Treatment of Fixed Assets under the new Corporate Profit Tax rules, amended IFRS 16 coming into force and changes in Property Tax Law – making it easier or less easy to report?
End of 2018 has brought many changes in Serbian tax landscape, making it easier to report accounting versus tax value of fixed assets for the accountants, but also causing huge homework for the beginning of 2019. Namely, changes in Corporate Profit Tax (CPT) have also addressed the tax value calculation of fixed assets, by removing the local specific of degressive tax depreciation and amortization method, with fixed depreciation and amortization rates. Amendments to IFRS framework have brought changes in recognition of rental agreements, broadening the scope of fixed assets identification process. On top of this, the Property Tax Law have brought back the possibility of using the fair value of the real-estates as the taxable base for certain types of property. How does this affect your business and is now really everything clear?
What is your add-on to fixed assets list?
Under the existing rules, valid till 31 December 2018, lessees account for lease transactions either as operating or as finance leases, depending on complex rules and tests. Similar to IAS 17, new rule includes all contracts that convey the right to use an asset for a period of time in exchange for consideration, except for licenses of intellectual property granted by a lessor, rights held by a lessee under licensing agreements (such as motion picture films, video recordings, plays, manuscripts, patents and copyrights), leases of biological assets, service concession agreements and leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources. There is an optional scope exemption for lessees of intangible assets other than the licenses mentioned above.
Both lessors and lessees are required to determine if a right to use an underlying asset is a separate lease component in their contracts if both of the following criteria are met:
- The lessee can benefit from use of the asset either on its own or together with other resources that are readily available to the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee has already obtained (from the lessor or from other transactions or events); and
- The underlying asset is neither dependent on, nor highly interrelated with, the other underlying assets in the contract.
Lessees should initially recognize a right-of-use asset and lease liability based on the discounted payments required under the lease, taking into account the lease term as determined under the new standard. Initial direct costs and restoration costs are also included (i.e. reflecting the put-into-use costs that are normally recognized in the acquisition cost of the assets). So, the concept of right-of-use is replacing the approach of risk coverage (that was the main factor in determining whether the business arrangement would be assessed as operating lease).
How is this affecting your company? Structure of your income statement and balance sheet will change, even without changing the total payments from your company to the lessor:
- Structure of income statement – basically, the lease payment will no longer be presented as the operating expense in total, but split in two components:
- Depreciation for the value of the contract recognized as fixed assets and
- Interest expense.
- Also, keep in mind the change in balance sheet – the recognition of the fixed assets and the lease liability is changing the total value of business assets/liabilities.
- The last, but not the least, the total expense recognition shall not change, but the distribution of the expense throughout the lease duration is different, i.e. there are no equal amounts on monthly basis. This is due to requirements of IFRS 15 (amended version in force since 1 January 2018 and applicable to financial statements for 2018) that splits the value of goods and service and distributes the “due date” of the expenses accordingly.
The effects will be mostly visible for the companies that have lots of lease arrangements, e.g. wholesale companies using car lease agreements for sales managers or renting valuable significant office space. Please note what you need to check to understand whether you need to change the presentation of the lease agreement in your financial statements:
- Does the contract contain “the right to control the use of an identified asset for a period of time in exchange for consideration” (requirement under IFRS 16, para. 9) meaning:
- Whether there is “identified assets” – this means that you have agreed on the asset that cannot be replaced by the lessor without your consent (e.g. agreement to use fixed place of electronic board instead of agreement to place electronic board in “several locations downtown, where the lessor will determine the locations on monthly level”)
- whether you as the lessor can collect all economic benefits from using the assets during lease period (whether you have the exclusive right to use the asset) and
- whether you have the right to direct the use of the asset?
- If there is a definite period of lease, to assess whether there is interest in prolonging the lease period, as well to confirm that probably there will be no cancellation of lease during the lease period agreed upon;
- Whether the lease agreements have “low-value” items – if the value of the lease agreement is not significant (significant = significant to your own volume of income statement and balance sheet) – in such case, you may continue simply booking this contract through operating expenses.
New system of tax value determination – changes in tax depreciation model
New system of calculation is not preventing the tax payers to establish useful life of the assets in accordance with their economic reality for accounting purpose but will keep prescribed rates of depreciation for tax purpose. The lower of the amounts (accounting depreciation and tax depreciation) shall be considered as the amount deductible through tax balance.
The continuum in application of the “old” rules to the assets acquired prior to 1 January 2018 will continue till 31 December 2028.
