Tax and Expenditure

The “general permission” under the Income Tax Act broadly allows expenditure to be deductible if it is:

  • incurred in deriving assessable income, or
  • incurred in the course of carrying on a business for the purpose of deriving assessable income.

A recent Taxation Review Authority (TRA) case provides a strong reminder to us of the importance of ensuring there is a connection (‘nexus’) between the expenditure you deduct for tax purposes and your business or income earning process.

In TRA 008/13, a taxpayer entered into an agreement in 2006 to purchase a block of land for the development and sale of retail units and residential apartments. By June 2007 four deposit payments had been made totalling $1.9m. Before settlement occurred, a number of conflicts arose between the vendor and the taxpayer.

Following several failed attempts by each party to cancel the agreement, they eventually went through a disputes resolution process where they agreed to split the deposit between them. The taxpayer also agreed to pay the vendor’s costs ($70,047). The taxpayer subsequently entered into an agreement to sell the plans for the project, including resource consent, for $650,000; however the transaction was not completed.

The IRD sought to disallow $1.4m of expenditure (including the lost deposit) incurred after 24 July 2008, when the taxpayer ceased negotiations to resurrect the agreement. The taxpayer disagreed with the IRD and the case went to the TRA.

The taxpayer argued:

  • the expenditure related to a business that operated until at least December 2011,
  • the agreement was entered into for the purpose of purchasing the land to derive taxable income or alternatively to escape an onerous contract, therefore all expenses are deductible, or
  • the business was operating in 2007 (the IRD agreed) and the lost deposit was deductible because it was paid at that time.

The TRA decided in the IRD’s favour, concluding that from July 2008 onwards the taxpayer’s focus changed from advancing the settlement of the purchase, to pulling out of the Agreement. From this point the taxpayer ceased being in business, and there was no nexus between the taxpayer’s business and the expenditure.

The TRA also broadly concluded that in order to deduct expenditure to derive income, income must be derived and here there was none. It was further stated that the taxpayer intended to acquire and sell full legal title to the land. However, the taxpayer only acquired an equitable interest in the land. The implication being that the taxpayer’s intention when the due diligence clause was fulfilled was not to sell an equitable interest, therefore there was no requisite intention of resale in respect of the interest that was acquired.

The TRA took the view that the settlement amount was paid from the deposit monies held by the taxpayers’ lawyer as a stakeholder; it was not payment of the deposit.

The IRD not only denied the deductions, but also charged a $39,194 shortfall penalty for taking an unacceptable tax position.

Decisions like this are unsettling because at face value, it would seem reasonable to claim a deduction for the expenditure. Especially given, if income had been derived, the expenditure is likely to have been deductible.

The lesson here is to think carefully about situations that may be outside ‘the norm’. Even if intuitively an expense appears deductible, it may not be. In these situations, a quick phone call to your advisor would be a good idea.

Is It Time To Review Your Finance Function?

To be successful, a business needs to strive for profitability and growth. An important element of this is the need to regularly review internal processes and functions. The finance function should be included in that process.

The finance function of any business needs to encapsulate the right tools, systems and processes to provide management with relevant, timely and accurate information to enable effective decision making.

Too often a business’s finance function is ignored because the business continues to operate as it always has. But what may have served your business well when you had 10 customers per month, will not necessarily be fit for purpose if you now have 400 – let alone if you aspire to have 1,000.

For some, current systems may be suitable, for others an investment may be required and this may range from small changes to a major overhaul. In this process it is important to take stock of what is working well and consider what could be improved. Examples to consider include your general ledger and payroll packages and whether your finance related staff still meet your business’s requirements. It may sound harsh, but the bookkeeper you hired 10 years ago (with his abacus) may no longer possess the skills you need as your business has outgrown him.

One of the biggest areas for potential improvement are ‘manual’ operations. Moving from manual processing to automated systems has many benefits. In this day and age, electronic cashbooks, Excel models and add-on’s (examples are inventory management and customer relationship management) need to be considered.

