TAXED ON LOSSES

Dominion, Volume 37, Issue 115, 10 February 1944, Page 4

TAXED ON LOSSES

Wasting Leasehold Assets EFFECT ON PRODUCTION

Increased production—the key-note in New Zealand today—finds no encouragement in some provisions of our taxation law (says a statement by . the Associated Climbers of Commerce of New Zealand). Illustration is provided by the existing lion-allowance, for taxation purposes, of depreciation of wasting leasehold assets in the assessment of lessees. A concrete case in point is that of a firm which had under consideration the taking up of a lease of a large block of unimproved land for some 30 years. The proposition would have involved, throughout the term of the lease, a very substantial outlay by the lessee in connexion with clearing, grassing and general improvements, but, at the termination of the lease, no amount was to be payable by the owner as compensation for improvements. The lease would have been arranged on these terms but when tfae lessee came to compute the effect of taxation on the fictitious income represented by his expenditure on the property, it was obvious that he would not be able to derive any profit from the operation of the property. It meant, for instance, that if he expended, say, £15,000 on leasehold improvements and derived no net gain from the venture, he would nevertheless be Hable for taxation on £15,000. In the same way, if his net gain amounted to, say, £lO,OOO, he would be liable for taxation on £25,000. Insuperable Obstacle. It is obviously, the statement continues, a matter of vital importance that no avoidable obstacle should be placed in, the way of increased national production, whether farming or industrial, but in the instance quoted the taxation disability involved in the non-allowance under the law of depreciation of leasehold expenditure provides an obstacle which is not only Insuperable, but is also illogical and unjust. The same principle, of course, operates with varying degrees of harshness in respect of all taxpayers who have incurred expenditure on leasehold assets, the existing high rates of taxation only serving to accentuate the burden of the anomaly.

Expenditure incurred on leasehold assets may fall into one or more of the following principal categories: — (1) The costGof buildings—or other improvements—erected by a lessee on leashold land, on terms providing for no compensation to be paid by the owmer of the property on the expiration of the lease.

(2) The cost of fixtures installed by a lessee in .premises occupied, on terms providing for no ■'Compensation to be paid by the owner of the premises on the expiration of the lease, (3) The cost of removable fittings installed by a lessee, in premises occupied. (4) The cost of renovating, painting or preparing leasehold premises—or rooms —for occupation on the comufenceinent of a lease. (5) The goodwill paid on the purchase of the unexpired portion of an existing lease. (6) The 9 purchase price of fittings, fixtures, etc., acquired on the taking over of an existing lease. It is fully recognized, of course, that expenditure of the foregoing nature is, from an accounting standpoint, properly to be regarded as being in the nature of capital expenditure, and that it is a primary principle of income taxation that no deduction shall be allowed for expenditure, or loss, of capital, in arriving at a taxpayer’s assessable income. On the other hand, the taxation Acts take cognisance of the fact that most capital assets diminish in value (or depreciate) during the period of their use (whether by fair wear and tear, or by reason of the factor of obsolescence) and provision is made whereby an appropriate allowance may be made by the Commissioner of Taxes to cover such depreciation in cases where the assets concerned have been used in the production of the taxpayer’s assessable income. In other words, the principle is recognized that an appropriate allowance must be made to cover the factor of depreciation of income-producing assets, in order to arrive at the true income of the taxpayer. Principle Established. In the case of wasting capital assets!, such as coal and timber.. special provision is made by the taxation Acts to enable the Commissioner of Taxes to grant an appropriate allowance to cover the depreciation, or wastage, incurred in respect of such assets in the p_roeess.of producing assessable income, while in the case of gold-mining companies the position is met by a special Statutory basis of assessment. On the same principle, there appears to be no sound reason why the loss—by way of depreciation—in respect of wasting leasehold assets should not be allowed as a deduction, since there is no question but that the expenditure involved is exclusively incurred in producing the income derived from the use of such assets during the period of the lease. In terms of the existing practice of the Commissioner of Taxes, however, the only allowance granted in respect' of expehdi'ture of this nature is limited to annual depreciation—at schedule rate?—o.n the cost of buildings, fittings and fixtures, and insofar only as such depreciation is attributable to the factors or fair wear and tear or obsolescence. In other words, no allowance is made for the balance of the loss incurred by the disappearance—or diminution in value—of the taxpayers asset on the expiration of the lease. The effect of the present practice is that in some instances —particularly where an amount of goodwill has been paid on the purchase of the unexpired portion of an existing lease —it is possible for a taxpayer to find himself assessed for tax on a substantial income, notwithstanding that his operations, may, in fact, have resulted in an actual loss The need for an appropriate amendment to the Act to remove the anomaly is obvious.