Depreciation on buildings - Ernst & Young
Depreciation on buildings
The change to the tax depreciation rates in the May 2010 Budget for
long-lived buildings has a major impact on future depreciation deductions
that can be claimed for tax purposes. It also has a significant effect on the
financial statements of entities that are required to account for deferred
tax under financial reporting standards. In this publication, we update our
June 2010 publication ‘Depreciation on long-lived buildings’ for proposed
changes to both tax legislation and accounting standards. We discuss below:
• The buildings to which the Budget 2010 depreciation rate changes relate
• A recent issues paper on the treatment of commercial fit-out going forward
• A recap of the accounting implications of the change to tax depreciation deductions
• Proposed changes to the accounting standard on deferred tax
October 2010
Financial reporting and tax considerations
Ernst & Young
Removal of tax depreciation for buildings –
tax implications
The depreciation rate change to 0% relates to buildings and not structures.
2
The 2010 Budget tax legislation introduced new tax depreciation rules for buildings with an estimated useful life of 50 years or more. From the 2011-12 income tax year (i.e. 1 April 2011 for
a standard 31 March income tax year), the depreciation rate for buildings will be 0%. This 0% rate will apply to existing buildings owned and new buildings acquired after the start of the 2011-12
income tax year.
Depreciation claimed prior to the
2011-12 income tax year will still give
rise to tax depreciation recovered if
buildings are sold in the future for greater
than tax book value. There will continue
to be no loss on disposal for tax purposes
when the building is sold.
The presumption of the new legislation
is that all buildings have an estimated
useful life of 50 years, as the default
estimated useful life of a building
is 50 years, unless a depreciation
determination provides for an estimated
useful life of less than 50 years.
If taxpayers consider particular buildings
have an estimated useful life of less
than 50 years, those buildings are not
automatically depreciable. It is necessary
to apply to the Inland Revenue for a
provisional depreciation rate for classes
of buildings considered to have an
estimated useful life of less than 50
years. It should be noted new provisions
in the Budget tax legislation remove the
right to apply for a special rate for
a particular building.2 Current indications
are that the onus of proof on applicants
to establish estimate useful lives for
classes of buildings of less than 50 years
will be high.
It is important to also note the depreciation rate change to 0% relates to buildings and not structures. The Inland Revenue issued an Interpretation
Depreciation on structures will continue to be available at the applicable rate as per the depreciation determinations.
Post-budget depreciation issues paper The Policy Advice Division of Inland
Revenue and the Treasury released an issues paper4 on 11 August 2010 covering certain issues relating to the Budget 2010 tax depreciation changes. Submissions closed on 1 September 2010.
Based on the issues paper, taxpayers should be able to continue to separate out commercial fit-out from the building on a broad basis and depreciate the fit-out separately. For taxpayers
who have not previously separated commercial fit-out from the building, the issues paper offers a mechanism to provide relief. Given the changes to building depreciation discussed above,
the distinction between buildings and commercial fit-out is now much more important. By allocating an appropriate amount to fit-out, some of the impacts of the change to building depreciation can
be mitigated, including the tax impacts, accounting impacts and the wider commercial impacts discussed later in this publication.
Ernst & Young 3
The main points in the issues paper are as follows:
• ►Commercial fit-out will continue to be allowed to be treated separate to the building and can be depreciated using appropriate building fit-out depreciation rates for items listed or the default
building fit-out depreciation rate for non-listed items.
►• The definition of commercial buildings will be restricted to the foundations,the building frame, floors, external walls, cladding, windows, doors, stairs,the roof, and load bearing structures such as pillars and load-bearing internal walls, effectively allowing everything else within the building to be depreciated separately. Further clarification is being sought in respect
of certain doors and stairs within a building. Plant integrated into buildings will be separately depreciable as plant; however, further clarification is required to determine the cut-off between plant
and buildings in certain situations.
• ►In certain situations, if a person has not separately depreciated commercial fitout in a building, they may be allowed a one-off transitional adjustment to carve out 15% of the adjusted tax value of the
building and depreciate it on a straight line basis at 2% going forward (being the current building depreciation rate). No loss on disposal will be allowed, nor will there be any depreciation
recovery on this depreciation claimed. The issues paper is silent on whether taxpayers, at their own cost, can separately identify commercial fit-out that has not previously been split out
and depreciate it at the appropriate rate instead of applying the general 15% fitout pool provision. Further clarification is being sought on a number of issues associated with the pool.
