Are embankments and runway end safety areas depreciable property? No says the Court of Appeal
2017 case note – Court of Appeal finds embankments and runway end safety areas not depreciable property - airport, hardstanding, decline in value, geogrid.
Due to updated Civil Aviation Rules, Queenstown Airport Corporation Limited ("QA") was required to provide a minimum 90-metre Runway End Safety Area (“RESA”) at each end of its runway. Due to the steep drop-off into the Shotover River on the east end of the runway, QA constructed a 45-metre high embankment upon which to place the RESA and sought to deduct the construction costs on the basis the RESA was a depreciable land improvement.
The High Court rejected this argument and QA appealed. The Court of Appeal agreed with the High Court, and found that the allowed depreciable land improvements contained within Schedule 13 was an exhaustive list. There was no indication that a generous interpretation could be taken to allow items such as RESAs to be included. The Court also agreed that the RESA was not the same as an airport runway, was not an improvement to a runway, and was not hardstanding so could not fall within those categories of depreciable land improvement. Nor was the RESA expected to decline in value. For these reasons the Court dismissed the appeal.
In general, the judgment provides a useful guidance as to how Courts will interpret ss EE 1, EE 6, EE 7 and Schedule 13 of the Income Tax Act 2007 ("ITA"). It also supports the approach to statutory interpretation adopted in Commerce Commission v Fonterra Co-operative Group Ltd  NZSC 36,  3 NZLR 767 ("Fonterra").
More specifically, the judgment illustrates the factors that will be taken into account when determining whether or not a RESA will come within any of the items of depreciable land improvements contained in Schedule 13 of the ITA.
QA is the owner and operator of the Queenstown Airport. The dispute concerns depreciation deductions for income tax purposes.
The appellant expended some $8.7 million in constructing QA's eastern RESA which was required under the Civil Aviation Rules. Due to the steep 45-metre drop-off into the Shotover River on the east end of the runway, QA formed a very substantial supporting embankment for the RESA. In the 2012 and 2013 income tax years, the appellant sought to deduct amounts for depreciation on the basis that the east RESA was an “airport runway” under the ITA, or alternatively, that the depreciation deductions were permitted as "hardstanding" or as a "road". The Commissioner of Inland Revenue ("the Commissioner") disallowed the deductions.
High Court decision
The dispute was first heard by the High Court, who held that the deductions were not permitted as the east RESA did not fit within any of the descriptions relied upon by the appellant (Queenstown Airport Corporation Ltd v Commissioner of Inland Revenue  NZHC 1299, (2016) 27 NZTC 22-054).
The appellant appealed this decision.
The Appellant's arguments
The appellant submitted that the High Court erred in concluding that the east RESA was not an airport runway or hardstanding under ss EE 6, EE 7 and Schedule 13 of the ITA. The appellant did not appeal the High Court finding that the east RESA was a "road" under the ITA.
The Court of Appeal (the Court") dismissed the appeal. They did not agree with the appellant's argument that the High Court lost sight of the proper approach to the statutory interpretation question. The Court commented that the High Court followed the approach of Fonterra at  in considering the meaning of the enactment from the text in light of its purpose, having regard to the immediate and the general legislative context and the social, commercial or other objective of the enactment and crosschecking the meaning against the purpose.
The interpretation issue - analysis
The Court stated that the policy underlying the current depreciation rules in the ITA is to allow the deduction of the cost of depreciation in respect of assets used or available for use in deriving assessable income when the value of those assets is reasonably expected to decline in value over their estimated useful life. The rationale for allowing a deduction for depreciation is that capital assets used in the production of income will eventually wear out and need to be replaced in whole or in part. Land (apart from certain specified land improvements) is not depreciable because it does not have a determinate design life after which replacement in whole or in part is expected to be necessary; nor is it expected to decline in value over time through ordinary wear and tear.
The Court concluded that the text of the ITA makes it clear that the items listed as improvements in schedule 13 are exceptions to the general rule that land is not depreciable. In the Court’s view, there is nothing to suggest Parliament intended that the generous approach advocated by the appellant should be adopted in interpreting the specified items. The structure of the relevant provisions does not support this. Rather, Parliament has chosen to specify the items it has concluded are to be treated as exceptions to the general prohibition on the depreciation of land.
The Court stated that the eastern RESA does not form part of the runway either in its natural meaning or as "airport runway" is defined under the Civil Aviation Rules. The eastern RESA was not intended or available for use by aircraft taking off or landing other than for use for safety reasons in an emergency.
