New Zealand

Depreciation and depletion

For tax purposes, depreciation of property can be computed under the diminishing-value method, the straight-line method, or a pooling method. The rates of depreciation depend on the following factors:

• Type of asset. 
• Whether the asset is acquired new or second-hand (i.e. used). 

Taxpayers must use the economic depreciation rates prescribed by Inland Revenue. Fixed-life intangible property (including the right to use land and resource consents) is depreciable on a straight-line basis over its legal life. Any depreciation recovered on the sale of an asset (up to its original cost) is taxable in the year of sale.

From the start of the 2020/21 tax year, depreciation deductions were reinstated for non-residential building with an estimated useful life of 50 years or more, including motels and hotels. The diminishing-value rate is 2% and the straight-line rate is 1.5%. Going forward, the new Government proposes to remove tax depreciation on commercial buildings. 

The depreciation rate for residential buildings with an estimated useful life of 50 years or more remains at 0%.

Assets with a cost of less than NZD 1,000 are immediately deductible in the year of purchase.

Goodwill

Goodwill is generally regarded as a capital asset, thus any payment for goodwill is non-deductible. There is a limited exception for payments made to preserve goodwill.

Start-up expenses

Expenses incurred by a company before the commencement of the business are generally regarded as outgoings of a capital nature that do not have a sufficient nexus with income and are therefore not deductible. However, certain expenditure on scientific research may be deductible, provided that it is incurred for the purpose of the company deriving assessable income.

Interest expense

Generally, interest incurred by most companies is deductible, subject to thin capitalisation, restricted transfer pricing, and anti-hybrid rules (see the Group taxation section).

Interest incurred specifically in relation to residential property is subject to a specific set of rules whereby interest deductions may be disallowed (with deductions for interest on existing loans to be phased out over time). However, there are exemptions for new builds and build-to-rent land. The rules do not apply to most companies whose core business does not involve residential land (as determined by reference to a formula where residential property [including new builds] makes up less than half of their total assets). However, close companies (i.e. companies where five or fewer individuals or trustees own more than 50% of the company) will be subject to the rules.

Under these rules, tax deductibility depends on the 'use' of the borrowing, determined using a 'stacking' approach whereby taxpayers allocate loans first to assets that are not residential investment properties based on the market value of assets at 26 March 2021. 

The rules also contain a grandparenting process that reduces the amount of deductible interest on mortgage debt in existence before 27 March 2021 relating to residential investment property. The process allows for 100% deductibility for interest incurred between 1 April 2020 and 30 September 2021, and reducing over the period to 0% from 1 April 2025 onwards.

From 1 October 2021, deductions are disallowed on all other interest on debt funding that is entered into on or after 27 March 2021 relating to residential investment properties, including drawdowns of debt that relates to the ownership or use of residential property on or after 27 March 2021.

Looking forward, the new Government proposes to restore interest deductibility for residential properties on a ’phased-in‘ basis (i.e. 60% interest deductibility for the 2023/24 income year, 80% deductibility for the 2024/25 income year, and 100% interest deductibility for the 2025/26 and following income years).

Bad debt

A company that carries on a business of holding or dealing in financial arrangements is generally allowed a deduction for bad debt in the income year in which the debt is written off by the company if the debt that is written off is a financial arrangement of the same or a similar type as the financial arrangements held as part of the company’s business, and the company is not associated with the debtor.

Charitable contributions

A company is generally allowed a deduction for charitable contributions it makes to an approved Inland Revenue donee organisation or a charity that performs its activities in New Zealand. The list of approved donee organisations is available on Inland Revenue’s website. The deduction available for charitable contributions is limited to the company’s net income for that income year.

Research and development (R&D) expenses

R&D costs are generally tax deductible. However, expenses written off as immaterial and not tested against certain asset-recognition criteria are not automatically deductible for tax purposes.

Unsuccessful software development costs

Taxpayers are allowed a deduction for expenditure incurred on unsuccessful software development projects in the year that the development is abandoned.

