TAX TREATMENT OF MIXED USE ASSETS
The Inland Revenue Department (IRD) has issued an Officials’ Issues Paper entitled “Mixed Use Assets” which looks at ways to adequately deal with assets that are used for both business and private purposes.
At present, there are some guidelines in relation to holiday homes, which are one example of mixed use assets. However, it is the intention of the Officials’ Paper to legislate the treatment of mixed use assets to clarify the position for taxpayers.
From an income derivation perspective, mixed use assets are straight-forward, in that any income derived is assessable income. However, the claiming of deductions is more problematic. Obviously, a deduction is allowed for expenditure that was incurred in deriving income, however, no deduction is allowed when the expenditure is private in nature. When an asset is a mixed use asset, the line between expenditure that is private or business in nature is not always clear.
Expenditure falls into three general categories:
- Expenditure which relates only to the time of earning income from the asset;
- Expenditure which relates only to the private use of the asset; and
- Expenditure which relates to the time an asset is not used
Some expenditure will fall clearly within the first two points, but for the last point it is not clear whether this expenditure is attributable to the income earning use or the private use of the asset. Some expenditure will fall into all three categories over the course of the year.
The Officials’ Paper suggests two alternative approaches to deal with the issue. The first uses a single test to identify whether an owner of an asset has an income earning focus. If this test is met, all deductions except expenditure that is directly in relation to private use will be allowed. If the test is not met, the owner will only be able to claim expenditure attributable to the actual income earning use.
The second approach is the same as the first, however, a third category of mixed use asset would be allowed where the asset is used to earn significant income, but also to provide a reasonable level of private use. Expenditure relating to assets in this category would be apportioned between deductible and non-deductible.
How it affects you
The proposed approaches will provide more clarity for taxpayers owing mixed use assets and provide a framework for determining whether expenditure is deductible. This may reduce some claims.
CHANGES TO LIVESTOCK VALUATION METHODS PROPOSED
The IRD has issued an Officials’ Issues Paper entitled “Herd Scheme Elections” which seeks to address two issues that have become prevalent in relation to the use of the herd scheme valuation method. Possible changes to the herd scheme elections were announced shortly after the Budget earlier this year.
At present, there are two valuation methods that are commonly used by farmers. The first is the herd scheme, and the second being the national standard cost. The main difference between the two methods is that the herd scheme effectively treats livestock as a capital asset, with annual changes in value being on capital account (not subject to tax). Whereas, under national standard cost, livestock are treated as normal farm inventory and movements in value give rise to taxable income or a tax deduction. At present, farmers are allowed to move between different valuation methods, including the other methods (being market value / replacement cost and self assessed cost).
The Officials’ Issues Paper intends to address two issues: the first being the switching by farmers between valuation methods; and the second being the misuse of the value lock-in concession for exiting farmers.
In its Officials’ Issues Paper, the IRD considers that it is inequitable for farmers to be able to value a major asset, such as livestock, as if it were on capital account in one year and in another year as if it were trading stock under the usual cost based regime, when other taxpayers do not have the opportunity to do this. This has been a fertile area of tax planning for farm accountants as it can give rise to tax-free gains under the herd scheme, followed by tax deductible write downs under the national standard cost method.
The Officials’ Issues Paper suggests that this problem can be solved by making the election to adopt the herd scheme method an irrevocable election, and not permitting taxpayers to change to another method.
In relation to exiting farmers, there has been some concern that the exit rules have been used to circumvent the two year time frame to exit the herd scheme, and as such, it is proposed that where livestock is transferred between associated persons the purchaser must adopt the same valuation method as the vendor.
How it affects you
It is likely that the proposals will result in the inability in the future to use livestock valuation methods as a tax planning tool. The proposed changes will not give rise to any immediate income tax consequences; however, they could prevent tax benefits arising in the future.