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Feasibility expenditure

Home > Publications > 2021 > Special report on the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021 > Feasibility expenditure


Special report on the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021

 

April 2021


 

Feasibility expenditure

(Sections CH 13, DB 66 and DB 67 of the Income Tax Act 2007)

The Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021 contains changes codifying when businesses can deduct expenditure over five years related to completing, creating or acquiring property (business assets) that is later abandoned. Immediate deductions are also available for such expenditure that in total is $10,000 or less in an income year. Together, the changes are intended to set out the circumstances when expenditure can be deducted for property that but for abandonment would have been depreciable property or revenue account property.

The rules complement the current tax depreciation rules in situations when property is abandoned and not completed.

Deductions for expenditure in relation to abandoned property are clawed back as taxable income if the property is subsequently completed, created or acquired. This effectively puts a taxpayer in the position that they would have been in if they had never abandoned the property.

Taxpayers may be able to obtain certainty on the tax treatment of feasibility expenditure (including for abandoned and completed property) incurred in particular arrangements by applying for a ruling from Inland Revenue’s Tax Counsel Office.

Background

From a policy perspective, the economic value of business expenditure that is expected to decline in value should be either immediately deductible or, when it provides an enduring benefit, deductible over time if that benefit declines over time. When the tax system does not provide for that treatment, an economic distortion is created.

An example of this distortion arises with feasibility expenditure incurred by taxpayers to determine the practicability of a proposal to acquire or create property that will decline in value over time. The Income Tax Act 2007 generally denies immediate deductions for expenditure when it has a connection with property that has the potential to yield future economic benefits beyond the current income year. If the expenditure is required to be capitalised and the property is not completed, the expenditure is not recognised for tax depreciation purposes and is unable to be deducted for tax purposes, resulting in what is referred to as “black hole” expenditure. This creates an incentive for businesses to complete capital projects that would otherwise be abandoned.

The non-deductibility of this expenditure effectively raises the cost of risky investments in new property (where the chance of a viable outcome is uncertain) and therefore can act as a barrier to businesses committing resources to developing new property – which is important to innovation and driving productivity improvements.

The new rules are intended to sit alongside the Income Tax Act’s rules for tax depreciation and Inland Revenue’s interpretation statement IS 17/01[4] for businesses that regularly incur feasibility expenditure.

The amendments respond to private sector concerns following the 2016 decision by the Supreme Court in Trustpower Limited v Commissioner of Inland Revenue,[5] which limited the deductibility of expenditure incurred on property that is subsequently abandoned. The rules reduce tax barriers for businesses seeking to invest in new property, by providing greater deductibility of expenditure where it relates to property that is abandoned.

The amendments do not give tax deductions for expenditure related to property that is not expected to decline in value, such as land, goodwill and shares. While property that is not expected to decline in value sometimes does, it would only be appropriate to provide deductions for this expenditure if the tax system taxed gains in property that appreciated.

The amendments do not alter the rules that exist for:

  • tax depreciation (although the rules do allow immediate deductions in some circumstances if the expenditure is less than $10,000 – this is explained in more detail below)
  • company administration costs
  • costs incurred in the course of abandoning property
  • research and development
  • resource consents
  • unsuccessful software projects
  • patents
  • plant variety rights.

The amendments also do not affect the application and effect of the general permission test relating to deductions. This is explained in more detail below under ‘Detailed analysis’.

Key features

Section DB 66 allows taxpayers to deduct expenditure incurred in relation to making progress towards completing, creating or acquiring property if:

  • the property would be:
    • depreciable property, including depreciable intangible property, or
    • revenue account property
  • progress on the property is abandoned with the outcome that the property is not completed, created or acquired, and
  • no deduction for the expenditure is allowed under any other provision in the Act.

The deduction does not apply to expenditure on certain items, such as land, shares and goodwill.

Deductions meeting the conditions above can be spread in equal proportions over a five-year period starting in the income year the property was abandoned (section DB 66(2)). However, there is no entitlement to any remaining portions of the deduction if the abandoned property is completed, created or acquired within the five-year spreading period.

