Change in depreciation rules may grow wineries’ tax bills (Spring 2012)

Changes in the depreciation rate of buildings introduced in the 2010 Budget could have significant impact on a winery’s tax position this year and attention to this is needed now to avoid nasty surprises, particularly for those that have made large scale investment.

From the 2012 income year, tax depreciation deductions for buildings with an estimated useful life of 50 years or more are no longer available and default to zero percent, which will apply to both existing and new buildings.

The implication of this is that wineries that previously claimed depreciation deductions, possibly to the tune of $50,000 to $100,000, can no longer do so and as a consequence, taxable profit levels could increase.

For most businesses the effective change will apply from 1 April 2011. However, businesses with a different income year approved by IRD will see the removal of depreciation applying from the start of the 2012 financial year.

The key features of these changes are:

  • The annual depreciation rates for buildings have been set to zero percent if the building has an estimated life of 50 years or more.
  • This rate applies regardless of when the building was purchased.
  • Building owners who have previously claimed a depreciation deduction on the buildings may still have depreciation recovered if they sell the building for more than what its tax book value is in the future.
  • Special depreciation rates are no longer allowed.
  • Commercial fit-out is still depreciable at the applicable rate.

In the context of the tax depreciation provisions, a ‘building’ is an item within the ordinary or conventional meaning of the term. Case law indicates that a ‘building’ would generally have the following characteristics:

  • Is a structure of considerable size.
  • Is permanent in the sense that it is intended to last a considerable time.
  • Is permanent in the sense that it is designed to be located permanently on the site where it stands, however, it need not be legally part of that land.
    Is enclosed by walls and a roof.
  • Can function independently of any other structure, however, it is not necessarily a physically separate structure.

Commercial fit-out allowance

All is not lost for taxpayers who are currently depreciating commercial fit-out as part of the building as a one-off transitional rule will apply and provide a one-off election opportunity. Essentially a building fit-out ‘depreciation pool’ can be created by taking 15 percent of the building’s adjusted tax book value as at the end of the 2011 income year.

An annual deduction will be available using the following formula:

15% x starting adjusted tax value (as at end of 2011 income year) x 2% x (whole months used or available for use/12).

No deduction will be permitted for any loss on the value of the pool that is sold or scrapped, and neither will there be any depreciation recovered, albeit the depreciation recovery rules will still apply to the building portion.

An important point to note is that to be eligible for this adjustment, no amount of depreciation can have been previously claimed on an item of commercial fit-out.

Depreciation loading

The 2010 Budget also removed the 20 percent depreciation loading applying to the purchase of new assets. This was subject to a ‘grand parenting’ rule with the key features being:

  • An item of depreciable property is eligible for loading if its owners either acquired it or were committed to its purchase or construction on or before 20 May 2010 (Budget Day).
  • For the purpose of this rule, ‘commitment’ can be demonstrated by an item’s owner either having entered into a binding contract for it or, alternatively, after deciding to purchase the item, the owner incurred some expense in relation to it.

With the above changes taking place it would be a good idea to discuss these with your financial advisor as, in many instances, depreciation is a material item in wineries’ financial statements with significant implications.

Published in WINE Hawke’s Bay Spring 2012.

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