How does this affect the accounting system of the company in practice? First of all, setting of linear depreciation method for tax purpose would enable keeping the fixed assets records at two different depreciation and amortization rates in the same accounting system and enabling direct review of temporary difference in value (as a component of deferred tax calculation) – previous set-up was almost impossible to be implemented in many software solution used by the foreign investors. As a result in most cases the companies were keeping records on tax value in Excel sheets, where the transparency of calculation always depend on the individual sense of the person in charge for technical presentation. So, the new rule should enable coming closer to most of European systems and keeping the records in the accounting software. However, the dual system i.e. treatment of the assets purchased by 31 December 2018 requires separate solution for calculation of degressive method and combined evidence (presumably, again manual work for lots of tax payers).
Property tax treatment – getting back to fair value and rehabilitation of SME sector
Apart from the income tax effects mentioned in terms of lease contracts, very important component and source of tax burden are the real-estates. Over last five years, many of SME companies have been affected by the distinction in SME IFRS version of IAS 16 – Fixed assets compared to full version of IFRS, that have been preventing them to account for real-estates, subject to property tax, at fair value (acquisition cost was the only method of recognition allowed). Hence, the standard rule that the tax treatment should follow the accounting treatment applied by the tax payer have not been respected and was discriminating SMEs due to failure of the Government to timely adjust the PTL to this matter.
With the changes in IFRS for SME, introducing fair value approach for fixed assets (previously, only for investment property), the real-estates owned by SMEs are to be taxed by applying the property tax rate at the fair value of the property under the following conditions (selected items from the list mentioned in the PTL, affecting manufacturing and service companies):
- The real estate is classified as:
- Plants (if used in processing industry, i.e. manufacturing)
- Warehousing capacities
- Waste treatment capacities
- The value of real-estate within fixed register assets is not separated from the value of the land where it is located;
- Fair value can also be applied for taxable base determination for the newly acquired assets (i.e. acquired during the business year).
The fair value assessment (appraisal report) should be performed with the date 31 December of the business year for which the property tax is calculated. The appraiser can be either court sworn expert in construction or the certified appraiser.
This alignment of IFRS framework and the PLT is improving the situation of SMEs owning the real-estate, although the requirement per IFRS framework is to re-assess the fair value in accordance with market changes and events that can cause significant change in asset value, while PLT envisages regular annual assessment (i.e. appraisal) which means additional burden for SMEs. So, the savings are somewhere in between in tax savings and value of expert services agreed upon and do not forget that, in order to keep the fair value as the chosen approach you always must re-assess the value of the complete group of assets.
The last, but not the least… How does IFRS changes help in understanding and justifying the cross-border taxation of lease agreements (i.e. split of right to tax between the countries)?
Serbia has concluded so far 58 double taxation avoidance agreement (DTA), helping to understand the split of right to tax between Serbia and counterparty-countries. One of the articles of each DTA (except for Croatia and Switzerland, until the protocol of mutual application of withholding taxation is signed) refers to taxation of right-of-use over the asset. This brings in the question how to justify whether the cross-border agreement reflects the right-of-use versus pure service agreement?
Serbian Tax office shall normally prescribe withholding taxation in all rental agreements where they identify the assets being used for production or commercial activity by the local user. Most of cross-border agreements including renting the equipment are concluded between the local entities and their related parties abroad, with the intention to shorten the procedure of searching for the appropriate assets and providing more beneficial terms of asset use for the local entity. Now, is it really that every cross-border contract should give rise to withholding taxation in Serbia?
To repeat, right-of-use of assets, per IFRS 16 includes:
- Identified assets;
- Exclusive use of the assets by the local entity, i.e. collection of all economic benefits over the period of use;
- Control over the use of assets.
For the general purpose assets having in mind that the foreign mother-company may use the benefit of regional presence to allocate the equipment as-available among the subsidiaries in the region, the exclusive use and identified assets become very flexible categories. Mother-company may opt for providing the subsidiary with the asset that is replaced with another item (of similar characteristics) if the first item of asset is needed in another subsidiary now. Control over the use of assets is also commonly determined by the mother-company.
So, as long as there is no clear guidelines how to determine the criteria for distinguishing between the right-of-use and the pure service contract, the taxpayers remain at risk that any cross-border rental agreement shall be subject to withholding tax in Serbia, due to conclusion that the equipment is used for production or commercial activity (either directly or indirectly), disregarding the specifics of the contract itself. We believe that the common principle of aligning the tax practice with accounting framework should also be applied in this case.