Section DB 67 allows an immediate deduction in the income year for expenditure incurred in relation to making progress towards completing, creating or acquiring property if the total expenditure incurred in an income year that could be subject to this provision is $10,000 or less and:

  • the expenditure is related to depreciable property or revenue account property, and
  • no deduction for the expenditure is allowed under any other provision in the Act.

As is the case with section DB 66, new section DB 67 does not allow a deduction for certain items, such as land, shares or goodwill.

Given that section DB 67 allows immediate deductions if the expenditure is less than $10,000 (even if the property has not been abandoned), this rule will in some circumstances override the general depreciation rules. This is explained in more detail below under ‘Detailed analysis’.

The expenditure under both sections must be incurred in relation to making progress towards completing, creating or acquiring the property.

The amount of the available deduction is equal to the expenditure the taxpayer incurs related to making progress towards completing, creating, or acquiring property.

For abandoned property that is later completed, created or acquired, new section CH 13 claws back the deductions allowed under section DB 66 by treating the amount deducted as income. The property may then be subject to the tax depreciation rules in subpart EE, or the revenue account property rules in section DB 23.

New sections DB 66 and DB 67 override the limitation for expenditure of a capital nature.

Application date

The amendments apply to qualifying expenditure incurred in the 2020–21 and later income years.

Detailed analysis

Spread deduction rule for feasibility expenditure

New section DB 66 is directed at expenditure incurred by taxpayers in relation to making progress towards completing, creating or acquiring property that is subsequently abandoned. The term “property” is defined by reference to property that if completed would be depreciable property, including certain types of intangible property, and/or revenue account property.

Progress will, generally, be considered to be abandoned when a decision has been made that no further progress will be undertaken to complete, create or acquire the property. For larger projects, such a decision will likely be documented by the taxpayer. However, for small businesses a decision to not proceed with the property may be reflected in that no further money has been applied to completing, creating or acquiring the property.

The available deduction is equal to the expenditure the taxpayer has incurred in relation to the abandoned property, which is not otherwise deductible under any other provisions of the Act. The intention is to permit a broad range of expenditures to be deducted, including direct costs that would ordinarily be considered to be the “cost” of depreciable or revenue account property, and expenses that have an indirect relationship with the property, such as administration or general overhead costs.

A deduction is not available for expenditure on acquiring property such as land, shares and goodwill in the course of developing another asset that is abandoned. This is because expenditure on such items is not typically associated with feasibility type activity but could potentially otherwise fall within the broad wording of the feasibility rules.

Deductions for the expenditure are spread in equal proportions (one-fifth) over a five-year period, starting in the year of abandonment. However, as discussed below, there is no entitlement to any remaining portions of the deduction if the abandoned property is subsequently completed, created or acquired before the five-year spreading period has expired.

Example 10: When the new sections apply – wind studies

Company A, an electricity generator, is exploring the practicability of establishing a new wind farm. It incurs expenditure in the 2020–21 income year associated with measuring wind frequency and speeds (anemology) relevant to the local geography. At the end of the 2021–22 income year, the studies regarding the site are inconclusive as to reliability of wind supply and the project is abandoned.

Tax impact

The anemology expenditure relates to the possibility of expanding the capital structure of the business and, as such, is capital expenditure. Regardless of whether or not this expenditure would have been included in the cost of the property for depreciation purposes had the property been completed, created or acquired, it will be deductible under section DB 66 to the extent that it does not relate to land or other property that is not depreciable property or revenue account property. This is because the expenditure was incurred after section DB 66 came into effect and made progress towards creating or completing property that, if it were created or completed, would have been depreciable property (wind turbines). The relevant expenditure will be deductible in equal parts over five years.

Example 11: When the new sections apply – nanotechnology study

Company B, a water management company, is working on ways to meet demand in times of low-aquifer inflows and drought, to prevent water restrictions. It is exploring the viability of desalination. The company carries out a number of studies on the practicability of building and operating a desalination plant, and researches how water from the plant could be connected to the wider network. Work on the project is abandoned after an assessment determines it is uneconomic, in terms of energy needs and water output, for the plant to meet forecast demand. The project is shelved pending future advances in desalination nanotechnology.

