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Revaluation gain on investments to be booked as profit, resulting in tax liability

The way in which companies have to account for revaluation gains on their investment properties - broadly defined as properties held to earn rent or capital appreciation or both - has changed this year, thanks to the introduction of a new accounting standard.

But what some may not have realised is that the new standard could also introduce a tax element into the equation - which will hit bottomlines, in a significant way, from this financial year.

In a nutshell, it could mean that companies would have to account for revaluation gains and losses on their investment properties through the income statement, together with the related deferred tax provisions.

And with property prices soaring as much as they have this year, it will mean substantial revaluation gains for most - and also substantial deferred tax provisions.

Property companies are expected to be the most affected, because they have extensive portfolios of investment property.

Some have played down the move as no more than an accounting adjustment. But others have expressed their displeasure with the need to provide for deferred tax on revaluation gains.

From Jan 1, 2007, companies will have to adopt Financial Reporting Standard (FRS) 40 - which prescribes accounting and disclosure treatments for investment properties.

Under FRS 40, any changes in the fair value of an investment property held have to be taken to the profit and loss account - instead of to a revaluation reserve in the balance sheet, as previously allowed. In other words, an upward revaluation of investment property will add to the bottomline, while a downward revaluation will eat into earnings.

Then, there’s the tax effect of that.

Under another standard already in place - FRS 12, on income taxes - companies should have to account for the future tax related to this increase in property value. In accounting-speak, it’s to ensure that there is proper matching of the timing of the recognition of an event and its tax effect.

Looking at future rental stream

It would mean that an upward revaluation of any investment property would indicate an increase in the amount of future rental income or proceeds from disposal of the property. This increase is recognised in the income statement and, hence, there would need to be a corresponding recognition of the deferred income tax expense in the income statement.

PricewaterhouseCoopers (PwC) partner and assurance leader, Yeoh Oon Jin, who supports this position, explains: ‘It’s essentially a deferred tax position that’s been created in conjunction with the revaluation of the property. But it’s important to note that it’s a deferred tax provision which companies will have to reflect in their books - there is no actual tax paid in the year when the provision is made.’

In addition, some companies won’t actually have to physically hand over this amount in tax, for example in the case when they sell their properties and recognise a capital gain. Still, they will have to recognise these deferred taxes as an expense in their income statement as long as there is no plan to sell the properties - hurting their bottomlines.

And the impact could be significant.

Before FRS 40, Singapore companies didn’t account for deferred taxes on revaluation gains of investment properties because the effect to the financial statements could be immaterial.

Mr Yeoh explains: ‘As the revaluation gain of an investment property is accounted for in the revaluation reserve, under FRS 12, the related deferred tax would be accounted for against the revaluation reserve. Therefore, the amount of deferred tax vis-a-vis the net asset value of companies would generally be less significant and may be immaterial.’

‘However, under FRS 40, the changes in fair value have to be included in the profit and loss account - and generally, the amount of profit and loss for the year is only a fraction of the net asset value of many companies, especially the property-owning companies. Therefore, the deferred tax expense on fair value gains would be more material on adoption of FRS 40.’

Tham Sai Choy, incoming regional Asia Pacific head of audit at KPMG, emphasises that there has been no change in the accounting standard for deferred tax. ‘What has changed is that the new FRS 40 will see revaluation gains on investment properties being taken up as profit. This has focused the spotlight on the tax effect arising from that profit,’ he said.

It’s not a change that’s sitting too well with property companies here. It’s not just the potential negative impact to their bottomlines that they’re concerned about - it’s also what appears to be a departure from the current treatment that bothers them.

Currently, companies don’t pay tax on the gain from the sale of any property - as there is no capital gains tax in Singapore. And some property companies feel that revaluation gains in investment property should be treated as a capital gain, and not subject to tax.

Under FRS 12, deferred income tax is recognised in the books - but companies are only taxed when the profit is realised. But since gains from the sale of properties are not taxed even when the property is sold - because there is no capital gains tax - some feel that the deferred tax shouldn’t even be reflected in the accounts.

CapitaLand’s group CFO, Olivier Lim, comments: ‘Accounting standards require deferred tax to be provided for even when the tax liabilities are not immediately payable. That is entirely correct. However, where there is no expectation of a tax liability payable now or in future, it would be inappropriate to book a liability.’

But as PwC’s Mr Yeoh sees it: ‘One cannot dismiss that an increase in the fair value of the property is a representation of an expected increase in the future rental stream and/or proceeds from the ultimate disposal of the property.’

KPMG’s Mr Tham, however, is concerned that this complex issue may be over-simplified. ‘As with any complex accounting standard, it is tempting to over-simplify its interpretation. The accounting standard on deferred tax is one of the more complex standards, dealing with an area that is difficult for accountants as well as the companies that issue the accounts,’ he says.

