Deductions - General

Buckley & Young Limited v. CIR (1978) (CA) - Richardson J

"..a deduction is available only where the expenditure has the necessary relationship both with the taxpayer concerned and with the gaining or producing of his assessable income or with the carrying on of a business for that purpose. The heart of the inquiry is the identification of the relationship between the advantage gained or sought to be gained by the expenditure and the income earning process. That in turn requires determining the true character of the payment. It then becomes a matter of degree and so a question of fact to determine whether there is a sufficient relationship between the expenditure and what is provided or sought to provide on the one hand, and the income earning process on the other." -Richardson J

CIR v. Banks (1978) (CA) - Decision

"It then becomes a matter of degree, and so a question of fact, to determine whether there is a sufficient relationship between the expenditure and what it provided, or sought to provide, on the one hand, and the income earning process, on the other, to fall within the words of the section." -Richardson J. The Court held that a house could be for both private and business uses and there was no requirement that the primary use of an asset is required for the income earning process. "... there is no reason, in principle, why a sufficiently substantial use from time to time or income related activities of part of the premises used as a family home, should not qualify current revenue expenses in relation to the premises as having, in part, a revenue character." -Richardson J. Court upheld the deduction sought by Banks.

CIR v. Banks (1978) (CA) - Facts

- Banks was a part-time polytechnic tutor. He was not provided with an office -he used his dining room table. - He claimed a proportion of the outgoings he incurred for his house based on the area of the dining room and the whole house. He claimed 20% of this sum to reflect the time the dining room was used for his tutoring activities. - The CIR disallowed his claim and the case was referred to the CA as a test case.

CIR (Cook Islands) v. A B Donald Ltd 1965 (SC) - Facts

- Taxpayer purchased fishing boar that was in a bad state of repair - Broke down and a considerable amount of money was spent returning the vessel to sea worthy condition

Poverty Bay Electric Power Board v. CIR - Decision

- capital nature - work was substantial - work would produce a different and operationally superior asset for the tax payer - improvement to create an asset of enduring benefit - cant be apportioned: it is either repairs/maintenance or an improvement of a capital nature - in some situations it can be but not here as the old lines were simply removed and presumably scrapped

CIR (Cook Islands) v. A B Donald Ltd 1965 (SC) - Decision

- money could not be classed as revenues unless the defects in the asset derived from the tax payers use of the asset in the pursuit of income - issue turned to the cause of the need of the repair - to the extent to that the work remedied an inherited legacy of disrepair, or went beyond restoration of wear and tear arising out of the taxpayers own use of the vessel, the result was an improvement and was just as much apart of the ships establishment as a capital asset as the purchase price

Poverty Bay Electric Power Board v. CIR - Facts

- taxpayer commenced a project of undergrounding all its electrical reticulation - more aesthetic - cost of keeping over headed wire exceeded revenue - long term economic advantage to put them underground - cost was 10 000 per km - cheaper to rebuild lower voltage overhead lines using softwood poles - not as good as underground (less safe, less reliable, more maintenance) - was the underground cabling an expense deductible as cost of repair to the old system

Expenditure or loss?

A loss is where there is no actual expenditure by the taxpayer, but is not voluntary.

DA1(1)b Cases

Amalgamated Zinc (de Bavay's) Limited v. FCT FCT v. Snowden & Willson Pty. Limited (1958) (HCA)

Capital Limitation Cases

BP Australia Limited v. FCT (1965) (PC) CIR v. McKenzies (NZ) Limited (1988)

BP Australia Limited v. FCT (1965) (PC) - Facts

BP Oil paid lump sums to obtain exclusive site agreements from petrol station operators. These agreements were for periods of varying lengths, but were for on average 5 years (range of 3 to 10 years). The issue before the PC was whether the amounts paid for this exclusive site agreements were deductible.

Colonial Motor Company Limited v. CIR (1994) (CA) - Decision

CA held it was capital - the seismic strengthening was an integral part of the upgrading of the building.

DA1(1) A Cases

CIR v. Banks (1978) (CA) Amalgamated Zinc (de Bavay's) Limited v. FCT Buckley & Young Limited v. CIR (1978) (CA)

Employment limitation

Employees should seek exempt reimbursements from their employer instead.

