Introduction: A$480 million. In the given assignment, we

Introduction:

Hotel
Property Investments (HPI) Ltd. is an internally managed Real Estate Investment
Trust (REIT) with investments in Australian hotels and pubs and associated speciality
stores located on these pub sites. The assets provide consistent income by leasing
them to quality tenants. Coles and ALH are its premium clients and the company
currently derives almost 95% of its revenue from these two companies. The
company has growth opportunities by the existing portfolio and capacity for
future acquisitions. It is listed in Australian stock exchange (Ticker: HPI)
and has a market capitalization of A$480 million.

In the
given assignment, we analyse the accounting for income tax expense of the
company. The accounting treatment for Income Tax is covered in AASB 112 “Income
Taxes”. The tax expense comprises of current tax and deferred tax, and how
these 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, the
trust income is exempt from tax subject to certain conditions. So, the majority
part of the company’s income is tax free.

However,
the company is liable to corporate income tax. It has formed a tax consolidated
group with its wholly owned subsidiaries and these are subject to tax at the
corporate income tax rate of 30% (2016: 30%).

The HPI
Rights Plan Trust, a subsidiary of the Company, is subject to income tax at the
top marginal tax rate of 49%.

 

 

Question
1: Corporate Accounting

i)

Equity

The
equity portion of the company comprises of contributed equity, retained
earnings and reserves. Equity or shareholder funds represent the contribution
of the owners of the company and the profits that have been retained by the
company for future growth and expansion. It also includes other comprehensive
income 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 the
shareholders. It consists of 146.1 million units issued by the company. These
units are stapled to the shares in the company and are known as “stapled
securities”. The holders of these units are entitled to dividends and have voting
power. There has been no change in contributed equity during 2016-17.

Retained earnings – It is the amount of profit not distributed
to the shareholders and retained by the company for growth and expansion of the
business. It comprises of the accumulated reserves of the company. It includes
the opening profits + current year profits – dividends paid and proposed
dividends. The company earned A$99 million during 2017. It paid a dividend of
A$32 million and has proposed dividend of A$15 for the current year.

Reserves – It comprises of other comprehensive income
and includes cash flow hedging reserves, treasury share reserves, and share
based payment reserve. There has been a profit of A$1.9 million with change in
fair value of hedging instruments. Moreover, there has been loss of A$186,000
as the company has purchased its own securities (treasury stock) and held by
the 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 tax
expense for 2017 is A$2,000. It comprises of current tax expense of A$35,000
and deferred tax income of A$33,000. It is lower than tax expense of A$15,000
for 2016. The majority part of the income is tax free as trust income exempted
from taxation liability.

The tax
expense is lower in 2017 because the company has recognised deferred tax income
in 2017, with an increase in deferred tax assets on account of employee
liabilities and accrued expenses.

Current
Tax – It is the tax payable which has been calculated in accordance with tax
laws of the country. In some circumstances, the requirements of these laws to
compute taxable income differ from the accounting policies applied to determine
accounting income. The effect of this difference is that the taxable income and
accounting income may not be the same.

Deferred
Tax – The differences between taxable income and accounting income can be
classified into permanent differences and temporary differences. Permanent
differences are those differences between taxable income and accounting income
which originate in one period and do not reverse subsequently. Temporary
differences are those differences between taxable income and accounting income
for a period that originate in one period and are capable of reversal in one or
more subsequent periods.

Permanent
differences do not result in deferred tax assets or deferred tax liabilities. The
tax effects of temporary differences are included in the tax expense in the statement
of profit and loss and as deferred tax assets (subject to the consideration of
prudence) or as deferred tax liabilities, in the balance sheet. Due to
temporary differences, if the company is paying higher current tax in this year
and will be paying lower taxes in the future by adjusting the higher tax
payment of this year, it will lead to creation of deferred tax assets. On the
other hand, if the taxable income is lower this year as compared to accounting
income due to certain temporary differences, it will lead to deferred tax
liabilities. The company is paying lower taxes this year and will have to pay
higher taxes in the future.  