Tax impact

Under section DB 66, the collective desalination study expenditure will be deductible as the expenditure was incurred in relation to making progress towards creating property that, if it were completed, would have been depreciable property (water treatment plant and reservoir). The expenditure will be deductible in equal parts over five years.

Example 12: When the new sections apply – design property rights

Company C, an aeronautics company, has plans to redesign the cockpit and airframe canopy for a model of small single propeller aircraft. The redesign is intended to improve flight performance and pilot visibility for such purposes as aerial crop dusting.

The company incurs expenditure in costing the project and scoping initial airframe designs. The multi-year project is shelved when a competing overseas company brings a comparable (and cheaper) improved aircraft to the market.

Tax impact

The design expenditure would be deductible under section DB 66 except to the extent the expenditure is deductible under another provision (for example, if some of the design expenditure resulted in depreciable intangible property).

Example 13: When the new rules will not apply – acquisition of shares

Company D is seeking to diversify the range of products it provides to commercial clients. It initially considers either directly acquiring the products or acquiring the shares in another firm that is offering comparable products. However, a decision is made to explore acquiring the shares in the firm in order to retain the firm’s existing staff, management and the client list built up by the firm. Company D subsequently incurs legal and other consulting expenditure in undertaking a due diligence of the firm. However, Company D’s bid to acquire the firm is unsuccessful.

Tax impact

The expenditure connected with Company D acquiring the shares in the firm is not deductible under section DB 66 as it relates to the acquisition of shares (which are specifically excluded from the scope of section DB 66 as excepted financial arrangements).

Example 14: When the deduction starts

The finance team at Company E is considering the expenditure debited in its work in progress account after balance date for the 2020–21 income year. The expenditure includes a study directed at improving the energy efficiency of the company’s plant. The finance team decides not to make any further progress on the energy efficiency work due to cash flow constraints. The abandoned work related to a potential refit of the company’s premises for lighting and heating. Had the work been completed, the completed property would have been depreciable property (fitout). No further amounts had been spent on the project after balance date and the decision is made in 2021–22 income year to abandon the project.

Tax impact

The expenditure would be deductible under section DB 66 given its relationship with depreciable property. A deduction of one-fifth of the expenditure can be made in the 2022 income tax return, being when a decision was made to make no further progress on the property, with the remaining deductions spread evenly over the next four years.

Application of general permission

The new rules override the capital limitation, but not the general permission requirements. The general permission requires that the expenditure must have a connection to an existing business or income-earning process of the taxpayer in order to be deductible under the rules. In situations where the expenditure is incurred before any decision is made to enter into the business or income-earning activity, the expenditure will have been incurred too soon and will not be deductible. Similarly, where a business already exists, feasibility expenditure incurred in relation to a new business will still need to have sufficient nexus to the existing business. However, feasibility expenditure that is recurrent and incurred as part of the ordinary income-earning process of a business is likely to be deductible under the new provisions (if not already deductible under existing law in line with the principles in Inland Revenue interpretation statement IS 17/01: Income tax – Deductibility of feasibility expenditure).

The correct time for considering whether the expenditure satisfies the general permission is when the expenditure is incurred, not when the relevant property is abandoned.

Example 15: Expenditure does not satisfy the general permission

After being made redundant from her job as an architect, Willow decides to investigate starting her own architecture business. She spends $3,000 on market research, a consultant to put together a business plan, brochures and contacts former clients to compile a client database.

Tax impact

The expenditure incurred by Willow is not deductible under section DB 66 because it does not satisfy the general permission. The expenditure is merely preliminary to establishing a business or income-earning activity. At the time of incurring the expenditure, a business had not yet commenced.

Example 16: Expenditure does not satisfy the general permission

Company F, an operator of a coal mine, is considering becoming involved in a project to construct an aluminium smelter to which it can supply coal. Company F forms a consortium with two other companies and conducts a feasibility study to determine the construction and operating costs and to assess the environmental consequences of building and operating an aluminium smelter. The company also undertakes its own feasibility study of the project and engages various consultants to advise on matters such as industrial relations, finance, environmental issues and negotiating a joint venture agreement. However, the development does not proceed because the other two consortium participants withdraw from the project.

