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Govt moves against surprise Supreme Court 'black hole' tax ruling

Monday 23rd September 2019

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The government confirmed today it will legislate to return the tax deductible status of feasibility study spending after a surprise Supreme Court ruling three years ago up-ended the Inland Revenue Department's advice on the issue.

In the final judgment of a long-running battle between Tauranga-based Trustpower and the IRD, the Supreme Court in 2016 ruled that the cost of feasibility studies should not be treated as a tax-deductible expense, even though the IRD had issued formal guidance that it should be.

The case revolved around Trustpower's attempt to claim $17.7 million in 'black hole' expenses incurred on the resource consent for a windfarm in the South Island, that did not go ahead, as tax-deductible expenses related to examining the feasibility of the abandoned project.

However, the Supreme Court never ruled on that question because it concluded that no feasibility study expenses should be deducted, Trustpower chief financial officer Kevin Palmer told BusinessDesk.

Revenue Minister Stuart Nash announced the change today, along with a decision to allow start-up companies to carry their accumulated losses forward, even if they were bought out or acquired a new majority shareholder.

BusinessDesk inquiries for detail on this latter announcement, which would ascribe value to an asset that companies can currently only exploit if there is no change of control, drew a blank. Nash's office was unable to provide immediate detail, while the IRD communications division was unaware an announcement was being made. A consultation document on the issue is expected later this year.

On the feasibility expenses issue, Nash and Finance Minister Grant Robertson used the costs of a feasibility study for a wind farm as an example of its impact on large businesses.

"A power company wants to build a new wind farm and has three possible sites in mind. It incurs expenditure over a five-year period associated with measuring wind frequency and speeds relevant to the three sites to determine the best place to build the windfarm," the example reads. "Under current rules, the costs relating to the unsuitable sites will not be deductible for tax purposes.

"This might discourage the power company from researching too many sites, which raises the risk of not choosing the best location."

The costs of researching the chosen site can be deducted over time as the wind farm depreciates.

The cost of assessing unsuitable sites will be deductible over five years.

At the time of the Supreme Court judgment, Trustpower said it was "very disappointed" and warned it was likely to result in a significant increase in non-deductible “black hole” expenditure across all industry sectors.

The elecriticity generator-retailer was seeking to overturn a Court of Appeal ruling disallowing the deductions in the 2006, 2007 and 2008 tax years, which cost it around $6.6 million in bottom-line profit.

"Business owners tell us this can deter them from spending money looking at better ways of doing things,” said Robertson. “We’re changing this so businesses can deduct ‘feasibility expenditure’ from their tax bills, including for projects that don’t end up going ahead.

“This is about creating an environment where businesses are encouraged to innovate and become more productive – even if some of these ideas don’t work out."

Qualifying expenditure totalling less than $10,000 would be deductible immediately under the legislation, which is expected to be introduced to Parliament early next year and could be passed in time for the new tax year, starting April 1.

On the loss carry-forward proposal, Nash said changes to the ‘loss continuity rules’ regime should "make it easier for start-ups to attract investment and get off the ground".

"As the rules currently stand, a firm that suffers a loss one year can use that loss to reduce its taxable income in the future, but the rules do not work well for start-ups who are trying to attract new investment."

If control of the company changes, for example by a new shareholder taking a greater than 50 percent shareholding, "these start-ups ... often breach the threshold under which they can continue to use these losses."

“Business and tax experts will be consulted on the proposals later this year, along with a review of the existing R&D tax loss cash-out rules. This is the normal process for tax policy changes,”  Nash said.


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