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IR 260 December Depreciation. a guide for businesses - PDF
IR 260 December Depreciation. a guide for businesses
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1 IR 260 December 2006 Depreciation a guide for businesses
3 Introduction This guide explains how businesses claim depreciation on their assets. You are required to claim depreciation on an asset and then account for it when you dispose of that asset. We recommend that you consult a tax agent when considering claiming for depreciation. However, it s still your responsibility to be aware of your tax obligations. Find the current depreciation rates: by using our Depreciation rate finder or checking our General depreciation rates (IR 265) guide You ll find both of these at The rates are set out in two categories industry and asset. For depreciation rates before 1 April 1993, check our Historic depreciation rates (IR 267) at Visit our website for services and information. Get it done online to file returns, register for services, access account information Work it out to calculate tax, repayments and due dates. Find depreciation rates using the Depreciation rate finder and calculate depreciation on a business asset using the Depreciation claim calculator Forms and guides for copies of our forms, booklets and other publications such as the Depreciation rates (IR 265) You can also check out our newsletters and bulletins, and have your say on items for public consultation. You can view copies of all our forms and guides mentioned in this booklet by going to and selecting Forms and guides or you can order copies by calling INFOexpress see page 39. How to use this guide Part 1 Overview Part 1 explains the main features of how depreciation works and the methods you can use to calculate it. Part 2 Detailed information on certain assets This gives detailed information on certain assets of particular interest. Part 3 Adjustments and disposals Part 3 looks at different circumstances from adjusting for business or private use; transferring, selling or disposing of assets; to applying for different rates for an asset. Part 4 Services you may need A list of Inland Revenue services. Glossary This lists many of the words and terms we use in this publication with accompanying explanations. The information in this booklet is based on the tax laws at the time of printing.
5 Contents Part 1 Overview 7 Main features of depreciation law 7 Compulsory depreciation claims 8 Electing not to depreciate 9 Assets that don t depreciate 9 Who can claim depreciation? 9 Cost of assets for depreciation purposes 10 GST and depreciation 10 Records 11 Individual or pooled assets 11 Diminishing value (DV) method 11 Straight line (SL) method 11 Changing methods 11 Pooling method 11 Rates 14 Part 2 Detailed information on certain assets 15 Buildings 15 Land 16 Leased assets 17 Renting out a residential property 18 Intangible assets 18 Computer software 22 Reservation of title clause (also known as Romalpa clause) 23 Assets costing $500 or less (including loose tools) acquired on or after 19 May Part 3 Adjustments and disposals 25 Newly acquired assets 25 Private use of business assets 26 Transferring depreciable assets between associated persons 27 Private assets becoming business assets 28 Disposals 28 Transferring assets under a relationship agreement 32 Transferring depreciable assets between 100% group companies 32 Local authority trading enterprises 33 Determinations to 2005 rates 34 1 April 2005 rates 34 Disputable decisions 34 Special depreciation rates 35 How we set a special rate 35 Provisional depreciation rates 36 Higher maximum pooling values 37 Deductions for assets you no longer use 38 Part 4 Services you may need 39 How to contact us 39 Call recording 39 Business tax information service and Mäori community officers 39 INFOexpress 39 Tax Information Bulletin (TIB) 40 Privacy Act If you have a complaint about our service 40 Glossary 41
7 Part 1 Overview Depreciation effectively provides you with a deduction for capital expenditure, where it is not normally deductible. Depreciation is an allowance that acknowledges that your business assets eventually wear out or become out-of-date, even though you routinely maintain and repair them. For tax purposes, the reduced value of an asset is recognised by allowing a deduction against income for the depreciation of that asset from the time it is used in a business until it is sold, disposed of or discarded. The end result is that the cost of the asset will be written off over its useful life. Once the whole cost price of the asset has been written off, no further deduction is allowed. When you calculate your depreciation deduction it s important to remember: the date you acquired the asset, since this determines which rates are available to you which industry and/or asset category best describes your depreciable asset. Main features of depreciation law As it applies from the 1994 income year, depreciation law relates to all depreciable assets regardless of the date you acquired them. You must make depreciation deductions each year, unless you elect that particular assets are not to be treated as depreciable assets. You may only claim a depreciation deduction once you own the asset and it s used or available for use in deriving your gross income or in carrying on a business that aims to generate your gross income. Depreciation is calculated according to the number of months in an income year that you own and use the asset. A daily basis applies to certain assets used in the petroleum industry. You may not claim depreciation in the year you dispose of any asset, unless it s a building. Although the general depreciation rates are set by a formula, you can apply for a higher or lower special depreciation rate if you can establish that the general rate is unsuitable for your particular circumstances. Higher depreciation rates, previously available for assets used for multiple shifts, do not apply to assets acquired after 1 April Expenditure for repairs and maintenance can be claimed as a deduction through business accounts. Anything more than repairs or maintenance is capital expenditure and isn t deductible, but will be subject to normal depreciation rules. In general terms the depreciation rate options available are as follows: 1. You must use the general rates set out in determinations we issue: For assets acquired on or after 1 April 2005 and buildings acquired on or after 19 May 2005 use the rates listed in part 2 of the General depreciation rates (IR 265) guide. For assets acquired between the 1996 income year and 31 March 2004 (or 18 May 2005 for buildings, including contracts of purchase entered into before 19 May 2005) use the rates listed in part 1 of the IR For assets you acquired on or after 1 April 1993, and before the end of the 1995 income year, you can use the general rates listed in part 1 of the IR 265 or the historic rates plus 25% interim loading and any shift allowances as applicable. 3. Generally, for assets acquired before 1 April 1993 you must use the historic depreciation rates available at Part 1
