The onset of the Covid-19 pandemic had an immediate impact on businesses nationwide. Lockdowns and the border closure have caused massive disruption. For many this was temporary, for some, permanent.
Inland Revenue has released a draft Interpretation Statement “Income tax and GST – deductions for businesses disrupted by Covid-19 pandemic”. The statement sets out Inland Revenue’s ‘draft’ view on to what extent businesses can claim tax deductions for expenditure incurred whilst impacted by Covid-19. The deadline for comment is 28 May 2021.
Within the draft document, Inland Revenue first covers the technical principles governing whether an expense is deductible or not and then covers a number of examples to demonstrate how the principles apply in practice. It appears Inland Revenue is taking a hard line.
Broadly, an expense is deductible if it is incurred to derive assessable income or in the course of carrying on a business. The leading case on whether a business exists was decided by the Court of Appeal in Grieve v CIR (1984). Inland Revenue revisits the principles of that case and outlines: whether a business exists or not is based on a two-fold assessment as to the nature of the activities carried on and the intention of the taxpayer in engaging in those activities. The end result being that if a business does not exist, then expenditure that is incurred post-cessation is non-deductible.
Whether a business has ceased is determined by the facts in each scenario and the nature of activities that continue to be carried on. The example is provided of a small international tourism business that has had to stop making sales while the borders are closed. To minimise costs it holds $100,000 of stock at its warehouse, which the owner visits weekly to maintain, he checks emails daily for new orders and continues to pay a security guard service to monitor and patrol the building. Inland Revenue take the view that “it is no longer possible to make a profit in the current climate” and that the pattern of activity, commitment of time and effort etc. do not suggest an existence of a business. A different interpretation could suggest that a business continues to operate as resources, time, money and effort, remain committed with the view to profit in the future.
There appears to be a lack of acknowledgement by Inland Revenue that the current global situation created by Covid-19 is more likely to be temporary than permanent and therefore if a business has not literally closed its doors, the owners will be doing everything possible to reopen once life returns to normal. As stated in Grieve:
The legislation sensibly allows for deductions and allowances to be claimed even where the overall result is a trading loss. It is not for the Courts or the Commissioner to confine the recognition of businesses to those that are always profitable or to do so only so long as they operate at a profit.
Inland Revenue also makes no allowance for whether the expense has been incurred to derive income in the future, nor how the need for the expense arose. For example, Australian case law supports the view that if the obligation to incur an expense arose as part of operating a business, it continues to be deductible after the business has ceased, e.g. interest on debt.
In the past Inland Revenue has cast doubt on whether the New Zealand courts would take a similar view. However, that uncertainty appears to have now been squashed.