He told BT that KPMG has had some ‘very involved discussions’ with property companies here - and is aware that there is a wide range of issues that will crop up from this.

One property company that foresees an issue with the new standard is City Developments Ltd (CDL). A CDL spokesman told BT: ‘Some accountants have interpreted the standard to mean that a deferred tax liability should be recorded immediately for the tax payable on future rental income. Yet, when the rental income is received, a further tax liability is set aside again. The tax is payable just once, but the liability would be set up twice. This distorts the accounts. When the asset is sold and assuming this is a non-taxable capital gain, it becomes clear that there is no tax liability to pay from the disposal. A gain gets recorded as a result of the reversal of the deferred tax liability previously recorded.’

Hidden gains and losses

Mr Tham believes the tax gain arising on disposal is an unintended effect of the accounting standards, and goes against the point of fair value accounting.

Other anomalies could also arise from careless interpretations of the standard, such as a company recording a loss immediately when it buys a property because of the deferred tax liability that will be recorded. And a property that requires no deferred tax provision might require one when the business decides it is no longer held for sale but is to be rented out instead.

Mr Tham also worries that the issue could be blind-sided by the current buoyant property market in Singapore.

‘Booking a deferred tax liability which is not payable means that the liability is reversed when the property is sold, creating an artificial gain. If property prices are falling, the reverse could happen, so that a ‘hidden’ loss arises when a property is sold,’ he said.

Mr Tham concludes: ‘We do not think the accounting standard, as with any standard, was meant to create accounts that are far removed from business realities. It falls on everyone concerned to apply business sense and professional judgement so that this accounting standard is applied correctly, ultimately so that the accounts make sense when they are issued.’

Source : Business Times - 2 Aug 2007

A new accounting rule has put frowns on the faces of some property companies here, as it could mean slimmer bottom lines for them from this financial year.

From Jan 1 this year, companies have had to comply with a new accounting standard for their investment properties - broadly defined as properties held to earn rent or capital appreciation or both. But what some don’t know is that there is a related tax element that is set to eat into earnings.

Property companies are expected to be the most affected, because they have extensive portfolios of investment property.

The issue stems from this year’s adoption of Financial Reporting Standard (FRS) 40. It says that companies who choose the fair value method of accounting for their investment properties will have to take any changes in the fair value of an investment property held to their profit and loss account. This is instead of taking the gain or loss to a revaluation reserve in the balance sheet, as previously allowed. This means, an upward revaluation of investment property will add to the bottom line, while a downward revaluation will whittle down earnings.

Companies are familiar with this new standard, but a debate is now raging about a related tax effect that comes with this new accounting treatment.

Some accountants believe that, according to another standard already in place - FRS 12, on income taxes - companies should account for the tax that is payable on any increase in the fair value of investment property. The logic is that an increase in the fair value of the property represents an expected increase in the future rental stream and/or proceeds from the ultimate disposal of the property.

And with FRS 40 saying that revaluation gains should be taken to the income statement, some are arguing that it is only right that the deferred tax payable is also taken to the income statement.

While there won’t be any actual tax paid, the sum will be recognised as an expense in the books from this year on.

The impact could be significant, with property prices soaring as much as they have this year - it will mean substantial revaluation gains for most property firms, and also substantial deferred tax provisions.

But property companies and some accountants don’t agree with this treatment. CapitaLand’s group chief financial officer, Olivier Lim, says: ‘Where there is no expectation of a tax liability payable now or in future, it would be inappropriate to book a liability.’

Some feel that since gains from the sale of properties are not taxed even when the property is sold - because there is no capital gains tax - the deferred tax shouldn’t even be reflected in the accounts.

Some accountants - and property companies like City Developments - also worry that the new suggested treatment would distort financial accounts unnaturally.

Source : Business Times - 2 Aug 2007

The Majestic, a historic three-storey building in Chinatown with a colourful past, is up for sale at an indicative price of about $43 million.

The commercial building in Eu Tong Sen Street is right next to another conservation block, the Yue Hwa Building, and is near the entrance of Chinatown MRT Station.

Formerly a cinema known as Majestic Theatre, The Majestic is owned by Cathay Realty, which in 2002 converted the cinema into a shopping mall at the cost of about $8 million.

It is still being used as a mall, though many tenants have moved out in view of the impending sale.

The freehold building has a gross floor area of 42,181 sq ft and a current net lettable area of 22,400 sq ft.

Assuming it is sold for $43 million, it will net the buyer a rental yield of about 5 per cent to 5.5 per cent, said Knight Frank, which is marketing the building.