8 DEPRECIATION Part 1 Both straight line and diminishing value methods are available for calculating depreciation on most assets and you can switch freely between the two. Assets that cost or have an adjusted tax value of $2,000 or less can be depreciated collectively rather than individually using the pool depreciation method. Subject to certain rules, assets costing $500 or less can be written off in the year of purchase or creation. Certain intangible assets first used or available for use after 1 April 1993 have been brought into the depreciation system. Intangible assets with a fixed life must be depreciated using the straight line method. Gains on sale or disposal must be recognised in the year of sale. Losses on sales of depreciable assets, other than buildings, are deductible in the year of sale. There are restrictions on the depreciation deductions that can be made to depreciable assets transferred between associated parties. From 1 April 1997, only those companies that are 100% commonly owned and that choose to consolidate will be able to transfer assets within their group at the assets adjusted tax value. Wholly owned companies which don t form a consolidated group are required to transfer assets at market value and recover or claim a loss of depreciation as applicable. You can write off the residual tax value of any depreciable asset that you no longer use to derive gross income. Some assets can t be depreciated for income tax purposes either because they are specifically exempted (for example, land or trading stock) or they do not reduce in value over time (for example, Lotto franchise fees). Compulsory depreciation claims You must claim at least the minimum amount of depreciation you are entitled to unless you elect an asset not to be depreciable property. It s usually not possible to defer or only partially claim allowable depreciation. If no depreciation deduction is claimed and no election is made, you are considered to have claimed depreciation for the purposes of calculating the adjusted tax value of the asset and when calculating the depreciation recovered (see Disposals on page 28). If you don t claim depreciation in your tax return, the adjusted tax value of the asset will still be reduced by the amount calculated using the appropriate method. The default method for calculating depreciation is diminishing value. For depreciation recovery purposes, where the depreciable asset is disposed of for more than the adjusted tax value then the taxable income will be the lesser of: the previously allowed depreciation (including deemed to be allowed), or the amount by which the amount received exceeds the adjusted tax value. For assets purchased before the 1994 income year, and depending on the disposal amount, the depreciation recovered is the actual depreciation permitted under the old system (when the depreciation deduction was not compulsory) plus the allowable depreciation for the 1994 and subsequent income years. Taxpayers don t have to have claimed extra depreciation on excluded depreciable assets (generally meaning assets purchased before 1 April 1993). This extra depreciation is allowed as either: a supplementary depreciation allowance, or a 25% interim loading. If you don t claim depreciation in your income tax return(s), for whatever reasons, you may still have to recover depreciation when you dispose of the asset.
9 Electing not to depreciate Although it s compulsory for you to claim a depreciation deduction, we recognise there can be instances where you may not want to. If you don t want to claim depreciation on an asset, and you want to avoid paying tax on depreciation recovered when it was not claimed, you should elect not to treat the asset as depreciable. You can t pick and choose the years in which you depreciate an asset. However, if an asset periodically will be and then won t be used in your business (such as a residential building that is temporarily let), you may choose whether or not to depreciate the asset in each period. The Rental income (IR 264) guide discusses this option in more detail. If you elect not to depreciate your asset, it will no longer be a depreciable asset and the depreciation recovery or loss on sale provisions won t apply to it. Assets that don t depreciate Some assets don t depreciate for tax purposes. These assets include: assets that you have elected to treat as not depreciable trading stock land (except for buildings, fixture or land improvements as specified in Schedule 16 of the Income Tax Act 2004) financial arrangements under the accrual rules intangible assets, for example, goodwill (other than depreciable intangible assets of the type listed in Schedule 17 of the Income Tax Act 2004) low-value assets (costing less than $500) that are fully written off on acquisition an asset whose cost is allowed as a deduction under some other tax provision an asset that doesn t decline in economic value because of compensation for loss or damage an asset whose cost was or is allowed as a deduction in any income year to any other taxpayer under any of the special provisions relating to primary sector land improvements. Who can claim depreciation? A depreciation deduction for a particular asset is only allowed once you own the asset and it s used or available for use in deriving your gross income or in carrying on a business that aims to generate your gross income. Ownership You are considered to own an asset when: you acquire legal title (binding contract), or you take up beneficial ownership, which occurs when an asset passes by way of gift, bequest or distribution to a new owner. Where there is both an equitable owner and a legal owner of the same asset, depreciation may only be claimed by the owner who uses the asset or has that asset available for use in deriving their gross income or in carrying on a business that aims to generate their gross income. So, to claim a depreciation deduction for an asset, you must: own it, or lease it under a specified or finance lease (see page 17), or be buying it under a hire purchase agreement starting on or after 1 April Your asset must also be expected to reduce in value while it is used or is available for use in your business. Part 1
