Introduction:HotelProperty Investments (HPI) Ltd. is an internally managed Real Estate InvestmentTrust (REIT) with investments in Australian hotels and pubs and associated specialitystores located on these pub sites. The assets provide consistent income by leasingthem to quality tenants. Coles and ALH are its premium clients and the companycurrently derives almost 95% of its revenue from these two companies.
Thecompany has growth opportunities by the existing portfolio and capacity forfuture acquisitions. It is listed in Australian stock exchange (Ticker: HPI)and has a market capitalization of A$480 million. In thegiven assignment, we analyse the accounting for income tax expense of thecompany. The accounting treatment for Income Tax is covered in AASB 112 “IncomeTaxes”. The tax expense comprises of current tax and deferred tax, and howthese reconcile based on tax laws of the country in which the company resides.HPI is a company structured as a trust, and under the Australian laws, thetrust income is exempt from tax subject to certain conditions. So, the majoritypart of the company’s income is tax free. However,the company is liable to corporate income tax.
It has formed a tax consolidatedgroup with its wholly owned subsidiaries and these are subject to tax at thecorporate income tax rate of 30% (2016: 30%). The HPIRights Plan Trust, a subsidiary of the Company, is subject to income tax at thetop marginal tax rate of 49%. Question1: Corporate Accountingi)EquityTheequity portion of the company comprises of contributed equity, retainedearnings and reserves. Equity or shareholder funds represent the contributionof the owners of the company and the profits that have been retained by thecompany for future growth and expansion. It also includes other comprehensiveincome of the company. Equity (A$ ‘000) As on 30th June 2017 As on 30th June 2016 Contributed equity 262,640 262,640 Retained earnings 124,729 72,709 Reserves (169) (1,937) Total Equity 387,200 333,412 Contributed equity – It is the amount contributed by theshareholders.
It consists of 146.1 million units issued by the company. Theseunits are stapled to the shares in the company and are known as “stapledsecurities”. The holders of these units are entitled to dividends and have votingpower.
There has been no change in contributed equity during 2016-17.Retained earnings – It is the amount of profit not distributedto the shareholders and retained by the company for growth and expansion of thebusiness. It comprises of the accumulated reserves of the company. It includesthe opening profits + current year profits – dividends paid and proposeddividends. The company earned A$99 million during 2017. It paid a dividend ofA$32 million and has proposed dividend of A$15 for the current year.
Reserves – It comprises of other comprehensive incomeand includes cash flow hedging reserves, treasury share reserves, and sharebased payment reserve. There has been a profit of A$1.9 million with change infair value of hedging instruments. Moreover, there has been loss of A$186,000as the company has purchased its own securities (treasury stock) and held bythe trust.
Particulars Contributed Equity Retained Earnings Reserves Total Equity As on 1st July 2016 262,640 72,709 (1,937) 333,412 Profit for 2016-17 98,899 98,899 Fair value for cash flow hedges 1,937 1,937 Distribution to security holders (46,879) (46,879) Share based payments 17 17 Treasury stock (186) (186) TOTAL 262,640 124,729 (169) 387,200 ii)The taxexpense for 2017 is A$2,000. It comprises of current tax expense of A$35,000and deferred tax income of A$33,000. It is lower than tax expense of A$15,000for 2016. The majority part of the income is tax free as trust income exemptedfrom taxation liability.The taxexpense is lower in 2017 because the company has recognised deferred tax incomein 2017, with an increase in deferred tax assets on account of employeeliabilities and accrued expenses.CurrentTax – It is the tax payable which has been calculated in accordance with taxlaws of the country.
In some circumstances, the requirements of these laws tocompute taxable income differ from the accounting policies applied to determineaccounting income. The effect of this difference is that the taxable income andaccounting income may not be the same.DeferredTax – The differences between taxable income and accounting income can beclassified into permanent differences and temporary differences. Permanentdifferences are those differences between taxable income and accounting incomewhich originate in one period and do not reverse subsequently. Temporarydifferences are those differences between taxable income and accounting incomefor a period that originate in one period and are capable of reversal in one ormore subsequent periods.
Permanentdifferences do not result in deferred tax assets or deferred tax liabilities. Thetax effects of temporary differences are included in the tax expense in the statementof profit and loss and as deferred tax assets (subject to the consideration ofprudence) or as deferred tax liabilities, in the balance sheet. Due totemporary differences, if the company is paying higher current tax in this yearand will be paying lower taxes in the future by adjusting the higher taxpayment of this year, it will lead to creation of deferred tax assets. On theother hand, if the taxable income is lower this year as compared to accountingincome due to certain temporary differences, it will lead to deferred taxliabilities. The company is paying lower taxes this year and will have to payhigher taxes in the future. iii)The taxexpense of the company is different from accounting income times the tax rate.
