Primary sector businesses and amortisable assets

(Clauses 18 and 23)

Summary of proposed amendment

The bill contains amendments to better align the amortisation rules for primary sector businesses (farming, aquaculture, horticulture and forestry) with the general depreciation rules in the Income Tax Act 2007.

Application date

The amendment allowing primary sector businesses to claim deductions for the removal cost of subpart DO improvements will apply from the beginning of the 2010–11 income year.

The amendment to the capital contribution rules will apply from the beginning of the 2011–12 income year.

Key features

The proposed amendments will:

• allow primary sector businesses to claim deductions for the cost to remove subpart DO improvements, as well as the tax book value of the improvements, that have been rendered useless, if it is caused by an action outside the control of the taxpayer; and
• amend the capital contribution rules, so they apply to payments that contribute towards an amortisable asset.

Background

The kiwifruit Psa (Pseudomonas syringae pv actinidiae) virus has had a significant impact on New Zealand’s gold kiwifruit industry. As a consequence, a number of kiwifruit gold orchards have been or will be destroyed. The effect of the virus has highlighted several minor technical problems with the tax rules.

Detailed analysis

Amortisation deductions for removal cost expenditure

The Income Tax Act 2007 allows primary sector businesses to amortise the costs of certain capital expenditure that are not expressly depreciable. This is similar to a taxpayer’s entitlement to claim depreciation on fixed assets. Specifically, and subject to certain criteria, when an orchardist removes a horticultural plant, the orchardist generally receives a deduction for the net tax book carrying value of the horticultural plant.

However, the extra cost of removing a horticultural plant is capital in nature and the Income Tax Act 2007 does not explicitly provide a deduction for these costs. In contrast, when a taxpayer with a capital asset (for example, an item of physical plant or machinery) writes that item off, the taxpayer is entitled to a deduction for the tax book carrying value, and a deduction for the costs of physically removing the item.

The Psa virus has also highlighted an anomaly in the tax treatment of primary-sector improvements to land, damaged by natural events. For example, if a natural event such as a flood, damages an orchard’s infrastructure (for example, trellising and wire) the orchardist would be allowed a deduction for the tax book carrying value of the infrastructure.

On the other hand, if an orchardist’s infrastructure is rendered useless due to the Psa virus (which only affects the fruit) and they wish to change the crops that they grow, the cost of removing the infrastructure and the tax book carrying value of the infrastructure once it is removed, is considered to be capital expenditure or a loss, and is therefore non-deductible.

The lack of a provision for these types of costs was unintended, and accordingly the bill will amend section DO 11 of the Income Tax Act 2007, to explicitly allow a deduction for these removal costs, where improvements to the land have been rendered useless, if it is caused by an action outside the control of the taxpayer.

Capital contribution rules and amortisable assets

If a person receives a subsidy (or similar payment) as compensation and the subsidy is used to acquire depreciable property, the receipt is dealt with under the “capital contribution rules” in the Income Tax Act 2007. The capital contribution rules prevent a person claiming deductions for expenditure for which they have not borne the cost.

Kiwifruit orchardists affected by the Psa virus may receive non-governmental financial assistance, and some of these payments may be used to subsidise the cost of replanting. However, the capital contribution rules do not presently apply to these receipts, because the capital cost of replanting does not result in depreciable property, but rather “amortisable assets”.

When the capital contribution rules were implemented, capturing contributions towards assets that were amortisable under subpart DO of the Income Tax Act 2007 was not considered.

This is inconsistent with the policy intent of the capital contribution rules, and the bill introduces an amendment to explicitly provide that the capital contribution rules apply where the relevant asset is amortisable, as well as where it is depreciable, so that taxpayers cannot claim a deduction for costs they have not in fact incurred.