 

iii)

The tax
expense 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 trust
income is tax free

·          
There are items of permanent differences in accounting income. Tax is
paid on taxable income, which may be different from accounting income. There
are certain expenses and income which may be disallowed as per income tax laws.
These differences may reverse in the future (temporary differences) or may not
reverse in the future (permanent differences). If there are permanent
differences, the tax expense of the company will be different from statutory
tax rate of the regime.

·          
Changes in tax rate also affect the value of deferred tax asset or
liability. Due to changes in tax rate of the regime, the tax expense is
impacted and will not tally with statutory tax rate.

A
reconciliation of the tax expense of the company with accounting income times
tax 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)

Deferred
tax is created due to temporary differences. The company has reported a
deferred 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, the
deferred tax asset was A$68,000. The deferred tax asset has increased by
A$33,000, which is reported as on income in income statement. The deferred
asset 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 of
the possible reasons for the deferred tax asset / liability are as follows:

1.       
Accrued revenue – The company has accounted for certain income on
accrual basis in the current year, while the tax will be paid on income
received in the future. Hence, the company has not paid tax on the particular
income in the current year, and will have to pay the taxes in the future when
the income is received.

2.       
Plant and Equipment – The company has charged lower depreciation as per
Income Tax Act, due to which it is paying higher tax now. The benefit will
accrue in the future when the depreciation as per IT Act will be higher in
future years. Hence, it will pay lower taxes in the future because of higher
tax base.

3.       
Accrued expenses – The deferred tax assets due to accrued expenses have
decreased in the current year. It means that there have been a reversal of
expenses, 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 related
expense as per Income Tax Act, while the entire expense have been charged to
income statement. So, the company is paying higher current tax in the current
year, and the same is expected to reverse in the future. In future years, the
expense will be amortized as per income tax resulting in lower taxable income. It
results in a tax benefit as the company will be paying lower taxes in the
future.

5.       
Tax losses – The trust income is exempt from tax. The company has
incurred losses as per Income Tax Act after adjustments. These losses expected
to set off in the future as the company has positive taxable income in the
future. It has resulted in creation of deferred tax assets.

 

v)

There
are no current tax assets or income tax liability in the balance sheet of the
company. 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 cash
flow 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 numbers
indicate that the tax paid in cash flow statement includes other tax also, like
GST. Alternatively, taxation liability might have been included in other
payables.

 

 

 

vii)

On
analysis of the company’s financial statements in relation to tax expense and
deferred tax asset and liability, there are certain observations which have led
to improvement in academic understanding on accounting for income tax. Some of
my observations are as follows:

·          
On detailed analysis of why tax expense is not same as accounting income
times the tax rate, one of the reasons was change in tax rate. If there are
changes in the tax rate, it will have an effect of deferred tax asset or
liability, and hence it will impact on tax expense. An increase in tax rate
will create an income if there is a deferred tax asset, and it will lead to a
loss in case of a decrease in tax rate.

·          
The current tax expense is lower than tax paid as per cash flow
statement. It explains that there was income tax liability in the beginning of
the year, which has been paid in the current year. However, no such tax
liability is reported in the balance sheet of the company. It might have been
grouped in other liabilities.

·          
Accrued revenues normally lead to creation of deferred tax assets as the
local tax laws require tax payment on earlier of accrual or cash basis, while
accounting standards require revenue recognition on accrual basis. However, the
company has recognised deferred tax expense and a liability in 2017, which is
not explained in the annual report.

 

 

 

References

Hotel Property Investments.
(2017). Annual Report. Hotel Property Investments.

Yahoo. (2018, Jan 12). Summary. Retrieved from
https://finance.yahoo.com: https://finance.yahoo.com/quote/HPI.AX?p=HPI.AX

 

 

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