Income tax


DEPRECIATION ON NON-RESIDENTIAL BUILDINGS


(Clauses 4, 5, 6, 7, 9, 10, 11, 12, 13, 14, 29(2), 29(4), 29(6), 29(7), 29(8), 29(9) and 30)

Summary of proposed amendment

New Zealand allowed depreciation for buildings in the tax base until it was removed in a package of tax reform effective from the 2011–12 income year. The proposed amendment would restore building depreciation but only for buildings that are not primarily used for residential accommodation.

Application date

The proposed amendment would apply for the 2020–21 income year.

Key features

A deduction for depreciation of buildings other than residential buildings would be allowed from the 2020–21 income year. It would apply to buildings owned at the beginning of that income year and also going forward to newly acquired buildings and capital improvements made to existing buildings. The depreciation rate would be 2% declining value or 1.5% straight line. This is a permanent measure.

Background

New Zealand allowed depreciation on all buildings in the tax base until 2010. Building depreciation was suspended for long-lived buildings from the 2011–12 income year. Long-lived buildings have an estimated useful life of 50 years or more. Buildings with a shorter estimated useful life have continued to be depreciable.

New Zealand’s position disallowing tax depreciation for almost all buildings is unusual internationally. International studies generally find that buildings do depreciate. The Tax Working Group reviewed this setting and recommended renewing depreciation for industrial, commercial, and multi-unit residential buildings. It did not recommend renewing depreciation for other types of residential buildings because data shows these buildings have a slower rate of economic depreciation than other buildings.

Detailed analysis

Depreciation of long-lived non-residential buildings would be allowed from the beginning of 2020–21 income year. The proposed depreciation rate would be 2% declining value or 1.5% straight line.

Opening tax book value

For buildings that were owned by the taxpayer in the 2010–11 income year, the tax book value for the beginning of the 2020–21 income year would be:

  • the adjusted tax book value at the end of the 2010–11 income year, less fit-out deductions taken under the section DB 65 transitional rule if applicable; plus
  • non-deductible capital expenditure incurred with respect to the building from the end of the 2010–11 income year to the start of the 2020–21 income year.

For buildings acquired after the end of the 2010–11 income year, the opening tax book value for the 2020–21 income year would be:

  • the cost of the building; plus
  • non-deductible capital expenditure incurred with respect to the building from the time it was acquired until the beginning of the 2020–21 income year.
Straight line depreciation

If a taxpayer elects to use the straight line method, the building’s cost for the purpose of calculating the depreciation deduction would be the opening tax book value for the 2020–21 income year and not the original cost (if different).

Depreciation recovery

If a building is sold, its depreciation recovery income would be calculated taking into account depreciation deductions taken before 2011–12 (if any) and depreciation deductions taken from 2020–21. The cost base would also reduce by the amount of deductions taken under the section DB 65 transitional rule.

Non-residential buildings

A non-residential building is any building that is not a residential building.

A residential building would be defined as:

  • a dwelling as defined in Section YA 1; and
  • a building in which accommodation is ordinarily provided for periods of less than 28 days at a time if the building, together with other buildings on the same land, has less than four units intended for separate occupation.

The definition of “dwelling” encompasses owner-occupied houses and apartments, and houses and apartments subject to residential tenancies.

The proposed additional category including some buildings accommodating short-term stays is to ensure there is certainty that the definition of “residential building” includes buildings such as a bach that the owner uses but also rents out on a short-term basis, and also buildings used exclusively for some short-term accommodation provided by owners such as Airbnb properties. These may be within the definition of “dwelling”, but this would put it beyond doubt those buildings remain non-depreciable. The less-than four units provision is meant to exclude larger commercial operations such as motels from being treated as a residential building.

Repeal of the 2010 transitional rule

As a result of reinstating depreciation on non-residential buildings, the transitional building fit-out rule introduced as part of the 2010 reforms would no longer be required. Accordingly, section DB 65 would be repealed, and the tax book value of the building adjusted for past DB 65 deductions.