There is no ‘one-size-fits-all’, so there should be a process of identifying the needs of your business, and preparing a wish list of information taking into account its size, turnover, growth and complexity. Different tools can then be designed to perform different functions, some more comprehensive and complex than others.

There are many tools in the market that offer plenty of bells and whistles, so it is important to check that their cost does not outweigh the benefits they provide. Getting the right fit is essential.

Just as you get a regular warrant of fitness for your car, your finance function should be no different.

Women In The Workforce

Thirty years ago, women would generally leave school at an earlier age than men and with fewer qualifications. The roles women assumed in society were very different and were often paid a much lower wage than what was received by their male counterparts. However, economic development, changing social beliefs and increased education has led to more women obtaining jobs in occupations once reserved for men. Employment opportunities are opening up as more and more females further their education through tertiary institutions. In fact, statistics from leading New Zealand universities put female attendance at almost half their student populations, allowing many to move on to obtain graduate level employment positions.

Despite these recent advances, there continues to be a pay gap between men and women (in 2014 the New Zealand gender pay gap was 9.9%) and many female employees continue to sit at a relatively low rung on the career ladder. At the top, in more senior, executive and board type positions, women continue to be in the minority. This means that their views and opinions are vastly under represented in the decision making processes, which can be problematic given that studies support gender diversity at the top being critical to sustaining performance.

The performance enhancing effects of women working in executive positions goes beyond simply boosting a company’s image and reputation. Reports out of Harvard University have shown that entities with women directors deal more effectively with risk and long term priorities, as women tend to be more strategic thinkers with a natural ability to scenario plan and find creative solutions. Having women in top positions can also improve the performance of other female employees who look up to the more senior women as role models.

Another benefit of having females at the top is that they are generally more familiar with consumer needs. Where women tend to drive the majority of consumer purchase decisions, having women involved at the top can enable more successful products and services to be developed. So with that being said, you would think the ratio of females to males would be higher at the top.

A number of factors contribute to women’s lack of presence in more senior positions. An obvious one is the implications of childbirth, where taking time away from work often means women do not experience constant levels of progression throughout their career. Other factors that can prevent women from reaching those top positions include a lack of support provided by other women, unconscious bias from males in more senior positions and potentially a lack of self-confidence.

It is important for both males and females to recognise and embrace the differences between each gender. It is not a matter of women trying to act like men. It is about people playing to their own strengths and earning the respect of their peers and subordinates by being themselves.

With studies suggesting that women are making a positive difference to the bottom line, it will be interesting to see whether firms that have a more balanced gender composition enjoy an unbalanced share of the profit.

Tax Payments – When Received In Time

Despite our best efforts, many of us are familiar with the consequences of making late tax payments to the IRD. Often, the problem is not just that we forget and leave it to the last minute, but that the payment we make is not processed or received by the IRD in time.

Late payment penalties and use-of-money interest can often be prevented by simply paying tax on time. The IRD has released an updated Standard Practice Statement (SPS 14/01) setting out when different types of tax payments will be accepted as having been paid by the due date. Importantly, it contains several amendments to the previous standards, particularly in relation to payments by post and payments made at Westpac. These changes took effect from 1 October 2014. To ensure your next tax payment is not late and subject to interest and penalties, it is important to familiarise yourself with the standards, as summarised below.

PAYMENTS BY POST – previously, the IRD based the payment date on the post date on the envelope. This is no longer the case. Instead, the IRD will deem the payment date to be the date the envelope is received. As a result, if your routine is to post the cheque on the due date, you may need to put it in the post a day or two earlier.

ELECTRONIC PAYMENTS – payments made electronically or by direct credit into an IRD account must be completed before the end of the bank’s online “business hours”.

For example, if a GST payment is made on 28 April at 10.30pm but the bank’s internet banking cut off is 10.00pm then the payment will not be processed that day and could be treated as late. This also applies to payments made from overseas (bearing in mind the international time difference).

