Depreciation review
SUBMISSIONS
of the
NEW ZEALAND RETAILERS ASSOCIATION
to the
DEPARTMENT OF INLAND REVENUE
in respect of
THE DISCUSSION DOCUMENT ON DEPRECIATION
September 2004
Introduction
These submissions are presented by the New Zealand Retailers Association.
Background
The Association is the largest trade association involved in the retail industry in New Zealand. We represent an industry that has annual sales of $50b, and which employs some 325,000 people (17% of the workforce) in some 49,000 outlets throughout New Zealand. Our membership includes the major supermarket and general merchandise chains, specialised chains, traditional department stores and thousands of owner operators. We also service a number of specialised trade groups of plumbing materials suppliers, metal fastener distributors, bicycle dealers, pet shops, jewellers and equestrian suppliers.
General Issues
The Association welcomes the release of this discussion paper. However, many of the more technical issues raised within the paper do not directly impinge upon the retail sector so we have confined our submissions largely to those parts of the discussion document which we consider have a direct interface upon retailing in New Zealand.
The Association has not undertaken any economic analysis re the accuracy or otherwise of the current depreciation regime. Accordingly, with regard to the fundamental structural issues raised in the Issues Paper, it simply agrees that the regime should 'provide a level playing field' for all classes of depreciable asset.
Economic life of shop fit-outs
Retail leases commonly require the tenant to periodically refurbish the premises, with three to five year cycles being the norm for shopping centres and malls. The refurbishment requirements are onerous, with leases including a minimum dollar amount per square metre to be spent.
However, the depreciation rate for the each of the various fit-out components (flooring, shelving, shop fittings etc.) is set with reference to its "estimated useful life", which is defined to mean "..the period over which such property might reasonably be expected to be useful in deriving gross income or carrying on a business in New Zealand, having regard to such factors as likely wear and tear, the passage of time, exhaustion, and obsolescence and based upon an assumption of normal and reasonable maintenance".
This gives rise to a generic economic life issue for retailers as the fit-out cycle is less than the "estimated useful life" of the replaced fit-out assets. Thus the depreciation rates for fit-out assets are too low in relation to the actual economic life of those assets, which means that retailers are over-taxed every year other than the last year in which a fit-out is used (as the retailer can deduct the loss on the old fit-out in the year that it is replaced).
The correct depreciation reflex for such assets would be obtained by depreciating them over the contractually determined life of the fit-out. This could be done by amending the estimated useful life definition to take account of contractual requirements to replace assets on a regular basis, or by creating a new category of (contractually) fixed life property.
The residual value of a replaced fit-out is minimal at best as a fit-out is premises specific, and a retailer are hardly likely to use another's cast-offs even if they fit their premises. Accordingly, the depreciation formula should use a nil residual value.
This is the primary submission of the Association, and we are more than happy to discuss it further with officials.
Narrowing depreciation bands
The Association sees merit in narrowing the number of depreciation bands. It would simplify matters for unsophisticated taxpayers, thereby reducing compliance costs and the risk of taxpayers being exposed to shortfall penalties and use of money interest as a consequence of using the wrong band.
Extending economic loading to currently excluded assets
As the Paper itself rightly notes at paragraphs 5.52 and 5.53, there is no good reason to deny economic loadings to second-hand assets, used imported motor vehicles and buildings. The Association is therefore in favour of economic loadings being made available in respect of such assets.
However, the Association does not support the suggestion made at paragraph 5.53 to the effect that extending eligibility for the loading must reduce the level of the loadings. That 'fiscally neutral' approach is, quite frankly, a bizarre motif that runs through most Government tax proposals these days.
It is bizarre two reasons. First, it locks in the tax effect of an unfair tax rule by robbing (innocent)Peter in order to pay Paul.
Second, requiring fiscal neutrality when the Government is running enormous surpluses (i.e., over-taxing the productive sector) is hypocritical. If fiscal neutrality was really so important, the Government would reduce tax rates in order to keep the tax take at the same level. It is obviously does not do so, so why is fiscal neutrality so important at the micro level when it is ignored at the more important macro level?