Tax impact

The feasibility expenditure incurred by Company F is not deductible under section DB 66 because it does not satisfy the general permission. No nexus exists between Company F’s existing business and the smelter feasibility expenditure. The latter was incurred in creating a new business structure.

Apportionment

Expenditure will be deductible under the rules only to the extent that it is connected with making progress towards depreciable or revenue account property. Where an amount of expenditure relates to a mixture of, for example, depreciable and non-depreciable property, then only a portion of the expenditure will qualify for a deduction under the rules.

The legislation does not specify a particular approach or methodology for how expenditure needs to be apportioned in these circumstances. This provides some flexibility to taxpayers in how they approach the apportionment exercise. Any fair and reasonable method of apportionment may be used.

Whether an apportionment is fair and reasonable will depend on the relevant facts and circumstances related to the expenditure. It is not necessary that the apportionment method applied be the most accurate, but it must reflect what an objective person would consider to be fair and reasonable in the circumstances. The method should reflect the contribution of the expenditure towards the relevant item of property. A method that could be considered fair and reasonable in some instances may be one based on estimates by qualified professionals of the values of respective in-scope and out-of-scope property at the time the property was abandoned. There may equally be other methods that can be applied that will provide a fair and reasonable apportionment.

Records that taxpayers would be expected to hold in support of their chosen apportionment method would include (but are not necessarily limited to) the following:

  • Any records detailing what their plan was, in terms of what property they were looking to complete, create or acquire.
  • Details of categories of expenditures that can be directly attributed to depreciable property, revenue account property, or property that is excluded from the scope of section DB 66.
  • Categories of expenditures that relate to both depreciable property/revenue account property and property that is excluded from the scope of section DB 66.

The Inland Revenue interpretation statement IS 17/01: Income tax – Deductibility of feasibility expenditure notes that expenditure that is not directed towards a specific project or which is so preliminary as to not be tangibly progressing or materially advancing such a project will be on revenue account and therefore immediately deductible if the business regularly carries out feasibility studies. This being the case, it is expected that, by the time that tangible progress has been made on a specific capital project, the taxpayer will likely have a better understanding of the share of remaining costs between depreciable property and revenue account property, and property that is specifically excluded.

Example 17: Deduction needs to be apportioned

Company G, a manufacturer of various cleaning products, is seeking to acquire the intellectual property for an outdoor cleaning product produced by a competitor that is going out of business, along with any remaining stock of that product. After engaging a law firm to provide legal advice on the transaction, Company G makes an offer of $10 million for the intellectual property, including brand rights and the formulation or “recipe” for the product, and an additional $5 million for the remaining trading stock. However, Company G’s offer is rejected as the manufacturer of the product receives a higher offer from a different competitor. Company G paid $33,000 for the legal fees.

Tax impact

A deduction for the legal fees is not available under section DB 62 (deduction for legal expenses) because the total amount of the expenditure on legal fees in the income year exceeds $10,000. Company G considers that a fair and reasonable allocation approach would result in a deduction of $11,000 (33 percent of the $33,000 it paid on legal fees related to the transaction) under section DB 66. This apportionment method is fair and reasonable in the circumstances because a third of the value of the transaction, had it been successful, would have been in relation to revenue account property.

A deduction is not allowed under section DB 66 to the extent that the expenditure relates to acquiring property that is not depreciable or revenue account property, such as intellectual property that is not fixed life intangible property.

An alternative apportionment methodology could be chosen by Company G if it was also fair and reasonable.

Example 18: Company unsure whether it would have bought shares or underlying business assets

Company H is considering purchasing either the shares in a competitor company or the underlying business assets of the company, 40% of the value of which comprises depreciable property and revenue account property. Company H incurs due diligence expenditure totalling $55,000 before committing to a decision as to whether to buy the shares or the underlying assets.

Based on the information gathered from the due diligence exercise, Company H determines that the respective prices the vendor is asking for the shares and for just the business assets are both too high, and so decides during the 2020–21 income year not to proceed with either option.