10 10 DEPRECIATION Part 1 Used or available for use The following are some examples of the criteria of used or available for use. You can t start claiming depreciation on any equipment purchased until your business commences. Example In April 2005, Enid purchases equipment in anticipation of setting up a home tutoring business in the near future. The business does not in fact commence until March The depreciation deduction for Enid s 2006 income year is restricted to one-twelfth of the yearly depreciation rate. Cargo ship in dry docks conducting normal ongoing maintenance is an ordinary incidence of business and the ship would still be wholly used or available for use in carrying on the business. Plant and machinery finished and awaiting other plant. Depending on the facts, if the completed plant and machinery were available for use in isolation or in another production line if required, the depreciation could be claimed. However, if a further machine or plant was required in order to produce a product, depreciation could not commence until that other necessary plant or machinery was completed. Plant and machinery in storage this depends on the degree and time of reconnection or installation required. If the item (for example, a transformer) were a back-up piece of equipment necessary to keep an operation going, it would be regarded as being available for use and would be depreciable. However, if a new piece of machinery or a new plant were being delivered and had yet to be installed (for example, being shipped in from offshore) there would be no entitlement to depreciation until the installation process was completed. Cost of assets for depreciation purposes Generally, the cost of an asset is the consideration paid by the purchaser normally the market value and this principle applies to associated persons. If you inherit depreciable assets, there can be no depreciation because there has been no cost to you. For further information on transfers between associated persons see page 27. For income tax purposes a deduction is not ordinarily available for expenses incurred in acquiring a capital asset. This includes legal fees charged by a solicitor for preparing and registering the various documents relating to the purchase. However, this type of expenditure may be added to the cost of the asset purchased when calculating depreciation on that asset. The depreciation you calculate each year is deducted from the value of your asset. The remaining value of your asset is called the asset s adjusted tax value. GST and depreciation If you re registered for goods and services tax (GST), you can generally claim a credit for the GST part of an asset s cost price. You calculate depreciation on the GST-exclusive price of the asset. If you aren t registered for GST, you base your depreciation on the actual price you pay for an asset, including GST. Assets temporarily out of operation for repair or inspection are regarded as being available for use and can be depreciated.
11 11 Records As with all tax matters you must keep sufficient and accurate records. There are specific requirements for depreciation purposes. Your records must be able to substantiate your depreciation claims, purchases and sales of your business assets so that if we need to, we can check your deductions (including losses) and depreciation recovered. You must keep your records for at least seven years. Individual or pooled assets You can account for depreciation on your assets in two ways: as an individual asset or as part of a group or pool of assets, see Pooling method. If you choose to calculate depreciation on individual assets you can use either the diminishing value (DV) method of calculating depreciation or the straight line (SL) method. If you decide to group your assets into a pool you must use the DV method for calculating depreciation. Diminishing value (DV) method Using this method means that depreciation is calculated each year by using a constant percentage of the asset s adjusted tax value. This method is sometimes also referred to as the written down value or tax book value. The DV method means that your depreciation deduction will progressively reduce each year. Example Depreciation on office equipment that cost $10,000 was calculated using the DV depreciation rate of 33%. The depreciation is calculated as follows: Adjusted Depreciation tax value of 33% Year 1 $10,000 $ 3,300 Year 2 $ 6,700 $ 2,211 Year 3 $ 4,489 $ 1,481 Straight line (SL) method With this method an asset depreciates every year by the same amount, which is a percentage of its original cost price. This method is sometimes called the cost price basis. Example Depreciation on office equipment that cost $10,000 was calculated using the SL depreciation rate of 24%. The depreciation is calculated as follows: Adjusted Depreciation tax value of 24% Year 1 $ 10,000 $ 2,400 Year 2 $ 7,600 $ 2,400 Year 3 $ 5,200 $ 2,400 Changing methods You can choose to use either the SL or DV methods for individual assets (except for pooled assets and fixed-life intangible assets) regardless of when you bought the assets. If you decide to change depreciation methods, you use the current adjusted tax value to calculate depreciation and not the original cost price of the asset. Once you have filed your tax return you can t change methods for that income year. Pooling method The pooling method allows you to group together (pool) a number of low-value assets and calculate depreciation on the pool. The advantage of pooling assets is that the cost of compliance is reduced because all the assets in the pool are treated as one asset for the purposes of depreciation. The disadvantage of pooling assets is that if you sell an asset in a pool for more than its cost price, this capital gain amount must be included as taxable income. Part 1