Front -ending depreciation deductions for plant
A report by the Advisory Group on Small and Medium Business in New Zealand was released by the Government on 25 August 2004. One of the reports recommendations is that the depreciation rate for plant should be increased for the first three years of the operation of the plant, with that increase then being offset by decreasing the depreciation rate for subsequent years. The Association notes that the implementation of the proposal would go some way to relieve the cash-flow strain that is often experienced by a business when it acquires new plant, and would therefore encourage investment in productive assets at no net cost to the revenue. Accordingly, the Association adopts the Advisory Group recommendation as part of its current submission.
Specific Issues
The specific proposals in relation to pollution expenditure, site restoration expenditure and depreciation in respect of patents and plant variety rights are not of any particular relevance to retailers. Nonetheless, they appear to be sensible proposals.
"Tied assets"
The Association notes that the tied assets issue is essentially the same as for fit-out assets.
However, the suggested change in the paper is not the Association's preferred option, as it would still require a special rate application to be made by every affected retailer in respect of each fit-out. To put this in perspective, fit-out clauses are a standard feature of shopping centre leases for retailers, and the Association estimates that there are approximately 4,500 such leases. The total number of such leases is significantly greater when non shopping centre leases are included.
Thus requiring a special application to be made for each affected fit-out will impose significant costs on the Inland Revenue Department as well as on the retailers.
As previously, the Association believes the best solution is to cater for fit-outs (and for any other assets that may have the same characteristics for depreciation purposes) in legislation itself. This will provide certainty for retailers, and will reduce compliance costs for all parties.
Special tax depreciation rates
The Association agrees with the proposals to liberalise the approval rules.
Clarifying the definition of "depreciable intangible property"
The Association agrees with the proposal that the legislation be clarified to make clear that property listed in Schedule 17 is unconditionally depreciable property. It is important that any such legislative amendment is truly confirmatory, rather than merely prospective in nature, in order to safe-guard past depreciation claims.
Losses on buildings and other structures
The proposal that losses be allowed in cases where a building is involuntarily destroyed is endorsed by the Association.
However, the unease expressed by officials at extending the principle to losses sustained from voluntary destructions and sales of buildings is not fully appreciated by the Association - in such cases the taxpayer has sustained an economic loss in respect of a business asset, so why should it not be able to deduct that loss? After all, taxpayers can 'manipulate' a number of taxable events (e.g., sales of revenue account property and other depreciable assets) in order to crystallise a loss without problem.
If, as is likely to be the case, the potential size of the deduction is of concern to officials, the Association suggests that the 'problem' could be managed from a revenue perspective by providing that the deduction is to be spread over the year of destruction/disposal and the following (say) four years.
Issues about which more information is needed
Deductibility of low cost assets
At very least, the Association advocates that the monetary threshold should be raised periodically in order to maintain its value. This point has been made in submissions by the Association a number of times over the years in relation to various thresholds that are set in dollar amounts, and it is frustrated that nothing is done to stop their value in real terms being progressively eroded over time.
The association appreciates that it is not sensible to adjust thresholds each year, but adjusting thresholds from the start of the income following the year in which the consumer price index had increased by a set percentage (e.g., 10%) over the level it was at the last time an adjustment was made to thresholds would be a workable compromise.
Rental Housing
The proposals in relation to rental housing are not of themselves of interest to the Association. However, it seeks assurance that the ambit of the changes will not subsequently be extended to cover business premises.
Black Hole Expenditure
The Association is of the view is that all expenses incurred in deriving gross income or in carrying on a business for the purpose of deriving gross income should be deductible, unless specifically excluded by statute. In other words, the black hole expenditure anomaly should remedied in toto.
Conclusion
We would like to have the opportunity of discussing these submissions with IRD officials.
New Zealand Retailers Association
September 2004
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