If you want to see what a bunch of excited tax specialists look like, throw some in a room with a copy of the Supreme Court’s recent ruling Trustpower Limited v CIR and watch the sparks fly.
Trustpower has been involved in an ongoing battle with Inland Revenue regarding the deductibility of feasibility expenditure. The general rule of thumb is that expenditure incurred to assist with determining whether to acquire an asset or not is deductible up until the point you make a decision to acquire it or not. This approach is typically accepted by Inland Revenue.
Trustpower developed a pipeline of potential generation projects upon which it undertook ‘feasibility expenditure’. As part of this process, and before committing to the construction of any particular project, Trustpower spent $6.5m on applying for resource consents across the March 31, 2006, 2007 and 2008 years. Trustpower treated the $6.5m as deductible on the basis that the process of acquiring the consents would enable it to confirm whether to commit to a particular project or not.
Inland Revenue contended that the resource consents themselves were depreciable intangible capital assets, and from the time Trustpower was committed to applying for the consents, the expenditure incurred in obtaining them was capital expenditure and therefore not deductible.
In 2013, the High Court found that the expenditure incurred by Trustpower in applying for and obtaining the resource consents was deductible feasibility expenditure. The expenditure was incurred in the course of deriving income from the generation and sale of electricity. The resource consents were not considered to be stand-alone assets separate from the project to which they related. The expenditure was to be treated in the same manner as other expenditure on the projects. The judgment reaffirmed that expenditure incurred in evaluating projects, up until the time that a definitive commitment is made to proceed, is deductible.
Inland Revenue disagreed with the High Court’s findings, and appealed the decision. The case was taken to the Court of Appeal (COA), which gave an entirely different view on the matter.
The COA’s view was that Trustpower’s business is the generation and retailing of electricity, not the development of a pipeline of new projects. Therefore, the expenditure was not incurred in carrying on Trustpower’s business or performing its income-earning operations and was therefore non-deductible. This outcome created considerable uncertainty because it basically meant all ‘feasibility expenditure’ was non-deductible, which completely contradicted the current status quo.
Trustpower appealed this decision to the Supreme Court and their verdict, released on July 27, decided in favour of Inland Revenue. The Supreme Court stated that the resource consent expenditure would be capital in nature and non-deductible, due to the fact that the projects could not proceed without them.
The Supreme Court also made comments on the general rule for ‘feasibility expenditure’ which have altered the general approach yet again.
The Supreme Court rejected the previous ‘commitment approach’– that expenditure up until the point of commitment to proceed with a particular project is deductible. Instead, it broadly concluded that everything relating to a ‘possible’ capital asset is non-deductible, whether or not a capital asset results. Softening the blow delivered by the COA, the Supreme Court did state:
“Expenditure which is not directed towards a specific project or which is so preliminary as not to be directed towards the advancement of such a project is likely to be seen as being on revenue account.”
Up until now, Inland Revenue’s Interpretation Statement 08/02: Deductibility of Feasibility Expenditure, supported the differentiation between amounts expended on initial investigations on potential projects vs amounts expended once a decision to proceed with a particular project had been made. Application of this approach has become common practice when determining whether feasibility expenditure is deductible.
The Supreme Court decision, although more agreeable than the COA decision, still leaves this area of law in a state of confusion. We have been left with a position where we have to interpret what constitutes as being ‘so preliminary’ as the only means of assessing whether such an expense is deductible. The Supreme Court pointed out that the legislation does not prescribe any specific test for determining the point at which expenditure ceases to be deductible, and did not think they should construct one. This is somewhat unhelpful given the Court’s ruling is used to assist with the interpretation of the legislation.
Furthermore, it is likely that this new norm will give rise to a significant increase in the volume of expenditure that is non-deductible. This will represent a significant increase to the cost of expansion and growth for New Zealand businesses.
Inland Revenue is expected to issue guidance on how we should interpret the Supreme Court decision. We don’t envy their position given the lack of solid guidance provided by the Supreme Court.
The comments in this article are of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.