Tax impact

As Company H does not know whether it would have purchased the shares or the assets at the time it incurred the due diligence expenditure, a fair and reasonable apportionment method could involve 50% of the expenditure potentially within scope of section DB 66. This proportion is further reduced by 40% to reflect the proportion of assets within scope of the rules (that is, depreciable and revenue account property) to those outside the scope of the rules. As a result, Company H claims $11,000 ($55,000 × 50% × 40%) of expenditure under section DB 66 over a five-year period, commencing in the 2020–21 income year.

An alternative apportionment methodology could be chosen by Company H if it was also fair and reasonable.

Partial abandonment

It is possible that a capital project may produce a number of distinct items of property that together achieve the overall objective of the project. In the process of developing the overall project, it is possible that some smaller items of property may be considered and abandoned even though the project as a whole is completed. Guidance on how to identify the relevant property can be found in Interpretation Statement IS 12/03: Deductibility of Repairs and Maintenance – General Principles.

If the costs that were incurred in exploring the viability of the abandoned property cannot be capitalised to the cost of depreciable or revenue account property resulting from the project and are otherwise not deductible, a deduction for the expenditure relating to the abandoned option may be available under section DB 66. As discussed above under ‘Apportionment’, any deduction would be limited to the extent the expenditure relates to depreciable property or revenue account property, had it been completed.

Example 19: Partial abandonment

Company I needs to add a line to its network to transport power from Point A to Point F. The company incurs expenditure in investigating three different potential routes for the power line (A to B to F; A to C to D to F; A to E to F). The expenditure includes resource consent costs and legal fees of more than $10,000 for negotiations with landowners to acquire access rights to the land on the alternative routes via points B, C, D and E.

As a result of its investigations, Company I decides to proceed with a route from A to E to F and the two alternative routes (from A to B to F and from A to C to D to F) are abandoned.

Tax impact

Company I cannot take a deduction under section DB 66 for the resource consent costs. This is because a deduction for the resource consent costs is already available under section DB 19. Whether or not a deduction can be taken under section DB 66 for the legal fees relating to negotiations with landowners will depend on whether the access rights would have been fixed life intangible property and therefore depreciable property. If the access rights would have been fixed life intangible property if acquired and no deduction is otherwise available, Company I is entitled to a deduction under section DB 66 for the legal fees. Otherwise, a deduction is not allowed.

Immediate deduction for feasibility expenditure

Section DB 67 works in a similar way to section DB 66, with modifications to reflect that section DB 67 is a compliance cost saving measure. That is, feasibility expenditure can be immediately deducted by the taxpayer if the total expenditure incurred is $10,000 or less in an income year. There is no requirement that the property be abandoned.

However, like the requirements of section DB 66, the expenditure must satisfy the general permission provisions and not be deductible elsewhere under the Act. Section DB 67 is not a replacement for tax depreciation for low-value assets. This means that a person who acquires an item of depreciable property must apply the depreciation rules from the year the property is actually acquired. A deduction for the cost of the property is not available under section DB 67 in this situation.

If the person had incurred expenditure in merely looking into purchasing the property, or started to make or construct the property but did not complete it within the income year so that it could then be depreciated, then a deduction for the expenditure would be available under section DB 67. In this situation, if the property is completed (resulting in an item of depreciable property), then any expenditure relating to the property that has previously been deducted under section DB 67 is excluded from the cost of the completed property for tax depreciation purposes.

Example 20: When the deduction cannot be immediately claimed – depreciable property

Retailer J acquires a secondhand vehicle to assist with deliveries. The vehicle and associated expenditure incurred during the income year totals $8,000.

Tax impact

The cost of the vehicle is not deductible under section DB 67 as the cost of the vehicle is deductible under the tax depreciation rules.

Only one deduction is allowed for the relevant expenditure

Once a deduction is claimed under section DB 66 or section DB 67, no further income tax deduction is available for this expenditure. This is a function of the income tax rules, which do not allow more than one deduction for the same item of expenditure.

However, if expenditure has been effectively denied by the application of the clawback in section CH 13 (discussed below), it is intended that the expenditure may be subsequently deductible if it otherwise satisfies the requirements to be part of the cost of depreciable or revenue account property.

Clawback of deductions

The feasibility expenditure rules include an integrity measure (referred to as the “clawback”) that applies where previously abandoned property is subsequently created, acquired or completed.