• ►Definitions are provided for distinguishing between commercial buildings and residential buildings.
We note that issues with distinguishing the difference will arise when buildings with mixed purposes have shared facilities, such as lifts and lobbies,
which may be treated differently for
commercial building purposes as
opposed to residential purposes.
Note that the Inland Revenue previously
released a residential rental property
depreciation paper.5
►• There is no comment on what is
considered deductible repairs and
maintenance, which means case law
should continue to be used when
determining whether an item is capital
or revenue account expenditure.
As this is an issues paper, we expect
that there will be a number of
submissions that will seek to clarify
or change any of the issues/solutions
discussed in the issues paper.
The final position in respect of the
issues discussed above may be quite
different to the solutions presented
in the issues paper. Given the greater
importance of separating commercial
fit-out from buildings, as discussed
above, we recommend taxpayers
continue to monitor progress and
seek advice on what it means to
them in respect of commercial fit-out.
Ernst & Young
Accounting implications of loss of
depreciation deductions
4
The change in tax legislation on depreciation deductions has a major impact on entities that prepare financial statements under New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) and that do not qualify for differential reporting concessions.
The accounting impact (explained below) has caused serious concerns in the business community – for many, the resulting deferred tax liabilities do not represent ‘real’ liabilities in an economic
sense, particularly when any potential future tax liability is unlikely to crystallise
for decades or even centuries. Those entities with investment properties and
revalued property, plant and equipment have already had to record deferred tax
liabilities arising from asset revaluations.
The removal of depreciation deductions for long-lived buildings has therefore increased some existing deferred tax liabilities, while creating some new deferred tax liabilities for entities that
may have not previously been faced with this troublesome issue in the past. We discuss below the accounting impact of the loss of depreciation deductions, based on the current requirements of
NZ IAS 12 Income Taxes (NZ IAS 12).
We also discuss some proposed changes to the standard, which could bring relief to some affected entities in the future. It is important to note that the first step in assessing the accounting impact of
the Budget changes is to understand the impact from a tax perspective.
The points discussed earlier, such as whether a particular asset is a ‘building’ for tax purposes or some other type of structure, the length of its estimated useful life for tax purposes, and whether
some portion of the cost should be allocated to fit-out, all need to be taken
into account.
The accounting impacts below only relate to those assets for which tax depreciation deductions have
been effectively removed.
Current accounting requirements
The accounting impact of the loss of depreciation deductions will need to be reported in financial statements prepared for a reporting period that ends after 21 May 2010, such as June,
September and December 2010 balance dates. The key impact relates to buildings
that an entity currently owns and holds with the intention of use in the future
(rather than sale), and that have an estimated useful life of 50 years or more
(as determined by the Commissioner of Inland Revenue). This is applicable for both investment properties within the scope of NZ IAS 40 Investment Property and for buildings
held for own use under NZ IAS 16 Property, Plant and Equipment.
Under NZ IAS 12, a “taxable temporary
difference” arises when the carrying
amount of an asset for accounting
purposes exceeds its tax base.
The tax base of an asset is defined as
the amount that will be deductible for
tax purposes against any taxable
economic benefits that will flow to
the entity when it recovers the carrying
amount of the asset. For buildings that
are intended to be held for use
The key impact relates to
buildings that an entity
currently owns and holds
with the intention of use in
the future, rather than sale.
The key impact relates to buildings that an entity currently owns and holds with the intention of use in
the future, rather than sale.
(either for own use or for use as an investment property),
the carrying amount of the asset will be recovered over the
estimated useful life of the asset. The removal of tax deductions
for depreciation means that there will no longer be tax
deductions to claim against the taxable benefits generated
through use of the asset. Therefore, the standard requires a
deferred tax liability to be recognised, based on the difference
between the carrying amount of the asset and its tax base.
Broadly speaking, the removal of the depreciation deductions
has the following implications for entities reporting under
NZ IFRS.
Existing buildings
The impact of the removal of depreciation deductions will
depend on an entity’s intended use of the building in the future:
►• Intention to hold for use (either for own use or as an
investment property): The liability is measured based on the
tax consequences of use. In this case, the use of the asset
is expected to generate future taxable income and, in the
absence of depreciation deductions to claim against that
taxable income after the end of the 2011 tax year, a taxable
temporary difference will arise based on the carrying value of
the building less the remaining year’s depreciation deduction.
