Guidelines

Is it appropriate to calculate the fair value of the deferred tax liability as a fixed percentage of the total possible tax liability 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 (DTL) are measured at the nominal statutory tax rate. Also, there may be initial recognition exemptions (for example, IAS 12 “Income Taxes”, paragraph 15) that affect the basis for the DTL calculation for the accounting purposes. The manner in which a vehicle expects to settle deferred taxes is generally not taken into consideration. Accordingly, the DTL provision calculated based on the respective accounting rules may not be representative of the fair value of the DTL (i.e., the actual tax effects expected to be crystalised upon disposal of the property assets or a disposal price deduction in respect of the “latent capital gain tax”, as discussed below).

In calculating the adjustment of the fair value of the DTL, 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 entities directly or indirectly owning 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 DTL 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 a portion of the latent capital gain tax within the property owning entity is made in arriving at the sale price. This amount in addition to any tax likely to crystalise 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 DTL 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 DTL 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 the other taxes, including transfer taxes, are not mixed with the deferred income taxes assessed in this adjustment. The positive effect of the INREV adjustment “Revaluation to fair value of savings of purchaser’s costs such as transfer taxes“ with regard to the valuation of property should however be considered when assessing the fair value of the DTL. This is because the latent capital gain, subject to an eventual discount granted to the buyer, will likely consider the effects of transfer tax savings on the asset fair value. However, if in market practice the "Revaluation to fair value of savings of purchaser’s costs such as transfer taxes" is excluded from the agreed discount calculation on deferred taxes, this addition to the property's fair value might not be applicable for the purpose of the INREV DTL fair value.

Example:

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 ownership structure, key assumptions, expected manner of asset disposals and broad parameters for each country (including quantum of assumed discounts), what the maximum taxation calculation would be on a traditional basis (i.e., without tax structures) and the approximate tax rate as a percentage.

* Excluding possible tax effects of other INREV NAV adjustments as discussed in NAV-Q06-2

How are the “tax effects of INREV NAV adjustments” calculated? Do all INREV adjustments give rise to the INREV tax effects adjustment?

The rationale behind this requirement is to account for a possible tax impact of all INREV adjustments onto the INREV NAV. Care should be taken not to double-count the tax effects with the INREV DTL fair value adjustment (NAV-Q06-1). It is likely that the INREV NAV adjustments, such as Revaluation to fair value of investment properties, self-constructed or developed, held for sale, leased or held as inventory, and other investments in real estate, are already considered when calculating the INREV DTL fair value adjustment (see the Example in NAV-Q06-1).

“Revaluation to fair value of indirect investments not consolidated” may give rise to extra tax effects on the NAV, depending on the direct taxation of the capital gain on the sale of associates and joint ventures, or other direct or indirect tax effects associated with them**.

“Revaluation to fair value of financial assets and liabilities (including revaluation to fair value of debt obligations)” will normally give rise to a tax effect in the INREV NAV if these financial instruments are at the level of a taxable entity. Indeed, had these instruments been fair valued in the balance sheet, a deferred tax would have likely been accrued. Economically, such deferred tax represents the tax effects associated with the financial instrument cashflows. For example, a higher fair value of debt (hence, a negative INREV NAV adjustment) will likely reflect the higher interest payments, which in turn will likely attract extra tax deductible effects and hence, a positive INREV NAV adjustment**.

A similar approach should be taken in relation to “Revaluation to fair value of construction contracts for third parties"**.

The adjustments to reflect the spreading of the set-up costs and acquisition expenses may also give rise to the tax effects in the future, depending on whether they are tax deductible at the level of the entity where they were incurred. It will be common that the set-up cost at a fund level will be non-deductible due to the fund tax regime, while the acquisition costs may be tax deductible. It is also important to consider that some of the acquisition costs will be capitalised as part of the property and thus are part of its tax value, hence captured by the DTL FV adjustment (“Property tax value” in the Example).

Adjusting for the Contractual fees may give rise to a positive tax effect if these fees are tax deductible in the future, and thus should be considered**.

Caution should be taken in relation to the “Revaluation to fair value of savings of purchaser’s costs such as transfer taxes” – as illustrated in the Example, and following the market practice, when this adjustment is applicable (intended sale of shares in a property-owning vehicle) the DTL FV adjustment (NAV-Q06-1) will likely consider the gross fair value (i.e. including savings of the purchaser’s cost) and thus no further tax effects should be reflected in the INREV NAV.

Other adjustments – goodwill, non-controlling interest effects, and INREV reclassifications – should not result INREV NAV tax effects.

** The tax effects of this INREV NAV adjustment are not illustrated in the Example in NAV-Q06-1.