Have you considered the tax implications of changing financial reporting standards
Tax Alert - July 2018
By Iain Bradley & Belinda Spreeuwenberg
There have been a number of new accounting standards introduced that have relevance to every for-profit entity that reports under Tier 1 and Tier 2. These new accounting standards address revenue from contracts with customers, leases and financial instruments and are now largely in effect or will be in the near future.
While there are obviously accounting implications that every entity will need to work through, there are also tax implications of each accounting standard that should be considered. This is relevant not only for the income tax return, but also for tax accounting.
To determine the tax implications, it is important to understand the accounting treatment under the new accounting standards. So what is changing?
NZ IFRS 15 – Revenue from Contracts with Customers
This accounting standard introduces a comprehensive model to use in accounting for revenue arising from contracts with customers (i.e. sale of goods and services). It supersedes several existing revenue recognition accounting standards and interpretations and will take effect from annual reporting periods beginning on or after 1 January 2018 unless it was adopted earlier.
The key change is the five step approach to the recognition of revenue. This approach also addresses the treatment of customer options (i.e. separate performance obligations that provide a material right to the customer) and warranties included with the sale of goods or services.
This five step approach will mean that the accounting treatment follows a substance-based approach based on the transfer of control of the goods or services. This may result in changes from the existing accounting treatment and situations where the recognition of revenue may not follow the legal form.
Tax has generally been aligned with accounting in terms of timing of revenue, but certainly not always. With the accounting treatment following a substance-based approach compared to the legal form approach that tax tends to follow for the recognition of income, the tax impact should be considered particularly if the accounting treatment has changed.
NZ IFRS 9 – Financial Instruments
This accounting standard also took effect from accounting periods beginning on or after 1 January 2018, and introduces amendments to the classification and measurement of financial assets, a new expected loss impairment model and increased eligibility to hedge account amongst other changes.
For entities applying this accounting standard, tax tends to follow accounting unless an alternative spreading method under the financial arrangements rules is available. A change in accounting treatment may provide an opportunity to change the spreading method, and therefore the timing of income and / or deductions may also be able to be changed.
NZ IFRS 16 – Leases
Applying for accounting periods beginning on or after 1 January 2019, the new accounting standard for leases eliminates the distinction between finance leases and operating leases. Instead, for lessees all leases will be recognised “on balance sheet” unless the lease term is less than 12 months or the underlying asset is low value. The right-of-use asset will be depreciated and the lease liability will be amortised for accounting. The accounting for lessors will remain largely unchanged.
Most, if not all, entities will have a lease of some sort and will be impacted by this accounting standard. In most cases tax adjustments would be expected as the lease may not be a finance lease for tax as defined in tax legislation or if it is a finance lease for tax purposes, the tax treatment is unlikely to follow the accounting treatment.
For some entities there will be an adverse impact to their net asset position. If an entity is owned by non-residents or is a New Zealand company with overseas subsidiaries, this could adversely impact the entity’s thin capitalisation position and could result in the effective limitation of interest deductions.
The requirements for transitioning to the new accounting standards will also require some consideration as amounts may go through equity. Some of the accounting standards also have a number of transition options available. Using NZ IFRS 15 as an example, income may be recorded under the old revenue accounting standard in the year prior to adoption of NZ IFRS 15, and then again in the following year under the new NZ IFRS 15 accounting standard with an adjustment made in retained earnings. Another scenario could arise where the income is not recorded in the year prior to adoption of NZ IFRS 15 under the old revenue accounting standard, and is not recorded in the following year under the new NZ IFRS 15 accounting standard, as the five step approach recognises the income in the year prior to adoption of NZ IFRS 15. In this scenario no income would be recognised in the P&Ls for the two years, instead an adjustment would be made through retained earnings. In both of these scenarios care would need to be taken to ensure that the income is taxed and is only taxed once.
These changes not only add complexity to accounting, but also add complexity to tax as each entity will need to determine whether tax can follow the accounting treatment or whether there will be additional compliance or deferred tax implications.
The tax implications for changing financial reporting standards will need to be considered, and ideally would be assessed at the same time as the accounting impact and before year-end reporting. If you would like assistance with this, please contact your Deloitte advisor.
July 2018 Tax Alert contents
- New Zealand companies may be Australian resident under ATO ruling
- Stop press – June Tax Bill introduced