Bad Debt Write-offs – Timing is Everything…
A recent TRA decision should be a reminder to us all, that a bad debt deduction may only be claimed in the income year that it is physically written off – section DB 31(1)(a)(i).
The basic facts in this case, was that the taxpayer was a barrister and solicitor in sole practice. He had set aside a pool of funds post a property sale, for lending to client’s who were in financial difficulties. His goal was to increase the size of the fund over time, with the ultimate aim of developing a sizeable bequest to a specified charity upon his death. He planned to grow the fund fairly quickly via the borrowers not only having to pay interest on their loans, but also bonuses (which the taxpayer would return as income).
In the 2011 income year, the taxpayer claimed bad debt deductions for two loans that had been written off, an amount of circa $170,000. IR contended both amounts had been loaned to individuals (although the taxpayer attempted to claim the $50,000 loan was to a company). One individual was bankrupted, and the company claimed as being the debtor (not accepted by the Court) was struck off.
Justification for the claim, was under section DB 31(3) – that the taxpayer was carrying on a business which included dealing in or holding financial arrangements. However the provision could only apply if the taxpayer could show that he had satisfied one of the requirements set out in section DB 31(1)(a), either:
- The amount had been written off in the income year in which it was claimed; or,
- The debtor(s) had been released from payment under the Insolvency Act 2006 or the Companies Act 1993.
In relation to the first limb, the Court confirmed that where the journals or ledger processing the bad debt write-off are written up after the end of the financial year, then the requirement of the section will not be satisfied and no deduction will be permitted. In the present date, the Court decided there was no evidence from the taxpayer that the relevant date was earlier than 20 September 2012 (when the 2011 financials were prepared), which was some six months post the end of the relevant income year.
With respect to the second limb and the release of the debts by operation of law, having decided that both debtors were individuals, the Court only had to determine whether either had been made bankrupt, and if so, within the relevant timeframe. In this last respect, the Court stated that it is the year of discharge that is relevant, as it is only at this point that a natural person is actually released from their debts. In the present case, since only one of the individuals had been made bankrupt, the provision could only have application to that debt. However in this instance, as the year of discharge was 2013, the second limb requirement was not satisfied.
It should also be noted, that the TRA judge disagreed with the taxpayer’s claim that his business included dealing in or holding financial arrangements (so section DB 31(3) did not apply in the first instance), predominantly due to the fact, that as a lawyer, he was required to comply with the provisions of the Lawyers and Conveyancers Act 2006 and other professional obligations, and that on this basis, it was difficult to see how a money lending business operated in the manner described by him could be part of his law practice. The Court felt that the two activities were actually being managed separately, and that the lending transactions could best be described as those of a private individual using his capital funds to make loans to assist clients in financial difficulty who also met his lending criteria.
Finally, to rub further salt into his wounds, the shortfall penalties IR had imposed for lack of reasonable care, were also upheld, on the basis that he did not take a tax position which, viewed objectively, met the standard of being “about as likely as not to be correct”. Accordingly it was not an acceptable tax position. The Court also felt that the issues involved were complex enough that he should have sought professional advice to ensure deductibility was available and he had failed to do so, therefore lacking the taking of reasonable care.
Door opens for R&D Incentives…
A public consultation document has been released jointly by the ministers of Revenue and Research, Science & Innovation, to seek feedback around the potential implementation of a R&D tax incentive. The document requests submissions on the topics of:
- which types of businesses, R&D activities and expenditure should be eligible;
- the minimum R&D expenditure threshold;
- the maximum cap on R&D expenditure; and,
- accountability measures.
It is proposed that the incentive be by way of a tax credit, applying in respect of eligible expenditure incurred from 1st April 2019, calculated at 12.5% of the amount incurred. Identical to the 2008 credit regime, in order to ensure shareholders receive a benefit from the tax credit when dividends are distributed, a credit to the imputation credit account equivalent to the amount of the tax credit will occur.
A key driver behind the introduction of the incentive, is Governments desire to lift the present rate of business expenditure on R&D from 0.64% of GDP (OECD average 1.65%) to 2% within ten years.
Other key components of the intended regime are:
- Application to all eligible R&D expenditure (although a $100k minimum spend and $120m maximum), however consideration still to be given as to whether regime should only apply to R&D labour costs or to a broader range of direct/indirect costs;
- Available to all business structure types;
- Eligibility will occur when business in NZ, undertaking NZ R&D activities (although up to 10% of offshore activities may qualify), over which the business has control, bears the financial risk and owns the results;
- The present definition of R&D considered unsuitable and will therefore be updated with a view to being as clear and robust and practical as possible;
- Tax credit is non-refundable so any excess will convert to a tax loss to carry forward (existing cashout regime may also be reviewed as part of this schemes implementation);
- Special rules could deal with shareholder continuity issues so tax credits are not lost when new equity investors are brought in; and,
- Claims made via MyIR portal, with 12 month claim period which will end one year post the end of the income year to which the claim relates.
- Should you wish to make a submission on the proposals, the final date for filing is 1st June 2018.
Richard Ashby BBus, CA, CPA
PARTNER
Ph: +64 9 365 5532
Fx: +64 9 309 5260
Mb: +64 21 823 464
