How should this adjustment be calculated? Is it appropriate to calculate this as a fixed percentage (e.g., 50%) of the deferred tax liability calculated for the vehicle under IFRS/local GAAP on a portfolio basis or any other aggregate basis?
The rationale behind this adjustment is that under IFRS (and many other GAAPs) deferred tax liabilities are measured at the nominal statutory tax rate. The manner in which a vehicle expects to settle deferred tax is generally not taken into consideration. Accordingly, the provision calculated on this basis may not be representative of the fair value of deferred tax liabilities (i.e., the actual amounts expected to be crystallised upon disposal of the property assets).
In calculating the adjustment of the fair value of the liability, based on the expected manner of settlement, the adjustment should be assessed on an asset-by-asset basis.
For each asset, therefore, consideration should be given as to the most likely form of disposal (e.g., asset deal or share deal) based on the intended disposal method and tax structuring of the asset as well as market conditions relevant to that property as at the date of calculation. Assumption of changes in disposal method based on as-yet unrealised future changes in market conditions are considered too subjective for the purposes of calculating the INREV NAV adjustments. If applicable, the history of the entity with regard to disposals should also be considered. The fair value of the deferred tax liability is then calculated in accordance with the assessed manner of settlement as well as the applicable rates at which the transaction would be taxed. IFRS allows only the rates that have been enacted or substantially enacted at the balance sheet date to be used whereas rates which have been enacted or substantially enacted after the balance sheet date can be used for the purposes of calculating the INREV NAV adjustment.
The calculation should also take into account any discounts to the sale price of a property sold via a share deal that are likely to be granted. For example, it may be that the sale of the shares of the property-owning entity is exempt from tax (or attracts minimal tax) but a deduction in respect of the latent capital gain within the property owning entity is made in arriving at the sale price. This amount in addition to any tax likely to crystallise on the disposal transaction should be taken into account when calculating the INREV NAV adjustment.
On this basis, therefore, a fixed percentage approach as outlined above will not be appropriate unless it represents a reasonable estimate of the adjustment required in respect of the deferred tax liability for each of the individual properties in the portfolio.
It is imperative to ensure that the calculation of the adjustment, either in part or in full, is not already included within the deferred tax liability calculated for the vehicle under IFRS/local GAAP, so as to avoid double-counting of the adjustment. Care should also be taken to ensure that there is no double-counting between this adjustment and the INREV adjustment on transfer taxes with regard to the valuation of property. For avoidance of doubt, transfer taxes should not be included within the scope of the deferred taxation adjustment calculation.
Given the subjective and complex nature of this calculation, therefore, it is recommended that managers document a formal internal policy with regard to the calculation methodology and review the policy on an ongoing basis (for example, with respect to changes in tax law and market conditions) in order to ensure that it remains appropriate. Disclosure should be given on the overall tax structure, including the overall ownership structure, key assumptions and broad parameters for each country, what the maximum taxation calculation would be on a traditional basis (i.e., without tax structures) and the approximate tax rate as a percentage.