Te wiki o te tāke – The New Zealand Tax Podcast – when are leaky building repairs deductible, any pointers in the Australian Budget for this week’s Budget?

In my view, the leaky building saga is an underappreciated factor in how our housing market got so expensive. At a time when population growth was accelerating, builders and resources had to be diverted to remediation work on buildings, many of which were fewer than 10 years old. These are expensive and time-consuming processes for all involved, and a major question has always been are these costs tax deductible where the building being remediated is being used for deriving rental income?

Inland Revenue doesn’t have a specific measure dealing with leaky buildings, but instead it’s covered in the general analysis under Interpretation Statement IS12/03 Income tax deductibility of repairs and maintenance expenditure general principles. Generally speaking, each case is really looked at on its merits.

That’s what makes a Technical Decision Summary from the Inland Revenue's Adjudication Unit released this week quite interesting.

The background is that the taxpayer owned a rental property which was part of a block of six units. This block of six was a freestanding building within a larger complex. Units within the block were connected by inter-tenancy walls. The block was largely clad with monolithic cladding but required remediation work to resolve weather tightness issues.

The work was carried out by the body corporate, and they levied special levies payable by each unit holder calculated by reference to their expected portion of the total expenditure. While the remediation work was being done, the unit was unoccupied, so the taxpayer independently organised for internal painting to be done during that time.

The question was whether this expenditure was deductible. The taxpayer, not unreasonably, claimed the levies were repairs and maintenance, as were the separate costs he paid for painting the unit. Inland Revenue didn’t agree, and the dispute finished up before Inland Revenue's Adjudication Unit. It determined the levies paid for the remediation were capital, however, the painting was deductible.

The Technical Decision Summary has a good analysis of how Inland Revenue goes through the process of determining whether the expenditure is capital or deductible. This analysis is based on the Privy Council decision in the Australian case of BP Australia Limited v Commissioner of Taxation. Based on that case there are three key elements:

 Whether the work done resulted in the reconstruction, replacement, or renewal of the asset, or substantially the whole of the asset.

 Whether the work done had the effect of changing the character of the asset.

 Whether the work was part of one overall project or was a series of projects that merely happened to be undertaken at the same time.

Overlaying that case is another Privy Council case, this time involving Auckland Gas from 1999, which suggests a two-stage process to determine whether the expenditure is of a revenue or capital nature. You first identify the asset being repaired and then analyse the nature and extent of that work.

In relation to the painting, the Adjudication Unit considered it wasn't part of the overall repair project for the block of units, and it was therefore considered separately. Ultimately, they concluded it was a repair and deductible.

As for the remediation work, this is quite interesting because they saw that it was a block of six units all under repair. But there's also a discussion about whether the fact that several other blocks in in the complex also required remediation work, whether the complex should be seen as the total asset. They discounted this in the end because although the units within each block were physically connected to each other, the blocks were not. Therefore, the block of six units represented an asset, but the complex of blocks overall did not.

This case, I think, might go further because over here the Adjudication Unit said although there was extensive work done the remediation did not result in the reconstruction, replacement or renewal of the block or substantially the whole of the block. The work was not so significant it could constitute reconstruction. However, they did consider the scale of the work was such that it changed the character of the block, because the cost of the remediation was high, around 20% of the value of the unit in the complex. (There are no numbers quoted in this TDS, they do that because of these are meant to be anonymous). And there were some significant improvements to the affected areas, and in the Adjudication Unit’s view, these were structurally significant and important to the operation of the asset.

There's a comment here that in addition the remediation of the block was necessary to prevent water ingress and protect the overall structural integrity and income earning capacity of the unit in the rest of the block. My view on that would be that's very true. But it’s also true of any building and buildings are built with that in mind. So, enabling it in the first place, or making sure that doesn't happen, seems to me it's more of a repair.

But I do wonder whether this might be taken further by the taxpayer. We shall see. Anyway, it's a useful case. It's good the way it runs through the principles involved. The taxpayer will not be entirely happy about that, I daresay, and my own view is the remediation issues around leaky buildings are one where erring on the side of deductibility would longer term be a good policy. But we are where we are at the moment, and we'll just have to see what turns up in other decisions.

