TAX CONSEQUENCES OF PREPAYMENTS
Generally, where expenditure is incurred in advance for goods and services, the expenditure must be matched with the income year to which each part of the expenditure relates. This can see us having to defer a deduction to a later income year even though the cash has been expended. Under the Income Tax Act 2007 (“the Act”), the unexpired portion of expenditure must generally be added back as income.
An amount of expenditure on goods is unexpired at the end of an income year if the person has not used up the goods in deriving income, and the goods are not destroyed or rendered useless. An amount of expenditure on services is unexpired at the end of an income year if the services had not been performed by the end of the income year.
However, relief is provided under the Act in the form of Determination E12, which excuses taxpayers from complying with the usual prepayment obligations.
Determination E12 provides that, where the specific criteria is met an add back of the expenditure is not required. For example, if an insurance contract of $5,000 is paid for in March that runs for the next 12 months no add back is required for the unexpired expenditure at balance date.
There are 23 specific types of expenditure that qualify for the concession under Determination E12.
Another cost that qualifies for the concession is expenditure on consumable aids, provided that the cost of consumable aids on hand at balance date does not exceed $58,000. Consumable aids are generally considered to be articles or materials which, without becoming component parts of a finished product, are used in the manufacture or production of goods from which a taxpayer derives assessable income. As soon as you breach the $58,000 threshold the entire amount must be added back as income.
In relation to goods, it must be remembered that goods must be in the possession of the person at balance date and the deduction for expenditure must not have been deferred to a subsequent income year for financial reporting purposes.
How it affects you
Determination E12 is an important departure from the usual matching rules that apply to income and expenditure under the Act. In some cases, Determination E12 may be a worthwhile tax planning tool, however, careful management is required as it is easy to breach the thresholds which would require expenditure to be added back as income in the year in question.
DEDUCTIBILITY OF COMPANY ADMINISTRATION COSTS
The Inland Revenue Department (“IRD”) has released an Exposure Draft of an Interpretation Statement entitled ‘Deductibility of Company Administration Costs’. The Interpretation Statement considers whether a range of expenditure incurred by companies is deductible under the Act. The expenditure in question is expenditure incurred by companies as a result of the regulatory environment applicable to them. The interpretation statement was originally released for consultation in March 2005 and following submissions made during that process, a revised and more generous Interpretation Statement has been prepared.
The draft Interpretation Statement provides a useful analysis of the capital and revenue considerations for each item of expenditure and concludes that a number of company administration costs are fully deductible, that some costs may be deductible depending on the particular circumstances that the costs were incurred, and that other costs are not deductible due to the application of the capital limitation.
Costs that are considered deductible include costs incurred in undertaking the annual general meeting, audit fees, the authorisation of dividends, special meetings to approve major transactions or enter into arrangements with creditors, and statutory filing fees.
Costs that are considered non-deductible include special meetings on the liquidation of a company, and costs incurred in the allocation of payment and disputes over allocation of dividends.
The revised Interpretation Statement has found that a number of costs are deductible when previously they were considered non-deductible.
In determining whether the costs are deductible, the draft Interpretation Statements goes into significant detail with respect to the usual capital and revenue distinctions to determine whether a deduction is allowed under the general permission and that no limitations apply.
How it affects you
The draft Interpretation Statement, just like the article above on pre-payments, illustrates that we cannot simply blindly take a deduction for costs that a company incurs without giving consideration to whether the capital limitation will apply. Where expenditure relates to both capital and revenue items, apportionment will be required to determine to what extent a deduction is allowed. If you are unsure as to whether a deduction is allowed, we suggest that you obtain advice prior to filing your income tax return.