WELLINGTON - The Inland Revenue Department has won a test case before the Privy Council on the deductibility of holiday pay when a business changes hands.
PricewaterhouseCoopers tax partner John Shewan says the upshot is a messy and murky situation which will need to be remedied by legislation.
The caseconcerns New Zealand Forest Research, a Crown research institute which in 1992 acquired the business previously conducted by the Department of Forests.
As part of the consideration, it took over various liabilities to staff, including accrued holiday pay.
The Court of Appeal overturned a High Court ruling that the Forest Institute could deduct the holiday pay.
But the Privy Council has reversed that decision.
It found that the holiday payments were capital in nature, having been factored into the consideration the Crown received for the business transferred to the institute.
The IRD's director of litigation, Mike Lennard, said the department had pursued the matter because the Court of Appeal decision was being widely taken as a precedent for the private sector, and created the potential for the same expense being deductible twice.
"It would have been at least arguable that, had the Crown been a taxpayer, it could have got a deduction for the accrued-but-not-taken leave entitlements, and then the Crown research institute could deduct them as they are taken.
"If you transfer that over to a situation where both the vendor and the purchaser are private-sector entities, the double deduction could be a potential concern," Mr Lennard said.
But Mr Shewan said now it was highly likely that neither the vendor nor the purchaser would end up with the tax deduction.
A standard transfer would involve the purchaser agreeing to assume the liability for holiday pay from the vendor.
The purchaser's position had been made clear by the Privy Council's decision, said Mr Shewan.
The vendor was now in a precarious position. The vendor had incurred the liability for holiday pay and effectively taken a reduction in the selling price to reflect that liability.
Yet the Privy Council had made it clear that that consideration was a capital rather than a revenue item and would therefore be denied as a deduction.
"It is a manifestly unfair result," said Mr Shewan. "It needs to be resolved by legislation as soon as possible."
