While the IRD has been busy reviewing submissions on its discussion paper on Mixed Use Assets, its audit division has embarked on a major new initiative this year by either risk reviewing or auditing a large number of taxpayers.
The typical scenario involves the claiming of expenses or losses arising from mixed use assets like baches, boats and planes. The mixed use arises from these assets being made available for third parties to rent, as well as being used by the “owner” (often the asset will have been owned in a look through company, loss attributing qualifying company (LAQC) or a trust) for private purposes.
While the IRD discussion document is more focused around the issue of apportionment of costs between private and third party use, the audits and risk reviews are focused more around disallowing some or all of the losses that usually arise.
In effect the IRD is saying that to the extent that a loss arises, the portion of the loss that relates to the private use percentage should be disallowed. This applies even where the owners have paid full arms length market rates on their use of the asset. This argument is based on a Taxation Review Authority (TRA) decision that found a taxpayer who bought their own family home in an LAQC and rented it off them, and claimed the resulting loss (interest and depreciation costs exceeded market rents) against other taxable income. The IRD is applying the TRA decision logic to the partial use of assets, with the loss being reduced by the private use percentage.
Naturally, there is always the additional problem that the IRD will also seek to impose shortfall penalties of at least 20% but often 100% plus interest!
In some cases the IRD is going one step further, and arguing that there is no actual business and that in reality the limited third party use is really just an adjunct to the private ownership or use of the asset. The consequence of this is that the IRD then sets out to deny the whole of the loss that arises, while again looking for shortfall penalties and interest. GST may also be more of an issue in such cases, as usually the IRD will also seek to retrospectively deregister the activity for GST.
So what should you do? If you do have assets which are used both by you and third parties we recommend that you review whether it is worth continuing to claim all of the resultant losses, or even if you continue to argue it is a business activity at all. Post Penny & Hooper the IRD has been very aggressive in its audits, and sadly we can’t see that subsiding any time soon.