The clawback is directed at situations where taxpayers may be incentivised to prematurely abandon work on property. For example, property may be partially abandoned to take advantage of the five-year deduction if this would accelerate the deductions that would have been allowed had the property been completed and depreciated. A further example is where the deductions under the feasibility rules would be greater than would otherwise be available under the tax depreciation rules if the property was completed.

The clawback applies in the income year that the abandoned property is completed, created or acquired. This also applies in the situation where the taxpayer subsequently acquires property that is similar to the abandoned property.

The effect of this measure is to put taxpayers into a similar tax position to where they would have been had they never abandoned the property.

The clawback in new section CH 13 deems an amount of income equivalent to the deductions previously taken under section DB 66 in relation to the property. The requirement to include as income amounts that were previously deducted does not apply to expenditure that has been immediately deducted under the $10,000 de minimis rule.

To minimise compliance costs and provide greater certainty to taxpayers, a seven-year time limit applies to the clawback. The seven-year time limit aligns with the general business record retention requirements in the Tax Administration Act 1994, starting in the year immediately following the income year for which the fifth and final deduction was taken under the rules. This means that the deductions are not clawed back if abandoned property is subsequently created or completed more than seven years after the income year to which the last deduction relates, or if the property or similar property is acquired more than seven years after that income year.

Example 21: Previous deduction clawed back

Company K, an electricity generator, regularly undertakes studies to determine the practicability of different power generating options. Following the initial study process many of the options will be shelved. However, some of these options may be reconsidered in the future and result in the creation of electricity generation assets.

One of these studies involves the creation of a wind farm in Gusty Hills, with work on the project abandoned in Year 1. Prior to abandonment, $10 million was expended on various fees. The $10 million incurred by Company K is deductible over a five-year period, starting in the year the project is abandoned. This results in equal deductions to Company K of $2 million in Years 1 to 5.

In Year 7 Company K decides to reinstate the wind farm project in Gusty Hills, with the property being completed in Year 9 using the information from the previous studies.

Tax impact

The clawback provision is triggered in the year that the relevant property is subsequently created, acquired or completed, being Year 9. In this case, the property was completed within seven years from the final year of deduction (that is, Year 5) under section DB 66. This means that Company K is required to return clawback income of $10 million in its Year 9 tax return. However, some of this expenditure may be deductible if it forms part of the cost base of depreciable property.

Example 22: Previous deduction not clawed back – example 11 continued

A decade after Company B’s decision not to proceed with a desalination plant, population growth in the region and the need for greater water infrastructure has led Company B to restart its earlier work on nanotechnology. Development of the plant and reservoir begins and seven years later it is operational and connected to the wider water supply network.

Tax impact

The earlier deduction taken for the previous study is not clawed back as the property is completed more than seven years after the end of the income year in which the final deduction was taken under section DB 66.

Abandoned property subsequently created, acquired or completed

In order to apply the clawback, taxpayers need to identify and monitor whether any property subsequently arises from the expenditure that has been deducted under section DB 66.

In many situations a taxpayer will simultaneously abandon work on multiple items that, if completed, acquired or created, would have been depreciable or revenue account property. This may be due to the abandonment of all or part of a project being undertaken by the taxpayer.

In determining whether the clawback applies, the rules require an analysis of each separate piece of property that is subsequently created, completed or acquired. In other words, the relevant assessment is not in relation to the wider project, but to individual items of depreciable or revenue account property for which a deduction was allowed under section DB 66.

This will require an understanding of what property the expenditure relates to, which is an exercise that is likely to have been undertaken as part of the process of claiming a deduction under section DB 66 (for instance, in claiming a deduction there needs to be an apportionment between depreciable/revenue account property and other property).

It is possible that expenditure could relate to multiple potential items of depreciable or revenue account property, of which only some is subsequently created, acquired or completed. In this case, it will be necessary to make an apportionment of this expenditure on a fair and reasonable basis for the purpose of applying the clawback.