Special depreciation rate

The ability to receive a special depreciation rate from the Commissioner would be restored for non-residential buildings.


INCREASE IN THE PROVISIONAL TAX THRESHOLD


(Clauses 21–28 and 29(5))

Summary of proposed amendment

This measure would permanently increase the residual income tax threshold for being required to pay provisional tax from $2,500 to $5,000. As a result, a number of taxpayers would no longer be required to make provisional tax payments throughout the year, which would assist those businesses with cashflow issues including during the COVID-19 outbreak.

Application date

The proposed amendment would apply for the 2020–21 and later income years.

Key features

This measure would change the threshold for paying provisional tax so that less taxpayers are required to pay provisional tax instalments throughout the year. For taxpayers with residual income tax of between $2,500 and $5,000, instead of paying provisional tax throughout the income year as under the current law, they would only have to pay by 7 February following the end of the income year.

Example 1: Increase in the provisional tax threshold

Jenny is a tour guide who provides tours of the Lord of the Rings filming location sites around Wellington through her company Jenstar Tours Limited (JTL). She gets the majority of her customers from tourist ships visiting Wellington. In the 2019–20 income year, JTL’s tax liability was $8,000, but because of the recent changes to restrict tourist ships in response to COVID-19, JTL’s tax liability in 2020–21 is expected to be half of that amount.

The Government’s proposed change to the provisional tax threshold from $2,500 to $5,000 would mean that JTL would not be a provisional taxpayer for the 2020–21 income year. Instead of paying tax in instalments throughout the 2020–21 income year, JTL would not have to pay tax until 7 February 2022, which would improve its cash flow during the year.

Background

Section RC 3(1)(a) of the Income Tax Act 2007 currently provides that a person whose residual income tax year is more than $2,500 is required to pay provisional tax. This threshold is used several times throughout subpart RC and elsewhere, such as for dealing with:

  • voluntary provisional tax payments;
  • the standard uplift method;
  • provisional tax instalments; and
  • the GST ratio method.

The threshold referred to in these sections, and others, would be changed in accordance with the implementation of this measure (with the exception of a terminating provision in section RZ 1).

Provisional tax is paid in three equal instalments over an income year. The requirement to make these payments imposes compliance costs on taxpayers. It also has an impact on cash flow as provisional tax instalments comprise cash that a taxpayer is unable to use during the year before terminal tax is due.

The proposed measure would remove around 95,000 taxpayers from the provisional tax regime.


INCREASE IN THE LOW-VALUE ASSET WRITE-OFF THRESHOLD


(Clause 8)

Summary of proposed amendment

This measure would temporarily increase the low-value asset write-off threshold from $500 to $5,000 in the short term before decreasing this threshold to $1,000 on a permanent basis. This would allow taxpayers to immediately deduct expenditure on assets that cost up to $5,000 (and subsequently $1,000) rather than depreciating them over the life of the asset. This would decrease the tax liabilities of taxpayers in the short term and therefore assist with cashflow including during the COVID-19 outbreak. It may also encourage continued investment in businesses in the short term.

Application date

The proposed amendment to increase the low-value asset write-off threshold to $5,000 would apply for property purchased on or after 17 March 2020. The proposed amendment to subsequently lower this threshold to $1,000 would apply for property purchased on or after 17 March 2021.

Key features

This measure would increase the value of property that is eligible to be written off in the year of purchase from $500 to $5,000, before decreasing that threshold to $1,000. This means that expenditure on assets up to the threshold can be deducted immediately, so that all of the tax benefit is claimed up front. This would provide increased cashflow in the short term.

The $5,000 threshold would apply for property purchased on or after 17 March 2020 only while the $1,000 threshold would apply for property purchased on or after 17 March 2021.