It is because of the following reasons:· The company is carrying on its operations as a trust, and the trustincome is tax free· There are items of permanent differences in accounting income. Tax ispaid on taxable income, which may be different from accounting income. Thereare certain expenses and income which may be disallowed as per income tax laws.These differences may reverse in the future (temporary differences) or may notreverse in the future (permanent differences). If there are permanentdifferences, the tax expense of the company will be different from statutorytax rate of the regime. · Changes in tax rate also affect the value of deferred tax asset orliability. Due to changes in tax rate of the regime, the tax expense isimpacted and will not tally with statutory tax rate.
Areconciliation of the tax expense of the company with accounting income timestax rate is provided below: A$ ‘000 Accounting Income 98,901 Tax @30% 29,670 Trust income exempted from tax (29,611) Tax effect of permanent differences (92) Impact of changes in tax rate 35 Tax expense charged to income statement 2 iv)Deferredtax is created due to temporary differences. The company has reported adeferred tax asset of A$103,000 and deferred tax liability of A$2,000,resulting in net asset of A$101,000. As on 30th June 2016, thedeferred tax asset was A$68,000.
The deferred tax asset has increased byA$33,000, which is reported as on income in income statement. The deferredasset and liability are on account of the following: Particulars (A$ ‘000) 2017 2016 Net Accrued revenue (2) – (2) Plant & Equipment 3 – 3 Accrued expenses 47 67 (20) Employee liabilities 51 1 50 Tax losses 2 – 2 Total 101 68 33 Some ofthe possible reasons for the deferred tax asset / liability are as follows:1. Accrued revenue – The company has accounted for certain income onaccrual basis in the current year, while the tax will be paid on incomereceived in the future. Hence, the company has not paid tax on the particularincome in the current year, and will have to pay the taxes in the future whenthe income is received.2. Plant and Equipment – The company has charged lower depreciation as perIncome Tax Act, due to which it is paying higher tax now. The benefit willaccrue in the future when the depreciation as per IT Act will be higher infuture years. Hence, it will pay lower taxes in the future because of highertax base.
3. Accrued expenses – The deferred tax assets due to accrued expenses havedecreased in the current year. It means that there have been a reversal ofexpenses, and the company has adjusted some of its previous year recognition.The deferred tax asset have reduced, and hence an expenses has been recognised.
4. Employee liabilities – The company has amortized certain employee relatedexpense as per Income Tax Act, while the entire expense have been charged toincome statement. So, the company is paying higher current tax in the currentyear, and the same is expected to reverse in the future. In future years, theexpense will be amortized as per income tax resulting in lower taxable income. Itresults in a tax benefit as the company will be paying lower taxes in thefuture.5. Tax losses – The trust income is exempt from tax.
The company hasincurred losses as per Income Tax Act after adjustments. These losses expectedto set off in the future as the company has positive taxable income in thefuture. It has resulted in creation of deferred tax assets. v)Thereare no current tax assets or income tax liability in the balance sheet of thecompany.
There is a current tax expense of A$35,000 in the current year.However, there are no separate line items for tax liability. vi)The cashflow statement shows that the tax paid by the company in 2017 is A$78,000.However, the current tax expense is A$35,000 and income tax expense is A$2,000.Moreover, there is no tax liability in the balance sheet. These numbersindicate that the tax paid in cash flow statement includes other tax also, likeGST. Alternatively, taxation liability might have been included in otherpayables.
vii)Onanalysis of the company’s financial statements in relation to tax expense anddeferred tax asset and liability, there are certain observations which have ledto improvement in academic understanding on accounting for income tax. Some ofmy observations are as follows:· On detailed analysis of why tax expense is not same as accounting incometimes the tax rate, one of the reasons was change in tax rate. If there arechanges in the tax rate, it will have an effect of deferred tax asset orliability, and hence it will impact on tax expense. An increase in tax ratewill create an income if there is a deferred tax asset, and it will lead to aloss in case of a decrease in tax rate.
· The current tax expense is lower than tax paid as per cash flowstatement. It explains that there was income tax liability in the beginning ofthe year, which has been paid in the current year. However, no such taxliability is reported in the balance sheet of the company. It might have beengrouped in other liabilities.· Accrued revenues normally lead to creation of deferred tax assets as thelocal tax laws require tax payment on earlier of accrual or cash basis, whileaccounting standards require revenue recognition on accrual basis. However, thecompany has recognised deferred tax expense and a liability in 2017, which isnot explained in the annual report. ReferencesHotel Property Investments.
(2017). Annual Report. Hotel Property Investments.Yahoo. (2018, Jan 12).
Summary. Retrieved fromhttps://finance.yahoo.com: https://finance.yahoo.com/quote/HPI.AX?p=HPI.AX