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Reduction in deferred tax on buildings

The Government’s response package to COVID-19 includes the reintroduction of tax depreciation on commercial and industrial buildings from the start of the 2020/21 income year. This change will result in a significant reduction in the deferred tax liabilities recognised by many entities.

Summary

The reintroduction of tax depreciation on commercial and industrial buildings will result in a significant reduction in deferred tax liabilities for many entities with building assets.

The adjustment to reduce the deferred tax liabilities in relation to buildings should be recognised in the 2020 accounts for March and June balance dates entities.

The credit associated with this adjustment should be recognised in tax expense.

This change generally applies to buildings classified as property, plant and equipment. It would also apply to investment property buildings, where the presumption of recovery by sale has been rebutted.

This change applies to income tax paying entities, using either the Tier 1 or Tier 2 standards (both public benefit entities and for-profit entities).

The most significant reduction in deferred tax liabilities will relate to pre May 2010 building costs.

In general, the deferred tax calculation will no longer need to include adjustments for non-depreciable building assets. This should simplify the deferred tax calculations for many entities.

Analysis

Deferred tax on buildings is generally calculated based on the difference between the carrying value of the asset and its tax base. The tax base of an asset is the amount that will be deductible for tax purposes.

The removal of tax depreciation on buildings in May 2010 reduced the tax base of certain building assets to zero. This resulted in the recognition of additional deferred tax liabilities for many entities. However, due to the initial recognition exception, this additional liability generally only applied to building costs recognised prior to 21 May 2010.

Legislation to reintroduce tax depreciation on commercial and industrial buildings was enacted on 25 March 2020. As a result of this change, the deferred tax liabilities previously recognised in relation to non-depreciable buildings can now generally be reversed.

For accounting purposes, the adjustment to reduce the deferred tax liabilities in relation to buildings should be recognised in the first balance date after the change was enacted. For example, the adjustment should be recognised in the 2020 accounts for March and June balance dates entities.

As the reduction in deferred tax is unrelated to items recognised in equity or other comprehensive income, the credit associated with this adjustment should be recognised in tax expense. The adjustment should be separately disclosed in the components of tax expense and the tax note reconciliation.

This change applies to income tax paying entities, using either the Tier 1 or Tier 2 standards (both public benefit entities and for-profit entities). It would not generally apply to public sector entities using the PBE Tier 3 standard, as these entities are not required to recognise deferred tax.

The reduction in deferred tax liabilities will generally apply to buildings classified as property, plant and equipment. It would also apply to investment property buildings, where the presumption of recovery by sale has been rebutted. It would not apply to buildings held for sale or to investment properties where the presumption of recovery by sale has not been rebutted, as deferred tax on these assets is calculated on a sale basis.

In general, tax base of building assets should now agree with the balances shown in the tax fixed asset register, and the deferred tax calculation will no longer need to include adjustments for non-depreciable buildings. This should simplify the deferred tax calculations for many entities.

In previous years, the deferred tax calculations for most entities would have included an adjustment to remove the tax book value of non-depreciable building assets from the value shown in the tax asset register. This adjustment is no longer required, as the assets are now depreciable in future. The calculation may also have included an exception adjustment to remove the cost-based accounting book value of non-depreciable building costs recognised after 21 May 2010. For these costs, the initial recognition exception generally applied, and no deferred tax needed to be recognised on the temporary difference associated with the initial recognition of these building costs. However, now that these costs are depreciable again, this temporary difference no longer exists. As a result, in our view, the exception adjustment for non-depreciable building costs is also no longer required.

The most significant reduction in deferred tax liabilities will relate to pre 21 May 2010 building costs. For these assets, the taxable temporary difference will be reduced by the tax book value of the previously non-depreciable assets. However, there will also be reduction in deferred tax for post 21 May 2010 building costs, as the difference between the cost-based accounting book value and the tax cost of these assets will not have been previously recognised in the deferred tax calculation.

This change is likely to have a significant impact on tax balances for many entities with building assets, particularly airports, licensing trusts, and port companies. For some entities, the adjustment may result in a swing from a net deferred tax liability to a net deferred tax asset. If these entities do not satisfy the probable test, the deferred tax asset will need to be written off.

It should be noted that tax depreciation has only been reintroduced for commercial and industrial buildings. There is still no depreciation on residential buildings. The deferred tax calculations for entities with residential buildings will need to continue to include adjustments for non-depreciable building assets.

Disclaimer:
This document is intended only as a general guide, and should not be used or relied upon as a substitute for specific professional advice. No liability is accepted for loss or damage incurred by persons who rely on this document.

Page created: 7 April 2020