Example 2: Increase in the low-value asset write-off threshold

Capes Comics Limited (Capes) is a comic store that sells comics and comic-related merchandise. The store’s owner, Clark, wants to expand by investing in two new display cabinets worth $4,600 in total. Clark believes that this will increase his sales of high-value action figures.

However, with the COVID-19 restrictions, he is anxious about investing $4,600, especially given that he can only deduct the cost of the cabinets over time through tax depreciation (rather than immediately).

The Government’s proposed change to the low-value asset write-off threshold would mean that Capes can claim an immediate deduction for the cost of the cabinets. This would allow Capes to reduce its tax paid this year by $1,288 (28% of $4,600), instead of that amount being spread over a number of years.

Background

Since 2005, the threshold value in section EE 38(2)(b) of the Income Tax Act 2007 for low-value asset write-offs has been $500. Assets costing up to this threshold can be immediately expensed, which provides all of the tax benefit in the year the asset was purchased.

For example, capital expenditure on property that cost $2,000 exceeds the low-value asset write-off threshold and so must be depreciated over a number of years. Expenditure on an asset costing $300, however, can be immediately deducted so that all of the tax benefit is generated in the year of purchase, even if the asset lasts much longer than one year.


RESEARCH AND DEVELOPMENT TAX CREDITS – BROADER ACCESS TO REFUNDS


(Clauses 15, 16, 37 and 38)

Summary of proposed amendment

The proposed amendment brings forward the application date of broader refundability rules, so that these can apply from the first year of the R&D Tax Incentive scheme.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

The proposed amendment changes the rules for R&D tax credit refunds to make refundable credits more accessible for businesses. It does this by bringing forward the application date of broader refundability rules to the 2019–20 income year (year one of the R&D Tax Incentive scheme). These rules would otherwise have applied from the 2020–21 income year (year two of the R&D Tax Incentive scheme).

Limited refundability rules currently apply in the 2019–20 income year (year one rules), which only allow businesses who meet certain corporate eligibility and R&D wage intensity criteria to access refundable credits. A $255,000 cap applies to limit the total amount of credits that can be refunded.

Broader refundability rules apply from the 2020–21 income year (year two rules). These rules remove the corporate eligibility and R&D wage intensity criteria, and replace the $255,000 cap with a cap based on labour-related taxes. The year two rules are aimed at enabling more businesses to access R&D tax credit refunds, and would also enable more of these businesses to access greater amounts of refundable credits.

The proposed amendment would shift the application date of the year two broader refundability rules, so that these apply one year early (from the 2019–20 income year).

It is proposed that the broader refundability rules would apply by default to all claimants in the 2019–20 income year. Businesses would have the option of using the year one limited refundability rules if they prefer. When filing an R&D supplementary return, each business would be asked to confirm which set of refundability rules they intend to apply to their claim.

From the 2020–21 income year onwards, all businesses would have to use the year two broader refundability rules.

Background

COVID-19 has caused significant disruption to all businesses in New Zealand. There is a significant risk that this disruption could cause many R&D-performing businesses in New Zealand to reduce or stop their R&D. While ceasing R&D saves businesses money now, it means some New Zealanders would lose their jobs, fewer innovative products would be developed, and there would be a deeper and more protracted decline in economic activity. This weakens our economy’s ability to recover once the global economy has stabilised.

The Taxation (Research and Development Tax Credits) Act 2019 introduced an R&D Tax Incentive regime from the 2019–20 income year (year one). The R&D Tax Incentive was developed under tight timeframes, so there was insufficient time to develop comprehensive refundability rules before the legislation was enacted. As a consequence, in year one of the Incentive, limited refundability rules (based on another R&D scheme, the R&D Tax Loss Credit) were put in place to provide refundable credits for a small portion of eligible R&D tax credit claimants.

The Government reviewed the R&D Tax Incentive’s refundability rules in 2019 and developed some new, broader refundability rules. The year two rules were put into place by the recently enacted Taxation (KiwiSaver, Student Loans, and Remedial Matters) Act 2020, and apply from the 2020–21 income year (year two).

