Taxation (Tax Administration and Remedial Matters) Act 2011

Canterbury earthquake relief measures

2011 legislation to provide relief for certain income tax liabilities following the destruction, loss or abandonment of property due to the Canterbury earthquakes.

Sections CZ 23, EE 1, EE 44, EE 45, EE 47, EE 48 and EZ 23B of the Income Tax Act 2007

Background

In the aftermath of the Canterbury earthquake and its aftershocks there are sound reasons for providing relief, in limited circumstances, for certain income tax liabilities arising from the destruction, loss or abandonment of property.

Key features

The Act contains the following amendments.

Firms in certain circumstances will be allowed to defer (or rollover) income tax liabilities arising from the receipt of insurance or compensation payments for irreparably damaged or abandoned buildings held on revenue account.
Includes as a disposal event, for the purposes of the tax depreciation rules, the damage of property in the neighbourhood of a building or grandparented structure, causing the building or grandparented structure to be useless for the purpose of deriving income; and the property is demolished or abandoned for later demolition.
The income year that an amount of depreciation loss or an amount of depreciation income is derived is now the earliest income year that the consideration can be reasonably estimated.
Firms in certain circumstances will be allowed to defer (or rollover) depreciation recovery income liabilities arising from the receipt of insurance or compensation payments for irreparably damaged, lost or abandoned items of depreciable property (not including intangible depreciable property) due to the Canterbury earthquakes and their aftershocks.

Application date

These changes apply from 4 September 2010.

Detailed analysis

Revenue account buildings

Section CZ 23 is intended to provide building owners that hold on revenue account a building that has been irreparably damaged or abandoned because of the Canterbury earthquakes, the option to defer (or rollover) income tax liabilities arising from the receipt of insurance or compensation payments—provided they acquire, build, or purchase a replacement building in greater Christchurch before the end of their 2015-16 income year.

Section CZ 23 applies if all of the following criteria are met:

a person receives a payment of insurance or compensation for buildings held on revenue account before their 2016-17 income year; and
the payment is received because a building has been rendered useless for the purpose of deriving income as a result of the Canterbury earthquakes and is demolished or abandoned; and
in the absence of new section CZ 23, the payment would have resulted in an amount of income under section CG 6 (receipts from insurance, indemnity, or compensation for trading stock); and
the person plans to acquire a building to replace the useless building before the end of their 2015-16 income year and the replacement building is located in greater Christchurch; and
the person provides the required annual notice of election to the Commissioner of Inland Revenue.

In such cases, the total amount of income under section CG 6 from insurance or compensation is not income of the person except to the extent that an amount is attributable to a later income year under subsection (5).

When a person acquires a replacement building its cost, for the purposes of section EA 2 (other revenue account property), is treated as being reduced by an amount of unallocated suspended income attributed to the replacement building by section CZ 23 (3)(a). Section CZ 23(3)(b) requires the person to reduce the amount of suspended income by the amount allocated to a replacement building.

Section CZ 23(5) provides that an amount of unallocated suspended income is income to the person in the earlier of:

the end of the person's 2015-16 income year; or
the income year the person decides not to acquire an amount of replacement property; or
the income year the person goes into liquidation or becomes bankrupt.

Section CZ 23(6) requires that a person that elects to rely on section CZ 23 must give written notice to the Commissioner of Inland Revenue by the later of 31 January 2012 or the date that the return is filed for the income year in which the amount of income can be estimated. Section CZ 23(7) requires that the written notice must:

describe the affected property; and
give details of the replacement property acquired in the current year; and
give the cost of the replacement property and the reduction of that expenditure under subsection (3) of that cost for the purposes of section EA 2; and
give the amount of the unallocated suspended income at the end of the current year.

Example 1

In February 2011, a 31 March balance date firm's revenue account building is destroyed in the earthquake. The building originally cost $3 million. The replacement insurance proceeds are $6 million and the insurance company "delivers" the replacement building on 15 June 2014. In the absence of any rollover relief the building owner will have taxable income of $3 million under section CG 6.

New section CZ 23 allows the owner to defer the CG 6 income tax liability by allocating an amount of the $3 million suspended income to the replacement building - provided the replacement building is located in greater Christchurch.

As a result of negotiations between the building owner and the insurance company, the insurance proceeds are capable of being reasonably estimated on 30 June 2011.

In the tax return for the tax year ending on 31 March 2012 the building owner files a written election to defer the $3 million of income - pending the acquisition of a replacement building. Provided the taxpayer continues to elect to defer the income the income remains suspended for the tax years ending on 31 March 2013 and 2014.

The replacement building is delivered on 15 June 2014. The tax return for the tax year ending on 31 March 2015 will include this new building at a cost of $3 million (being the $6 million cost of the new building less the $3 million of rollover relief). A notice will have to be filed with the tax return for the tax year ending on 31 March 2015 advising that the deferred income has been rolled into the tax base for the replacement asset. The person must also give notice that the amount of unallocated suspended income has been reduced by $3 million to $0.