The resulting deferred tax liability will be measured based on
the company tax rate.
►• Intention to sell: The liability is measured based on the tax
consequences of sale. For example, for a building held on
capital account for tax purposes, this typically means the
deferred tax liability is based on the amount of depreciation
to be recovered on sale.
For existing buildings, any adjustment to increase a deferred tax
liability must be recognised in profit or loss in the year in which
the adjustment is made, creating a potentially large increase in
that year’s tax expense.
However, some entities might have unused tax losses
(or deductible temporary differences) that have not been
recorded as an asset in the balance sheet because previously
the entity could not demonstrate that future taxable profits
would be available against which those tax losses/deductions
could be used. Entities in this situation should consider
whether some or all of those tax losses/deductions could now
be recognised to offset the taxable temporary difference that
has now arisen on existing buildings because of the removal
of depreciation deductions.
►Future building purchases
The removal of depreciation deductions is not expected to impact an entity that buys a building after 21 May 2010 (other than in a business combination).
NZ IAS 12 contains an exemption that, in most cases, allows an entity to ignore any deferred tax relating to a non-deductible asset when first acquired. Therefore, typically, no deferred tax would be
recognised in this situation. (However, there will be an impact for buildings acquired in a business combination, as the exemption in NZ IAS 12 does not apply in this situation.)
The following numerical examples highlight the significant impact the removal of depreciation deductions can have on an entity’s financial statements.
Example 1: Building carried at cost
An entity purchased a building 2 years ago on 1 July 2008
for $10,000,000. For accounting and tax purposes it has
been depreciated at 2% per annum. As at the company’s year
ended 30 June 2010, the carrying amount of the asset for
accounting purposes was $9,600,000. Prior to the changes in
tax legislation, the tax base of the asset would have also been
$9,600,000, as the deductions an entity would receive for
tax purposes would be equal to the depreciation it will deduct
over time. This means that there is no difference between the
accounting carrying amount and the tax base of the building.
Hence, no deferred tax is recognised.
However, with the change in tax legislation, the entity can now
only claim a depreciation deduction for one further year, before
the tax legislation change takes effect. Therefore, the new tax
base of the building is only $200,000, but its carrying amount
for accounting purposes is $9,600,000. The difference between
these two amounts is $9,400,000. This difference is referred to
as a “taxable temporary difference” in NZ IAS 12. The deferred
tax liability on this taxable temporary difference at the 28%
company tax rate equals $2,632,000. An entity would thus be
required to recognise a deferred tax liability of $2,632,000 and
tax expense of the same amount.
The above analysis assumes that the building is intended to be
held for use. However, if the entity intends to sell the building,
then deferred tax is calculated based on the tax consequences
of sale. For example, if the building is held on capital account,
then there would be tax on the depreciation recovered of
$400,000 x 28% = $112,000.
Example 2: Revalued building
An entity purchased a building 2 years ago on 1 July 2008 for
$10,000,000. For accounting purposes, it has been revalued
to its current fair value of $15,000,000. For tax purposes,
depreciation has been claimed at $200,000 per year, totalling
$400,000. Prior to the changes in tax legislation, the entity
would have expected to claim depreciation deductions totalling
$9,600,000 over the life of the building ($10,000,000 cost
less $400,000 claimed to date). Following the change in tax
legislation, only one further year’s depreciation of $200,000
can be claimed.
If the building is held for use, then taxable economic benefits
of $15,000,000 (the current carrying amount of the building)
will be generated over its life, but only $200,000 depreciation
deductions can be claimed against this taxable income. Hence,
the tax consequences of use are: ($15,000,000 - $200,000) x
28% = $4,144,000. This liability comprises the deferred tax on:
(a) the revaluation of the building: ($15,000,000 less
$9,600,000) x 28% = $1,512,000; and
(b) the reduction in the tax base following the change in tax
legislation from $9,600,000 to $200,000, i.e. a reduction
of $9,400,000, which at 28% results in deferred tax of
$2,632,000.
However, if the entity intends to sell the building and the
building is held on capital account for tax purposes, the
tax consequences on sale would be tax on the depreciation
recovered = $400,000 at 28% = $112,000.
