Business smarts TAX & FINANCE
Is the expenditure capital or revenue? It’s not always straightforward, says Brett Crombie.
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recent decision by the Tax Review Authority (TRA) has highlighted the potential cost to businesses when they incorrectly classify capital and revenue expenditure. The case yet again demonstrates that determining the correct classification for tax purposes can be a complicated business.
Why does it matter? A tax deduction is allowed for expenditure that is incurred for the purpose of deriving income. This is called the ‘general permission’. It is the reason why, from a tax perspective, in any given period it is usually beneficial to maximise the expenditure (deductions) and therefore reduce the tax payable. While many business owners have a good understanding of the ‘general permission’
and often seek to apply it with great gusto, somewhat less well understood is another rule called the ‘capital limitation’. The ‘capital limitation’ works to disallow deductions for expenditure of a capital nature. Instead, the accounting method is to create a capital asset and depreciate that asset over time. While this still results in a tax deduction for depreciation, it is spread over several years, which is less appealing for business owners seeking to lower their tax bill.
The recent decision A TRA case decided last December provides a good example of the type of scenarios the Inland Revenue is likely to challenge. In this case, the taxpayer purchased a property and decided to undertake a programme of
work. This was completed over a period of about three years and included an internal refurbishment, the addition of a covered veranda, extension of a deck, additional toilets and the fitout of a container. The total expenditure amounted to $332,071.90 and the taxpayer classified it as repairs and maintenance, deducting it across the three years as it was spent. The taxpayer’s reasoning was that the work was a series of separate and independent repair and maintenance projects rather than a single capital improvement project. Inland Revenue disagreed and disallowed the tax deduction. TRA Judge Sinclair concluded that the work undertaken was a single project, which involved a substantial reconstruction and improvement of the original premises. She
Disclaimer: This is general information only and not intended to be treated as professional advice. It is recommended you seek professional advice before acting.
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