Cost of obtaining resource consents held to be capital

Summary

The Court of Appeal held that expenditure incurred in obtaining resource consents was capital expenditure and was, therefore, not deductible under s DA 1 of the Income Tax Act 2004 ("ITA"). As a result, s EE 7(j) of the ITA did not prevent the resource consents of fixed duration from being "depreciable property" under s EE 6 of the ITA.

Facts

This case is an appeal by the Commissioner from the High Court judgment of Andrews J in Trustpower Ltd v Commissioner of Inland Revenue ([2014] 2 NZLR 502 (HC)).

It concerns whether expenditure incurred by TrustPower Limited ("Trustpower") in applying for and obtaining resource consents in the 2006, 2007 and 2008 income years is deductible. The resource consents were acquired in respect of four possible future new generation projects in the South Island.

Trustpower argued that the expenditure was part of its feasibility costs and was, therefore, deductible as a revenue expense. The Commissioner argued that the expenditure was of a capital nature and was not deductible.

Decision

The Court of Appeal allowed the Commissioner's appeal on the grounds that the expenditure was capital in nature, so the capital limitation in s DA 2(1) of the ITA applied to disallow a deduction.

Application of subpart EE

The Commissioner argued that resource consents (except land use consents of unlimited duration) were "depreciable intangible property" under subpart EE of the ITA so that the expenditure incurred for those consents was on capital account.

The Court noted that "property" in subpart EE includes certain consents granted under the Resource Management Act 1991. It also noted that such consents were listed in Schedule 17 of the ITA and, as such, were "depreciable intangible property". However, the issue was whether, as an item of "depreciable intangible property", the resource consents were "depreciable property" under s EE 6 of the ITA.

The Court rejected Trustpower's argument that the resource consents did not fall under s EE 6 because they were not "used or available for use" in deriving income until Trustpower decided to proceed with the particular project. The Court stated that "available" simply meant "capable of being used".

However, because s EE 7(j) of the ITA provided that if a person is allowed a deduction outside of the depreciation regime then the depreciation regime will not apply, the Court decided that it was necessary to first consider whether a deduction was allowed under the general permission.

This approach was consistent with the scheme and purpose of the legislation and with the Commissioner's acknowledgement that there may be some circumstances in which resource consents would be stock in trade and, therefore, the expenditure incurred in acquiring them would be deductible.

The income/capital distinction

The Court noted that the correct approach to the distinction between income and capital was well established. It cited several cases by the appellate authority recounting the general factors to be taken into account in deciding whether an item of expenditure was capital or revenue, including Hallstroms Pty Ltd v Federal Commissioner of Taxation ((1946) 72 CLR 634 (HCA)) ("Hallstroms"), which the Court said was the starting point, Commissioner of Taxes v Nchanga Consolidated Copper Mines ([1964] AC 948 (PC)) ("Nchanga") and BP Australia Ltd v Commissioner of Taxation for the Commonwealth of Australia ([1966] AC 224 (PC)) ("BP Australia").

The Court emphasised that no rigid test could be applied. Instead, the Court was required to reach a common-sense appreciation of all the guiding features that provide the ultimate answer. It stated the following:

1. The general principles stated in Hallstroms and Nchanga remained the best guide for distinguishing between income and capital and may well be sufficient for that purpose without resort to the BP Australia factors.
2. The BP Australia indicia were just that, and were not determinative.
3. The answer will depend on a close examination of the facts of the particular case and the character of the particular payment to ascertain the nature and purpose or effect of the relevant expenditure.
4. There needs to be a sufficient relationship or connection between the expenditure or loss and the income or capital as the case may be. It is the object or effect of any given payment that will be determinative.

The Court further noted that the general principles apply equally to the characterisation of expenditure on intangible property. It cited cases in which expenditure incurred in investigating a new source of income was held to be of capital nature (Re Griffin Coal Mining Co Ltd v Commissioner of Taxation [1990] FCA 343 and Esso Australia Resources Ltd v Commissioner of Taxation of the Commonwealth of Australia [1992] FCA 851). It also stated that the High Court had been wrong to rely on The Commissioner of Taxation v Ampol Exploration Ltd ((1986) 13 FCR 545), which could be distinguished on its facts. The Court then went on to cite several cases in which expenditure incurred in obtaining resource consents and permissions was held to be capital (ECC Quarries Ltd v Watkis (Inspector of Quarries) [1977] 1 WLR 1386 (Ch), Waste Management New Zealand Ltd v Commissioner of Inland Revenue (1995) 17 NZTC 12,147 (CA), Case T53 (1998) 18 NZTC 8-404 (TRA) and Milburn New Zealand Ltd v Commissioner of Inland Revenue (2001) 20 NZTC 17-017 (HC)).

The Court stated that determining which side of the line the expenditure fell involved an objective analysis of the factual background relating to the nature and purpose or effect of the expenditure, and not a subjective approach based on the views of the witnesses for Trustpower.

On this basis the Court concluded that the disputed expenditure was capital. Its reasons were as follows:

1. The expenditure was incurred for the purpose of enabling Trustpower to extend or expand its electricity generation business.
2. The resource consents gave Trustpower valuable rights, which were essential to Trustpower's long-term programme of future capital works, and valuable options.
3. The High Court finding that the resource consents were not stand-alone assets separate to the projects to which they relate is irrelevant.
4. The disputed expenditure was not incurred in carrying on Trustpower's business or in earning the income of the existing business or in performing the income-earning operations of the existing business. Trustpower's profit-making enterprise was the generation and retailing of electricity, not the development of its pipeline of possible new projects.
5. The disputed expenditure was incurred in respect of possible future capital projects, including the resource consents needed to proceed with them.

The Court stated that by obtaining the resource consents, Trustpower invested unequivocally in capacity, whether or not it was committed at that time to proceed with the build. The expenditure on the projects was incurred for the purpose of enabling Trustpower to extend or expand its electricity generation business. That investment was inherently capital in nature and, on balance, there was not a sufficient nexus between the expenditure and the deriving of income.

It followed that Trustpower would be entitled to make deductions for the depreciation value of its assets under subpart EE of the ITA, but not under the general permission in s DA 1.

Even though it was not necessary for the determination of the case, for the sake of completeness, the Court went on to assess the BP Australia factors and concluded that it would assess the expenditure as capital in nature having regard also to the principles in that case.

Accordingly, the Court of Appeal confirmed the Commissioner's re-assessments disallowing the respondent's deductions and quashed the order for costs awarded to Trustpower in the High Court. Orders for costs in the High Court and Court of Appeal were also awarded in favour of the Commissioner.

An issue about the classification of expenditure incurred by Trustpower after the dates it was committed to acquiring the resource consents was remitted back to the High Court for determination.

Trustpower has sought leave to appeal the decision to the Supreme Court. Until the appeal process is completed, the Commissioner will continue to apply Interpretation Statement IS 08/02.