To provide cash to businesses now and encourage them to continue with their R&D despite COVID-19, this proposed amendment would bring the application date of the broader year two refundability rules forward. Instead of applying from the 2020–21 income year, the year two rules would apply from the 2019–20 income year. This would enable more businesses to access refundable R&D tax credits, and would provide some businesses with larger refunds than they would have obtained under the existing year one limited refundability rules.

Detailed analysis

The proposal brings forward the application date for the broader refundability rules introduced in the Taxation (KiwiSaver, Student Loans, and Remedial Matters) Act 2020. Instead of applying from the 2020–21 income year, these new rules would apply from the 2019–20 income year.

The broader refundability rules (default option)

It is proposed that broader refundability rules would apply from the 2019–20 income year, and would apply by default unless a business chooses to apply the limited refundability rules in section LZ 14 (section LA 5 (4B), (5B), (5C), and (5D)).

A loss-making business can be eligible for R&D tax credit refunds provided it is eligible for the credit more generally. It can obtain R&D tax credit refunds up to a labour-related tax cap. The cap is made up of any labour-related taxes (PAYE, ESCT, and FBT):

  • paid by the business; and
  • paid by companies the business is controlled by or which sit within the same wholly-owned group, if these companies have allocated amounts to the business for the purposes of the cap.

No cap applies to refundable R&D tax credits paid to levy bodies, or derived from eligible expenditure on approved research providers.

Note that it is proposed that the “transitional 2020–21 amount” portion of the refundability cap formula (see section 101 of the Taxation (KiwiSaver, Student Loans and Remedial Matters) Act 2020) would be deleted. The “transitional 2020–21 amount” is not needed if this proposed amendment is passed, because businesses would be able to apply the year two broader refundability rules if they provide a better outcome for them in the 2019–20 income year.

The limited refundability rules

Proposed new section LZ 14 sets out the limited refundability rules, which businesses can choose to apply instead of the broader refundability rules if they prefer. A business can obtain R&D tax credit refunds under the limited refundability rules, provided it is a company and:

  • is in a tax loss position, or has insufficient income tax liability to utilise all of its R&D tax credits in the 2019–20 income year;
  • satisfies the R&D tax loss cash-out corporate eligibility and wage intensity criteria in sections MX 2 and MX 3;
  • does not derive exempt income, and is not associated with a person who derives exempt income;
  • is not a listed company, and is not associated with a listed company; and
  • does not have an outstanding tax liability.

Only the first $255,000 of the business’s R&D tax credits is refundable, which is the equivalent of $1.7 million of eligible expenditure. Any remaining R&D tax credits may be carried forward to the 2020–21 income year if the shareholder continuity requirements in section LY 8 are met.

Choosing between the year one and year two refundability rules

Businesses would have the option of applying the existing year one limited refundability rules in the 2019–20 income year if they prefer (proposed new section LZ 14). Businesses may choose to use the limited refundability rules or the broader refundability rules in the 2019–20 income year, but they cannot use both. Only the broader refundability rules would be available from the 2020–21 income year.

Example 3: Applying the broader refundability rules

Moppy’s Chicken Factory (“Moppy”) has brought forward tax losses from the 2018–19 income year. It claims R&D tax credits in the 2019-20 income year, but does not have enough income tax to pay to use all of its credits. Moppy determines that it will be able to receive more refundable R&D tax credits if it applies the broader refundability rules, because it has $500,000 of surplus R&D tax credits and has paid $500,000 of PAYE in the 2019-20 income year (so its refundability cap is $500,000).

Moppy files its income tax and R&D supplementary returns soon after 31 March 2020. It advises Inland Revenue that it would like to apply the broader refundability rules. Inland Revenue processes Moppy’s claim and refunds Moppy $500,000 of R&D tax credits.