Coalition argues that the costs of strengthening buildings against earthquakes should be deductible

How's this for an anomaly: if a commercial property is munted in an earthquake, and maybe even kills someone, it gives rise to a tax deduction, but seismic strengthening work to reduce the risk of that happening does not.

The Seismic Tax Coalition, which includes Local Government New Zealand and the Kiwi Income Property Trust, has been trying to persuade the Government - so far without success - that the costs of seismic strengthening should be deductible.

Its convener, director of OliverShaw and former deputy commissioner of Inland Revenue in charge of tax policy Robin Oliver, puts up both a pragmatic and a principled case.

The pragmatic argument is that commercial necessity is requiring seismic strengthening to be undertaken if property owners are to retain tenants.

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But the difference between their bearing 100 per cent of the cost or 72 per cent (if a deduction were allowed) could be the difference between whether the work is done or the building gets drained of tenants and then abandoned.

And such an outcome is not good for neighbouring properties either. Concern about that sort of blight, not least in main streets of provincial cities, is one reason Local Government NZ is on board.

The broader issues around seismic strengthening are challenging. To what standards should existing buildings have to be strengthened? Over what time-frame? Should it be one-size-fits-all nationwide or reflect regional variations in seismic risk? Are the engineers being too conservative? And what is the role of the insurance companies in this process?

These issues are being thrashed out before a select committee and in a working group of central and local government representatives.

But the Seismic Tax Coalition says its issue need not and should not be parked until those broader and vexed questions are sorted out.

"The longer Government delays in addressing this anomaly, the greater the risk commercial property seismic strengthening will either languish or property owners will have incurred costs in the expectation of a legislative fix that would need to be increasingly retrospective so as to deal with the past expenditure," Oliver says.

The more strengthening is done in the meantime, the easier it becomes for officials to ague that to allow a deduction would just be a windfall for those who have done the responsible thing without any expectation of their costs being recognised for tax purposes.

Clearly there is a potential fiscal cost. Recognising this, the coalition says that, while there is no reason in principle that the costs should not be deductible as soon as they are incurred, if fiscal constraints are binding it would be possible to spread the cost over a number of years.

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The argument in principle relates to whether seismic strengthening expenditure is a capital or revenue matter, given that we don't have a capital gains tax and don't recognise capital losses for tax purposes either.

"Officials are more or less arguing that we should not allow this [deduction] because it is like a capital loss. We are arguing it is not like a capital loss," Oliver says.

Building owners who undertake strengthening work face actual expenditure, not merely a change in the book value of their asset. They have to write pretty hefty cheques.

The tax laws currently pretend that cost - incurred in the course of earning a taxable income, rent - does not happen.

"Current tax rules do allow a deduction for the value of a building destroyed by a natural disaster such as an earthquake," Oliver says. "Thus, if a building is strengthened so that it withstands an earthquake, the loss is not recognised for income tax purposes. If it is not strengthened and then collapses in an earthquake, with the possible loss of lives, the loss is recognised under the income tax rules." How perverse is that?

Officials' advice to ministers expresses concern about "the asymmetry created by allowing a deduction for a capital loss but not taxing windfall capital gains". This misrepresents the coalition's position, which would allow the revenue to claw back the deduction to the extent that the building is eventually sold for a profit.

In trying to get the Government to take this issue seriously the coalition has been bedevilled by classic Beehive buck-passing.

It has probably not helped that a Minister of Revenue, Peter Dunne, and a Minister of Building and Construction, Maurice Williamson, have both had to resign.

More recently the issue has been shovelled from the Finance Minister, Bill English, to the new Building and Construction Minister, Nick Smith.

Smith's initial response was that the tax issue should be put on hold until a regulatory regime had been established through the Building Amendment Bill. When the coalition objected he referred the matter back to where it began, in the office of the Revenue Minister, now Todd McClay.

The suspicion is that the stumbling block is the potential fiscal cost.

The Government's 2012 consultation document included very preliminary estimates of the cost of seismic strengthening which ranged from $1.7 billion for 34 per cent of new building standard (NBS) over 15 years to $12.4 billion to achieve 67 per cent of NBS within five years.

Officials proposed moving to a 34 per cent standard but Oliver says the market for tenants is tending to require a higher 65 to 100 per cent of NBS. The consultation document estimates achieving 67 per cent over 10 years would cost about $7.7 billion.

However, Oliver reckons that once allowance is made for the proportion of building owners who are outside the tax base and for costs that are already deductible under existing tax law, that would reduce to around $3 billion. "At a 28 per cent tax rate this gives a fiscal cost of immediate deductibility of something less than $100 million per annum."

In the context of a small and distinctly fragile projected Budget surplus that sort of number might still cause ministerial lips to curl.

But Oliver argues that any such costs should be seen as part of the normal variation of revenue out-turns. "The Government does not react to droughts by taxing affected farmers at the same income levels as in prior years, nor should it treat building owners in such a way."