Topic 5: Specific deductions

Trading Stock: Tax Accounting Formula (EA 1)

Closing stock value is assessable income under CH 1; opening stock value is deductible under DB 49 (determines Cost of Goods Sold)[cite: 17].

Section EB 2 (Trading Stock Definition)

Property owned or carried by a business for selling or exchanging in the ordinary course of business, including WIP and materials[cite: 17].

Explicit Exclusions from Trading Stock (EB 2(3))

Consumable aids, spare parts not for sale, depreciable property, land, and financial arrangements[cite: 17].

Cost Method: Non-Separately Identifiable Stock (EB 6)

Must comply with NZ IAS-2 and consistently use either FIFO or Weighted-Average cost-flow assumptions[cite: 17].

Market Selling Price Method (EB 11 & 12)

Permitted if lower than cost ("lower of cost or NRV"); equals expected sale price less completion and direct selling costs[cite: 17].

Sections DB 5 & DB 6 (Interest Deductibility)

Deductions allowed for borrowing costs and interest incurred if there is an income-earning nexus; capital limitation DA 2(1) does not apply[cite: 17].

The Security Fallacy: Borlase v CIR

The asset mortgaged or offered as security is completely irrelevant; interest deductibility depends strictly on what the loan principal was spent on[cite: 17].

Corporate Automatic Interest Deduction (Section DB 7)

Companies get an automatic interest deduction without establishing a nexus, except for Qualifying Companies (who must meet DB 6)[cite: 17].

Inter-Company Interest Deduction (Section DB 8)

Interest on debt used by a company to buy shares in another group company (66%+ common ownership) is fully deductible without establishing a nexus[cite: 17].

Section DB 31 (Bad Debts Rule)

Deductions are strictly conditional on writing the debt off in accounts during the income year; general provisions/reserves are non-deductible[cite: 17].

Bad Debts: Capital Principal vs Moneylenders

Normal businesses cannot deduct defaulted loan principal (it is capital, per Mainzeal); only businesses in moneylending can deduct lost principal[cite: 17].

Subpart DD (Entertainment 50% Rule)

Corporate boxes, pleasure craft/boats, holiday accommodation, off-premises events, and restricted senior staff parties are only 50% deductible[cite: 17].

Subpart DD (100% Deductible Entertainment)

Food during business travel, conferences >4 hours, overtime meals, public promotions with equal access, and offshore entertainment[cite: 17].

Prohibited Deductions (Statutory & Common Law)

Bribes to public officials (DB 45), income tax and tax penalties (DB 1), and fines are completely non-deductible[cite: 17].

Section DB 62 (Legal Expenses Threshold)

If total annual legal expenditure is under $10,000, it is automatically deductible without needing to test if it is capital or revenue[cite: 17].

Section EA 3 (Accrual Expenditure)

Requires expenses prepaid in one year that benefit subsequent years (e.g., rent, insurance) to be apportioned and deferred, unless excused[cite: 17].

Determination E12: Prepaid Rent Exemption

Excused from deferral if unexpired period is ≤1 month; or if unexpired portion is <$26,000 AND expires within 6 months of balance date[cite: 20].

Determination E12: Prepaid Insurance Exemption

Excused from deferral if the total annual premium is ≤$12,000 and the policy expires within 12 months of balance date[cite: 20].

Determination E12: Unlimited Exemptions

Rates levied under the Local Government Act, audit fees, and mandatory accounting costs have unlimited dollar and time exemptions from EA 3[cite: 21].

Exam Trap: Uninvoiced Sales at Year-End

Goods sold and dispatched before balance date must be added back to taxable income, even if invoicing and recording occur in the next income year[cite: 15].

Exam Trap: Equipment Repairs Doubling Speed

Costs that substantially improve an asset's efficiency or double its speed are capital improvements, not deductible R&M, and must be added back[cite: 12, 16].

Exam Trap: Legal Fees Under $10,000

Even if legal costs relate to a capital asset (e.g., purchasing land for a warehouse), they are fully deductible if total legal fees are under $10,000 (DB 62)[cite: 16, 17].

Exam Trap: Home Office Roof Repair vs Extension

Structural room additions/extensions are capital (non-deductible); ordinary roof maintenance is deductible R&M and apportioned to business % area[cite: 12, 16].