The impacts of the economic response package on accounting standards and annual accounts will be the last thing that businesses are thinking about at the moment. But these impacts could be significant and hugely positive according to Grant Thornton New Zealand.
“In the mysterious world of accounting standards, entities have to account not only for their current tax obligations, but also for something that is known as deferred tax”, says Don MacKenzie, Tax Partner at Grant Thornton New Zealand.
“Deferred tax can either be an asset or a liability. When depreciation was removed from buildings, for some it resulted in large deferred tax liabilities on the balance sheets of businesses that owned buildings. It also created a large one-off increase in tax expense which reduced accounting profit.
“As this was just an accounting entry no actual tax was paid – but increased tax would be paid over the life of the building as the tax deduction for depreciation had been removed. The large accounting adjustment takes into account that more tax would have to be paid in one go all upfront”, says MacKenzie.
As part of the Government’s COVID-19 economic response package announced on Tuesday, deductions for depreciation on industrial and commercial buildings have been reintroduced from the 2021 income year onwards. This will mean from 1 April 2020 most businesses that own buildings, will be able to once again deduct depreciation. Some businesses may already now be able to deduct depreciation, depending on their balance date.
MacKenzie says, “This is good news for Kiwi businesses that own commercial buildings; they will be able to claim depreciation when calculating their income tax, and will therefore pay less tax which will ease some of the pressure from the COVID-19 pandemic.
“And for some there’s a second hidden gem in those mysterious accounting standards.
“Ten years ago, businesses took a large one-off hit to accounting profit and a reduction to their net assets. As of Tuesday, they have the opposite. There will likely be a one-off increase to their accounting profit and an increase in net assets due to the reversal of the deferred tax liability that has been recognised on buildings that have an economic life of 50 years or more.
“Even though this change is spread over future years, the benefit is recognised in one go upfront. And this could even be the case for accounting periods that have finished but have not been signed off - for example, 31 December 2019 - as the accounting standards impose a disclosure requirement where the effect of applying changes that have been announced but not yet substantively enacted is expected to be significant.
“It may mean for instance that some companies will stay solvent. That’s because the test of solvency is that assets exceed liabilities and liabilities have been decreased as a result of the Government announcement. This increases the ability for company directors to do certain things like pay dividends, consolidate entities and the like.
“It may also mean that some businesses will continue to meet their banking covenants for longer,” says MacKenzie.
Don MacKenzie
Partner, Tax
Grant Thornton New Zealand
T +64 21 221 3275
E don.mackenzie@nz.gt.com