These examples demonstrate that the loss of depreciation
deductions can have a huge impact on the financial statements.
The examples also demonstrate that the impacts can vary
widely, depending on whether deferred tax is calculated based
on the tax consequences of sale or the tax consequences of use.
For instance, in Example 2 above, the deferred tax recorded on
the balance sheet would be either $112,000 (if the building is to
be sold) or $4,144,000 (if the building is held for use).
The accounting impact of the loss of depreciation deductions has caused major concerns in the New Zealand business community.
Other impacts of the loss of depreciation deductions
Over and above the financial statement and tax impacts, there are other implications arising from the loss of depreciation deductions. In particular, debt covenants could be affected – the
accounting impact significantly increases an entity’s liabilities, so debt covenants
(such as debt to equity ratios) that do not exclude deferred tax liabilities could be compromised.
Affected entities also need to consider the impact on profit announcements and other communications with stakeholders.
Due to the significant impact this might have on an entity’s after-tax profit or loss for the year, affected entities should consider whether profit announcements and other communications will need to
be made or amended.
New Zealand reactions
The accounting impact of the loss of depreciation deductions has caused major concerns in the New Zealand business community.
As noted earlier, many consider that the resulting deferred tax liabilities do not represent ‘real’ liabilities in an economic sense, particularly when any potential future tax liability is unlikely to crystallise for
decades. In addition, for buildings that are measured at current market values,
any economic impact of the loss of tax deductions would be reflected in the building valuation – thereby raising concerns that recording a deferred tax liability is ‘double-counting’ the impact
of the loss of tax deductions. In response to these concerns, the Accounting Standards Review Board
(ASRB) and Financial Reporting Standards Board (FRSB) considered whether amendments should be made to NZ IAS 12 or whether exemptions from the standard should be given.6
However, the Boards concluded that this would not be a viable solution, because
of time constraints (i.e. the time required to consider, consult on and finalise any such amendments or exemptions) and because of the wider implications for the New Zealand financial reporting
framework, if New Zealand accounting
standards were to depart from IFRS.
New Zealand constituents, including
the FRSB and members of the Audit
Committee Leadership Network7,
contacted the International Accounting
Standards Board (IASB) to raise their
concerns about the standard and to
request changes be made – either as
part of the IASB’s short-term project
on income taxes (discussed below)
or as part of a subsequent project to
comprehensively review the standard.
Proposed changes to IAS 12
Income Taxes
The IASB currently has a limited-scope
project to address problems arising
in practice with IAS 12, but without
fundamentally changing the standard.
This is because any fundamental change
would require a comprehensive review
of the standard, which would take a long
time to complete.
One of the issues currently being
considered is the calculation of deferred
tax on investment property, especially
in jurisdictions like New Zealand where
no capital gains tax exists. In these
situations, the differences between
calculating deferred tax on a ‘sale’ basis
or a ‘use’ basis can be very large – as
shown in the examples set out above.
Yet, in practice, it can be difficult to
determine whether a property will be
sold or held throughout its economic life
or a combination (e.g. held for several
years and then sold).
On 10 September 2010, the IASB
issued an Exposure Draft to propose
adding a new exception to IAS 12.
The exception would apply to investment
property, property, plant and equipment,
and intangible assets, but only where
the entity revalues these assets for
accounting purposes under the relevant
accounting standards. The exception
would also apply to investment
properties, property plant and equipment
and intangible assets acquired in a
business combination, provided that
the acquirer intends to subsequently
revalue these assets under the relevant
accounting standards. The exception
would not apply to buildings or other
assets that are carried at cost. The
limited scope of the exception reflects
the limited scope of the IASB project.
Where the exception applies, deferred tax
would be calculated using the rebuttable
presumption that the asset will be sold.
In the examples discussed earlier, this
would mean that deferred tax would be
calculated on the depreciation recovered
on sale, so would only be $112,000.
However, the proposals in the Exposure Draft also state that if there is clear evidence that the entity will continue to use the asset throughout its economic life, then the ‘sale’ presumption is rebutted. In this situation, deferred
tax will be calculated on a ‘use’ basis.
In Example 1 and 2 above, this would
result in deferred tax of $2,632,000 and
$4,144,000 (respectively).
Therefore, if the proposed changes to IAS
12 go ahead, an important issue will be
identifying the circumstances in which
‘clear evidence’ exists that the entity will
use the asset throughout its economic
life. This would likely include considering
such things as documented business
plans, minutes of board meetings and
examples based on previous practice.
