KEY POINTS:
Forest owners wrestling with whether to opt into the emissions trading scheme, or whether to replant upon harvest, will have to consider the tax implications of their actions.
The Government has issued a discussion document on the tax matters arising from the scheme, which will apply to the forestry sector from the start of next year and then progressively to other sectors over the next six years.
The aim, officials say, is to follow general tax principles and rules, such as allowing a deduction for expenses incurred in earning taxable income.
But the rules are different for forests planted before January 1 1990 and those established after it.
From the start of next year if a forest is cut down and not replanted the carbon stored in the trees is deemed to be emitted then and there. New Zealand has to answer for those emissions to other Kyoto countries.
The emissions trading scheme will devolve that obligation to the landowners. That reduces the value of the land, especially if it is suitable for some other use such as dairying.
As partial compensation for that loss of value the Government plans to allocate free tradeable emission allowances, known as New Zealand units or NZUs, pro rata to the owners of pre-1990 forests.
Those who opt to replant their forests upon harvest - historically the vast majority - will have an asset they can sell (though if they or later owners decide to deforest in the future they will need units to cover the deforestation liability).
Those who opt to change the use of the land will need to buy more units.
The discussion document says a change in land use is usually regarded as a capital matter so the allocation of free units should be regarded as a capital receipt and not taxed.
The flipside is that buying more units to cover the deforestation liability would not be a deductible expense.
Forest Owners Association chief executive David Rhodes said for forest owners who regarded the deforestation liability itself as a retrospective tax, that just added salt to the wound.
If the owners of post-1990 forests opt into the emissions trading scheme they will have to report periodically on changes in the stock of carbon in their forests, earning units when it goes up as the trees grow, but having to surrender units when it goes down, if the trees are felled or if they are consumed by fire or pests.
A forest of one age class would face a large carbon liability upon harvest, while one with a mix of age classes would face more moderate changes.
In the case of the post-1990 forests the discussion document regards the allocation of NZUs as a revenue account and not a capital account one.
That means the units are taxable income when the forester receives them, but a deductible expense when he surrenders them.
That is a logical approach, said PricewaterhouseCoopers partner Julia Hoare. "They have elected to enter into a trading regime," she said. "But the issue is timing."
Unlike a smokestack emitter with continual emissions and an annual liability, with a forest there is a degree of flexibility about when to harvest so the timing of its associated expenses is more uncertain.
Officials suggest two options for dealing with this. One is to recognise income from NZUs as it is received, but match that by allowing a deduction for expenditure on an emerging basis over time, provided there is an intention to harvest.
The other is to defer recognition of the income from NZUs and the associated deductions for expenditure, until they are used to settle an obligation to the Government under the emissions trading scheme or they are sold.
Timing issues also arise for oil companies which have to join the emissions trading scheme in 2009 and for power stations and large industrial emitters which are brought into the scheme the following year.
Their usual balance dates will seldom align with the scheme's December 31 balance date. The value of a company's holding of units, and its accrued liability, will have to be marked to market at its own balance date. Those values could be significantly different from the firm's actual income or liability, Hoare said.
Even though the proposed rules allow for a wash-up calculation the following year, when large tonnages were involved the cost of what would be in effect the early recognition of income could be substantial, she said.
KPMG partner Brahma Sharma said the timing issue would be particularly relevant for firms not eligible for an allocation of free NZUs and who had to buy them on the market.
Such firms were likely to use their treasury management expertise to determine the most advantageous time to buy units and might well hold at their financial balance date more units than they needed to meet their obligations under the scheme, he said.
PROPERTY PLAN
* The Government plans to create a new form of property - tradeable rights to emit greenhouse gases - as the centrepiece of its climate change policy.
* It has outlined the principles of how the tax system will treat them.
* Accountants say the broad approach is logical but the devil, as ever, will be in the detail.
* The discussion document can be found at www.taxpolicy.ird.govt.nz