Unlike the airport runway, which has a five- to 10-year design life after which its surface will require complete replacement; the eastern RESA’s overall design life is at least 120 years, after which only one of its components (the Geogrids) is likely to require major work.
"RESA as an improvement to the airport runway"
The Court noted the appellant’s submission, made in his reply that a deduction for depreciation should be allowed, under s EE 37 of the ITA, as the eastern RESA was an improvement to an item of depreciable property. The Court noted that "improvement" is defined in s EE 67 of the ITA as an "alteration, extension or repair of an item of depreciable property that increases its capital value."
The appellant submitted that the eastern RESA was an extension of the airport runway, an acknowledged depreciable asset.
The Court was unable to accept the argument as they did not find the eastern RESA and supporting embankment could be regarded as an extension of the airport runway. As the Court found the eastern RESA was not "airport runway", it also found, for the same reasons, that it cannot be regarded as an extension of the airport runway.
The Court agreed with the High Court that the eastern RESA is not "hardstanding" for the purposes of the depreciation provisions. The Court noted that the eastern RESA is designed and constructed to allow aircraft to sink into its surface to decelerate the aircraft in an emergency situation and that this is the opposite of an area that is "hard". It also noted that the eastern RESA might be designed to bear the weight of an aircraft for a short period in an emergency, but this does not fall naturally within the meaning of "standing" which refers to an area where a vehicle or aircraft might stand when not in use. There is nothing in the characteristics or purpose of a RESA to suggest otherwise.
Decline in value
The High Court also found that the eastern RESA was not property that in, normal circumstances might reasonably be expected to decline in value while used or available for use in terms of s EE 6(1) of the ITA. Noting that, given the Court of Appeal's conclusions above, it was not strictly necessary for it to deal with the second element the appellant was required to satisfy before being entitled to deduct depreciation loss, the Court of Appeal gave its view on this issue.
In interpreting s EE 6(1) of the ITA, the Court first stated that "normal circumstances" refers to circumstances that might ordinarily be expected to affect the value of the relevant asset over time (contrasted with "abnormal circumstances" such as an earthquake). Second, the assessment is ordinarily made at the time when the relevant deduction is sought. This necessarily involves a prediction of future events. Third, the test is objective - it would not be sufficient for a taxpayer to believe that the asset might deteriorate in time. There must be a reasonable basis for that expectation. Fourth, the expression "might reasonably be expected to decline in value"sets a relatively low threshold. So long as there is a reasonable prospect that the asset might decline in value in the future, that is sufficient. Fifth, it is not necessary that the asset is actually used, only that it is available for use. Finally, the test does not require that the asset in question would require complete replacement at the end of its useful life (See, by analogy, the discussion of the distinction between repairs or maintenance and improvements of a capital nature in Poverty Bay Electric Power Board v Commissioner of Inland Revenue  2 NZLR 438 (CA) at 445). Nevertheless, the extent, nature and cost of any work required to reinstate the relevant asset may have a material bearing on the assessment of whether a decline in value might reasonably be expected.
The Court of Appeal noted that contrary to the view of the High Court, the expert evidence that Geogrids reached the end of their design life after about 120 years and that major work would then be required must be accepted, although it should be considered in context. The Court noted that the Geogrids, while an important component of the overall eastern RESA, comprised only a minor part of the overall structure, which is massive in scale.
The Court concluded that there was no evidence to suggest that any work would be required to repair or reinstate the great majority of the compacted soils and gravels comprising the eastern RESA (only the Geogrids would require replacement). The Court noted that no evidence was placed before the High Court as to the extent and nature of any work required at the end of the Geogrid design life, the cost of that work or the anticipated effect on the value of the asset overall. The Court of Appeal stated that it was reasonable to infer on the evidence that the cost and any consequent effect on the long term value of the asset would likely amount only to a small fraction of the cost of the structure overall. Any amount properly deductible as depreciation would accordingly be reduced to a very low level.
Dr Emery's brief of evidence
The Court of Appeal noted that the High Court did not make a ruling on the challenged admissibility of Dr Emery's brief, but it made no reference to this evidence in the judgment. Given that the Court of Appeal could not determine what weight, if any, the High Court placed on Dr Emery’s evidence, and given that the Commissioner’s counsel accepted that the Commissioner was not prejudiced by the High Court’s failure to rule on the admissibility (because she was able to put the relevant, but challenged parts of Dr Emery’s briefs to the appellant’s witnesses), the Court of Appeal did not place any weight on the brief for the purposed of its judgment and no ruling as to the admissibility of that evidence was required.
Income Tax Act 2007 ss DA 1, EE 1, EE 6, EE 7, EE 37, EE 67 and Schedule 13