The “general permission” under the Income Tax Act broadly allows expenditure to be deductible if it is:
- incurred in deriving assessable income, or
- incurred in the course of carrying on a business for the purpose of deriving assessable income.
A recent Taxation Review Authority (TRA) case provides a strong reminder to us of the importance of ensuring there is a connection (‘nexus’) between the expenditure you deduct for tax purposes and your business or income earning process.
In TRA 008/13, a taxpayer entered into an agreement in 2006 to purchase a block of land for the development and sale of retail units and residential apartments. By June 2007 four deposit payments had been made totalling $1.9m. Before settlement occurred, a number of conflicts arose between the vendor and the taxpayer.
Following several failed attempts by each party to cancel the agreement, they eventually went through a disputes resolution process where they agreed to split the deposit between them. The taxpayer also agreed to pay the vendor’s costs ($70,047). The taxpayer subsequently entered into an agreement to sell the plans for the project, including resource consent, for $650,000; however the transaction was not completed.
The IRD sought to disallow $1.4m of expenditure (including the lost deposit) incurred after 24 July 2008, when the taxpayer ceased negotiations to resurrect the agreement. The taxpayer disagreed with the IRD and the case went to the TRA.
The taxpayer argued:
- the expenditure related to a business that operated until at least December 2011,
- the agreement was entered into for the purpose of purchasing the land to derive taxable income or alternatively to escape an onerous contract, therefore all expenses are deductible, or
- the business was operating in 2007 (the IRD agreed) and the lost deposit was deductible because it was paid at that time.
The TRA decided in the IRD’s favour, concluding that from July 2008 onwards the taxpayer’s focus changed from advancing the settlement of the purchase, to pulling out of the Agreement. From this point the taxpayer ceased being in business, and there was no nexus between the taxpayer’s business and the expenditure.
The TRA also broadly concluded that in order to deduct expenditure to derive income, income must be derived and here there was none. It was further stated that the taxpayer intended to acquire and sell full legal title to the land. However, the taxpayer only acquired an equitable interest in the land. The implication being that the taxpayer’s intention when the due diligence clause was fulfilled was not to sell an equitable interest, therefore there was no requisite intention of resale in respect of the interest that was acquired.
The TRA took the view that the settlement amount was paid from the deposit monies held by the taxpayers’ lawyer as a stakeholder; it was not payment of the deposit.
The IRD not only denied the deductions, but also charged a $39,194 shortfall penalty for taking an unacceptable tax position.
Decisions like this are unsettling because at face value, it would seem reasonable to claim a deduction for the expenditure. Especially given, if income had been derived, the expenditure is likely to have been deductible.
The lesson here is to think carefully about situations that may be outside ‘the norm’. Even if intuitively an expense appears deductible, it may not be. In these situations, a quick phone call to your advisor would be a good idea.
