The Week in Tax; home office deductions, when is development work ‘minor’, and are our tax policy settings right?

The big news this week, obviously, is the reintroduction of the Level 3 Lockdown restrictions in Auckland and Level 2 around the country in general. Under Level 3 the requirement is people must work from home where possible unless they're an essential worker. So, of course, this comes back to something we looked at in some detail several months ago, which is what is the position for employees claiming a deduction for home office expenditure?

Now, this turned out to be quite a matter of great interest to a lot of people, understandably. And Inland Revenue came to the party with the Determination EE002 Payments to employees for working from home costs during the Covid-19 pandemic.

Now, the Determination laid out the rules that apply where employers have either made or intend to make payments to employees to reimburse costs incurred by employees as a result of having to work from home during the pandemic.

And a reminder is that only the employer can claim a deduction for such expenditure, but they can reimburse employees for the costs and such payments would be exempt income for employee. The Determination is not binding on employers who can work out their own allocations within the rules.

Now, remember, the Determination also sets out the amount of allowances that Inland Revenue thought to be acceptable. Under the Determination an employer paying an allowance covering general expenditure to an employee working from home during the pandemic can treat up to $15 per week as exempt income.  This applies in a pro-rata basis:  $30 per fortnight or $65 per month. Anything above that threshold, the excess would be taxable income and subject to PAYE, unless the employer can show that the costs are higher.

Additional payments can be made for the cost of furniture and equipment. And these are to recognise the fact that an employee would have suffered a depreciation loss on furniture and equipment used in a home office. But because of the employee limitation rule they can't claim a deduction.  Instead, there's a safe harbour option where the employer can pay up to $400 dollars to the employee and it would be treated as exempt income. Alternatively, the employer, can reimburse employees for the actual cost of furniture and equipment used purchase for use in a home office.

This is all great stuff with generally simple rules. The one caveat is this determination was initially a temporary response, and it applied to payments made for the period from 17th of March to 17th of September. Now, 17th of September isn't that far off. So, I would hope we'd see soon Inland Revenue issuing an extension to this determination if the lockdown is extended.

Regardless of that, this Determination is a useful set of rules for future lockdowns, if any, to cover the position for working from home. But just note the Determination is temporary and expires in just over five weeks’ time.

"Minor" development work

Moving on, as is well known. New Zealand does not have a general capital gains tax, but and it's a very big but, there are a number of transactions which would normally be treated as capital gains that are taxed. And there's a whole series of transactions in particular which relate to the taxation of land.

One of these provisions is Section CB 12 of the Income Tax Act 2007.  Under that provision an amount a person receives from the disposal of land is taxable if the development or division work carried out as part of the sale is “not minor”.

This provision highlights one of the key problems of our current taxation of capital which is that many of the provisions which would tax capital are very subjective in their approach.  For example, the general provision in section CB 6 taxes the sale of land where the land was acquired with a purpose or intent of sale.

During last year’s debate over taxing capital gains, I was always frustrated to hear when people said capital gains taxes were complicated. There are definitely complexities in it, but at least the imposition of a general capital gains tax clarifies the position. We're not then relying on matters of subjectivity as to intent or in this particular section CB 12 what is the meaning of the word “minor”.

Now, in this context, Inland Revenue has just released an Interpretation Statement, IS 20/08, which sets out when development work or division work is “minor”. This Interpretation Statement is an update and replaces a previous Interpretation Guideline, IG0010 “Work of a minor nature” which was issued in February 2005.

The main conclusions in the 2020 Interpretation Statement are unchanged from that previous Interpretation Guideline. But some parts have been updated for clarity and, extremely importantly, also identified safe harbour figures for absolute cost and relative cost to assist with compliance.

And this is a big, big step forward because the previous Interpretation Guideline wasn't very specific as to what would represent work of a minor nature.  Under that guideline, work of a minor nature was very relative and the cases, some of which went back to the 1970s before the massive inflation in property prices took off, involved what seem relatively small sums being deemed to be not of a minor nature.

So to just quickly recap the provision here. Section CB 12 deems an amount from the disposal of land to be income when the person carries on an undertaking or scheme (that doesn't necessarily mean in the nature of a business), and this undertaking or scheme involves the development of the land or the division of the land into lots; the development of division work is carried on by the person or another person for them, this work is not minor, and the undertaking or scheme was begun within 10 years of the date on which the person acquired the land.

So the 10 year time limit is the often critical part of this provision.  People are probably well aware of the bright-line test, which now applies for five years from the date of acquisition. However, people are less aware that these set of rules in section CB 12 have a ten-year clock on them. And by the way, just a reminder that the bright line test in section CB 6A only applies if any other taxing provision doesn't apply. Remember it’s a fallback provision.