When the replacement asset is eventually sold, the difference between the $3 million cost and the sales proceeds will be taxable provided it is sold for at least $3 million

Losses on buildings

After the central New Zealand floods of 2004 section EE 48 of the Income Tax Act was amended to allow a generic write-off for any loss on buildings that were destroyed by an event beyond the owner's control. Floods and earthquakes are good examples of such events.

After the 4 September 2010 Canterbury earthquake submissions were received that this provision should be extended to cover the situation where the building has to be destroyed as a result of such an event, even if the building itself was relatively undamaged or repairable. Examples include where the building has to be demolished to allow the land underneath the building to be repaired, or to allow for another building to be demolished.

In response to these submissions section EE 47(4) has been amended. It now includes as a disposal event the damage of property in the neighbourhood of a building or grandparented structure, causing the building or grandparented structure to be useless for the purpose of deriving income; and the property is demolished or abandoned for later demolition. It is a generic amendment - not limited to the Canterbury earthquakes.

Recognition of consideration

The amount of insurance or compensation arising from damage to assets destroyed, lost or abandoned due to the Canterbury earthquakes and their after shocks may not be quantifiable until months or even a year after the event. Following more general tax and accounting practice, section EE 48 has been amended so that amounts of depreciation loss or an amount of depreciation recovery income are derived in the earliest income year in which the consideration can be reasonably estimated.

This amendment is effective from 4 September 2010. It is a generic amendment - not limited to the Canterbury earthquakes.

Depreciation roll-over relief

In the context of the Canterbury earthquakes and insurance recoveries, the Government has decided that it is appropriate to provide taxpayers with the ability to defer a depreciation recovery income liability in certain circumstances.

Rollover relief is provided by section EZ 23B. This section is intended to apply when:

a person, in an income year before their 2016-17 income year either:
- receives insurance or compensation for items of plant and equipment lost or irreparably damaged as a result of the Canterbury earthquakes; or
- owns a building or grandparented structure that is rendered useless for the purpose of deriving income; and is demolished or abandoned for later demolition because of damage to this property or the neighbourhood of this property as a result of the Canterbury earthquakes; and
in the absence of this section, the person would have an amount of depreciation recovery income under section EE 48 for the items of affected property;
the person plans in the current year to acquire depreciable property (being replacement property) that meets the following requirements:
- it is not intangible depreciable property; and
- it is acquired in or before the end of the person's 2015-16 income year; and
- it is included in the same category of property if the old property was a building or a grandparented structure, or commercial fit-out (neither of which were depreciated under the pool method) and it is located in greater Christchurch, unless the replacement item is plant and equipment; and
the person provides written notice to the Commissioner of Inland Revenue by the later of 31 January 2012 or the date that the return of income is filed for the income year in which the amount of depreciation recovery income can be estimated; and
the person provides the required annual notice of election to the Commissioner of Inland Revenue.

Provided the above conditions are met, an amount that would be depreciation recovery income, in the absence of this section, becomes an amount of suspended recovery income (section EZ 23B(2)). The amount of suspended recovery income is available to be allocated to replacement items. Any unallocated amount of suspended recovery income can be attributed to the earlier of:

the end of the 2015-16 income year, where an amount of suspended recovery income remains unallocated under subsections (3) or (6); or
the income year that a person decides not to acquire an amount of replacement property. The amount they decide not to spend is depreciation recovery income in that year; or
the income year that the person goes into liquidation or bankruptcy.

Subsections (3), (4), and (5) allocate an amount of suspended recovery income for old items of depreciable property where the pool method was not used. Subsection (3)(a) reduces the amount of expenditure or costs for calculating an amount of depreciation loss for the replacement item for the purposes of section EE 16(4) or section EE 22. Subsection (3)(b) reduces the amount of unallocated recovery income available for future allocation. The amount of the reduction in subsections (3)(a) and (3)(b) is given by subsection (4).

Subsection (4) calculates the relevant proportion of remaining suspended recovery income that can be allocated to the replacement item. The amount of unallocated suspended recovery income (that is available for future allocation) is reduced by the amount that has been allocated to the replacement item in that income year. If, in an income year, the amount spent on replacement items is equal to or greater than the unallocated suspended recovery income, then the amount of the reduction to additional replacement property is zero. The formula in subsection (4)(b) uses the lesser of the amount of unallocated recovery income remaining or the amount of expenditure on the replacement item. This also limits the total amount of suspended recovery income that can be allocated to replacement items.

