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.
"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.
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.