Deferred tax liabilities make accounts hard to read

Inland Revenue believes users of financial information, including banks, will look through the large deferred tax liabilities companies are currently reporting.

But there is significant concern in the accounting profession about how the liabilities erode the usefulness of financial accounts for users, as they distort profit and loss accounts.

Freightways and Smiths City are the latest companies to report deferred tax liabilities resulting from policy changes in the May government budget.

Auckland Airport, SkyCity, Fletcher Building, The Warehouse, Vector, Goodman Fielder and Kiwi Income Property Trust have earlier disclosed large liabilities, the largest being $132 million by Kiwi Income Property Trust.

The deferred tax liabilities are an "accounting item" but they reduce the bottom line profit in the profit and loss account.

IRD policy deputy commissioner Robin Oliver said government advisers did not realise the accounting consequence of the decision to remove a depreciation on buildings in the budget. Nor did accountants.

Silly result

"Are we concerned about it? We believe that banks and other organisations that are looking at financial accounts should be aware that this result is silly. They should not be using this to exercise rights on covenants that may occur.

"We see it essentially as an accounting issue. Companies have same cash flow as before. This is an accounting quirk and it doesn't alter the fundamental policies that were in the budget," he said.

He believed there would be a common sense approach to the issue.

Geof Nightingale, tax partner at PricewaterhouseCoopers, said there was a cash impact. A company claiming 2% depreciation annually on a $100 million building in the past had an annual depreciation deduction of $2 million, which at a 28% tax rate saved $560,000 a year.

But the larger issue is the deferred tax liabilities that result from International Financial Reporting Standards (IFRS) incorporated in the NZ IAS 12 accounting standard.

The previous SSAP 12 used what is known as an income statement approach to accounting, while the new IFRS standard adopts a balance sheet approach.

The deferred tax liabilities are non-cash items that reflect the difference in tax value and book value in accounts.

If someone buys a building for $100 million and has claimed $20 million in depreciation, the building will have an accounting value, or book value, of $100 million and a tax value of $80 million.

The so-called temporary difference is reflected in deferred tax liabilities.

The $80 million will no longer be depreciable for tax purposes under the new government policy so the tax value of the building will fall to zero, increasing the difference between the tax value and accounting value and the deferred tax liability.

No debate

Mr Nightingale said there was no debate about what the accounting rules were but there was significant concern that the deferred tax liabilities were not useful information for users of financial accounts.

A further "quirk" of the standard was that if someone bought a building they were never entitled to claim depreciation for tax purposes there was no deferred tax liability. This would apply to people buying buildings after the government move came into effect.

"Depending on when a building is purchased it will be treated in different ways. Unfortunately that is where we find ourselves," Mr Nightingale said.

Another tax partner who declined to be named said the depreciation change in the budget was a "stuff up" and the Tax Working Group, which advised the government, did not believe such a policy should apply to commercial buildings.

IRD argued that buildings should not be depreciated for tax purposes because they increase in value. Accountants were keener to see the policy applied to residential investment property but argued that commercial buildings, like meat works, did not necessarily rise in value.

The removal of depreciation on commercial buildings was a surprise in the budget.

"What does this do to the readability of these accounts?" asked the tax partner, who declined to be named.

Accountants said Treasury's advice on the issue will be made public and they will be looking at that advice with interest.

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All the government needed to do was ring fence domestic rental losses no matter what structure they were generated in. How hard was that.

The loss of a depreciation deduction on commercial buildings (esp) is a nonsense and further distortion of the market.

The wholesale stuffing up of the us of the QC regime across 'every other sector of the economy' is as momentous in its detrimental impact as it is insane in its inception.

We are ruled by heavy handed idiots.

(If you want to see what sort of a mess results from leaving the kiddies alone in the sandpit, look at NZ's tax laws.)

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' ... The wholesale stuffing up of the use of the QC regime ...'

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It isn't just the deferred tax issue that is making financial statements hard to read. The whole IFRS (international Financial Reporting Standards) set up makes them downright impossible!

These were set up to endeavour to stop people being ripped off by unscrupulous businesspeople but they have become so complex that in fact the opportunity is there to rip them off that much more. Nobody can fathom the meaning of them and there is always the excuse that the relevant information was 'on the bottom right had paragraph of page 53(c) of the notes to the Financial Statements'.

Auditors spend their time checking that there has not been a breach of an IFRS in the way a transaction has been treated rather than looking at the transaction itself.

I'll bet Lehman Brothers Financial Statements were considered to be a 'showhome' in terms of Accounting Standards - didn't stop them going broke though.

We can no longer see the wood for the trees in this profession(as Alan Hubbard would, I am sure, attest)

Incidentally in the paragraph above the 'no debate' byline above the tax value will not fall to zero - it will stay at $80million. Presuming Accounting depreciation continues (as it is required to do) the deferred tax figure will change but the 'tax' value of the building will stay the same.

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"We can no longer see the wood for the trees in this profession(as Alan Hubbard would, I am sure, attest)"

Yes. It's become absurd. I'm sick and tired of waking with cold sweats and panic attacks at 4.00am in the morning wondering if I've missed anything in our mess of complex laws.

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With depreciation no longer an issue for commercial property, why not get back to accounting for true current values in the balance sheet, by way of owners undertaking annual year end revaluation of property investments. Any appreciation in asset value to be taxable and any depreciation deductible in the current year. As an annual exercise valuation improvement costs are current and therefore easy to identify as will 12 month market value changes. All registered valuation and accounting capture and reporting costs will be deductible as business expenses. All too simple perhaps?

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This is not a new problem - and it is serious.

Since 2004 the effect of the NZIAS12 Standard has been seriously to weaken the balance sheets of corporate NZ by $billions - and as collateral damage weaken reported NTA/share and any debt/equity covenants.

Nowhere else (to my knowledge) are fictitious liabilities required to be reported on the face of the balance sheet as a transfer from/reduction in Equity.

This fictitious liability occurs because, unlike elsewhere, NZ does NOT have a capital gains tax regime. This means that the only 'real' deferred tax liability is the potential claw-back of formerly claimed tax depreciation on the sale of an asset.

If the tax depreciation of a Building is to be zero then the difference between the tax effect of accounting vs tax depreciation (at zero) is reporting the full deferred tax liability under NZIAS18 Balance Sheet accounting. The bigger the accounting depreciation, the bigger the fictitious reported deferred tax liability.

There is a solution. NZ ought to have an 'Urgent Issues Group' (or equivalent) able to recommend to the FRSB/ASRB on the proper reporting of NZ Financial Statements for NZ special conditions - until such time as IFRS can be amended to recognise such anomalies - if ever. This is a classic example of one of those rare occasions.

The reason for so doing is better to enable Directors to present a more realistic 'true and fair view' of their Financial Statements as required under the Financial Reporting Act for the benefit of users and stakeholders alike.

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Correction, with apologies - reference to NZIAS18 should be to NZIAS12.

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