A Week in Review

Resource Consents – tax treatment

IR has issued interpretation statement IS 18/06, which outlines the Commissioner’s views with respect to the tax treatment of costs incurred to obtain a resource consent. In this regard, while different types of expenditure can be incurred on a resource consent, IS 18/06 only focuses on expenditure that is the “cost” of a resource consent.

The costs may be deductible immediately, depreciable, or be those where a deduction will never be available, and naturally the type of the expense, the type of resource consent being applied for, and the nature of the resulting assets, will in most cases determine the taxing outcome.

Resource consents are applied for in accordance with the provisions of the Resource Management Act 1991 (RMA). While there are various types of consents that can be obtained under the RMA, our income tax legislation recognises two types of consent – environmental consents and land use consents.

Since an environmental consent is usually granted for a finite period of time, it qualifies as an item of depreciable intangible property, and consequently the expenditure incurred which then forms that items cost base, is able to be depreciated over the life of the consent.

Where the expenditure incurred in applying for a land use resource consent is not immediately deductible, whether those costs are subsequently claimable via the deprecation regime will then depend on the nature of the asset to which they relate, and whether the consent application costs themselves are able to be capitalised to the cost base of that asset. If the asset is either land, or buildings with an estimated useful life of 50 years or more, no entitlement to depreciation of these particular assets exists, and consequently the land resource consent costs are essentially non-deductible.

In terms of costs incurred where depreciable property considerations will not be required, simply because the expenditure will be immediately deductible in the income year incurred, IS 18/06 provides the following guidance:

• Feasibility costs incurred that align with the Commissioner’s views espoused in IS 17/01 which was issued subsequent to the principles outlined by the Supreme Court in “Trustpower”, may qualify for immediate deduction. This will be where the expenditure is associated with early stage feasibility assessments to the extent they are not intended to materially advance the capital project in question. Note the Commissioner’s comment as a warning in this regard however, that since an application for any resource consent is usually directed towards making tangible progress on a specific capital asset, IS 17/01 is unlikely to apply to the “costs” of a resource consent.
   
• Revenue costs from the perspective that the resource consent relates to assets held on revenue account, will usually qualify for immediate deduction. The classic example is of course your client in the business of land development, where all costs incurred in completing the development will usually be deductible against the ultimate disposal proceeds.
   
• Specific deductibility provisions of the legislation, the two that first spring to mind being section DB 62 which governs legal costs for the income year not exceeding $10,000, and section DB 19 (the “black hole” exception), which permits a deduction for costs where the consent is never granted or used. Note in this last regard however, that you still must be able to show, that had the consent been granted or used, the costs would have been able to have been capitalised to a depreciable asset. Consequently if your asset is land or a building with an estimated useful life exceeding 50 years, section DB 19 is unlikely to help your cause.

For a quick guide on the IS 18/06 commentary, refer to the two flow charts included towards the end of the interpretation statement, which are likely to at least give you an initial view as to the likely tax treatment of the expenditure under consideration, prior to you having to dive into the detail.

IR having a bad run

Two recent cases, one High Court and the other in the Court of Appeal, were found in favour of the taxpayer. Naturally the focus of the cases were quite specific (although I often find the narrative still useful to understand both the Commissioners and our judicial Overseers current line of thinking), so they may or may not be of interest to you.

The first case dealt with the use of optional convertible notes (“OCN”) (remember Alesco), with both domestic and offshore parties involved, some of which were not related to the NZ based borrower, in particular, the NZ based subscriber (lender) to the OCN’s (although ultimately via the arrangement the shares would end up in the NZ borrower’s Singapore parent’s hands). IR attempted to smell a rat (which was never really there), and denied deductions claimed by the NZ borrower with respect to the OCN’s it had issued, submitting the arrangement was not “economically real”, was therefore tax avoidance and that shortfall penalties for either an unacceptable tax position or an abusive tax position should be applied.

The High Court disagreed with IR and found for the taxpayer, determining the arrangement was certainly one that was contemplated by Parliament, it was economically real, and itself was distinctly different from the arrangements exhibited in Alesco, where a zero-interest coupon rate was used. Additionally, and interestingly, the Court said that even if tax avoidance had been proved, there was no basis for shortfall penalty imposition as the taxpayer was always credibly in a position to challenge the relevance of the economic analysis on which the Commissioner relied.

The second case dealt with a now repealed provision of the income tax legislation, which provided a deduction for expenditure incurred in deriving an exempt dividend. So in essence it was a nexus question, to which the Commissioner formed a view that the expenditure was not incurred by the taxpayer to the extent of the connection required by the legislative provision, in deriving the exempt dividend income received from the taxpayer’s offshore subsidiaries. It should be noted here that the taxpayer lost their case in the High Court.

On appeal in the Court of Appeal however, the High Court decision was overturned. The Appeal court took the view that the nexus was indeed sufficient to establish deductibility, the expenditure clearly in respect of activities the taxpayer undertook to facilitate the operational performance of its subsidiaries, thereby generating the dividend income streams. Furthermore, the capital limitation did not apply to the expenditure incurred, because it represented recurrent and regular business expenses as opposed to improving the capital of the respective subsidiaries.

Long may the losing streak continue!