Amalgamated Zinc (de Bavay's) Limited v. FCT (B)

Expenditure which has a direct relation to income of a past year can be deducted in a later assessment year where it is of such a character that, in a continuing business, it must be met from time to time as a part of the process of gaining assessable income. It is the purpose sought from the expenditure that counts rather than the effect of the expenditure An deductible business expense may be one which results in decreased future expenses rather than future income. Amounts voluntarily paid but have business objects or benefits are still potentially deductible

Exempt income limitation

Fairly obvious that if certain income is exempt from tax (as defined in Subpart CW) then any expenditure incurred to produce it is non-deductible. Note that this does not apply to capital gains - holding expenses of an asset may be deductible if its produces income but also produces non-taxable capital gains on sale refer - Pacific Rendezvous v. CIR.

Mitsubishi Motors NZ Ltd v. CIR (1996) (PC) - Law

Four propositions were quoted from A M Bisley Limited v. CIR. Expenditure is "incurred" if: - it constitutes an obligation which arose in the course of that income year; - it arises under a deed/contract -whether it is an existing obligation is a question of construction of that deed/contract; - the expenditure is payable at some future date does not destroy it as an existing obligation; - expenditure that is a defeasible liability does not destroy its nature as an existing obligation. Each item of expenditure must be an "existing obligation" in order to be deductible. They must be considered individually. To determine whether the expenditure has been incurred involves the nature of the legal relationship between the taxpayer and the person to whom the obligation is owed.

Additional deductions

In addition Subparts DB to DZ permit deductions for specific types of expenditure -in these cases the general permission does not have to be satisfied if it expressly "supplements" it. [Refer DA 3(1) and (2)] However, any supplementary deduction in Subparts DB to DZ is still subject to the general limitations unless expressly provided otherwise. [Refer DA 3(3)] Provisions in Subparts DB-DZ may also override the general permissions and/or the general limitations but only if expressly provided. [Refer DA 3(4) and (5)]

Colonial Motor Company Limited v. CIR (1994) (CA) - Facts

Industrial building in Courtenay Place originally constructed in 1920 for use as a car factory. In the 1990s was converted into an office building costing $5.7million: ○ $1.28 million seismic strengthening ○ $942,706 repairs and maintenance ○ $3.5 million new capital works CIR and taxpayer agreed that R&M was deductible while the new capital works were capital expenditure - but what about the seismic strengthening???

DA1(1)A vs DA1(1)B

It has been recognised that this test is wider and permits a deduction of expenditure that would not otherwise be deductible under DA 1(1)(a), (due to the lack of direct connection with the income earning process), but has been incurred in the interests of furthering a business activity.

Expenditure cases

Mitsubishi Motors NZ Ltd v. CIR (1996) (PC)

Repairs and Maintenance

Now R&M expenditure fall under the general permission and limitations -the critical issue with this type of expenditure is whether it is revenue or capital in nature. To be repairs and maintenance the expenditure must be on revenue account. Capital expenditure is not deductible but is subject to depreciation. Expenditure required to maintain an asset in the condition it was in when it was acquired is normally deductible. Expenditure incurred in replacing an asset is capital. Expenditure over and above making good wear and tear is capital. Replacement or renewal of part of an asset is a repair, but to do the same to a whole asset is capital.

One key issue is what is the asset which is being repaired? This issue is at the heart of many R&M cases:

Poverty Bay Electric Power Board v. CIR Auckland Gas Company Ltd v. CIR (PC) Colonial Motor Company Limited v. CIR

Dilapidation repairs

Repairs of recently acquired assets are normally deductible, except where repairs are required to get the asset into their income earning condition, when it becomes capital expenditure. CIR (Cook Islands) v. A B Donald Ltd

FCT v. Snowden & Willson Pty. Limited (1958) (HCA

Taxpayer carried on a business of building houses. Its business practices were severely criticised in the WA Parliament and a Royal Commission of Inquiry was convened to investigate. The taxpayer incurred significant legal costs to represent itself before the Commission and advertising costs to protect its company's image in the media. Were these legal expenses deductible? It was argued that some of the expenditure could be regarded as capital in that it sought to protect the company's capital structure (i.e. its image and place in the market). The court held that all expenditure was deductible. It had been incurred to maintain and protect the existing business including the debts owing to the company from its customers. "The relation between the expenditure and the carrying on of the business is clear. The expenditure was incidental to the carrying on of the business. It was incurred in the carrying on the business, and it was necessarily incurred because the exigencies of the business imperatively demanded that it should be incurred." -Fullagar J.