12 12 DEPRECIATION Part 1 Main features of the pooling method Only diminishing value (DV) rates can be used for the pool method. Where items in the pool have different depreciation rates, the lowest rate is applied to the pool. Buildings can t be depreciated using the pooling method. The maximum pooling value is generally $2,000 for each individual asset, but you may apply for a higher pooling value for specific assets see page 37. For GST-registered people, the maximum pooling value excludes GST. All poolable assets must be used wholly in business (no private use), or be subject to fringe benefit tax (FBT). Once an asset is included in a pool it can t be separated out later, except where the asset must be isolated because you now use it privately. There is no restriction on the depreciation recovered for a pooled asset. Any capital gains are taxed see page 30. All assets that were previously accounted for under the globo accounting method (ceased from the 1994 financial year) should be pooled. From 12 December 1995, taxing profits from the sale of any such assets is limited, unlike ordinary pools. When all assets in a pool have been disposed of but the pool still has a positive value, ie the proceeds of the sale are less than the pool value, this remaining value of the pool is deductible from your gross income. Calculating depreciation for an asset pool Assets can only be pooled if individual assets within the pool each have a value equal to or less than the maximum pooling value. This maximum is currently set at $2,000, so assets that can be pooled are those that: individually cost you $2,000 or less, or have depreciated and whose adjusted tax value has been reduced to $2,000 or less. Example Hiram bought a computer for $3,300 and calculated depreciation using the DV method. Cost Depreciation Adjusted tax value at 40% DV the end of year $3,300 $1,320 $1,980 Hiram could include the computer in a pool of assets for the second year. If your assets meet this requirement, you may pool any number of them and you may have as many pools as suit your circumstances. You can also combine two or more pools to form one pool. Depreciation is calculated on the average value of the pool for the income year, using the DV method. Work out the average value of the pool by adding together the pool s value at the beginning and end of the income year, before depreciation has been deducted, and then dividing by two.
13 13 Example Adam has a pool of assets with an adjusted tax value at the beginning of the year of $18,000. During the year he purchases three assets for $2,000 each. At the end of the year, he decides to include them in the pool. The value of the pool at the end of the income year (before deducting depreciation) is $24,000. The average pool value is: In the first year of pooling, it s very important that you carefully consider the date from which you will pool your assets. This date will have a significant effect on the average pool value used when calculating depreciation. If you decide to pool your assets part-way through an income year, the pool value at the beginning of the income year will be nil. The amount of depreciation you can claim will be based on half the pool value at the end of the income year. Part 1 Example $18,000 + $24,000 = $ 21,000 2 If we assume that Adam is using the DV rate of 22%, the depreciation deduction and the adjusted tax value of the pool will be calculated as follows. Value of pool at the end of income year $ 24,000 Less annual depreciation ($21,000 x 22%) $ 4,620 Adjusted tax value of pool $ 19,380 Where your income year is longer or shorter than 12 months because of a change in balance date, you ll need to apportion the annual depreciation to the number of whole or part months in your income year. When the assets in the pool have different depreciation rates you must use the lowest rate. This could happen when different types of assets are included in a pool. Richard owns a shop and these are some of his assets that he could pool. Cash register Electric sign Fittings Furniture 33% DV 18% DV 18% DV 18% DV The rate for this pool would be 18% DV. In a case such as this, Richard may decide to pool only those assets with the 18% DV depreciation rate and account for depreciation on the cash register separately or as an asset in another pool. Example Anne starts a business on 15 May 2005 and purchases five assets for $2,000 each, which she pools. She has a 31 March balance date and uses a depreciation rate of 18% DV. Her 2006 depreciation deduction is calculated as follows: Calculate average pool value: Pool value at beginning of year (1 April 2005) nil Pool value at end of year (31 March 2006) $ 10,000 Divide by 2 to average $ 5,000 Calculate annual depreciation: $5,000 x 18% x 11 months = $825 depreciation 12 (The 11 months is 15 May 2005 to 31 March 2006.)
14 14 DEPRECIATION Part 1 Adding assets to a pool The adjusted tax value of an existing pool is increased by: the cost price of the asset (if it s newly acquired), or the adjusted tax value of the asset (if it was previously depreciated separately). If assets are added to the pool at the beginning of an income year, the pool values at both the beginning and end of the year will increase. If the assets are added to the pool part-way through the income year, only the pool value at the end of the year will increase. Rates Once you have decided on the method (or methods) that you will use to account for depreciation, you have to identify the correct rate for calculating the amount of the deduction. The correct depreciation rate to use depends on the date you acquired the asset. Provisional and special rates If we have not set a general depreciation rate for your particular type of asset you may apply for a provisional rate to be set see page 36. General depreciation rates are based on the average usage of an asset. If you believe that you use your asset more heavily or less heavily than is generally the case, or the conditions in which the asset is used are abnormal, you may want to apply for a special rate see page 35. How rates are calculated If you would like to know how we work out the general rates for assets see page 33. There are three groups of rates: General depreciation rates 1993 to General depreciation rates 1 April Historic depreciation rates. Historic depreciation rates must be used for assets that were used or available for you to use in New Zealand before 1 April Most new assets acquired between 16 December 1991 and 31 March 1993 qualify for a further 25% to be added to the historic rate for that asset.
