Depreciation loading grandparenting

2010 amendment to the Income Tax Act 2007 covers depreciation loading and amends the grandparenting provision.

Sections EE 31 and EE 37 of the Income Tax Act 2007

Depreciation loading was removed on a prospective basis as part of Budget 2010. The policy intention was that an item for which there was a commitment for its purchase or construction in place on or before 20 May 2010 would continue to be eligible for loading. However, while the legislation that gave effect to this grandparenting worked in most situations, its result could be unclear or inconsistent with the policy intention in other instances.

Accordingly, the grandparenting provision has been amended to clarify the rule and ensure it works as intended.

Key features

  • An item of depreciable property is eligible for loading if its owner either acquired it or was committed to its purchase or construction on or before 20 May 2010 (Budget day).
  • For the purpose of the rule, "commitment" can be demonstrated by an item's owner either having entered into a binding contract for it or alternatively, after deciding to purchase the item, the owner incurred some expense in relation to it.

Detailed analysis

New rule for depreciation loading grandparenting

Section EE 31 has been amended to clarify when depreciation loading should be grandparented. Under the amended rule, there are two circumstances in which an item of depreciable property continues to be eligible for depreciation loading after 20 May 2010.

The first circumstance is when the item was acquired on or before 20 May 2010. The second is when the item's owner had decided to purchase or construct the item and, on or before 20 May 2010, either entered into a binding contract for it or incurred expenditure in relation to it after making the decision to acquire it.

One example of the second circumstance is when a person began building an item themselves before 20 May 2010 but had not finished it as at 20 May. Another example is when a person who was in the process of acquiring an asset comprising multiple components, but had only entered into contracts to purchase some of those components as at 20 May. In both cases the finished asset is eligible for depreciation loading.

It is important to note that the amended grandparenting rule only confers potential eligibility for depreciation loading. The item must still meet the other relevant criteria, for example, it cannot be a building or an imported second-hand car and cannot have been used previously in New Zealand.

Meaning of "in relation to"

An item may be eligible for depreciation loading if expenditure is incurred "in relation to" that item, and certain other criteria are met. Expenditure should be "in relation to" an item if the expenditure is on:

  • the item itself (for example, if it is under construction);
  • services relating directly to the item, such as having a contract for purchase drawn up;
  • component pieces of the item (the item is a single depreciable asset that is made up of multiple components); or
  • another item, if that item has a reasonable connection with the item in question. An item has a reasonable connection with another item if it would not function effectively or work as intended without the other item. For example, a piece of machinery and a shed designed to house it would have a reasonable connection with each other.

It is not necessarily the case when a decision is made to acquire multiple items as part of the same decision-making process that all of those items will have a reasonable connection with each other. While this suggests that there may be such a connection, it is not sufficient.

The requirement for a decision to purchase or build the item in question must also be met. If no decision had been made, the asset itself is not eligible for loading.

Administrative requirements

The Act introduces new subsection EE 31(4), which must be met for the amended grandparenting rule to apply. This requires a person to have either documenting evidence that they had, on or before 20 May 2010, decided to purchase or construct an item, or they must send to the Commissioner of Inland Revenue a statutory declaration that states the same.

In some situations, a project may have been approved involving multiple items but there may not be evidence for specific items. For the administrative requirement to be satisfied for the item, it must be clear that the item was contemplated as part of the project approved on or before 20 May 2010.

Whether a set of documents provides sufficient evidence that a person had decided to purchase or construct an item on or before 20 May is a question of fact and circumstance. However, generally the documents would need to show that the business's standard purchasing process had been followed for the type of acquisition being made and approved in accordance with delegated authority levels. For example, if a purchase would usually only require a purchase order signed by the relevant manager, that would be sufficient evidence. If more detailed documentation was usually required, this would be needed to satisfy the administrative requirements.

If a person does not have the necessary documented evidence, the administrative requirements can be satisfied by providing to the Commissioner a statutory declaration that states the date when the person decided to acquire the item. This should cover smaller businesses that may not have formal purchasing processes that involve creating various documents.

These requirements are necessary but not sufficient conditions for an item to be eligible for depreciation loading. Regardless of whether they are met, the Commissioner can challenge whether a person had in fact decided on or before 20 May 2010 to purchase or construct at item.

Treatment of improvements

The Act makes a consequential amendment to section EE 37(3) to reflect the new grandparenting rule. This section provides that, if a person makes an improvement to an asset to which loading still applies, that improvement (being treated as a separate item) is eligible for loading if it meets the criteria of the amended grandparenting rule. If it does not meet the requirements, the improvement will not qualify for loading.

Example 1

In 2007 Electric Co embarked on a large-scale project to build a new hydro-electric dam which was due to be completed in January 2011. The project involves the construction and purchasing of many different components that, once complete, will form a single item of depreciable property (the dam). As at 20 May 2010, $60 million in costs had been incurred out of a total budget of $75 million but contracts had not yet been entered into for all of the remaining work.

In this case, the dam is eligible for depreciation loading. While as at 20 May 2010 Electric Co had not entered into contracts for all of the remaining work, it is clear that there was a firm decision to build the dam and that Electric Co had incurred expenditure in relation to it.

Example 2

Widget Co uses highly specialised production lines to produce its widgets. They build the construction lines themselves as they cannot be sourced externally. On 15 February 2010, Widget Co's board decided that a new production line should be made. Work started on the new line on 25 February and was expected to finish mid-July. As the line was being built internally no contracts were entered into for its construction.

As at 20 May 2010 the line was not complete and Widget Co's staff continued to work on it and purchase additional supplies as required.

The production line is eligible for depreciation loading in this situation. It is clear that Widget Co had decided on or before 20 May that it would build that production line and that expenditure had been incurred on producing the line. The board minutes should satisfy the administrative requirements and the invoices for the various components would be evidence that expenditure had been incurred on or before 20 May 2010.

Example 3

In 2008 Company A embarked on a project to completely redesign and build its computer systems. The project was split into four work streams; the first three were non-discretionary while the fourth depended on the outcome of the other three. Accordingly, Company A's board decided in 2008 that the first three streams would continue and that a decision would be made regarding the fourth in mid-2010.

Work began immediately on the first three streams. On 1 July 2010, Company A's board met and confirmed that the fourth work stream would proceed.

In this situation depreciation loading would apply to the first three work streams but not to the fourth. This is because Company A did not decide that the fourth stream would proceed until after 20 May 2010.

On the other hand, if the board had decided to proceed with the fourth stream on or before 20 May 2010 but work did not begin until after 20 May, it may be eligible for loading. This would depend on how closely related the streams are. For example, if they all relate to the same software package it is likely the expenditure on the first three streams would be "in relation to" the fourth stream and it would be eligible for loading. However, if they were for completely different software packages then it is unlikely that the expenditure on one stream would be "in relation to" another.

Example 4

When Company A's board originally decided to upgrade its computer systems, it was informed that the new software would not run on the company's current servers. The board therefore decided to upgrade its servers and allocated funds in the project's budget for this to occur, but due to the long timeframes for the software's development, contracts for the servers were not entered into until after 20 May 2010.

The servers would be eligible for depreciation loading in this situation because the expenditure on the software is in relation to the hardware. The software would not operate effectively without the server upgrade and the decision to upgrade was made on or before 20 May 2010.

Application date

The amendments apply from 20 May 2010.