Quake affected farmers and other rural businesses will have one less thing to worry about following the Government’s announcement today on depreciation roll-over relief, said Federated Farmers President Dr William Rolleston.
In 2011 the Government amended the Income Tax Act to provide taxpayers with property damaged or destroyed by the Canterbury earthquakes with the ability to defer a depreciation recovery income liability when property is destroyed and replaced using insurance settlements.
“In the wake of the Hurunui-Kaikoura earthquakes I wrote to the Minister of Revenue to seek a similar legislative change”, said Dr Rolleston.
Where a depreciated insured asset is destroyed there is often depreciation recovered, especially where the asset is insured for replacement cost. This depreciation recovered, which is taxable, is a reversal of depreciation previously claimed.
“For earthquake affected taxpayers this could have resulted in a big tax liability, which is not something hard pressed farmers and other business owners need at the moment”.
Depreciation rollover relief rules allow taxpayers to elect to defer depreciation recovery income where the insurance proceeds are used to acquire a replacement asset (thereby at least deferring the payment of taxation that could otherwise have arisen). In such cases, the depreciation recovery income is effectively deducted from the tax value of the replacement asset so that the income will not arise until that replacement asset is sold.
“This seemingly dry technical change will be a relief to people and will make a difference to the recovery.
“We are therefore very pleased that the Government has acted to advance the necessary change and we look forward to it receiving cross-party support as it is progressed through Parliament”, said Dr Rolleston.
The Kaikoura earthquake destroyed a firm’s building.
The building originally cost $6 million. The building would cost $12 million to replace. However, the tax book value is $4 million, reflecting prior depreciation of $2 million.
The insurance proceeds are $12 million (the replacement cost).
In the absence of any rollover relief the building owner will have depreciation clawback of $2 million since instead of depreciating, the building has gone up in value (but only because of the reinsurance claim).
The insurance proceeds over and above the $6 million cost price are still a tax free capital gain.
The difficulty is that the building owner has received insurance proceeds of $12 million to rebuild but at a 30 percent tax rate has a $0.6 million tax liability on the $2 million depreciation clawback. The building owner is left with $11.4 million to meet the reconstruction cost of $12 million.
The proposal is that depreciation clawback rollover relief allow the owner to carry forward the depreciation clawback to reduce the book value of replacement assets. This is often referred to as rollover relief.
In this example, the building destroyed is replaced by a new $12 million building. The $2 million of earlier depreciation is rolled over to the replacement building which although costing $12 million has an immediate book value of $10 million. If the building is subsequently sold for $12 million the $2 million excess depreciation would be clawed back as a tax liability for the vendor at that time.