15 15 Part 2 Detailed information on certain assets This section provides further information on certain assets that are of particular interest: Buildings Special rules which apply to buildings. Buildings can t be pooled. Depreciation on buildings, unlike other assets, can be claimed in the year of sale. When disposing of a building a loss can t be claimed as a deduction. Buildings don t qualify for the increased loading of 25% on the historic rates or 20% on the general rates. Buildings are not eligible for the special deduction for assets that you no longer use see page 38. Generally, when a personal (non-business) asset is introduced into a business, the market value at that time is used to calculate depreciation. This rule doesn t apply to buildings, where the original cost (excluding land) must be used for calculating depreciation. Deductions are allowed for losses on buildings resulting from a qualifying event (eg earthquakes, floods and other natural disasters) if the building has been destroyed or become useless for the purposes of deriving income. New lower depreciation rates apply to buildings acquired on or after 19 May Buildings transferred between companies where there is 100 percent common ownership or transfers under a relationship agreement can continue to use the depreciation rate applying to the building at the time of transfer. Depreciation claims on buildings acquired before the 1994 income year must be calculated using the SL method. However, you can choose between the SL and the DV methods to calculate depreciation for the 1994 and future income years on assets acquired before 1 April Depreciation on buildings is calculated on either the original cost or the adjusted tax value depending on which depreciation method you use. The first time you use the DV method you need to calculate the adjusted tax value of your building. The building s depreciation is calculated on this amount. To work out the adjusted tax value, deduct the amount of depreciation that you have claimed since you bought the building from the original cost of the building (excluding land). The rates for buildings acquired before 1 April 1993 are available at under Historic depreciation rates (IR 267). You ll find the rates for buildings acquired after 31 March 1993 in our depreciation rate finder at or by looking in our General depreciation rates (IR 265) guide. Sale of buildings When a building is sold for more than its adjusted tax value, the depreciation recovered is taxable income. The amount of depreciation recovered is the smaller of: the original cost price of the building minus the adjusted tax value, or the sale price minus the adjusted tax value. This ensures that any capital profit made on the sale of a building is not included as taxable income. Losses made when selling or disposing of buildings are not deductible. Part 2
16 16 DEPRECIATION Part 2 Land You can t claim depreciation on land because land, generally, doesn t depreciate. When land and buildings are purchased and the price does not specify the cost of the buildings, the government valuation (at the time of purchase) may be used to calculate this cost: Value of improvements (buildings) Capital value (land and buildings) purchase cost of x = price buildings Land improvements Land improvements on the other hand may depreciate, and since 1 April 1993 there has been the provision for specific fixtures on the land (non-primary sector land) to be depreciated. These fixtures as listed in Schedule 16 of the Income Tax Act 2004 are: airport runways bores and wells bridges chimneys culverts dams fences hardstanding (for example, asphalt carpark) reservoirs retaining walls roads spillways swimming pools tanks tunnels wharves. In the same manner as plant and machinery, these fixtures are depreciable at the general rate plus 20% loading if made in the 1996 and later years, or the historic rates plus 25% loading for the 1995 year. Expenditure on farm and forestry land and aquaculture improvements Although land is not a depreciable asset, there are provisions that allow you to progressively deduct expenditure incurred in preparing or otherwise developing land within the farming, agriculture, forestry and aquaculture industries. This differs from the depreciation of other land improvements. While depreciation is subject to the period of time the asset was used during the financial year, the deduction for the development expenditure is not time based. You can claim the full percentage of the deduction (plus loading) even if the development expenditure occurs near the end of the financial year, provided the expenditure is of benefit to the business in that income year. Deductions are allowed for losses on farm land improvements where a qualifying event has occurred either destroying or rendering the improvements useless for deriving income. When the land is sold there is no taxable recovery of any deductions allowed for the capitalised development expenditure. The undeducted balance of the development expenditure can be transferred to the new owner in case of sale of the land. The capitalised development expenditure effectively stays with the land rather than with the person who incurred it. We recommend you consult a tax agent when considering this option. Taxpayers involved in the primary sector may claim depreciation for assets listed in Schedule 16, however they may only do so when they are unable to claim the expenditure under section DO 1 or DO 2 or Schedule 7 of the Income Tax Act 2004.