Private and domestic limitation

Term is not defined in the ITA. Noted in Banks v. CIR that expenditure is not private and domestic if it qualifies for a deduction under [DA 1(1)(a)]. CIR v. Haenga: "An outgoing is of a private nature if it is exclusively referable to living as an individual member of society and domestic expenses are those relating to the household or family unit."

CIR v. Auckland Gas Company Limited (2000) (CA) - Decision

The CA held (and PC confirmed) that the expenditure was capital. The outcome depended on what was identified as the asset and the extent of the work done. "A question of this kind is necessarily one of fact and degree, requiring a judgment of how the law applies to the particular factual situation." The asset was held to be the Auckland wide gas mains network. The insertion of the new plastic pipes was not a repair of the existing network because it created a different and substantially improved asset. Here the existing asset was no longer operating and it merely acted as protection for the new network.

CIR v. McKenzies (NZ) Limited (1988) - Decision

The CA held that the lease was a capital asset of the taxpayer and that the consideration paid was for the surrender of the taxpayer's interest in the lease. Therefore the surrender payment of $190,000 was non-deductible. (Note: Subsequent legislative amendments in 2013 now permit a deduction for such amounts.) It probably did not help the taxpayer that they had received a sum from another landlord in respect of surrendering a lease on another warehouse, which both the taxpayer and IRD had held to be on capital account.

Buckley & Young Limited v. CIR (1978) (CA) - Decision

The Court found that the expenditure had a dual character. Part of the expenditure was deductible because it removed an unsatisfactory director and would improve the efficiency of the taxpayer's business (i.e. revenue). The obtaining of the restrictive covenant was capital and not deductible because it related to the taxpayer's capital structure. The expenditure was entitled to be apportioned but was not able to be done so on procedural grounds, so the entire deduction was denied.

CIR v. Banks (1978) (CA) - Law

The Court noted two important features of (now) DA 1(1)(a). - Firstly a deduction is only available where the expenditure has the necessary relationship both with the taxpayer and the gaining or producing of his income. - Secondly, the statutory language expressly contemplates apportionment. A deduction is allowed to the extent that the standard is met. A deduction is not denied just because the expenditure in question cannot be dissected into distinct and severable parts directly referable to the production of income. The test for deductibility is to be applied at the time the taxpayer became definitively committed to the expenditure for which a deduction is sought.

BP Australia Limited v. FCT (1965) (PC) - Result

The PC held that the expenditure was deductible. The payments were made to enhance the revenue of the taxpayer and were part of their selling costs. They were from circulating capital which would be recovered from additional sales. The average time period of 5 years was a neutral factor.

Mitsubishi Motors NZ Ltd v. CIR (1996) (PC) - Decision

The PC looked at the terms of the warranty provided with each new vehicle. They held that the defects existed at the time the vehicle was sold. That 63% of vehicles would have faults was an existing fact not a contingency. The legal obligation to meet claims arose when the vehicles were sold. Warranty costs were held to be deductible when the vehicles were sold.

BP Australia Limited v. FCT (1965) (PC) - Factors to consider

The need or occasion which required (or resulted in) the expenditure; Whether the expenditure is recurrent in nature or not; Does the expenditure create an identifiable asset? Does the expenditure create an asset or advantage which is of enduring benefit to the business? Whether the payment related to the profit-yielding structure of the business or the money earning process; Whether the amount is paid from fixed or circulating capital; (Less important now in NZ - old fashioned idea) How the expenditure was dealt with for financial reporting purposes; (Not so relevant in NZ.) Whether the expenditure was ordinary expenditure in the course of the regular income-earning conduct of the business?