Ground-floor rents at The Majestic can range from $30 per sq ft to $32 per sq ft, with the second and top floors attracting much lower rents, said the property consultancy.

The buyer could refurbish the conservation building to freshen it up, it said. In any case, the buyer will secure a piece of Singapore’s history.

The Majestic dates back to 1927 when philanthropist Eu Tong Sen - after whom the street is named - built it as an opera house on a whim for his opera-loving wife, after she was refused entry into another opera house.

Known then as ‘Tin Yin Moh Toi’ or Tin Yin Dance Stage, the opera house attracted glamorous opera stars from China who performed to full houses.

In 1938, Shaw Brothers rented the building and renamed it Queen’s Theatre. It screened Cantonese movies to keep up with changing times.

During the Japanese Occupation, it was renamed Dahe Theatre and screened Japanese movies.

After the war, it was renamed Majestic Theatre, a name which stayed until the end of its cinema days in 2002. The tender for The Majestic will close on Sept 13.

Source : Straits Times - 2 Aug 2007

Owners of five fairly small adjoining freehold residential developments in Mergui Road have banded together to sell the properties as one medium-sized lot for up to $125 million.

The properties - Norfolk Court, Mergui Lodge, Northern Mansion, Mergui Court and The Mergui - are located near Rangoon Road and Moulmein Road.

They are single apartment blocks and sit on relatively small plots of land.

But when combined, along with small pieces of state land in between, they will form a land area of about 93,355 sq ft.

This would allow the buyer to build a medium-scale condominium of up to 30 storeys and about 200 units, said Credo Real Estate.

The company yesterday put the properties up for sale through an expression of interest exercise, with an indicative price range of $115 million to $125 million.

This works out to between $488 per sq ft (psf) and $526 psf of potential gross floor area, including development charges of about $474,000 and a premium for the state land.

At this price, the buyer should be able to break even at about $800 psf to $850 psf, said Credo Real Estate’s executive director, Ms Yong Choon Fah.

In Mergui Road, Fragrance Properties’ new 60-unit freehold development Pristine Heights is selling well, with the 37 units sold in June achieving a median price of $981 psf.

Of the five developments, only Mergui Lodge does not yet have the required approval level of 80 per cent by share value to go ahead with a sale.

Mergui Lodge has only nine units, Northern Mansion and The Mergui have 18 units each, Norfolk Court has 20 units, while Mergui Court has 23 units.
 
Source : Straits Times - 2 Aug 2007

Price stability will be good for the market, says analysts

CAPITALAND Ltd, the biggest buyer of existing apartment blocks for redevelopment in Singapore in the past year, said en bloc sales have “peaked” as owners asked for record prices for their homes.

The market for existing buildings has hit a high “in terms of pricing”, said Mr Liew Mun Leong, chief executive officer of CapitaLand.

The developer, South-east Asia’s largest, had an 18.3-per-cent share in the city-state’s $13.49-billion en bloc collective sales from July last year to June, according to data from real estate consultant Knight Frank.

A frenzy of redevelopment around the Orchard area and the prime Holland Road residential district prompted the Government to raise a tax on property companies rebuilding some older apartments.

The purchases are done through collective or en bloc sales, where home owners jointly sell their developments.

“The problem now is that en bloc owners’ expectations are raising the hurdles,” said 61-year-old Mr Liew yesterday. “Going forward, en bloc owners must be realistic about what is marketable.”

Developers were buying older homes in prime areas to redevelop and resell at prices more than four times higher as demand for luxury apartments pushed prices to records.

Last year, a record 70 older developments were sold, totalling $8.1 billion, Knight Frank said. In the first half of this year, there were 48 transactions amounting to $9.48 billion.

“En bloc sales are about derived demand,” said Mr Nicholas Mak, Knight Frank’s research director. “As long as high-end property demand continues, the en bloc sales would continue.”

CapitaLand in June said it was buying Farrer Court in the Holland Road area for a record $1.3 billion. SC Global Developments Ltd, a builder of luxury homes in Singapore, said the same month it agreed to buy No 6 Ardmore Park for $262 million, or $2,338 per sq ft, the highest for an existing complex.

“There will come a time when the market cannot bear” the prices, Mr Liew said.

Some developments are having a harder time with en bloc sales. Pacific Mansions in River Valley had an asking price of $1.18 billion, or $2,400 per sq ft.

But the owners reportedly did not get bids that met their asking price, and are negotiating with possible buyers to achieve their reserve or minimum price, which is 10 to 20 per cent lower.

“We are seeing vendors adapting to be more accommodating,” said Mr Donald Han, managing director of Cushman & Wakefield Pte.

“Instead of expecting record price after record price, there is some price stabilisation, which will be good for the market.” — BLOOMBERG

Source : Today - 2 Aug 2007