FRS40 on Investment Property
From 2007, annual changes in the fair value of investment properties are carried to P&L account.
So increased valuation of such properties would increase profit and consequent tax burden, vice versa. Recently, Overseas Union Enterprises (OUE) recorded fair value gains of $105.9 million in Q207 (nil in Q206) on its investment properties, due to the escalation in property values in line with the present exciting real estate market.
Such property firms would have already a cashflow issue in complying with FRS40 ie. cash to pay income tax on unrealised revaluation gains.
In addition to the above, property firms has another angle to consider ie. the impact of FRS12 on Income Tax on FRS40.
Companies have to account for the FUTURE tax consequence of a CURRENT event. This element of deferred income tax for any upward revaluation would have to be accounted for as an expense in the P&L.
What is “future tax consequence of a current event”?
An upward revaluation of an investment property
==> an increase in future stream of rental income OR increase in proceeds from disposal
==> make provision for the future tax liability today ie. deferred tax
While there is no actual cashflow for the provision, it is accounted for as an expense to create that provision.
Consequently, higher tax expense and higher effective tax rate.
Reference – “Property companies could be hit by deferred tax provision issues”, Aug 2, 2007 Busines Times, Michelle Quah