17 17 Below are some examples of the specific provisions applying to farming and agriculture (Schedule 7 of the Income Tax Act 2004) for land improvements. Clearing land The expenditure incurred in clearing land is deductible in the year it was incurred. Cultivating land The expenditure incurred in cultivating land is deductible on a DV basis (similar to depreciation) at the rate of 5% per annum. Expenditure incurred between 16 December 1991 and the end of the taxpayer s 1995 income year qualifies for a 25% loading, that is, 6.25%. Expenditure incurred in the taxpayer s 1996 or any subsequent income year qualifies for a 20% loading, that is, 6%. Irrigation system and plant This is capital expenditure so normal depreciation rules apply. Installing tile drains This is deductible on a DV basis at the annual rate of 5% (plus any loading). This same rate would apply to the cost of replacing a tile drainage system. The fact that the retiling may be done over a period longer than one year doesn t affect the deduction that can be claimed. A loss can t be claimed on the old system because it is scrapped, nor can a continued deduction be made for the old system since the asset is no longer of benefit to the business. Sinking a bore This is deductible on a DV basis at the rate of 5% (plus any loading) per annum. Regrassing and fertilising Expenditure incurred in connection with significant capital activity, such as a change from one type of farming to another, is deductible on a DV basis at the rate of 45% per annum. Leased assets For tax purposes there are four kinds of lease. The type of lease determines whether the lessor (owner) or the lessee (person paying to use the asset) is entitled to claim depreciation on the asset. Specified leases A specified lease is a lease agreement entered into between 6 August 1982 and 19 May 1999 that meets certain criteria. The lease is a specified lease if: it has a guaranteed residual value, or the lease term is more than 36 consecutive months (or, if we consider the economic life of the asset is less than 36 months, a term equal to the economic life of the lease asset), and the lessee becomes the owner at the end of the term, or the lessee has the option to purchase the asset at the end of the term at a price significantly lower than market value, or the total of all payments and the guaranteed residual value is more than, or roughly equal to, the cost price, or both parties agree that the lessee is liable for the payment of all, or nearly all, maintenance and other incidental costs. Specified leases include: leases acquired by any means whatsoever, whether from the lessor or another person, and leases entered into between 28 October 1983 and 19 May 1999 (both dates inclusive) if a person other than the lessee acquires the asset and they are associated with the lessee. Finance leases A finance lease is an agreement entered into on or after 20 May 1999 under which: ownership of the asset is transferred to the lessee (or an associate of the lessee) at the end of the term, or the lessee (or an associate of the lessee) has the option of acquiring the asset for an amount significantly lower than market value, or the lease term is more than 75% of the asset s estimated useful life (as determined under sections EE25(4) and EE25(5) of the Income Tax Act With both specified and finance leases, the lessor is treated as selling the asset to the lessee at the beginning of the lease. Therefore, the lessee is the owner and is entitled to the deduction for depreciation. Part 2
18 18 DEPRECIATION Part 2 Hire purchase A hire purchase agreement that passes ownership to the person paying the hire purchase will allow that person to claim any allowable depreciation. This provision overrides the general provision that limits the claim to the owner of the asset. Leasehold improvements A lessee is considered to own and be entitled to claim depreciation on the cost of leasehold fixtures or improvements incurred by that lessee, but under land law principles are technically owned by the lessor. When the lease expires, to calculate the loss on disposal, the lessee is considered to have disposed of the fixture or improvement. The lessor, including subsequent lessors, will not be able to depreciate such fixtures or improvements during the term of the lease. However, once the lease has expired, the lessor will be able to depreciate the fixtures and improvements if they have paid the lessee for these. This also applies when the lessee transfers the lease and the person the lease is transferred to pays the original lessee for the leasehold improvements. The same applies to licences to occupy. Non-specified and operating leases If a lease was entered into between 6 August 1982 and 19 May 1999 and it isn t a specified lease it is known as a non-specified lease. If the lease was entered into on or after 20 May 1999 and it isn t a finance lease, it is an operation lease. For these kinds of leases, the owner (lessor) of the lease asset, claims the deduction for depreciation. Renting out a residential property You must claim depreciation on a house or flat you are renting out as a deduction from the rent you receive, unless you make an election for the asset not to be a depreciable asset. You must also claim depreciation on any contents in the house or flat that are being used or are available for use by the tenants, unless you elect otherwise see page 9. Depreciation rules for the house itself are covered under Buildings on page 15. The contents of the house may be depreciated either on an individual item basis or using the pooling method see page 11. If you are calculating depreciation on contents for the first time, the adjusted tax value will be the lesser of the cost of those items or their market value at the time they are first used or available for use in earning rental income. Rates for the contents of houses or flats that were acquired before 1 April 1993 are listed in Historic depreciation rates (IR 267) at The rates for house contents acquired after 31 March 1993 are set out in the industry category Residential rental property chattels. You can find this in our depreciation rate finder on or our General depreciation rates (IR 265) guide. For more information, read our Rental income (IR 264) guide. It explains the taxable income and deductible expenses for people who own rental property. Intangible assets Depreciating intangible assets Certain intangible assets have been included in the depreciation rules, and can be depreciated under the general rules applying to other depreciable assets. The only difference is that the rules apply to intangible assets acquired or created on or after 1 April 1993, rather than from a taxpayer s 1994 income or non-standard balance date accounting year. Intangible assets acquired or created after 1 April 1993 that are depreciable, intangible property, are limited to those listed in Schedule 17 of the Income Tax Act 2004 and they all have a finite useful life that can be estimated with a reasonable degree of certainty on the date of creation or acquisition.
