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Kaikoura earthquakes relief provisions for depreciation recovery income

The Government has introduced relief provisions for "depreciation recovery income" from insurance and compensation payments resulting from the earthquakes in the Hurunui, Kaikoura and Wellington areas (the Kaikoura earthquake).

This covers any earthquake that occurs in, or significantly affects, the earthquake-affected areas on or after 14 November 2016.

In most circumstances, when you dispose of a depreciable asset, if the disposal amount on that asset is more than the adjusted tax value (book value) of the asset the excess (depreciation recovered) is generally treated as income for tax purposes.

The earthquake relief provisions mean you can delay including the excess as income in your tax returns, when insurance or compensation payments are more than the book value of the affected asset(s).

Affected assets must be in an earthquake-affected area

Earthquake-affected areas are:

  • the districts or regions of the Hurunui Kaikoura area:
    • Canterbury Regional Council
    • Hurunui District Council
    • Kaikoura District Council
    • Marlborough District Council
  • the districts or regions of the Wellington area:
    • Wellington City Council
    • Hutt City Council
    • Wellington Regional Council
  • parts of the coastal marine area (within the meaning of section 2(1) of the Resource Management Act 1991) that are part of, or next to, the above districts and regions, and
  • the areas of other districts or regions that contain transport or other infrastructure.

When the relief provisions apply

You can elect to be covered by the relief provisions if you meet the following conditions before the beginning of your 2019-20 income year:

  1. You receive insurance or compensation for affected assets damaged in the earthquake-affected areas that are one of the following classes:
  • plant and equipment
  • commercial fit-out
  • pool-method property/assets
  • a building or grandparented structure you can't use any longer to earn an income from, and is demolished or abandoned for later demolition
  • assets that have been assessed by the insurer as uneconomic to repair.
  1. You would have an amount of depreciation recovered due to insurance or compensation received for affected assets.
  2. You plan to buy replacement property that is:
  • physical depreciable property
  • bought in or before the end of your 2019-2020 income year, and:
    • included in the same class of property if the old property was a building or a grandparented structure,or
    • fit-out (not depreciated under the pool method), and
    • located in an earthquake-affected area (unless the replacement item is plant and equipment).

Applying for the relief provisions

You need to provide written notice of election to use the relief provision to the Commissioner by the later of :

  • 31 January 2018, or
  • the date that the return of income is filed for the income year in which the amount of depreciation recovery income can be reasonably estimated.

What happens if you meet the conditions for relief provisions

If you meet the above conditions, payments, you get that would result in depreciation recovery income, become suspended recovery income. The suspended income is allocated to reduce the cost prices for depreciation purposes when the replacement item is acquired.

Any unallocated suspended recovery income must be attributed to the earlier of:

  • the end of the 2020-21 income year, where suspended recovery income remains unallocated,or
  • the income year that you decide not to acquire replacement property. The amount you don't spend is depreciation recovery income in that year, or
  • the income year you go into liquidation or bankruptcy.

Where insurance or compensation payments cover more than one item of property:

  • calculate the suspended recovery income for each item and
  • match it to the replacement asset plan.

Assets included in a pool can be grouped under a class of assets for the purposes of buying a replacement item. Specific rules give some flexibility in case the asset can't be bought.

Example 1

Plant and equipment (not previously depreciated under the pool method) destroyed by the Kaikoura earthquake had a cost of $1 million. On the day of the earthquake the plant and equipment had a book value of $700,000. The owner gets a $1 million insurance payment. The net depreciation recovered is, $300,000.

The replacement assets were bought over two years at a cost of $400,000 a year. In year three the owner decides to buy no more replacement assets, even though they originally expected to spend well over $1 million on the replacement assets.

The $300,000 suspended recovery income is allocated in the following way:

Year 1 ($400,000 x $300,000) divided by $1,000,000 = $120,000
Year 2 ($400,000 x $300,000) divided by $1,000,000 = $120,000
The $60,000 balance is taxed in the year that the taxpayer decides to make no further investment in replacement property.

Damaged depreciable property that is uneconomic to repair

When damage to assets happens from multiple earthquakes and aftershocks, you can use the date of the final damage as the date the asset is written off, and then put to another use.

So that post-earthquake repairs are correctly capitalised (and not treated as a revenue expense), the asset is treated as being reacquired on the same date as the write-off for nil consideration.

Under the provision applying to the Kaikoura events, for an asset to be written off and put to another use:

  • The depreciable asset must be damaged by a Kaikoura earthquake
  • The owner of the asset must be entitled to an amount of insurance or compensation for the damage to the item
  • The asset has been assessed by the insurer as uneconomic to repair
  • The damage has not caused the asset to be damaged beyond repair or unable to be used to earn income

Working out your depreciation recovery income

Once you can estimate or know how much the insurance and compensation payments are, you can work out the amount of depreciation recovery income.

If you want to suspend an amount of income you must let the Commissioner know in writing for each year covering the period of the depreciation recovery income.  Your notice should include:

  • a description of the affected property
  • which class the affected property is in
  • separating pool assets from non-pool assets
  • a description of the replacement property you bought in the current year and the class of the affected property the replacement is in
  • the cost of the replacement item minus the depreciation recovery income you got for that item, and
  • how much of the recovery income you've still got at the end of the income year in each class.

You must elect each year to suspend returning the income. Even if you don't acquire any replacement assets in an income year, you must still notify us that you are electing to suspend the income.

We don't need a notice for the income year after you've completed your return for the 2019–20 income year as there is no deferral for the 2020-21 income year.

Example 2

In November 2016, a firm's building is destroyed in the Kaikoura earthquakes. The firm has a 31 March balance date.
The building originally cost $3 million. The book value is $2 million. Accumulated depreciation is $1 million. The replacement insurance payment is $6 million.
On 15 June 2019 the new building is complete. Without rollover relief the building owner will have depreciation recovered taxable income of $1 million. The insurance proceeds over the $3 million cost price are still a tax free capital gain.

The law now lets the owner roll the depreciation recovered into the replacement building, as long as the replacement building is in the same earthquake-affected areas. The insurance proceeds are known on 30 June 2017. The depreciation recovery income would be allocated to the tax year ending 31 March 2018.

In the return for the tax year ending on 31 March 2018, the taxpayer elects to suspend returning the depreciation recovered until they've bought a replacement building. For the tax years ending on 31 March 2018 and 2019 this income stays suspended, as long as the taxpayer continues to elect to do so.

The replacement building is completed on 15 June 2019. The 31 March 2020 tax return will include this new building at a cost of $6 million, and, as soon as the owner takes possession, it will have a book value of $5 million ($6 million less the $1 million recovery income). If it applies, the straight line depreciation cost will be $5 million.

Again, notice will have to be filed with the 31 March 2020 tax return advising that the deferred depreciation recovered income has been allocated to the replacement building.

When the replacement asset is sold the difference between the book value and building cost, in this case $1 million, will be fully taxable as depreciation recovery income (assuming it's sold for at least $6 million). So the tax liability associated with disposal of the destroyed building has been rolled forward until disposal of the replacement building