2006 amendment to the tax treatment of regrassing and fertilising expenditure clarifies when it is fully deductible and when it is to be treated on capital account.

Sections DO 1, DO 4, OB 1 and Schedule 7 of the Income Tax Act 2004

Sections DO 3, OB 1 and Schedule 7 of the Income Tax Act 1994

The treatment of regrassing and fertilising expenditure has been realigned to clarify when it is fully deductible and when it is to be treated on capital account. The changes are designed to provide more certainty when accounting for such expenditure and to bring the tax treatment into line with modern short-rotation pasturemanagement practices.

Under the new rules, regrassing and fertilising expenditure is fully deductible in the year incurred unless is associated with a significant capital activity, such as a farm conversion. When incurred as part of a significant capital activity it is amortised at 45% per year, instead of 6% as previously.

Amortisation rates for farming and agricultural expenditure will in future be updated by Order in Council.

Background

Inland Revenue published guidelines (Operational Statement 007) in July 2004 on the treatment of expenditure in converting farms from one agricultural purpose to another. These guidelines set out Inland Revenue's position on the treatment of regrassing and fertiliser expenditure - that it should be treated on capital account and amortised over time.

Concerns were raised by accountants and farmers over the result of this position, given the realities of modern farming practices and, in particular, because any regrassing and fertilising expenditure not considered to be fully and immediately deductible were required to be amortised at a rate of 6% a year - a rate not updated since 1986. The updated rules were developed in consultation with accounting and farming representatives, and take into account the significant shift in farming practices towards short rotation grassing practices.

Key features

The main changes introduced are:

  • Capital account treatment: Regrassing and fertilising expenditure incurred in connection with a significant capital activity, such as a farm conversion, will be amortised at 45% of the diminished value of that expenditure each year. Schedule 7 to both the Income Tax Acts 1994 and 2004 has been amended to achieve this while retaining the 6% amortisation rate for expenditure incurred when preparing land for farming or agriculture.
  • Revenue account treatment: Regrassing and fertilising expenditure will be fully deductible in the year it is incurred unless it is required to be treated on capital account and amortised. Section DO 3 of the 1994 Act and section DO 1 of the 2004 Act have been amended to provide for this.
  • Specific limitations: Two limitations further clarify the boundary between capital and revenue account and exclude from capital account treatment expenditure that is associated with:
    • pasture that has an estimated useful life of one year or less because it would ordinarily be deductible under ordinary principles (see the amendments to section DO 3 of the 1994 Act and section DO 1 of the 2004 Act); and
    • Changes in the intensity of farming activities. This could include, for example, moving from 8 (low intensity) to 12 (high intensity) sheep or other stock units per hectare. The change is to provide consistency regardless of whether the change occurs in one year, more gradually over a number of years, or as a result of changes in the general technology of farming practices (see the amendments to section OB 1 that define "significant capital activity").

Application date

The amendments apply to expenditure incurred on or after 1 July 2004.