Example 23: Restart of hotel development

Company L is constructing a hotel on the Auckland waterfront as part of a larger development that includes residential apartments and retail space. Progress on the project stopped and was put on hold indefinitely in 2021 because overseas tourists stopped coming into the country. However, work on the hotel resumes in 2023 (but not the rest of the development) as international travel picks up again, with completion of the hotel in 2025. The design of the hotel is modified from its original design and includes a gym and larger swimming pool. However, the hotel is located on the same site and serves the same purpose (hotel accommodation) as was originally planned. The previously abandoned property was simply finished off (with some adjustments) when the project restarted.

Tax impact

Although there are some differences between the completed hotel and the original construction plans for it, the property is based on the original design, performs the same function and is in the same location and as such is considered to be the completion of the abandoned property. Section CH 13 will apply to claw back any expenditure that was deducted under section DB 66 in relation to the hotel after it was abandoned. However, it will not be necessary to claw back any expenditure to the extent it relates to part of the project that has not been completed (the residential apartments and retail space).

Similar property

A feature of the clawback is that it also applies to property acquired that is “similar” to the property that was abandoned. The need for the rules to apply where similar property is acquired is to protect against the clawback being ineffectual if the acquired property has even a slight modification or difference to the abandoned property.

It is important to note that the “similar property” requirement only attaches to property that is acquired by a taxpayer, rather than property that is created or completed by the taxpayer. This is because taxpayers will have greater opportunity to acquire property that is similar to (but not the same as) the original property that was abandoned. However, this is not expected to hold true for property that is created or completed by a taxpayer. In this case, the created or completed property is likely to be a continuation of the property that was abandoned.

The term “similar property” is not defined in the legislation. Acquired property is likely to be similar to abandoned property where it has a resemblance in appearance, character, function, purpose or quantity to the property that was abandoned. In determining the appearance, character, function, purpose or quantity of the property, regard may be had to any project and design plans relating to the abandoned property, which may include details of the assets required to be acquired for the project and their respective specifications.

Example 24: Acquisition of non-similar property

In order to expand its vegetable handling operations, Company M seeks to develop a new facility that will include an additional potato washing facility. After considering a number of options, Company M decides on a preferred option of a flatbed potato washer and incurs engineering and design costs for integrating the new machine into the existing processes and facilities. Due to a new form of fungal disease that reduces potato crops, Company M decides to abandon the project and does not acquire the potato washing plant. Company M claims a deduction under section DB 66 for the engineering and design costs.

Two years later, new fungus resistant potato varieties have been planted resulting in increased crop yields. As a result, Company M decides to acquire a new potato washing plant. However, instead of acquiring a flat bed washer, it acquires a barrel washer, which is able to wash more potatoes and is able to clean a wider range of vegetables. The original engineering and design work relating to the flat bed washer cannot be used for the barrel washer due to differing specifications.

Tax impact

The barrel washer and flatbed washer have similar functions in that they both wash potatoes. However, the specifications between the two different washers are significantly different. This is reflected in that the barrel washer can clean a larger quantity of potatoes and can also clean other types of vegetables, as well as the engineering and design work for the flatbed washer not being able to be directly applied to the acquired barrel washer. Accordingly, the barrel washer is not similar to the flat bed washer and the clawback does not apply to the engineering and design expenditure deducted under section DB 66.

No further deductions once clawback is triggered

In some situations, abandoned property may be reinstated and completed before the five-year spreading period has ended, resulting in the clawback being triggered before all the deductions available under section DB 66 have been claimed. In this situation, all the previously claimed deductions are clawed back as taxable income. There is no entitlement to the remaining deductions under s DB 66 once the relevant property is completed, created or acquired. As noted above, clawed back expenditure may be deductible under the depreciation or revenue account property rules, subject to meeting the relevant deductibility criteria.

Example 25: Interaction between deduction provision in section DB 66 and clawback

Company N is undertaking a capital project that, if completed, will result in depreciable property. Work on the project is abandoned in Year 1 but is subsequently resumed and then completed in Year 3.

The clawback in section CH 13 applies to the expenditure deducted in Years 1 to 2, meaning that Company N is required to return the deduction portions for Years 1 to 2 as taxable income in Year 3. Company N has no entitlement to the remaining deduction portions for Years 3 to 5.