably the ability to deduct feasibility expenditure. This exacerbated the black hole problem (that is, costs not being able to be recognised for tax, as there is often no depreciable asset to which these costs can be added and depreciated).

More recently, the Tax Working Group recommended the Government should change the tax rules to give business certainty over the tax treatment of their project spend. The Tax Working Group’s recommendation was to deduct business expenditure that is black hole, including in respect of abandoned assets and projects, over five years (with a claw back if an abandoned asset or project was restored). It also recommended a $10,000 threshold for immediately expensing feasibility expenditure.

The Government proposal adopts the Tax Working Group’s recommendations to amortise costs over time (and de minimis expenditure immediately). In contrast, the 2017 proposal was to allow an immediate deduction where a capital project did not proceed or was abandoned and written-off for accounting.

One of the interesting design questions will be the treatment of feasibility expenditure on projects relating to buildings (which, while depreciable, generally have a 0% rate). The 2017 proposal specifically excluded such black hole costs. The Tax Working Group’s solution was to reintroduce tax depreciation on commercial and industrial buildings. Thus far, the Government has not signalled its intention here.

The feasibility expenditure proposal raises the treatment of black hole expenditure more generally. Australia allows a general deduction over a five year period. Remaining black hole expenditure will continue to be non-deductible in New Zealand.

Tax losses and shareholder continuity
The loss continuity proposal reflects the fact that a greater than 51% shareholding change (including over time) can result in tax losses being forfeited at present. This is particularly an issue during the start-up phase of a business, when losses tend to be common, and new equity funding may be required to grow. The press release suggests this issue will also be addressed next year.

The shareholder continuity rules are aimed at preventing tax loss “trading”. The rules allow some shareholder changes but otherwise are aimed at only allowing losses to be used when the shareholders who incurred the loss remain shareholders. This has the effect of inadvertently impacting on mergers and acquisitions, which have no tax loss trading purpose. (For example, a takeover of one multinational by another invariably has little concern for New Zealand tax losses.) It also means that companies which are struggling are limited in their ability to raise new capital to trade their way out of difficulties.
A wider review of the tax loss shareholder continuity rules to find solutions to these problems is justified.

Also on the cards is a review of the cash-up mechanism for R&D tax losses, which seems sensible given the new R&D tax credit regime and the proposal to make credits refundable from the 2021 income year.

Next steps

Consultation on the various design issues is expected later this year, with legislation to be introduced in a 2020 tax bill. The good news is that the Government is proposing to apply the changes from the start of the 2021 tax year.

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