Special report on the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021
April 2021
COVID-19 tax relief for donations of trading stock
(Sections FZ 9, GZ 4, GZ 5, CZ 38 and YA1 of the Income Tax Act 2007; section 225ABA of the Tax Administration Act 1994)
The new legislation provides tax relief for businesses that have made, or are contemplating making, donations (or supplies for less than market value) of trading stock during COVID-19.
Rules in the Income Tax Act 2007 impose tax on the market value of trading stock disposed of for no consideration or an amount that is less than the market value. The application of the rules can act as a significant disincentive to donate trading stock. As a COVID-19 relief measure, a temporary amendment has been made so that disposals of trading stock between 17 March 2020 and 16 March 2022 (inclusive) are not subject to these rules if the recipients are donee organisations, public authorities, or other persons not associated with the transferor.
The amendment requires trading stock deductions to be offset by an amount of deemed income in certain circumstances.
A new section authorises the making of an Order in Council to extend the period for which the new sections apply or to declare a later period for which the new sections apply.
Background
Trading stock is generally deductible in the income year it is purchased as a business expense. If it is not sold in the year of purchase, closing stock is included as income at the end of the year and then becomes deductible as opening stock the following year.
Deemed income rules in sections GC 1 and FC 2 apply when a person disposes of trading stock for less than market value or when it is transferred on the making of a gift. The rules deem the market value of donated trading stock to be assessable income. This means businesses are effectively taxed on a deemed profit margin for the donated goods, (that is, the difference between the deemed market value and the deduction obtained on purchase or in the opening stock adjustment).
The deemed income rules were introduced to counter tax avoidance, including situations where sole traders use their trading stock for private purposes. However, the application of the rules can act as a significant disincentive to donate trading stock. For example, a hand sanitiser business may be liable for tax if it donates some of its products to a hospital, or a farmer may be liable for tax if they donate livestock for meat to be sent to a foodbank.
In 2010–2011 an 18-month exclusion was introduced to provide relief for trading stock donations made in response to the Canterbury earthquakes. A permanent provision allows relief when trading stock is donated to a person not associated with the donor for the use in a farming, agricultural or fishing business that is affected by a self-assessed adverse event.
Key features
The following changes have been made to the Income Tax Act 2007 and to the Tax Administration Act 1994.
- Inserting new sections GZ 4 and GZ 5. Section GZ 4 provides an exclusion for disposals of trading stock to public authorities and donee organisations from section GC 1. Section GZ 5 provides an exclusion from section GC 1 for disposals of trading stock by a business to persons not associated with that business.
- Inserting new section CZ 38, which applies where a business disposes of trading stock to a person not associated with that business (other than a public authority and donee organisation) and there is no business purpose for making the disposal. In these circumstances, the deduction they have taken for the trading stock is offset by a deemed income amount.
- Amending the definition of trading stock in section YA 1 for the purposes of the new sections to exclude timber or a right to take timber or land whose disposal would produce income under any of sections CB 6A to CB 15.
- Inserting new section FZ 9, which provides an exception from the rule in section FC 2(1) that requires the transfer of property on the making of a gift to be treated as a disposal and acquisition at market value.
- Inserting new section 225ABA into the Tax Administration Act 1994. That section authorises the making of an Order in Council to extend the period for which the new sections in the Income Tax Act 2007 apply or to declare a later period for which the new sections apply.
Application date
The amendments to the Income Tax Act 2007 apply from 17 March 2020.
The amendment to the Tax Administration Act 1994 applies from the date of enactment.
Detailed analysis
Sections GZ4 and GZ 5 of the Income Tax Act 2007
Sections GZ 4 and GZ 5 both provide exceptions from the deemed income rule in section GC 1 for the period that starts on 17 March 2020 and ends on 16 March 2022.
Section GZ 4 provides an exception from section GC 1 where a business disposes of trading stock to a public authority or donee organisation. The exception applies even if the public authority or donee organisation is associated with that business. This exception recognises that public authorities and donee organisations exist for the public benefit, are subject to regulation and are publicly transparent, so it is appropriate to remove disincentives to donate to these organisations, particularly as a response to COVID-19.
Section GZ 5 provides an exception from section GC 1 where a business disposes of trading stock to a person not associated with that business (that is not a public authority or donee organisation). However, this provision includes a new offset rule, which applies when there is no business purpose for disposing of the trading stock. It ensures that if trading stock is disposed of to a person that is not a donee organisation or public authority for no business purpose (for example, by way of gift), a net deduction for the trading stock is not available to the business. The deduction the business would normally take for the trading stock, being either the cost or the value under section EB 3 at the end of the previous income year, is offset by a deemed income amount under section CZ 38. The deemed income amount is reduced to take into account consideration received for the trading stock (if any).
For the purposes of sections GZ 4 and GZ 5, trading stock has the meaning given in section YA 1 paragraph (b). However, it does not include timber or a right to take timber or land whose disposal would produce income under any of sections CB 6A to CB 15. This narrower definition of trading stock has been used because the temporary amendments are a COVID-19 relief measure and are not directed at significant disposals of this nature.
Section GC 1 will continue to apply where trading stock is disposed of to associated persons, which are not donee organisations or public authorities, for no consideration or an amount that is less than the market value of the trading stock at the time of disposal.
Section CZ 38 of the Income Tax Act 2007
When trading stock disposals are excluded from the deemed income rules in sections GC 1 and FC 2, the person disposing of the trading stock will typically qualify for a deduction. The deduction is available under section DA 1 if the stock is purchased in the year it is disposed of and section DB 49 if the disposal is from opening trading stock.
If section GZ 4 applies, the person disposing of the trading stock will not be required to offset the deduction by a deemed income amount.
If section GZ 5 applies, the person disposing of the trading stock may be required to offset the deduction by a deemed income amount under section CZ 38. The formula for the deemed income offset is contained in section GZ 5 and is explained above.
Section FZ 9 of the Income Tax Act 2007
Section FC 2(1) requires the transfer of trading stock, being revenue account property, to be treated as a disposal by the transferor at the market value.
There is some overlap between subpart FC and section GC 1 in the case of gifts. To have effect, any adjustment to section GC 1 must be accompanied by a corresponding adjustment to subpart FC.
Section FZ 9 provides an exception from the rule in section FC 2(1) in respect of trading stock, provided the transferee is not associated with the transferor or, if they are associated with the transferor, the transferee is a donee organisation or a public authority. The exception applies to transfers made in the period that starts on 17 March 2020 and ends on 16 March 2022.
For the purposes of section FZ 9, trading stock means property that is trading stock under section EB 2 as well as livestock not used in a dealing business and consumable aids to be used in the process of producing trading stock.
Section 225ABA of the Tax Administration Act 1994
Section 225ABA authorises the making of an Order in Council to extend the period for which the new sections in the Income Tax Act 2007 apply or to declare a later period for which the new sections apply.
The Minister of Revenue may only recommend extending the period if satisfied that people in New Zealand are likely to continue to be significantly adversely affected by COVID-19.
The Minister may recommend specifying a new application period if satisfied that there is an emergency event that significantly adversely affects people in New Zealand. The event must meet the requirements of paragraphs (a) and (b) of the definition of emergency in section 4 of the Civil Defence Emergency Management Act 2002.