Claiming business expenses: Environmental expenditure
Deduction rates for environmental expenditure
Default expenditure categories and deduction rates
Section DB 37 along with Schedule 6B set out categories of deductible environmental expenditure and the rate at which a deduction is available to business taxpayers. The schedule of deductible environmental expenditure is based around the following four categories of costs:
| General description of expenditure | Rate |
|---|---|
| Testing and feasibility expenditure | 100% |
| Construction/improvement expenditure | Default rate based on the lesser of 35 years (1/35) or the length of the applicable resource consent granted 1/life of resource consent). |
| Restoration expenditure | 100% |
| Monitoring expenditure | 100% |
Category-specific deduction rates
Where the default deduction rates do not result in the correct calculation and taxation of income from business activities, a business can apply to Inland Revenue for a category-specific rate.
Detailed analysis
Default expenditure categories and amortisation rates
Section DB 37 along with Schedule 6B set out categories of deductible environmental expenditure and the rate at which a deduction is available to business taxpayers.
Taxpayers are now able to claim a tax deduction for environmental expenditure under section DB 37 if:
- they carry on business in New Zealand;
- they incur, as part of that business, or in ending the operations of the business, expenditure listed in Schedule 6B;
- the expenditure is not listed in Part C of Schedule 6B (land reclamation expenditure, nonenvironmental dredging expenditure or expenditure related to the acquisition of land);
- the expenditure is not incurred in relation to revenue account property (other than land that is subject to a section CB 6B election); and
- no other provision allows a tax deduction for the expenditure.
Farming businesses are included in these provisions so that when the specific agricultural provisions do not provide for an environmental tax deduction, farmers can now rely on section DB 37.
| Example 1: No deduction available under other provisions |
|---|
| Parkways Limited builds and operates inner-city parking buildings. It has purchased a site in the central city for a new parking building and obtained the necessary resource consents. However, before construction can begin, Parkways Limited needs to deal with a contamination issue left by the previous owner. It will be necessary to remove contaminated soil, fill the area with clean soil and then construct an impermeable surface cap to prevent further contamination. Parkways Limited will then construct the normal car park surface on top of the cap. The process of removing the contaminated soil and the installation of an impermeable surface cap should constitute expenditure on remedying, or mitigating detrimental effects on the environment. An immediate tax deduction should therefore be available under section DB 37. However, if a tax deduction were available under another provision, for example it if were not possible to separate the restoration activities from the construction of the car park, then a tax deduction would have to be claimed as tax depreciation rather than under section DB 37. |
To avoid the uncertainty surrounding the definition of industrial waste, section OB 1 now contains a definition of "contaminant". The definition is linked to section 2(1) of the Resource Management Act 1991 and an item can still be a contaminant even if it is never discharged into the environment.
Businesses planning to take advantage of these changes to secure tax deductions for the investigation, remediation and aftercare of contaminated land should refer to the best practices for management of contaminated land set out in the Ministry for the Environment's Contaminated Land Guidelines series and, in particular, the minimum reporting standards in Guideline Number 1 of that series.
| Example 2: Types of environmental expenditure |
|---|
| Green Limited is a plastics manufacturer. A number of by-products are produced as a result of its manufacturing processes. Green Limited is therefore looking at potential options for dealing with the byproducts. These include changing its manufacturing process, immediate treatment of the by-products, and storing the substances for a period and processing at a later date. Green Limited pays for a report from an environmental consultant evaluating the different options. Alteration of the manufacturing process proves to be impractical and, due to its location and economies of scale, immediate treatment of the substances is not cost efficient. Green Limited therefore makes an application for a resource consent to store the by-products. The expenditure incurred on the environmental report is expenditure on investigating and testing an activity intended to avoid, remedy or mitigate detrimental effects on the environment. Expenditure incurred prior to the date a decision is made to use one particular option, (likely to be the date that a resource consent application is made) is environmental feasibility expenditure and immediately deductible under section DB 37. Expenditure incurred from this date would constitute construction expenditure. If no other tax deduction is available (for example for tax depreciation) this expenditure would be deductible over the lesser of 35 years or the period for which the resource consent is granted. If Green Limited felt that this did not accurately reflect the life of the expenditure then they could apply to Inland Revenue for a category specific deduction rate. |
| Example 3: Types of environmental expenditure |
|---|
| Pinot NZ Limited runs a winery. A portion of a neighbouring property has been contaminated as a result of past business activities. Pinot NZ Limited is worried about the impact this may have on its own property, business reputation and income. The owner of the site and person responsible for the contamination cannot be identified. Pinot NZ Limited therefore works with the local council to rectify the contamination (removing and replacing the soil and replanting the area in native bush). While Pinot NZ Limited is not responsible for the contamination and does not own the neighbouring site, this expenditure should qualify under section DB 37 for an immediate tax deduction. It is expenditure incurred by a business in remedying the detrimental effects on the environment from a discharged contaminant and expenditure on replanting land in New Zealand in association with expenditure to avoid, remedy, or mitigate detrimental effects on the environment. |
Amount and timing of deduction
Section DB 37 sets out the amount of the tax deduction and when this can be claimed. The amount of the deduction for an income year is calculated by multiplying the value of the expenditure by the applicable rate.
The default rates are 100% for testing and feasibility, restoration and monitoring expenditure (listed in Schedule 6B, Part A, item 1 and Part B) and based on the lesser of 35 years or the length of the applicable resource consent for construction and improvement expenditure.