Example 2

Plant and equipment (not previously depreciated under the pool method) destroyed by the Canterbury earthquake had a cost of $1 million. On the day of the earthquake the plant and equipment had an adjusted tax book value of $700,000. The owner receives an insurance payment of $1 million. The net depreciation recovered is, therefore, $300,000. The replacement assets were acquired over two years at a cost of $400,000 per year. In year three the owner decides to acquire no more replacement assets, even though they originally expected to spend well over $1 million on the replacement assets.

The $300,000 suspended recovery income is allocated in the following way

Year 1 ($400,000 x $300,000) ÷ $1,000,000 = $120,000

Year 2 ($400,000 x $300,000) ÷ $1,000,000 = $120,000

The balance of $60,000 is taxed in the year that the taxpayer decides to make no further investment in replacement property.

Example 3

Plant and equipment (not previously depreciated under the pool method) destroyed by the Canterbury earthquake had a cost of $1 million. On the day of the earthquake the plant and equipment had an adjusted tax book value of $700,000. The owner receives an insurance payment of $1 million. The net depreciation recovered is, therefore, $300,000. The replacement assets were acquired over two years at a cost of $400,000 per year. In year three the taxpayer decides to acquire a further $400,000 of replacement assets.

As per the previous example, the taxpayer has already rolled over $240,000 of depreciation recovery income in years 1 and 2. Applying the formula in EZ 23B(4)(b) the limited replacement cost is the lesser of $1,000,000 - $800,000 = $200,000 and the $400,000 spent on acquiring the replacement property. The amount of the reduction to the item's opening adjusted tax value and the amount of suspended recovery income (under subsection (3)(a) or (b)) is $60,000 (($200,000 x $300,000) ÷ $1,000,00).

One month later the taxpayer decides to acquire another item of plant for $10,000. Applying subsection (4)(a) the amount of the reduction under subsection (3)(a) or (b) is zero. This is because the cost of the affected property is less that the person's total expenditure in acquiring other replacement property. In this example the person has spent $1,210,000 replacing property that originally cost $1,000,000.

Subsection (6) provides the reduction method for the cost or adjusted tax book value of replacement items where the old item was accounted for under the pool method. Subsection (6)(a) reduces the amount of expenditure incurred on replacement items and the reduction is applied depending upon the depreciation method applied to the replacement item. Subsection (6)(b) is intended to reduce the amount of unallocated recovery income (that is available for allocation in the future) by the amount allocated by subsection (6)(a).

Under section EZ 23B(9) and (10) a person seeking to suspend an amount of depreciation recovery income under this section is required to file a notice annually with the Commissioner of Inland Revenue providing the following details:

describing the items of old property; and
indicating which of the following categories each item of old property is included: (i) a building or grandparented structure not previously accounted for under the pool method; (ii) commercial fit-out not previously accounted for under the pool method; (iii) depreciable property previously accounted for under the pool method; and (iv) depreciable property previously accounted for as plant and equipment; and
each item of replacement property acquired in the current year and the category of old property the item is being linked to; and
the amount of expenditure on the replacement item and the reduction of that expenditure because of the deprecation recovery income being linked to the replacement item; and
giving the amount, for each category of old property, of the unallocated recovery income at the end of the current year.

The annual notice is not required for the income year after the person has filed their completed return for their 2015-16 income year.

Example 4

In February 2011, a 31 March balance date firm's building is destroyed in the Canterbury earthquake. The building originally cost $3 million. The book value is $2 million, reflecting accumulated depreciation of $1 million. The replacement insurance proceeds are $6 million and the insurance company "delivers" the replacement building on 15 June 2014. In the absence of any rollover relief the building owner will have depreciation recovered taxable income of $1 million. The insurance proceeds over the $3 million cost price are still a tax free capital gain.

The law now allows the owner to roll the depreciation recovered into the replacement building, provided the replacement building is located in greater Christchurch. The insurance proceeds are known on 30 June 2011. The depreciation recovery income would be allocated to the tax year ending 31 March 2012.

In the tax return for the tax year ending on 31 March 2011, the taxpayer files a written election to defer the depreciation recovered pending acquisition of the replacement building. Therefore the depreciation recovery income is suspended for taxation purposes. For the tax years ending on 31 March 2013 and 2014 this income stays suspended, provided the taxpayer continues to elect to defer the depreciation recovery income.

The replacement building is delivered on 15 June 2014. The 31 March 2015 tax return will include this new building at a cost of $6 million, and, immediately upon acquisition, it will have an adjusted tax value of $5 million. However, for straight line depreciation purposes, its cost will be $5 million.

Again notice will have to be filed with the 31 March 2015 tax return advising that the deferred depreciation recovered income has been allocated to the replacement building.

When the replacement asset is sold the difference between the adjusted tax value and building cost, in this case $1 million, will be fully taxable as depreciation recovery income (provided it is sold for at least $6 million). Therefore the tax liability associated with disposal of the destroyed building has been rolled forward until disposal of the replacement building.