According to the Inland Revenue (IRD), commercial building owners should be denied a deduction for expenditure incurred in determining whether their buildings meet new earthquake protection standards. IRD’s draft Questions We’ve Been Asked pub00223, (QWBA) publication asserts that expenditure incurred on detailed seismic assessments (DSA’s) is capital in nature and therefore non-deductible because it relates to a capital asset.
DSA’s are becoming increasingly popular for building owners where a growing number of city councils and bank regulations now require certain buildings to be assessed for earthquake weaknesses. A DSA identifies any vulnerabilities or weaknesses that a building may have to seismic activity, provides recommendations to mitigate or eliminate these weaknesses, and often gives an estimated cost of such an exercise.
To ascertain whether the capital limitation applies, the landmark case Privy Council in BP Australia Ltd v FC of T [1965] 3 All ER 209 formulated a number of factors that serve as a useful guide in determining whether expenditure is revenue or capital in nature. These factors have been applied in numerous New Zealand cases.
However, in the QWBA IRD outlines its opinion that while the approach of the Privy Council has been recognised in New Zealand, it may not always be necessary to consider the BP Australia factors. The Commissionaire cites the recent Court of Appeal CIR v Trustpower Limited (2015) 27 ZTC where expenditure on resource consents were considered capital in nature, and extends this decision to apply to expenditure on earthquake strengthening assessments.
The IRD’s viewpoint is that expenditure incurred in obtaining a DSA is to determine the nature, scale, and possibly an estimate of the costs of the seismic strengthening required on an important capital asset; with a view of determining the best action to take on the building, such as, to strengthen, sell, demolish or take no action. The IRD concludes that the DSA expenditure is therefore directed to the future preservation or otherwise of an important capital asset and therefore is incurred on capital account.
For the purpose of completeness, IRD steps through the BP Australia principles and unsurprisingly, arrives at a mixed outcome. In working through the tests, IRD agrees the expenditure does not produce an asset or advantage of enduring benefit to the business, nor does it create an identifiable asset. Further, the cost of obtaining a DSA would be funded from circulating capital expenditure and is likely to be expensed for accounting purposes. Despite these arguments in favour of revenue expenditure, IRD is quick to disregard such arguments, stating that these tests are not a reliable indicator of the nature of the expenditure.
The key factors which IRD heavily weighted include the need for the expenditure to preserve the future of the building, the one-off nature of the expenditure and the fact that the expenditure relates to the business structure rather than day-to-day business operations.
The IRD also dismisses the argument that the DSA is deductible ‘feasibility’ expenditure. It referred to the IRD’s Interpretation Statement 08/02 on feasibility expenditure where costs relating to the potential acquisition or development of a new asset were considered deductible. It applied the principles to DSA expenditure and stated this situation is different because it relates to an existing asset and therefore the expenditure is not deductible.
The impending appeal of the Trustpower decision to the Supreme Court will provide taxpayers with more clarity on this issue and potentially correct IRD’s draft view.
