Many building owners may be considering demolishing or abandoning earthquake-prone buildings if an anomaly in tax treatment is not remedied, according to property tax expert Ross McKinley.
Under Building Act changes introduced following the Canterbury earthquakes, building owners must conduct a seismic assessment to establish whether their building meets new, more stringent strength standards.
The Inland Revenue Department (IRD) is taking the view that neither the cost of the seismic assessment - nor bringing the building up to standard if it falls short - are tax-deductible.
McKinley, National Managing Partner, Taxation, at accounting and consultancy giant KPMG, says the IRD's stance creates a contradiction: "If remedial work is undertaken, the costs are non-deductible. But if such work is not undertaken and the building collapses, or is irreparably damaged as a result of an earthquake or other natural disaster, a tax deduction will be available for the loss."
In other words, McKinley says, owners can claim a tax loss if a building collapses but no tax relief for trying to ensure it does not collapse in the first place.
The present value of the cost of upgrading buildings New Zealand-wide to meet the new standards is $4 billion, according to a policy analysis conducted for the Ministry of Business, Innovation and Employment by Martin Jenkins & Associates.
Ian Harrison, an economist at Tailrisk Economics, says it is substantially higher: "A range of $5 billion to $7 billion is not unreasonable."
McKinley acknowledges figures of that magnitude justify government concern at the potential fiscal cost of changing current tax treatment - but says the problem could be mitigated by spreading the tax burden, requiring building owners to amortise the costs over, say, 15 years. A number of building owners, like charitable trusts, also fall outside the tax net and there is no cost to the Government in extending tax relief to such owners.
KPMG, along with other tax experts and the Property Council of New Zealand, argue the IRD's view is based on an inconsistent treatment of the tax deductibility of business costs.
Operating expenditure (wages and salaries, for example, or the cost of raw materials) is tax deductible - but capital expenditure is not.
The argument that the costs of seismic assessment and earthquake strengthening are capital expenditure rests on the assumption they will result in an improvement to the building structure, allowing owners to charge higher rents.
However, says McKinley, identification of a building as earthquake-prone is likely to undermine its market value. Money spent remedying seismic defects is incurred to preserve a building's income-earning ability, rather than to improve income-earning capacity.
"Expenditure on seismic strengthening is incurred to preserve a building's income-earning condition, rather than to improve its income-earning capacity," says McKinley.
The expense of repairs and maintenance are normally treated as tax-deductible operating costs.
"So classifying seismic strengthening costs as capital expenditure stands in contrast to the tax treatment of almost all other New Zealand business assets - for which there is recognition of loss of economic value through the combination of tax depreciation, a deduction for maintenance and a deduction for any loss incurred when the building is irreparably damaged through natural disaster."
McKinley says the issue concerns only businesses, not other building owners, such as charitable trusts, who fall outside the tax net.
Buildings must meet 34 per cent of the New Building Standard within a timeframe of between 10-20 years after a "yellow notice" is issued, depending on the priority accorded to a building's earthquake vulnerability.
McKinley says most modern buildings easily exceed 34 per cent and many tenants demand 66 per cent or higher.