Horticultural plants - replacement plants and economic amortisation rates

Sections CG 11(7), DO 4, DO 4B, DO 4C, DO 4D, DO8(c), FD 10(3)(b), OB 1 and Schedule 7, Part A, item 12 of the Income Tax Act 1994

Sections DO 4, DO 4B, DO 4C, DO 4D, DO 4E, DO5, DV 13, OB 1 and Schedule 7, Part A, item 8 of the Income Tax Act 2004

Sections 44C and 91AAB of the Tax Administration Act 1994

Introduction

Under amendments to the Income Tax Acts 1994 and 2004 and the Tax Administration Act 1994, the Commissioner of Inland Revenue will be able make determinations to list various types of plants and provide specific amortisation rates that reflect the estimated useful life of each type listed.

When the Commissioner sets a particular rate for a type of plant, that rate will apply instead of a default rate for plants that are not of a type listed. The amortisation rate set by the Commissioner for a plant will be based on the estimated useful life of the plant.

The plants listed by the Commissioner also qualify under rules that allow immediate deductions for a limited proportion of replacement planting. The rules for replacement plants are designed to give certainty in law but flexibility for managing plantations.

The amendments apply from the 2003-04 income year but, in practice, come into effect in accordance with the Commissioner's determinations.

Background

An immediate deduction for plants was previously allowed by the Commissioner only for the replacement of a small number of dead or destroyed plants of the same species and variety. As such, the scope of what was considered a repair to or maintenance of a plant extended to include a limited amount of replacement planting in addition to other repair and maintenance activities such as pruning - though a significant limitation was that, to be deductible, replacements had to be made on a like-for-like plant basis.

If a plant is replaced to repair or maintain its productive contribution to a business, the most commercially appropriate plant should be used. Ideally, the replacement plant should not be limited to the same type of plant as that replaced but should be of a type that represents the best choice for the business - this might be an improved or different type of plant. Other considerations include the number of plants that would be economic to replace at a time. In some cases it is desirable to replace whole rows of plants or an area of plants for reasons including the control of disease, to provide consistent growing conditions or simply to make use of the same type of plants being planted elsewhere on the same orchard or in the same horticultural business.

These concerns were raised by the New Zealand Fruitgrowers Federation, who sought a more certain legal position to provide more flexibility to manage replanting activities, particularly so that using the most commercially desirable varieties would not produce different tax effects when that meant a different plant would be used.

Key features

Who do the rules apply to

In most cases the rules will apply to commercial horticultural growers like orchardists, though the rules are cast in broader terms to apply to a person who carries on a horticultural business on land developed for that purpose.

What do the rules relate to

The rules relate to expenditure on the development of land by planting horticultural plants - typically this will be an orchard.

Expenditure incurred from planting the kinds of plants listed by the Commissioner must be amortised at the rates determined by the Commissioner, based on the estimated useful life of those plants. An exception is provided so that some expenditure incurred in planting may be deducted in the year it is incurred if the plants are replacement plants. In either case this is the treatment for "listed horticultural plants".

Expenditure incurred from planting plants that are not listed by the Commissioner is deducted under a rule provided for "non-listed horticultural plants". It retains the same treatment that was previously provided for vines and trees and operates as a kind of default rule for horticultural plants not listed by the Commissioner.

Amortising planting expenditure

Under section DO 4C of the Income Tax Act 1994 and section DO 4B of the Income Tax Act 2004, expenditure on planting listed horticultural plants must be amortised at the rates determined by the Commissioner under section 91AAB of the Tax Administration Act 1994, unless it is deducted in relation to planting replacement plants under section DO 4D of the 1994 Act or section DO 4C of the 2004 Act.

Non-listed horticultural plant expenditure must be amortised at the 12 percent rate provided under section DO 4 and item 12 in Part A of Schedule 7 of the 1994 Act or section DO 4 and item 8 in Part A of Schedule 7 of the 2004 Act.

Deducting replacement planting expenditure

Section DO 4D of the 1994 Act and section DO 4C of the 2004 Act allow a limited amount of replacement planting expenditure to be fully deducted in the year it is incurred. These deductions are limited to a maximum of 15% of an orchard being replaced over a three-year period. Allowing some replacement planting expenditure to be deducted is comparable to the treatment of repair and maintenance expenditure such as for pruning plants. Within a three-year period, replacements in any one year may be deducted in that year in relation to up to 7.5% of an orchard. Thus if 7.5% of an orchard is replaced and immediately deducted in each of the first two years of a three-year period, no replacement planting can be deducted in the third year of that period.

These rules are based on allowing up to 5% of an orchard on average to be replaced and deducted in a year. Any other replacements must be capitalised and amortised using the rates set by the Commissioner.

For example, 4% of an orchard could be replaced and deducted under this rule for the current year when in the preceding year 7.5% and the year prior to that 3.5% of the orchard was replaced and deducted. Replacement planting of more than 4% of the orchard in the current year would have to be amortised.

The proportion of the orchard replaced is measured by reference to the land affected by replacement planting activities. Changing the density at which plants are planted should not affect the extent to which a deduction is allowed for replacement plantings.

Writing off planting expenditure

A plant that is not replaced with a plant for which an immediate deduction is taken can be written off by deducting its book value when it ceases to exist or to be used as part of a business to derive income (section DO 4C(5) and section DO 4B(6)).

However, if a plant is replaced with a replacement plant for which an immediate deduction is taken, the plant cannot be written off because it is, in effect, treated as repairing and maintaining an existing plant. For tax purposes, the new plant is treated as a continuation of the old plant. Thus the book value of the old plant can be allocated to the new plants or any other plants, such as those in the same block. The rules leave it open for growers to choose the method of allocating these book values in a way that best suits their business (section DO4C(6) and section DO 4B(7)).

Definitions

Key definitions in both the 1994 and 2004 Income Tax Acts are "diminished value", "estimated useful life", "listed horticultural plant", "non-listed horticultural plant", "planting", "plot", "replacement area fraction" and "replacement plant".

Application date

The amendments to the Income Tax Act 1994 came in to force on 21 December 2004, the date of Royal assent, and apply from the 2003-04 income years. The amendments relating to listed horticultural plants will not have effect until an administrative determination is made by the Commissioner under new section 91AAB in the amendments to the Tax Administration Act 1994. Amendments to the Income Tax Act 2004 come into force from 1 April 2005. A related consequential amendment is made to section 44C of the Tax Administration Act 1994, also with force from 1 April 2005.