New Zealand: A change in tax approach to feasibility expenditure

The Court of Appeal has overturned a High Court decision which would have allowed Trustpower Limited to deduct expenditure incurred in assessing the feasibility of capital projects before any commitment was made to seek resource consents.

If the case is correct, it suggests that expenditure incurred in assessing the feasibility of a possible capital project or capital investment is not deductible.

The Appeal Court's approach departs from how many taxpayers have treated this type of expenditure to date, and from Inland Revenue's policy as reflected in Interpretation Statement 08/02: Deductibility of feasibility expenditure.

As yet, it is unclear whether Trustpower will appeal.

The decision

The Court held that all expenditure that was incurred for the purpose of assessing feasibility of possible future capital projects was non-deductible capital expenditure. In the Court's view, from a practical and business point of view, the expenditure incurred by Trustpower had the purpose of assessing the feasibility of acquiring assets that would be part of the profit-making structure of the business.

The Court's approach departs from how many taxpayers have treated this type of expenditure to date and from Inland Revenue's approach in IS 08/02: Deductibility of feasibility expenditure (the Interpretation Statement). Under Inland Revenue's Interpretation Statement, feasibility expenditure in relation to a capital project/capital investment is regarded as deductible expenditure for the period up until the taxpayer's board or management makes a decision to commit to the project.

The facts

At issue in Commissioner of Inland Revenue v Trustpower Limited is around $17.7 million incurred by Trustpower to assess the feasibility of four resource consents for electricity generation projects which were part of Trustpower's continually evolving "development pipeline". No commitment had been made to building them and Trustpower did not own the property or assets relating to these projects.

Each project was subject to the same two-step process:

  • in-house exercises to assess the project's merit (which the parties agreed was deductible expenditure, but even this may now be considered of a capital nature in light of this decision), and
  • external project viability assessments, but with part of the expenditure also involving expenditure on the resource consent applications relating to the projects (the expenditure in dispute).

Inland Revenue's argument

Inland Revenue's case was that:

  • the resource consents were intangible capital assets and so all expenditure incurred on them was non-deductible from the moment Trustpower committed to the application process, and
  • in any case, the expenditure was of a capital nature and subject to the capital limitation.

Trustpower's argument

Trustpower argued that:

  • the expenditure was on revenue account, as it was incurred as part of its normal income earning process
  • the resource consents were not "stand-alone" assets, and
  • even if the resource consents were "stand-alone" assets, they were held on revenue account.

Chapman Tripp comment

The judgment appears to suggest the expenditure incurred in purchasing a capital asset may not meet the nexus test under section DA 1, i.e., nexus to producing income or to a business producing income. We believe this view is incorrect. In our view, the cost of a capital asset does meet the nexus test, but is non-deductible because it is excluded by the capital limitation.

In our view, the Commissioner should not put forward arguments in court or in a formal disputes process which are inconsistent with her public statements as to how she will apply the Income Tax Act. If this case is appealed and the Commissioner intends to make arguments that are inconsistent with those statements, it is essential that those statements are withdrawn before the argument is made. This is required by the Commissioner's duty to uphold the integrity of the tax system under section 6 of the Tax Administration Act 1994.

The decision raises an important question as to whether Inland Revenue will seek to apply this new view on a retrospective basis to taxpayers who have relied on the Interpretation Statement when filing their tax returns. In our view, Inland Revenue should apply the approach to feasibility expenditure set out in the Interpretation Statement (i.e. that feasibility expenditure in relation to the purchase or construction of a capital asset prior to any definitive commitment to the purchase of the asset is deductible) for tax returns filed prior to this judgment.

If, as the Court holds, it is irrelevant whether the taxpayer has committed to the project, it appears that generally all pre-commitment expenditure incurred in exploring the feasibility of acquiring a capital asset or a share purchase is non-deductible. This would be a major change to current practice.

The case does not appear to address the question of whether salary costs of employees who work on the preliminary steps or applications for resource consents are deductible or alternatively should be allocated to capital projects and capitalised (see Christchurch Press Co Ltd v Commissioner of Inland Revenue (1993) 15 NZTC 10,206). Suggestions that this approach should be applied to all salary costs would result in all company employees being required to keep timesheets. In our view that cannot have been contemplated by Parliament.

The case demonstrates the compelling need for funding from Government or Inland Revenue for taxpayers in a range of test case disputes. Our view is that legislation should be introduced that provides that, where taxpayers succeed in a dispute in the High Court or the Taxation Review Authority but the Inland Revenue chooses to appeal the decision (and that will generally be for reasons relating to its broader interest rather than the tax in dispute), the Government or Inland Revenue should fund all of the costs of the taxpayer relating to the conduct of the appeals.

In our view, it would have been helpful for the Court to determine that, having held the expenditure was on capital account, it should be attributed to the resource consents as "stand-alone" capital assets and depreciated. The Court appears to believe that the resource consents were assets and were capital assets. But it preferred not to address the High Court's finding that the resource consents were not stand-alone capital assets. The Court's suggestion that Trustpower has discretion to choose to capitalise and depreciate the disputed expenditure for tax purposes is probably not strictly accurate. In the absence of a court ruling this may rely on an exercise of Inland Revenue's discretion to open the tax return.

Our thanks to Benjamin Corbett for writing this Brief Counsel.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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