So as I said these these rules are complex. They provide plenty of work for tax advisors let's put it like that. And the key takeaway I want to bring out today is about the safe harbour figures that have been introduced into this Interpretation Statement.

Now, under the case law relating to this provision, and there's plenty of it, there are four factors that have to be considered when you're trying to assess whether work is minor. Firstly, what is the total cost of the work done in both absolute and relative terms? What are the natures of the professional services used, the extent of the physical work undertaken and the significance of the changes to the physical nature and character of the land and so forth.

One sticking point in dealing with this section is around what amount of costs in absolute or relative times is minor? Because in recent years, compliance costs, particularly in relation to the Resource Management Act, have risen quite considerably. What this determination sets out is that the Commission of Inland Revenue will accept that costs of $50,000 or below will be regarded as low in absolute cost terms. And similarly, that relative costs of less than 5% of the value of the land at the start of the development are low in relative cost terms.

So these are now the safe harbours. They would be considered in conjunction with the other three factors I mentioned: the nature of services used, the nature of the extent physical work required, and the significance of the changes to the physical character and nature of the land. But right now, the good thing about this Interpretation Statement is we have some form of baseline. And that actually would clear up quite a lot of these issues I encounter straight away. People know above those thresholds they've got to think very hard that they're looking at a potential tax bill, and they have to consider the tax consequences.

So it's this is a good move by Inland Revenue. It clarifies the position and sorts out quite a bit of the wheat from the chaff on this matter. Also it gives a realistic number to people who think that subdivision work is pretty easy, just take a slice off the excess land at the back of a house and there you go. It's not as simple as that. And the fact that Inland Revenue considers $50,000 of costs to be relatively low in absolute terms should make people thinking of subdivisions as, simple, quick and easy projects pause for thought.

But no doubt, as always, people will charge ahead and then they'll come to advisors like myself looking to see, well, “where we go with this and what are the tax consequences?” I'm sure other advisors will say the same that it’s remarkable the number of times people go a long way down a project before they start thinking about the tax implications of it. By which time, more often than not, it's too late.

What's the rush?

Moving on, as you might expect I was very interested to read John Cantin of KPMG’s piece asking whether or not we have our tax settings right.

There was a lot of good stuff to consider in John's article, which I thoroughly recommend.

In particular I think the two considerations around which he framed his discussion were very important.  Firstly, we have time. That is, we are likely to be cushioning the economic impact of Covid-19 for some time. And his second point was and Covid-19 relies on availability and how that might apply to tax policy. I thought those were two really salient points, which you have to keep in mind.

Clearly, we are going to be stuck with the consequences of this virus for quite some time. So rushing ahead into tax changes and other changes is not necessarily what we need to do at this stage. It's perhaps a softly, softly approach as we work out where the changes can be made without damaging a recovery, and also what fits with the longer-term shape of the economy post the pandemic.

So his first conclusion is we don't really need a charge in and make changes right away now. But you can expect that sooner or later the question of how we’re going to pay for all this debt the government has incurred will arise. And you can imagine how much more difficult those conversations are going to be in other countries which do not have the margin for lending that New Zealand currently does.

John’s commentary around tax policy was quite interesting as he noted tax policy has tended to be done on a “in time basis”. That is when a decision is made to proceed on topic that's when the thinking about what is required is done.  His view here is that we should think about investing in tax policy so we can consider different options sooner. That does increase the cost of running the tax system but means we're better able to respond.

That said and it needs repeating, Inland Revenue has responded extremely quickly to the demands of this pandemic. It would be very churlish to be critical of its response.  But its responses have highlighted a thought I’ve had for some time that we need to beef up the tax policy staffing and resources because we are going to have ongoing issues with this pandemic and we have to really think about them.  

In addition and I raised it at the beginning of April, at some stage we are going to have to pay for this. So how is the tax system going to need to adapt to meet those demands? John’s article is really worthwhile with a lot of very interesting commentary in it. Well worth a read.

Reminder

Finally, talking about having to pay for the bill, just a quick reminder that the first instalment of Provisional tax for the year ended 31st March 2021 is due in two weeks time on 28th August. I imagine clients will be starting to get letters and reminders about this from their accountants.

Remember, one of the options we’ve talked about before is tax pooling. But if you think you may be struggling to make those payments get in front of your advisor and Inland Revenue straight away. Don't leave it to the last minute because although Inland Revenue has a lot of discretion, one senses that sooner or later its patients may run out.

Well, that's it for this week. I'm Terry Baucher and you can find this podcast on my www.baucher.tax or wherever you get your podcasts. Thank you for listening. Please send me your feedback and remember to tell your friends and clients. Until next week. Ka kite āno.

This article is a transcript of the August 14, 2020 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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