Feasibility expenditure 

'Blackhole feasibility expenditure' has been an issue for taxpayers where expenditure is incurred but that expenditure could not be capitalised nor deducted. Often this arises where the project is abandoned before a capital asset is created. This issue was further exacerbated due to the decision in Trustpower Ltd v Commissioner of Inland Revenue [2016] NZSC 91, which further reduced the scope of deductible feasibility expenditure. 

The feasibility expenditure provisions in the Income Tax Act 2007 override this decision and confirm the deductibility of feasibility and other blackhole expenditure incurred by taxpayer situations where the project does not result in a capital asset. It also provides for an immediate deduction where a taxpayer incurs less than NZD 10,000 of this kind of expenditure in an income year.

Residential rental expenditure

From 1 April 2019, deductions for expenditure incurred in relation to residential rental properties are limited to the extent of the residential income derived. Any excess expenditure is 'ring-fenced' and available to carry forward to offset against future residential rental income but, generally, will not be available to offset against other income streams. 

Entertainment expenditure

Entertainment expenditure is generally only 50% deductible. However, entertainment expenditure incurred overseas is 100% deductible.

Legal expenditure

Legal expenditure is deductible if the expenditure is:

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

However, the expenditure is not deductible if it is of a capital, private, or domestic nature.

Taxpayers with business-related legal expenditure of NZD 10,000 or less are able to deduct the full amount of the expenditure in the year it is incurred, whether or not it is capital in nature.

Fines and penalties

Generally, no deduction is available where a company has incurred expenditure on fines or penalties paid in respect of breaches of statute or regulation. Expenditure on other fines and penalties requires further evaluation before its deductibility can be determined.

Taxes

FBT is deductible, as is GST payable on the value of a fringe benefit.

Net operating losses

Losses may be carried forward indefinitely or offset against future profits, subject to the company maintaining 49% continuity of ownership or meeting the 'same or similar business' test. That is, if a loss company cannot carry forward its tax losses due to a loss of shareholder continuity, it may still be able to carry forward those tax losses if it maintains a same or similar business. 

The new 'same or similar business' test supplements the 49% continuity threshold and will allow tax losses to be carried forward where there is no major change to the nature of the business before and after the change in shareholding. This is assessed based on factors such as:

• business processes
• use of suppliers
• markets supplied to, and
• type of product or service supplied.

However, it is recognised that businesses will naturally evolve over time, resulting in changes to business activities and assets. Therefore, there are several carve-outs from what might otherwise be considered a 'major change'. These include changes to:

• increase efficiency
• increase the scale of the business
• keep pace with technology, and
• product or service types, which relate to those already being produced by the business in some way.

The 'same or similar' business test applies from the 2021 income year and can apply to losses from the 2014 income year onwards. The business continuity test also applies to the carry forward of hybrid mismatch amounts.

Losses of a subsidiary are preserved on a spinout (i.e. when shares in the subsidiary are transferred to shareholders of its parent company).  

In response to COVID-19, the government introduced a temporary loss carryback regime for businesses that incur tax losses in the 2020 or 2021 year. The regime allows such businesses to carry back the losses to the immediately preceding tax year (i.e. to 2019 or 2020, respectively), thereby allowing the business to obtain a tax refund comprising previous tax paid. This concession was temporary and is not available going forward (i.e. from 2022 and subsequent income tax years). 

Payments to foreign affiliates

A New Zealand corporation can claim a deduction for royalties, management service fees, and interest charges paid to non-resident associates, provided the charges satisfy the ‘arm’s-length principle’, which forms the basis of New Zealand’s transfer pricing regime.

The hybrid and branch mismatch rules eliminate tax benefits arising (whether in New Zealand or elsewhere) from an entity or financial arrangement being treated differently for tax purposes by different countries. Broadly, the rules could apply where: 

• a group company in one jurisdiction is allowed a deduction (or is not taxed on receipt) in relation to an instrument that is classified differently in another jurisdiction
• a group company is classified differently in two jurisdictions, giving rise to double deductions or deductions without income pick up, or
• a payment from New Zealand is not of a hybrid nature, but it funds a further payment that gives rise to a mismatch. 

If the rules apply, deductions may be disallowed or taxable income increased.