19 19 In brief, the intangible assets covered by Schedule 17 are: a patent, or the right to use a patent the right to use a copyright, trademark, design, plan or similar the right to use land, plant or machinery software copyright management rights and licence rights created under the Radiocommunications Act 1989 consents granted under the Resource Management Act 1991 copyright in a sound recording plant variety rights, or the right to use them. To be depreciable, an intangible asset must be both: an asset of the type listed in Schedule 17, and an asset that might reasonably be expected to decline in value under normal circumstances. The most common feature of the assets listed in Schedule 17 is the right to use. Take, for example, costs incurred in designing and producing a logo. A logo is not listed in the Schedule so the costs are considered to be a oneoff capital cost and not depreciable. If the logo, once created, is then trademarked and the rights to use are sold, the purchaser can depreciate those rights. The depreciation rules vary according to whether or not intangible assets have a fixed life or an economic life. Intangible assets with a fixed life An intangible asset with a fixed life is any intangible asset that is depreciable with a legal life that could reasonably be expected, on the date of creation or acquisition of that asset, to be the same length as the asset s remaining estimated useful life. If an intangible asset falls into this category, the depreciation rate is self-assessed by the owner using the formula: 1 Legal life (years) In such cases the legal life is defined as the length of time the intangible asset may exist as specified by the contract or statute that created it. In addition, legal life will include any renewal or extension period where those renewals or extensions are essentially unconditional, or conditional on the payment of a predetermined fee. The formula gives an SL depreciation rate. The SL method is the only depreciation method that can be used for fixed-life intangible assets. Intangible assets with a fixed life are not eligible for the 20% loading that applies from the 1996 income year. Example Mark acquired the right to use a registered trademark from 1 April 2006 with a value of $10,000 and a legal life of five years. Using the above formula, the depreciation rate Mark would use is: Note 1 5 = 0.2 or 20% Mark can claim a $2,000 deduction for depreciation each year. A special depreciation rate may be applied if the economic life may be different from the legal life of the intangible asset. Intangible assets with an economic life If the intangible asset does not have a fixed life, it can be expected to have an economic life that is shorter than its legal life. Unlike fixed-life intangible assets, economic-life intangible assets are depreciated using the same methods that are applied to all tangible depreciable assets, that is, a DV or SL depreciation rate. They can be pooled, and are eligible for the 20% loading that applies from the 1996 income year. Taxpayers can also apply for a special or provisional depreciation rate for economic-life intangibles. For example, a taxpayer may obtain a licence to use computer software for life, whereas the economic life of that software would possibly only be three years. Part 2
20 20 DEPRECIATION Part 2 Franchises Franchise agreements are not a category of intangible assets listed in Schedule 17 so they aren t normally considered to be depreciable intangible assets. However, any particular franchise agreement may give rise to specific rights that are listed in Schedule 17, for example, the right to use a trademark. Remember, it s the rights that are depreciable intangible assets, not the franchise agreement. If a franchise agreement stipulates a mixture of rights, and one particular right is specifically listed in Schedule 17 and is capable of being separately and clearly isolated and valued, that right will be a depreciable intangible asset provided it might reasonably be expected to decline in value under normal circumstances. Whether or not the rights conferred under a franchise agreement are considered to be the type listed in Schedule 17, they will not be depreciable if any of the following situations apply. You can t estimate with any reasonable degree of certainty a finite and defined period of life. The rights aren t expected to decline in value over their life. The payment is made to purchase goodwill rather than the rights to secret formulas, processes, trademarks or similar. If a right conferred under a franchise agreement is depreciable, it will usually have a legal life equivalent to its estimated useful life. Accordingly, it must be depreciated using the SL method as an intangible asset with a fixed life. If a right conferred under a franchise agreement is automatically renewed or the right to renewal is only subject to the payment of a predetermined fee, the legal life of that right will be equal to the full term of the agreement, assuming the right to renewal is taken up. Example Cherrypoppin Ltd paid $50,000 to acquire the New Zealand franchise rights to manufacture and distribute Rolloseal towel rails. The franchise agreement is for a 10-year period. The majority of the $50,000 franchise fee went to capital expenditure, however, $20,000 of the fee related to the right to use a patent. The franchise was acquired on 1 April 2006 to extend until 1 April The right to use the patent is a fixed-life intangible asset. When the franchise was purchased, it appeared that the right to use the patent would remain valuable to the end of its legal life. The legal life of this fixed-life intangible asset is 10 years. The SL depreciation rate to be used by Cherrypoppin Ltd for the right to use a patent is therefore: 1/10 = 10% on cost of $20,000. The annual depreciation is $2,000. Additional costs Any additional costs, incurred in relation to an intangible asset with a fixed life during the legal life of that asset, are added to the tax book value. This is done at the beginning of the income year in which the costs are incurred. The aggregate costs are depreciated over the remaining legal life of that intangible asset (calculated from the beginning of the year in which they are incurred). A legal life includes any renewal or extension period where the renewal or extension is essentially unconditional or conditional only on the payment of predetermined fees. Therefore, the depreciation rate for the fixed-life intangible asset changes. In effect, the fixed-life intangible asset is treated as newly acquired from the beginning of that year for the sum of the adjusted tax value and additional costs.