PHYSICAL DELIVERY – payments made by cheque must be delivered to an IRD office before it closes, by the due date.

CASH & EFTPOS – all cash and EFTPOS payments must be paid over the counter at a Westpac branch by the due date. It is important to note that returns must still be filed electronically, posted or delivered to the IRD (Westpac will accept the payment but not the actual tax return).

POST-DATED CHEQUES – post-dated cheques will not be banked by the IRD until the specified date. If it is post-dated after the due date then it will be treated as a late payment (even if it was received before the due date).

Take note that from 1 October 2014, Westpac stopped accepting cheque payments so these must now go directly to the IRD.

WEEKENDS & PUBLIC HOLIDAYS – if a due date falls on a weekend or a public holiday then electronic payments will be accepted on the next working day. This includes all provincial anniversary days.

Whatever your preferred method of payment, adhering to these updated and clarified standards will enable you to avoid unwanted interest and penalties.

Financial Reporting For SMES

Recent changes to the Financial Reporting Act 2013 (FRA 2013) have changed the requirements for entities that are not “large” by definition.

Broadly, this means that most NZ businesses will no longer have to prepare financial statements that comply with New Zealand Generally Accepted Accounting Practice (NZ GAAP). Recognising that this could lead to a reduction in the disclosure of financial information by a business, the IRD has introduced its own minimum standards. The standards are aimed at providing the IRD with a basic level of information so that it can adequately assess a business’s performance.

From 1 April 2014, the IRD requires companies (including look-through companies) that have annual revenue of $30 million or less, and assets of $60 million or less (or subsidiaries of multinational companies with less than $10 million of annual revenue and assets of less than $20 million) to prepare financial statements that meet its stated minimum requirements.

Entities that exceed these thresholds are required to prepare more extensive financial statements as per the standards set out by the External Reporting Board.

Some extremely small companies will be exempt from the IRD’s minimum requirements, as follows:

  • Companies that:
    • are not part of a group of companies, and
    • have not derived income of more than $30,000, and
    • have not incurred expenditure of more than $30,000 in an income year.
  • Non-active companies who are not required to file a return.

Under the IRD’s minimum requirements, the financial statements must contain:

  • a balance sheet setting out the assets, liabilities and net assets of the company at the end of the financial year,
  • a profit and loss statement showing income derived and expenditure incurred for the year,
  • a statement of accounting policies describing the basis on which the accounts have been prepared, and a description of any material changes in accounting policies used since the previous income year.

The statements must be prepared using double entry and accrual accounting principles. There are also certain valuation principles that may be applied. Tax values may be used where they are consistent with double entry and accrual accounting, or historical cost when tax values are not consistent with the accounting principles used, or when historical cost provides a better basis for valuation. Market values may be used if they provide a better basis of valuation than tax values or historical cost. Interest and dividend income must be grossed up to include resident withholding tax and imputation credits.

There are also presentation requirements that state the accounts must show:

  • comparative figures for the prior income year,
  • if the accounts are GST inclusive or exclusive,
  • tax reconciliation to accounting profit,
  • tax fixed asset register,
  • reconciliation of shareholders equity for the year,
  • relevant amounts from the financial statements summary (IR 10),
  • notes to support any amounts disclosed as exception items on the IR 10.

In addition to the above requirements, specific disclosures are required for foresters, livestock owners, and transactions with associated persons.

These are a minimum set of requirements. A higher level of reporting can be adopted if required. The IRD will also accept accounts prepared under NZICA’s special purpose framework.

In recent years the IRD has become more adept at collecting and analysing financial information for investigative purposes. Care needs to be taken to disclose the right level of financial information, but always put it through an IRD lens to ensure it is presented in the most favourable light. A misunderstanding by the IRD when reviewing information could lead to unnecessary and costly IRD scrutiny.