Moving on, last Tuesday night it was the Australian budget and that first of all produced a surprise. There was a small surplus, apparently the tax take was above expectations. The Australians are actually going to proceed with the so-called Stage Three, tax cuts package. This is controversial because they are weighted to benefit the top end earners above A$120,000.

From a New Zealand perspective looking at the Australian budget, there are a few interesting snippets in there. They're going to give extra funding to boost skilled migration.

Part of this is they're increasing the temporary skilled migration income threshold of A$70,000 and additional places for the so-called Pacific Australia Labour Mobility Scheme, for workers in priority sectors for the Pacific and Timor-Leste regions. I think that's interesting because putting it in context, we're not the only country looking for skilled migrants.

There's a huge increase in rent assistance and I wonder whether we might see something in that. It's the largest in nearly 30 years. And there's also moves to encourage investments in build to rent projects. We’ve seen something similar this because of our interest deductibility rules. The depreciation rate for build-to-rents has increased from 2.5% to 4% per annum. By contrast, residential buildings over here do not attract depreciation.

There's also a measure to support small businesses, including what they call a small business instant write off. This enables small businesses with an annual turnover of less than $10 million Australian to be able to immediately deduct eligible assets, which cost less than $20,000 for a one-year period starting 1st July 2023. Now, that's something it's often called for here.

There's a small business energy incentive, as well as more tax breaks to help small and medium businesses electrify and save on energy bills. And these target businesses with an annual turnover of less than $50 million. They get special depreciation claims.

Interestingly, a couple of things have happened in relation to international tax. More work on anti-avoidance is happening and they're implementing a global and domestic minimum tax - the two pillars international tax solution.

Basically, from 1st January 2024 large Australian multinationals and the Australian operations of large foreign multinationals will pay an effective tax rate of at least 15%. And then from 1st January 2025, Australia will also be able to tax the foreign operations of large foreign multinationals that operate in Australia to ensure they've paid at least 15%. This is following through from the international measure.

Then there's changes around tax breaks for the superannuation scheme system. This is something I'm seeing all around the world actually. Governments are looking at dialing back some of the generous tax relief they've given. In Australia from 1st July 2025, earnings on super funds balances exceeding $3 million will be taxed at 30%, whereas those earnings and balances below $3 million will continue to be taxed at the concessional 15% rate.

As always with the Australian budget, because they have a bigger economy and a more interventionist approach there’s a lot of little details where they’re happy to tinker around the edges with the tax system.

Budget predictions

Our budget is this Thursday. Now generally speaking, there are typically very few tax measures in a budget. You could always rely on Bill English sneaking in a tax increasing measure normally in the form of non-indexation. But another example would be introducing superannuation withholding tax on KiwiSaver employer contributions from 1 April 2012.

On the other hand, Grant Robertson seems almost averse to mentioning the word tax. That said, because this government and the last National government have done nothing about tax thresholds since October 2010, there is a huge amount of pressure for something to happen in that space. Robertson's problem is that he's also trying to manage inflation, and reducing taxes isn't generally seen as a positive inflation fighting move.

For all that, my guess is that we might see some action directed at lower income families. That might include some changes to thresholds especially for those earning around the $48,000 threshold. We might also see some changes in the Independent Earner Tax Credit and adjustments to the Working for Families thresholds and possibly abatement rates.

Businesses have long called for higher thresholds for instant write-offs as has just happened in Australia, but I don’t see that happening. There might be some Cyclone Gabrielle related reliefs, perhaps an extension of the Small Business Cash-Flow scheme or a temporary reinstatement of the ability to carry back tax losses to earlier years.

Whatever, I sense it is going to be a more interesting budget than usual. And as usual, we will be in the Budget lockup, and you'll have our views on it soon after 2 p.m. this Thursday.

In the meantime, I’m Terry Baucher and you can find this podcast on my website or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.

*Terry Baucher is an Auckland-based tax specialist with 25 years experience. He works with individuals and entities who have complex tax issues. Prior to starting his own business, he spent six years with one of the "Big Four' accountancy firms including a period advising Australian businesses how to do business in New Zealand. You can contact him here.