Let's make sure we have the scenario and question clear first. The scenario is that you've paid a deposit to a company on some land, and they'll build you a house as part of that deal. The company goes bust and you won't get your deposit back. (Yes, it happens. All investment has a certain amount of risk.)
The question is, can you write off this deposit as a bad debt? The short answer is no.
Why is this? When you buy in such a scenario, you have bought on what is called "capital account". That means that you are not buying and selling houses and making money on the profits, which is called buying on "revenue account." Rather, you have spent money to acquire or improve a long-term asset such as equipment or buildings. When you sell the asset, at present there will be no tax on the capital gain. Likewise, if you make a loss when you sell, you can't claim that loss. And in a similar way, if your calculated risk ends up in losing your deposit, that too is not claimable.
Q: Is the deposit really a deposit?
In other words, could you argue that the deposit is not a deposit? Rather, that it is payment for a set of services including designs, council fees, etc, meaning that this is not an asset?
A: No. This doesn't really change things. However it may depend on what your contract states. If your contract indicates that the monies given to the builder are a loan to be repaid (irrespective of their nature) then it would possibly fall under the definition of a bad debt. It would be best to check the wording of your contract with your lawyer. If it reveals that this is the case, then the possibility of claiming this can be examined. However, we stress that this is very very low.
Q: The house is not an asset at this stage, so shouldn't the deposit be able to be recorded in the Profit & Loss as an expense?
A: No. Again one comes back to the purpose. The house was, in this scenario, part of a capital account purchase, not a revenue account purchase. Therefore, the lost deposit is not deductible.
Q: Any company that I have worked for where the supplier has gone under has been able to capture the loss associated in the Profit & Loss. What's the difference here?
A: No. The sort of situation where a supplier has gone under is a revenue situation. That is, supplies are bought to on-sell. A supplier is paid for goods that it doesn't deliver. Therefore, the undelivered goods for on-sale can be treated as a bad debt, provided that matters are handled correctly.
Q: I thought that a debt can be written off as "bad" when a reasonably prudent commercial person would conclude that there is no reasonable likelihood that the debt will be paid. Isn't that what the law says?
A: Yes (see here), but again that is not the situation here. That only applies in a "revenue" scenario, and only where the other requirements are met.
Q: What about legal expenses? Are they deductible?
A: Yes and No. If the legal action is taken to recover items such as interest reimbursements not paid (which would have been declared as income, i.e. as revenue) then the legal expenses are fully deductible if they come to less than $10,000 in one financial year. If more than $10,000 they are capitalised and depreciated.
However, where legal action is taken to recover deposits not paid on land/buildings ie items of a capital nature and this cost exceeds $10,000 in the financial year, then the portion of legal costs related to this would not be deductible.
The converse is also true: even if your legal costs are a mix of costs related to capital items and revenue items, the entire amount can be claimed so long as it doesn't exceed $10,000 in one financial year.
Q: So does that mean that nothing is deductible then?
A: No. The usual expenses (see here for a sample list) are still deductible.
We trust this is useful. If you have further questions, please consult your lawyer or tax professional.
What is FATCA?
The IRD explains it nicely here. As they put it:
The Foreign Account Tax Compliance Act (FATCA) is United States of America (USA) legislation that aims to reduce tax evasion by USA citizens, tax residents, and entities.
Essentially, it's a reporting regime to make sure that USA persons (and New Zealanders with accounts in the USA) meet their tax obligations.
As part of FATCA, USA citizens/tax residents who have certain foreign financial assets that exceed certain thresholds must report those assets to the United States Internal Revenue Service (IRS), whether they live in the USA or not.
Who does FATCA apply to?
FATCA requires foreign financial institutions (namely, financial institutions outside the USA) that are not exempted, to register and report to the IRS on details of financial accounts held by USA citizens, tax residents and others.
If you are a US citizen or your parents are:
Please note that if you fall into one or both of these categories, then you will now be required to file yearly tax returns with the USA, even if you have never lived or worked there. There are firms that specialise in this; please also see this article.
I'm not a US citizen or tax resident. Why is my bank writing to me about it?
You'd have to ask them that. Probably covering themselves to make sure they are compliant with FATCA.
Hmmm, it's a worry! Please read this excellent article from Fortune Manning Lawyers:
All directors need to be aware of the statutory duty they owe to the company not to trade recklessly and of their potential personal liability for the debts of the company if they do so. There are now several recent cases where the Courts have taken a hard line against directors. The Court of Appeal has recently upheld a High Court decision which found a director liable for reckless trading and personally responsible for the debts and liabilities of the company to the tune of $8,400,000 plus interest from the date of liquidation of the company, not including his liability to related party creditors.
The relevant provision is section 135 of the Companies Act 1993:
A director of a company must not -
There are some peripheral points to note:
The best guidelines for determining whether or not the actions taken by the director were legitimate or illegitimate business risks were set down by the High Court (in South Pacific Shipping Limited (in Liquidation), Re; Traveller & Anor v Löwer (2004) 9 NZCLC 263,570).
The Court said the following factors were relevant:
The "legitimacy" test, used to determine director's culpability, was also supported by the High Court in Mountford v Tasman Pacific Airlines of NZ Limited (2005) 9 NZCLC 263,864.
These decisions have no doubt given liquidators and creditors confidence that where directors are reckless the courts will hold them personally liable for the company's debts.
However, directors can take some comfort in the finding that the taking of legitimate business risks is not reckless. Although, it is a fine distinction. In the two cases decided after South Pacific Shipping and Walker v Allen the Courts have found in favour of the director.
In Global Print Strategies (in Liquidation); Re Mason & Anor v Lewis & Anor (High Court Auckland) the Court found that recklessness requires more than mere negligence. The director must make a conscious decision to allow the business to be conducted in such a way as to pose a substantial risk of serious loss to the company's creditors, or must be wilfully or grossly negligent in turning a blind eye. This introduces a degree of subjectivity to the otherwise objective test of whether a director's conduct was reckless.
In Petros Developments Limited (in Liquidation); Re Advanced Plastics Limited v Harnett & Anor (High Court Auckland) the Court found that the director's conduct was not reckless as the director had the full support of the creditors and the creditors were fully aware of the risks which incidentally were substantial. There was a common strategy between the director and the creditors. The Court made the observation that all business is inherently risky.
The question will always be whether the director's conduct can fairly be regarded as reckless but it is important for directors to bear in mind the principles or guidelines in the South Pacific Shipping case. It is still open for directors to authorise their companies to take risks in business (this is often necessary to promote the company's best interests) but all care should be given to those decisions to ensure the risk taking is legitimate.
Read the full article here here. Note that this article is under review due to some recent courtroom developments. We'll update it as more information comes to hand.
Accounting for your rental residential investment property; general taxation advice.