21 21 Example Karion Ltd acquires the right to use a copyright for five years for $10,000 and has an option to renew for a further five years on payment of an additional $5,000. The legal life is therefore: 1/10 = 10% on cost of $10,000. The annual depreciation is $1,000. In the first five years, Karion Ltd claims annual deductions totalling $5,000. In year six, they pay the additional $5,000. The sum of the adjusted tax value and additional costs are $10,000 ($5,000 + $5,000). The remaining legal life of the right is five years, so the depreciation rate for years six to ten is: 1/5 = 20% on cost of $10,000. The annual depreciation in years six to ten is $2,000. Depreciation rates for patents Patents have a legal life of 20 years, which is 240 months. To work out the depreciation rate divide the number of months in that year by 240. For patents with applications lodged before 1 April 2005 and granted in the tax year or later, divide the number of months the patent was pending by 240 to give the catch-up depreciation rate. Further details on the tax implications of selling patents are covered on page 30. Example 1 Patent application lodged before 1 April 2005 Amnah filed for a patent on a new type of footwear on 4 April The patent is granted on 2 June The total patent costs were $10,000. The depreciation for the patent would be calculated as follows: Part 2 It is necessary to calculate a loss or gain on disposal of a depreciable intangible asset see page 29. Patents Patent rights acquired after 1 April 1993 are also depreciable intangible assets. Timing of depreciation For patent applications lodged before 1 April 2005 and granted in the tax year or later, depreciation begins from the date the application is granted. However, there s a catch-up deduction for the period between when the application is lodged and when it s granted. For patent applications lodged on or after 1 April 2005, depreciation begins from the date the patent application is lodged with a complete specification. Depreciation catch-up (April 04 May 07) 38 months/240 months = 16% on cost of $10,000 = $1,600 depreciation* Annual rate for the year (June 07 March 08) 10 months/240 months = 4% on cost of $10,000 = $400 depreciation* income year onwards 12 months/240 months = 5% on cost of $10,000 = $500 depreciation (as the SL method must be used). Amnah will be able to claim $500 each year until the patent expires. * the total depreciation for the income year would be $2,000 ($1,600+$400)
22 22 DEPRECIATION Part 2 Example 2 Application lodged after 1 April 2005 KIZ limited files for a patent on a new type of cat-door. It lodged its application with complete specification on 15 September The patent is granted on 21 February The depreciation rate for the patent application and for the patent (once granted) would be calculated as follows: Depreciation rate for patent application income year (Sept 05 to Mar 06) 7 months/240 months = income year 12 months/240 months = income year (April 07 Jan 08) 10 months/240 months = 0.04* Depreciation rate for patent income year (Feb 08 Mar 08) 2 months/240 months = 0.01* income year onwards 12 months/240 months = 0.05 * the total depreciation rate for the income year would be 0.05 ( ) For more information on depreciation on patents see our Tax Information Bulletin Vol 17, No 7. Fishing quotas There are two types of fishing quota: individual term quotas (ITQs), which are issued in perpetuity, and transferable term quotas (TTQs), which are issued for fixed periods. Most fishing quotas give the owner the right to catch a defined percentage of the total allowable commercial catch, so do not fall within any of the classes of intangible assets listed in Schedule 17. Also, the majority of quotas issued to date have been ITQs, which have an indefinite life, and therefore are not depreciable anyway. Computer software This section explains our policy on the tax treatment of computer software expenditure. Some of the terms used in our software policy are explained below. Development The following activities are likely to be part of a development phase: gathering and analysing user requirements designing systems developing detailed software specifications constructing programs testing software testing the user or customer (acceptance testing) developing manuals and training material preparing documents for use in ongoing software product maintenance providing management review throughout the development phase (for example, quality assurance). Maintenance The following activities will generally be accepted as deductible maintenance payments: developing helpdesk facilities fixing program bugs bringing performance up to the original specifications making minor changes, such as increasing field sizes. Predevelopment This term refers to a feasibility study of a project as part of ongoing business. Software Software includes all programs or routines used to cause a computer to perform a desired task or set of tasks, and the documentation and training materials required to describe and maintain these programs. Please note that a TTQ is depreciable property specifically, it is fixed-life intangible property. For more information about fishing quotas, please refer to our Tax Information Bulletin Vol 12, No 3.