For example, typically, an investment
property is not held throughout its
entire economic life and, therefore,
it is likely that clear evidence to rebut
the ‘sale’ presumption will not exist.
In this situation, deferred tax would be
measured based on the tax consequences
of sale. on the other hand, for major
infrastructural assets or specialised
plant and equipment that are essential
to the entity’s operations, there could
be clear evidence that the entity will
continue to use the asset throughout its
economic life. In this situation, the ‘sale’
presumption might be rebutted, in which
case deferred tax would be measured
based on the tax consequences of use.
Next steps
The IASB Exposure Draft is out for
comment until 9 November 2010.
Depending on the responses from
constituents, the IASB intends to finalise
the amendments to IAS 12 relatively
soon – possibly within the next six
months. However, it is not known what
the reactions from constituents will be
and, therefore, whether the amendments
will be finalised as proposed in the
Exposure Draft. The amendments cannot
be applied until they have been finalised
and incorporated into NZ IAS 12.
If and when NZ IAS 12 is amended,
affected entities will need to consider
the impact on the measurement of
deferred tax liabilities under the amended
standard. It is likely that the amendments
will apply retrospectively. Therefore,
when preparing 2011 annual financial
statements, comparative figures for 2010
would be restated to be consistent with
the revised measurement approach.
Concluding comments
The change to depreciation deductions on buildings in the 2010 Budget has had a major impact on
many organisations, both from a tax perspective and also from an accounting perspective. In turn,
these impacts have flow-on effects, such as impacts on banking covenants, profit announcements and other stakeholder communications. Also, further proposed changes to both tax legislation and accounting standards mean that further impacts are in the pipeline. For affected entities, it will be essential to be aware of these on-going developments and understand how they could impact on
your business.
1 Taxation (Budget Measures) Act 2010
2 Section EE 35(2) of the Income Tax Act 2007 from 2011-12 income year
3 IS10/02 - Meaning of “building” in the depreciation provisions
4 Post-budget depreciation issues – An officials’ issues paper August 2010
5 IS10/01 - Residential rental properties - Depreciation of items of depreciable property
6 ASRB-FRSB communiqué, 18 August 2010 (
7 The Audit Committee Leadership Network is a group of audit committee chairs and members
from some of New Zealand’s leading companies interested in improving the performance of audit
committees. Its primary focus is to access emerging best practices and share insights into issues
that dominate the changing corporate governance environment.
Assurance | Tax | Transactions | Advisory
Ernst & Young is a global leader in
assurance, tax, transaction and advisory
services. Worldwide, our 144,000 people
are united by our shared values and an
unwavering commitment to quality.
We make a difference by helping our
people, our clients and our wider
communities achieve their potential.
Ernst & Young refers to the global
organisation of member firms of
Ernst & Young Global Limited, each
of which is a separate legal entity.
Ernst & Young Global Limited, a UK
company limited by guarantee, does
not provide services to clients.
For more information about our
organisation, please visit www.ey.com
© 2010 Ernst & Young, New Zealand.
All Rights Reserved.
SCORE No. NZ00000246
This communication provides general information which
is current as at the time of production. The information
contained in this communication does not constitute
advice and should not be relied on as such. Professional
advice should be sought prior to any action being taken
in reliance on any of the information. Ernst & Young
disclaims all responsibility and liability (including, without
limitation, for any direct or indirect or consequential costs,
loss or damage or loss of profits) arising from anything
done or omitted to be done by any party in reliance,
whether wholly or partially, on any of the information.
Any party that relies on the information does so at its
own risk.
Kimberley Crook
Partner and national FAAS leader
Tel: + 64 9 300 7094
kimberley.crook@nz.ey.com
'NZ .호주부동산' 카테고리의 다른 글
| Any Time You Own a Rental Property a Tax Depreciation Schedule Is Necessary (0) | 2013.10.11 |
|---|---|
| Budget 2010: No tax depreciation on commercial, rental property May 20, 2010 (0) | 2013.10.11 |
| Depreciation on Buildings – New Rules new zealand (0) | 2013.10.11 |
| General information about New Zealand Limited Partnership (0) | 2013.10.03 |
| New Zealand Tax (0) | 2013.10.03 |