New rules on the deductibility of aircraft engine overhaul expenses apply from the 2017-18 income year.
The new rules will provide welcome clarity around the tax treatment of aircraft engine overhaul expenses. There has been uncertainty in this area following the Commissioner’s previous publication of a draft statement concluding that the amount of an accrued provision for future overhaul expenditure is not incurred in the year the provision is made.
Overhaul now separate from depreciation
The key change is that costs relating to the engine overhaul component of an aircraft are now treated separately from the depreciation rules. The engine overhaul component is no longer included as part of the aircraft itself for depreciation purposes.
Under the new regime, the cost of the engine overhaul component and subsequent overhaul of that component is generally deductible, with the deduction allocated to an income year on a time-in-service basis.
IFRS taxpayers can elect to apply IFRS for tax purposes, subject to agreement with Inland Revenue (“the IFRS method”).
In cases where the overhaul includes a significant increase in engine performance, the deduction is limited to the amount that would have been incurred if no increase in performance had occurred. The non-deductible portion is capitalised to the cost of the aircraft and depreciated.
When an aircraft (or engine) is disposed of, engine overhaul deductions are recovered in a manner that is consistent with the application of the depreciation recovery rules.
Maintenance reserve payments under a finance lease
The new rules also clarify the treatment of regular maintenance reserve payments made by a lessee under a finance lease. Where an aircraft operator acquires an aircraft under a finance lease and is required to make payments to the lessor in relation to return conditions contained in the lease agreement, the lessee is unable to obtain a deduction for these payments. A deduction is allowed at the end of the lease for the maintenance reserve payments retained by the lessor.
Transitional provisions apply to allow a catch-up deduction for the engine overhaul component of existing aircraft, and to recover accounting provisions for future overhaul expenses that were used to value tax deductions for aircraft maintenance expenses prior to the 2017-18 income year.
Extent of application
The new rules only apply in relation to expenditure incurred for the engine overhaul component. The existing general deductibility and timing rules will continue to apply to all other maintenance and overhaul costs.
Continued uncertainty for IFRS taxpayers
There are a number of operational matters with respect to the IFRS method, such as making elections and agreeing methods and adjustments, that are not covered by the new rules but which Inland Revenue has stated will be covered in a upcoming Tax Information Bulletin.