Buckley & Young Ltd v. CIR - Richardson J

The purpose of an apportionment is to ascertain how much of the sum actually expended is attributable to the deductible item The circumstances of the particular case will usually determine what is the most apt way of deciding how much of the expenditure is attributable to the deductible item. .... Each such case depends on its own circumstances. It is the yardstick of factual use, or availability for use of business purposes, that satisfies the requirements that the apportionment must be fair, not arbitrary, and must be done as a matter of fact. The more difficult class of case is where each advantage is intangible and does not lend itself to measurement against any conventional yardstick. It then becomes a matter of deciding whether there is any and if so sufficient, evidence to justify a conclusion that some particular part of the total expenditure is actually attributable to the deductible item, or at least that a minimum fractional share of the total expenditure can be recognised as so attributable. in such an apportionment case as the present the taxpayer must be able to point to some intelligible basis upon which a positive finding can be made that a defined part of the total sum is deductible. Where the CIR has refused a deduction and his assessment is challenged, then the taxpayer must establish that the decision is wrong and the extent to which the assessment should be varied. That last matter does not require an answer of absolute precision or one that has been calculated by some kind of scientific process but, unless the taxpayer can demonstrate affirmatively that at least a minimum quantifiable sum is deductible, he will have failed to discharge the onus.

CIR v. Auckland Gas Company Limited (2000) (CA) - Facts

The taxpayer "repaired" a leaky, old iron pipe gas network designed for low pressure gas, by inserted new plastic pipes inside the old ones creating a high pressure gas network. Significant efficiency gains and costs savings resulted. The taxpayer treated the costs as repairs and maintenance while the CIR argued that the expenditure was capital.

Mitsubishi Motors NZ Ltd v. CIR (1996) (PC) - Facts

The taxpayer assembled motor vehicles which were sold with a 12 month warranty against faulty parts and workmanship. Extensive statistical records showed than on average 63% of vehicles sold gave rise to warranty claims. The taxpayer could predict with reasonable accuracy what these warranty costs would be. The tax deduction sought for the provision for warranty expenses accorded with the financial accounting treatment. The CIR asserted that a deduction for warranty expenses could only be allowed when specific warranty claims had been accepted. Hence to be "incurred" the taxpayer must have either paid or been definitely committed to the expenditure.

Buckley & Young Limited v. CIR (1978) (CA) - Facts and Issue

The taxpayer had reached agreement with one of its directors to retire early due to reasons of unsatisfactory performance. The director received a consultancy contract, further superannuation contributions, reimbursement of legal expenses and retained the use of a company car in consideration of him retiring and granting a restrictive covenant. The issue before the court was whether the payments made pursuant to this agreement were deductible to the taxpayer.

CIR v. McKenzies (NZ) Limited (1988) - Facts

The taxpayer held a lease on a warehouse which it had entered into in 1968 for a 50 year period. This warehouse was no longer needed after a takeover and was proving difficult to sublease. The taxpayer negotiated with the landlord to surrender (cancel) the lease by paying $190,000. Was this $190,000 payment deductible?

Amalgamated Zinc (de Bavay's) Limited v. FCT

The taxpayer sold its zinc mine in 1924 and invested the proceeds in shares and bonds. It was legally obliged to contribute to a workmen's compensation fund by virtue of its previous mining business for many years after the sale of its mine. The issue before the court was whether these payments for workmen's compensation in respect of its earlier mining business were deductible against its investment income. The court held that the payments were not deductible because there was no nexus between the payments and the income earned in the current year. "The expression 'in gaining or producing' has the force of 'in the course of gaining or producing' and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure rather than to purpose in itself." -Dixon J.

Approtionment

The wording in section DA 1(1) contains the phrase "to the extent to which" has been held expressly to contemplate apportionment -noted in Banks v. CIR after the term "exclusively" was removed from the ITA.

Incurred

To be deductible the expenditure or loss must be incurred. It does not necessarily have to be paid, but there must be some liability to pay. Accounting type provisions in contemplation of expenditure or the likelihood of loss or expenditure are not normally sufficient to be incurred -hence timing differences between financial reporting and tax accounting.