The formula for calculating the rate for construction and improvement expenditure is set out in section DB 37(7). Businesses can opt for either a straight-line or diminishing value deduction by adjusting the rate accordingly. The rate is 100% divided by the assumed life of the environmental expenditure and rounded to the nearest rate listed in Schedule 11. For expenditure that does not require a resource consent the assumed life is 35 years. For expenditure that requires a resource consent, the assumed life is the lesser of 35 years and the number of years remaining in the resource consent period at the time the expenditure is incurred.
Businesses can also obtain a rate for specific categories of environmental expenditure by applying for a determination from the Commissioner (section DB 37(4)(c)).
| Example 4: Calculating the correct deduction rate |
|---|
| Olivia Limited is a large multinational corporation. It applies for a resource consent regarding emissions from a new factory. While the factory will undertake all necessary steps to reduce emissions there will still be a small discharge made. To counter this, and as part of its resource consent process, Olivia Limited agrees to spend $50,000 planting and maintaining an area of native bush. A resource consent is granted for 25 years. As the planting expenditure is incurred by Olivia Limited for the purposes of obtaining a resource consent for its new factory it is viewed as business expenditure. The planting expenditure is an activity that is intended to avoid or mitigate the discharge of a contaminant. As such, a tax deduction should be available under section DB 37. The annual deduction for the expenditure is calculated by multiplying the cost ($50,000) by the deduction rate. The deduction rate is calculated by dividing 100% by the assumed life. As the planting expenditure is associated with a business activity that requires a resource consent, the assumed life is 25 years (being the lesser of 35 years and the resource consent period). The closest straightline rate in Schedule 11 is 4%. Alternatively, a diminishing value rate of 6% can be used. |
Section DB 37 also provides for the destruction of an environmental improvement or closure of a business. In these situations, a business can claim the remaining unamortised balance of the expenditure.
The definition of diminished value has been amended to take into account the new environmental expenditure rules. For environmental improvements, diminished value is calculated by taking the amount of environmental expenditure as described in section DB 37, adding any claw-back income under section CB 24B(8) and deducting any environmental tax deductions previously claimed.
| Example 5: Closure of a business |
|---|
| After 10 years, Olivia Limited closes its operations in New Zealand. Up until the year of closure, Olivia Limited has claimed $20,000 of tax deductions under section DB 37 for its native planting expenditure. On the closure of its New Zealand factories, the operations for which the expenditure was incurred have come to an end. Olivia Limited is therefore able to claim the remaining $30,000 of expenditure in the year of closure. |
Claw-back
While the default deduction rate for environmental construction and improvement expenditure is based on the life of the applicable resource consent, there is a clawback mechanism in section CB 24B. This is intended to prevent businesses from manipulating the period of their resource consent for the purpose of obtaining a faster tax deduction.
Where a business has claimed a tax deduction based on the period of a resource consent and then substantially altered the period of that consent (consent period is extended or renewed by more than 50%) the taxpayer will be required to calculate tax deductions based on the default rate of 35 years. Any difference between the deductions claimed to date will be clawed back as taxable income in the year that the consent is altered.
| Example 6: Claw-back |
|---|
| Forest Fields Limited runs a timber treatment plant. It spent $200,000 constructing a settling pond for dealing with the by-products of the treatment process. It has a five-year resource consent for operating the pond. As such it has claimed tax deductions of $180,000 under section DB 37 based on an assumed life of five years. At the end of five years, Forest Fields Limited applies for a 30-year extension to its resource consent. If Forest Fields Limited had claimed tax deductions based on an assumed life of 35 years, the tax deductions claimed to date would have only been $30,000. Forest Fields Limited is therefore deemed to derive income of $150,000 in the income year in which the consent is extended (because the consent period was extended by more than 50%). |
Other changes
A tax deduction for restoration expenditure will not always equate to the loss in land value from contamination but in the majority of circumstances it provides a practical solution. However, landfill operators are likely to suffer a complete loss in land value no matter how much is spent on site restoration. The new environmental tax rules therefore allow taxpayers who acquire and use land for the purpose of constructing and operating a landfill to file a revenue account property election under section CB 6B. This ensures a tax deduction is available for the cost of land used for a landfill.
The section CB 6B election must be made before 24 June 2006 or 12 months after the date of acquisition (whichever is the latest). To ensure a consistent treatment, all of a business's landfill sites and those of any associated parties also need to be subject to the same election. Any consideration received on the disposal of the landfill property will also be taxable income of the business under section CB 6B.
Sections DB 16 (amounts paid for non-compliance and change in use) and DP 10 (cost of timber) have been amended to ensure that section DB 37 remains the section of last resort for deducting environmental expenditure.
Category-specific deduction rates
Where the default deduction rates will not result in the correct calculation and taxation of income, a business is able to apply to Inland Revenue under section 91AAN of the Tax Administration Act 1994 for a category-specific deduction rate.
The Commissioner may determine that a person, group or class of persons is to use a particular diminishing value or straight-line rate listed in Schedule 11 for certain types of environmental expenditure.
In making the determination, the Commissioner may consider a number of factors including:
- the length of time that the expenditure is expected to be effective for its intended purpose;
- the length of time that the expenditure is expected to earn income;
- the accounting treatment (including depreciation method);
- the period of any associated resource consent; and
- a valuer's estimate.
The Commissioner may decline to issue a determination if the information supplied in support of the determination request is insufficient or if the proposed rate does not differ sufficiently from the existing rate.
Within 30 days of issuing a determination the Commissioner must give notice of the determination to the applicants and publish a notice in the New Zealand Gazette stating where copies of the determination can be obtained. A business affected by a determination may dispute or challenge the determination under Parts 4A and 8A.
Date published: 09 Dec 2005
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